India - Sixth, Seventh, and Eighth Industrial Credit Projects

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 949 PROJECT PERFORMANCE AUDIT REPORT on INDIA SIXTH, SEVENTH AND EIGHTH DFC LOANS (41-, 515 and 683-IN) INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LTD (ICICI) December 17, 1975 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY PREFACE This report covers an audit of achievements under three Bank loans: 41-IN, 515-IN, and 683-IN, made to the Industrial Credit and Investment Corporation of India (ICICI) Ltd. in May 1965, September 1967, and June 1970, respectively. These loans were closed in August 1973, January 1974, and February 1975. The audit has been based on the Completion Report prepared by the South Asia Projects Department, as well as on materials from loan files, country and sector analyses, and, last but not least, on information and views collected during a brief mission to India. Discussions of the draft with Bank staff and ICICI management contributed importantly to the report. The size of the present Project Performance Audit Report somewhat exceeds the average size of reports of this type. There are at least three reasons for it. First, a new format was tried out here, with all factual findings integrated in reduced table forms, inserted in the text, and only a minimum of statistical material was relegated to the annex. Secondly, ICICI is the largest borrower among the DFCs the Bank has supported, and benefited from 17% of all Bank loans to DFCs. The three loans reviewed here span a full decade of ICICI activity. Thirdly, ICICI, perhaps more than any other DFC, had to conduct its activity within the strict framework of Indian Government's priorities and its all-pervasive and complex rules and regulations. This background had to be reflected, however fleetingly, in the report. CURRENCY EQUIVALENTS Prior to June 6, 1966 : US$1.00 - Rs 4.76 Rs 1.00 - US$0.21 From June 6, 1966 to mid-December: US$1.00 = Rs 7.50 1971 Rs 1.00 = US$0.13 Mid-December 1971 to end-June : US$1.00 = Rs 7.28 1972 Rs 1.00 = US$0.14 After end-June 1972 : Floating rate Spot rate (March 31, 1975) : US$1.00 = Rs 7.72 Rs 1.00 = US$0.13 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY TABLE OF CONTENTS Page Summary i I. General Background 1 A. Structure of the Economy 1 B. Dynamics of Growth 3 II. Targets, Recommendations and Expectations 7 III. Achievements 11 A. Resource Allocation 11 1. Industry-wise Orientation 11 2. Regional Distribution of Loans 11 3. Lending to Small-Scale Industry 15 4. Promotion of New Projects 15 5. Lending Strategy 17 6. Exports 19 7. Economic Analysis of ICICI Projects 23 8. ICICI's Influence on Projects 26 B. Institution-Building 28 1. Lags and Delays in Project Processing 28 2. Follow-up Procedure and the Problem Companies 28 3. IBRD Comments and Advice on ICICI-Assisted Projects 30 4. Predictive Capacity of ICICI 33 a. Forecast of Operations 33 b. Project Cost Forecast 34 5. Use of Management Techniques by ICICI Clients 35 C. Resource Mobilization 36 1. Mobilization of Rupee Resources 36 2. Capital Market Operations and Equity Investment 39 3. Foreign Resource Mobilization 40 4. Profitability 4O 5. Interest Rate 41 IV. Conclusions 43 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. - 2 - TABLE OF CONTENTS (Continued) List of Tables 1. Business Cycles and Growth of Long-Term Lending 2. Dependence of ICICI Operations on Import Controls 3. Distribution of Long-Term Lending by Industries 4. Regional Underdevelopment and ICICI Assistance to Backward Areas 5. ICICI Assistance to Backward Regions 1965-73 6. ICICI Lending According to Broad Strategy Program 7. Exports of Manufactures from ICICI Companies a. Dynamics b. Sectoral Distribution 8. Contribution of Sixth, Seventh and Eighth IBRD Credits to Export Performance 9. Economic and Financial Results of Projects Financed Out of Sixth Loan 10. Economic and Financial Rate of Return on ICICI Projects - by Industry 11. ICICI Influence on Projects 12. Loan Processing Lags 13. Problem Cases Under Three Bank Loans 14. Bank Comments on ICICI-Assisted Projects 15. Degree of Achievement of Forecasted Operations 16. Capital Cost Overruns and Delays 17. Domestic Resource Mobilization 18. Equity Portfolio and Capital Gains 19. Profitability of ICICI Operations 20. ICICI Interest Rates Annex Tables 1. Summary of Operations - Actuals and Forecast 2. Economic Indicators for Projects (ICICI Assistance Above Rs 5 million) SUMMARY The ICICI is the largest beneficiary of Bank loans to both private and public development finance companies, having received from the Bank $426 million in 11 loans, about 17% of all the Bank Group financing of DFCs approved through FY75. It was founded in 1955, partly as a result of the Bank's active involvement and technical help. The audited loans 41-IN, 515-IN, and 683-IN were for $50 million, $25 million, and $40 million, respectively. They were signed in May 1965, September 1967 and June 1970 and closed in August 1973, January 1974 and February 1975; the first with a three-year delay, the second with two years delay and the third with four months delay from original target closing dates. Delays in disbursement of the first two loans are attributable to the economic recession in India. The loans carried a number of general and specific objectives. In terms of resource allocation, they were to be channeled into the newer sectors of industry, to be granted to enterprises with a proven and high degree of competitiveness, tested internationally through exports of their goods and tested at home as supplying efficient substitutes for imports. ICICI was also to make an effort toward an increase of its lending to backward regions of India. In terms of institution-building, ICICI was expected to reduce lags between approvals, commitments and disbursements. It was also expected to improve its market analysis, its follow-up on projects and its economic analysis of them. Finally, in the resource mobilization field, ICICI was expected to maintain unchanged its distribution between foreign currency loans, domestic currency loans, underwriting and direct equity investment, and, to do this, was to make an effort to replenish its domestic resources. ICICI was also expected to raise its interest rate. ICICI depended, in its planning, organizing and implementing of lending programs, on two important factors. It depended, similarly to DFCs in other countries, on the general level of economic activity and on entre- preneurs' willingness to invest, but the drawback here was that during practically half of the reviewed period, the industrial activity was depressed or sluggish. It also depended, similarly to DFCs in other countries, on the system of Government economic controls, but the drawback here was that these controls were all-pervasive, and their rationale and the way they were implemented was frequently at odds with business or economic considerations. Despite these clearly adverse conditions, ICICI successfully managed to achieve practically all the above objectives. ICICI loaned 52% of its resources to capital goods industries. Most of those were considered as "growth" industries, mainly because, together with some industries reserved only to Government-sponsored investments, in which ICICI did not participate, they were at the core of a rapid import substitution process and were considered to become a seed-bed for new tech- nical skills and managerial techniques. These industries proved to be, in other countries as well as in India, most vulnerable to errors in resource allocation and work organization. However, enterprises financed by ICICI appear to have largely escaped from such mistakes. Recent economic analysis of 42 ICICI projects (of which 12 projects were financed from Loan 41-IN, - ii - but none from the other two loans reviewed because those were channeled into projects not yet in operation at the time this analysis was made) shows a weighted economic rate of return of 19.3% and a weighted financial rate of return of 17.3%./ Of these 12 projects, nine have economic rates of return exceeding 18% and the remaining three show rates of return ranging from 7 to 10%. Out of some 212 companies financed from all three loans, only 15 are facing difficulties of long-term nature, and of those, five have begun to show notable improvements. About two-thirds of all companies assisted by ICICI export their goods. The share of exports in sales, while still low, is increasing, and reached 5.8% of total sales of all companies or 7.6% of sales of exporting companies, in 1973-74. The exact reasons behind the export decisions of Indian firms are hardly known. They could include, on the positive side, their idle productive capacities, their export obligations imposed by the Government, or even the favorable foreign market price, compared with the domestic price. On the other end, a problem of exacting quality requirements of foreign buyers, of still weak export incentives and the difficulty and costliness of a marketing effort may well offset these positive elements. The problem of quality is particularly important because, if international and domestic production costs are roughly comparable, but the quality of domestic goods is much below that of the foreign traded goods, one would tend to conclude that, in order to reach the expected quality, production costs of exported goods have to be higher than those related to production for the domestic market. It is noteworthy that the economic analysis of projects compares normally not the international price with production costs of exported goods but the international price with average production costs, and those are heavily tilted toward costs of production for the domestic market. Whenever this is true, the results of the economic analysis of projects leave room for doubt. ICICI decided recently to enquire into all these issues and undertook a detailed export study. ICICI has established two fully staffed regional offices in Madras and Calcutta and its efforts to diversify its lending away from already industrialized regions, largely thanks to a parallel action by the Central and by the States' Governments, have begun to bear fruit. About 18% of its loan portfolio went to 70 backward districts in India, or to about one-third of all districts considered to be backward. While the average share of its lending to backward districts in total lending hardly exceeded 10% in the 1960s, the dynamics of such lending grew more intense in the 1970s and this share attained 12% in 1971, 18% in 1972 and 32% in 1973. An additional important element here was the activity of Joint Institutional Study Teams, in which ICICI staff members participated alongside with other term-lending institutions. These teams prepared 18 industrial surveys, in which development possibilities of backward regions are reviewed and flagged to potential investors, and which led to joint projects, to which ICICI is contributing a part of lending or is underwriting share issues. 1/ After excluding one large pharmaceutical project with a high negative rate of return. - iii - The market analysis in ICICI appraisals has improved. A somewhat more tangible result of such improvement could be sought in the capacity utilization rates of projects. It is nonetheless still a flimsy evidence because in India - unlike in other countries - capacity utilization stands not only for the production having met a market demand, but also for this production suffering from the lack of availability of imported inputs, from unreliability of transport facilities and power supply and from many other factors capable of disrupting flows between the Indian industry, the other sectors of the economy, and the final consumer. This said, capacity utiliza- tion for ICICI projects, calculated for projects within one year from their completion, was quite high, with two-thirds of the enterprises operating at more than 60% of their designed capacity. Economic analysis is now applied by ICICI to all projects receiving loans exceeding $0.7 million. This analysis is prepared in four different versions, not so much to learn more from each version as to suit everybody's tastes in this matter. ICICI, similarly to a number of other DFCs, is not using the results as a criterion for an outright loan approval or its rejection, but rather as an indicator that some aspects of the project should undergo a more thorough scrutiny which in turn could point to a need for projecb remoulding. This is a judicious procedure. The follow-up procedures have considerably improved, with a detailed reporting system instituted, with a large number of enterprises (about 170 out of 630 enterprises submitting reports) visited annually, and with problem enterprises monitored continuously and provided with professional advice. The lags between approvals, commitments and disbursements have been somewhat reduced. They sometimes reflect not so much the processing capacity of ICICI as the delays in the scrutiny and approval procedure, instituted by the Government, beginning from decisions to issue capital goods licenses and ending with customs clearances. Also the financial procedure, in which participation of other lenders than ICICI is secured, is usually unduly lengthy and influences the lag between approvals and commitments. In the light of the procedural complications and considering the vagaries of business cycle in India, the ICICI forecasting capacity proved to be quite high. Its forecasts of approvals, commitments, and disbursements during 1965-73 sometimes show considerable annual deviations due to unforeseeable slumps and peaks, but these deviations cancel themselves out in the longer run, and the overall deviation for the entire period does not exceed 10% from original targets. Also, the overall capital cost overrun on almost 200 projects for which information is available and which were financed from the three Bank loans is less than 20%, which is not unreasonable considering the rapid inflation during the recent few years. ICICI mobilized its domestic resources by borrowing from the Govern- ment of India, from the Industrial Development Bank of India (IDBI) and by floating debentures. ICICI has kept its direct lending in rupees at the low level of about 231 of its total lending, roughly as it originally intended. This should be viewed in the light of a situation where ICICI, as a part of a consortium of Indian development banks, specializes mainly in making foreign - iv - exchange loans. As much as 83% of its foreign exchange resources were provided by the Bank, but it made, in the past few years, some efforts to raise resources abroad, through a small bond issue in Switzerland, which was successful, by attempting to raise Euro-currency, unsuccessfully, and by negotiating now a loan from Kuwait. ICICI was also quite active in the equity market, although in relative terms its equity investment accounted for only 7% of its lending. It succeeded in having almost tripled during 1965-74 the number of enterprises to which it has contributed equity; it has rotated, on the average, about 10% of its equity portfolio every year; and, despite sluggishness in the growth of security prices in India, it has managed to realize a capital gain of about 5.1% annually during the last decade, or twice the average benefit on All-India securities trade. ICICI profitability is acceptable, never falling below a 10% return on equity. Its dividends increased from about 4-7% of the nominal share value in the mid- to late 1960s to about 9-10% in the early to mid-1970s. Its administrative expenses as a percentage of total assets, remain one of the lowest among all DFCs for which statistics are computed by the Bank. The interest rate spread of ICICI has hovered around 3 percentage points. Interest rates on its lending were following the general interest rate trend, and were increasing steadily from 8.5% in 1965 to 10.5% in 1974. The Bank had often suggested - in particular in relation with the Eighth Loan - that ICICI increase its lending rate to avoid a decline in its profitability, in the face of increasing borrowing costs. But the economic considerations as to what the "appropriate" level of interest rate should be in the Indian condi- tions have never been seriously enquired into, either by the appraisal missions or, for that matter, by Bank economists: e.g., what rate would be attractive enough for primary savers and for the commercial banks - the main potential collectors of such savings and providers of domestic resources to term-lending institutions, including ICICI; whether the debt service would be bearable to the foreign currency borrowers, caught between the exchange risk, acute and continuous in a country with a weak balance-of-payments situation, and a difficulty in using a price mechanism, relatively inelastic in India, in order to cushion such a risk. In absence of these more analytical premises to establish a desir- able interest rate, the Bank decided, not unreasonably, to base its suggestions on pragmatic considerations. A probability cannot be excluded that, in the final account, the outcomes of both approaches might not differ much from each other. ICICI is a successful, well-managed development finance company, and had a highly useful and durable impact on the development of private manufacturing industry in India. ICICI considered, for a long time, that its main area of activity is circumscribed within the guidelines of the industrialization strategy which the Indian Government formulated for the entire Indian industry. Consequently, ICICI did not develop any area of particular specialization. Neither did it concentrate on any particularly promising and hitherto undeveloped industry, where it could have applied a specific lending strategy. It also did not become very active in project identification and promotion, mindful of the fact that eachproject idea had to receive first a seal of Government approval, and that the Government referred then projects to ICICI. While this - v - could imply a somewhat passive streak in ICICI activity, it was largely imposed by the general framework of Indian economic policies. Fortunately, this practice, on the part of ICICI, is now undergoing a slow change. ICICI began recently to work on its lending strategy. Its staff members were invited during the last two years to meetings of the Capital Goods Committee of the Government, which decides on industrial licenses and ICICI representatives were able to submit comments in specific cases and to see them applied. Its project promotion has also become more active. Out of 270 projects financed under the three Bank loans - of which two-fifths were of minor expansion type where no special advice or initiative was needed - about 30 were formulated as a result of discussions with ICICI and only then submitted by investors for the Government approval. Over and above this number, five projects were entirely due to ICICI's initiative. ICICI was also influencing project designs and had introduced changes in cost assessment, market analysis, product mix, or technology, in 40% of all projects financed from the three Bank loans. Finally, ICICI has recently (late 1973) established its own Project Promotion Department, expected to focus on the identification of projects with linkages with already existing plants, to fill identifiable gaps in the industrial sector, and to take particular care of projects located in backward areas and conceived by new entrepreneurs. This Department has already generated a few projects. The Bank appraisals of ICICI were professionally thorough and were taking into consideration the broader economic framework of India, which made the appraisals largely free from unrealizable recommendations and from wishful thinking. The Bank's recommendations, especially with respect to expanding the follow-up procedures and improving the market analysis in appraisals, proved to be of considerable value to the ICICI. Other Bank recommendations, while quite justifiable, might have gained in power to convince the ICICI and would have had a more long-term impact, had they been based on a more searching analysis of a wider scope of issues, relevant to these recommendations. For instance, the recommendation to increase the interest rate was based only on financial premises. A certain narrowness of approach could also be seen in Bank's recommendations to ICICI suggesting that it should step up its efforts in domestic resource mobilization so as to increase rupee lending, and that it should become more involved in lending to the small-scale industries. While suggestions to undertake the above efforts are usually perfectly justifiable when made to a DFC which is created to play a pioneering role in a country devoid of financial institutions, this is not the case of India, where commercial banks are efficient collectors of primary savings, where large term-lending institutions, such as IDBI or IFCI,are specialized in long-term rupee lending and where the State Financial Corporations have both the expertise and the geographical location which make them main and effective lenders to small-scale enterprises. Finally, the Bank's comments on projects above the free limit were of a somewhat standard type. The Bank commented on 17 large projects, benefitting from loans equal to 40% of all three Bank loans. It raised 23 queries with respect to these projects, most if not all of them aiming to fill the apparent "gaps" in the appraisals rather than to question the rationale of appraised projects. Such appraisal of an appraisal, rather than that of a project, was, and still remains, a customary practice, aiming at improvement of DFC's appraisal techniques. While the general educative impact of Bank's comments is undeniable and these comments might have drawn the attention of ICICI appraisal staff to oversights which could occur in similar projects, - vi - appraised on other occasions, a direct impact from a review of highly complex projects, conducted from a distance and without a direct familiarity with local conditions, may not be as large as it would seem. ICICI management made it clear that it welcomes nonetheless the Bank comments on its subprojects' appraisals. One is, however, inclined to surmise that this attitude is based on an assumption that, firstly, an additional screening by the Bank and a related technical information which the Bank could provide on such occasions is never harmful, and sometimes useful, and that, secondly, no project submitted by the ICICI has ever been rejected or seriously questioned or considerably delayed by the Bank. Therefore, the cost benefit function of this procedure is unavoidably positive to ICICI. A question as to whether this function is also positive to the Bank, which has to spend a considerable time and effort to keep up with the mounting inflow of DFC subproject appraisals, and these of a growing complexity and sophistication, still awaits an answer. The OED Evaluation Report of the DFCs suggested that for the "mature" DFCs - and ICICI is without doubt close to the top of the list of mature DFCs - such comments should be provided by the Bank in response to a DFC request only. However, these minor comments on the past Bank-ICICI relationship are of rather marginal incidence and should in no way mar the general picture which is that of know-how, efficiency and perseverance on the part of ICICI and of confidence, pertinence and high professional standards on the part of the Bank. ?ROJECT PERFORMANCE AUDIT REPORT INDIA SIXTH, SEVENTH AND EIGHTH DFC LOANS (414, 515 AND 683-IN) INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA LTD (ICICI) The Bank Group has made, in all, 11 loans to the ICICI, totaling $426 million and accounting for 17% of all Bank Group DFC financing approved through FY7. The ICICI was 20 years old in January 1975, and the Bank involvement with it predates its foundation. It was the 1953/54 Bank mission to India which was to "explore the possibilities of establishing a privately owned and operated development corporation to finance the expansion and modernization of private industry," and a Steering Committee, which was set up as a result of Bank missions' discussions with the Government of India, that coached ICICI into existence, with technical help from the Bank. The period related to commitment and disbursement of proceeds from the three Bank loans reviewed in the present report spans an entire decade, 1965-75. During this decade, the Indian economy, and its industry, have known the hopes and failures of the Third Five-Year Plan, plunged into a recess4on, went back into a revival and recently returned to vicissitudes of stagnats-*n. Indian economic policies continued to exert predominant, if not decisive .nfluence on the choice of industrial investment. It is against this background that successes or failures of ICICI should be measured. Loan 41-IN was the sixth granted to ICICI. The loan agreement was signed in May 1965. The amount of the loan was $50 million of which $2.8 million was subsequently canceled. The original closing date was June 30, 1970, before which time four-fifths of the loan amount was disbursed. The closing date was revised three times, mainly because recession delayed loan disbursements. The loan was closed in August 1973. Loan 515-IN was the seventh granted to ICICI. The loan agreement was signed in September 1967, for $25 million, of which $1.1 million was subsequently canceled. The original closing date was December 31, 1971, but, after it had been twice revised, the actual closing date became January 1974. However, three-fourths of the loan amount was disbursed by the originally established closing date. The reason for delay was the slow utilization of the sixth loan, explained above. Loan 683-IN was the eighth to ICICI. The loan agreement was signed in June 1970 for $40 million, of which $1.2 million was subsequently canceled. There were practically no delays in the disbursement of this loan, which was closed by February 1975, four months after the original closing date. I. GENERAL BACKGROUND A. Structure of the Economy India's mpufacturing sector turns out an annual output valued at about $8.7 billion,!, which situates it at about the 13th place in the world, 1/ Rs 65 billion in current prices, in 1973/74, converted into dollars at the prevailing exchange rate. - 2 - and in the third place in the developing world.1/ The growth of the manu- facturing sector of India during the period under review was, at 3.1% p.a. in real terms, a relatively slow one, roughly equal to the GDP growth. Its 16.4% share in the total product remained practically unchanged. Only two-thirds of industrial output of India is produced by organized (registered) plants, the remainder is contributed by the small-scale sector, which largely escapes any statistical scrutiny. The organized manu- facturing sector consists of about 40 thousand factories, and employs 4 mil- lion workers, while another 10 million workers are employed by small-scale manufacturing. The public sector accounts for roughly one-half of the total annual investment in manufacturing, which, in its turn, is assessed in current prices to have been about $700 million annually in the late sixties and about $850 million in the early seventies. However, despite the high share of public sector in investment, the share of Government-owned companies in total output of the organized manufacturing sector is still small and equals to some 15% in the early seventies, contributed by about 25 enterprises. While industrial output figures appear to be impressive, investment in the private manufacturing industry was slow. Gross assets in current prices were growing at 8% p.a. during 1967/68-1973/74, and net assets even slower, at 4.9% p.a., the latter reflecting rather sluggish modernization efforts. It is to be noted that prices of machinery and equipment were growing during this period at L.9% p.a /which reduces the capital growth in real terms to a rather negligible figure.- Within the organized sector, the concentration of output and invest- ment is quite high, with some 90 large firms responsible for almost one-half of output. Of this, about 31% is contributed by Government companies, 26% by foreign-owned companies, and the remainder by privately owned Indian large industrial companies, mostly belonging to the so-called large houses. The role of the banking system, and in particular, of the term- financing institutions in supporting the industrial investment, is considerable. The disbursements of all term-financing institutions of India amounted to about $150 million annually during 1965-70, and increased to about $270 million during 1970-7L. Their contribution to new invEstment in the manufacturing sector has increased accordingly, from about 20% in the former period to about 30% in the latter. The share going to the private sector of manufacturing is probably even higher, considering that only about 28 of disbursements by all 1/ With Brazil and Mexico disputing the first and second place, with manu- facturing output of $12.- billion equivalent in each of these countries in 197?. 2' The growth figures reflect, however, only investment made by the already established companies. To this should be added investment made by new companies, but even then growth cf industrial investment in real terms would remain unimpressive. term-lending institutions has been directed to the public and cooperative sector. Also, the role of the commercial banking system, lending out % of their deposits in long-term loans, is not negligible and may account f3r additional financing of about one-fifth of the value of new investmet. ICICI's participation in the financing operations of term-lending institution was considerable. It maintained its share in total disbursements at 14.3% both in 1965/66-1969/70 and in 1970/71-1973/74. As far as foreign currency loans are concerned, ICICI share was preponderant, about 90%. ICICI was disbursing annually $16 million in foreign currency loans during 1965-69, and $31 million duig. 1%0--3. To compare, overall imports of machinery and equipment by India amounted to some $600 million annually and remained oractically unchanged in both period--, but a sizeable part of this amount, about 60%, were goods for sectors other than manufacturing. Of the remainder, a sizeable part of imports was financed from tied project aid.i/ B. Dynamics of Growth As it might have been expected, ICICI's activity, similarly to Lhe activity of any DFC which services the private manufacturing sector, was closely related to the ups and downs of the business cycle. £ns Indian economy followed a checkered path of development during 1905-73. The major influence was exerted by bad harvests, such as those experienced during 1965/66-1966/67 and 1971/72-1972/73. It is evident from Table 1 that the years of low crops were also the years when the GNP declined or, at best, remained stagnant. The resulting decline in purchasing power of the popcLa- tion led to reduction of demand and consequently of production of industria. goods. There were two apparent lags b_it into the relationships between the crops 4 GNP 4 industrial product>i)n and the investment 4 approvals + disbursements cycles. One of these lags has to be attributed to the delayed reaction of investment to the dezline in economic activity. In turn approvals by financial institutions w-3re closely related to decline in investment, and, as disbursements weri delayed with respect to approvals, another one-year lag was created. This, a decline in economic activity influenced disbursement of financial institutions only with a two-year lag and, consequently, ICICI's disbursements declined in 1967/68 and especially in 1968/69, as a result of a decline in economic activity two years before. Such decline - at least relative to previous years - also took place in 1973/74, two years after the new steep decline in the GNP and in manufacturing production had occurred. In this year (1973/74) the increase in machinery prices reduced the growth of disbursements in real terms almost to nought. The decline in requests for ICICI assistance during the years of recession was notable. Thus, in 1965, ICICI received 176 applications for Rs 360 million. The volume of applications declined to 127 for Rs 330 mil- lion in 1966 and further to 122 applications for Rs 250 million in 1967. The pickup in economic or more specifically industrial activity, observable in subsequent years, also boosted up the ICICI activity. Also, ICICI was active in inducing business efforts of some of the established firms which, while they had projects on anvil, were still hesitant to proceed with their schemes. 1/ Non-IBRD/IDA project aid, which represents basically tied aid, accounted for about $200 million annually. Table 1: India - Business Cycles and Growth of Long-Ferm LetidDlf (in % - annual variations) Wholesale Investment Manufacturing Term-lending institutions price index GNP Private production All institutions ICICI on1Z for machinery (fixed 60/61 sector (physical Disburse- Uxiburse- and transport Year prices) Total only index) Approvals ments Approvals ments equipment (1) 727 (3) (4) (5) (6) (7) (8) (9) 1965/66 -4.5 9.3 3.6 +9.1 n.a. +37.2 n.a. n.a. 5.3 1966/67 1.3 13.5 32.2a/ -1.5 n.a. +4.9 -30.5 -8.5 6.8 1967/68 8.9 4.1 -1.8 -1.4 -28.6 -6.3 13.2 -13.4 4.8 1968/69 3.5 0.6 7.8 +6.1 +57.9 -19.0 40.9 -18.7 0.7 1969/70 5.3 10.6 14.9 +7.5 +10.6 +22.0 -2.3 +9.7 2.2 1970/71 4.2 9.4 4.0 +L.9 +39.2 +17.4 +14.2 +53.0 8.8 1971/72 1.7 10.5 12.3 0 +35.8 +19.8 +19.1 +10.7 7. 1972/73 -1.4 3.1 3.1 +7.0 -1.6 +13.5 +29.2 +22.6 5.7 1973/74 n.a. 13.2 13.2 -0.2 +27.0b/ +26.lb/ +13.2 +11.0 9.5 Annual growth (% p.a.) 1965/66-1973/74 2.3 8.2 9.8 3.9-O +10.5 +11.0 +10.1 +6.3 5.7 NOTE: All rates of growth apply to current price figures unless stated otherwise. Growth is calculated always with respect to the preceding year. g/ Reflects effects of the devaluation of the rupee. b/ Estimate. £/ Growth of the manufacturing sector is much slower, when calculated in value tens. Thus, during 1965/67-1972/73 the manufacturing sector contribution to GDP (in current prices) grew from Re 30.5 billion to Ra 53.0 billion, while wholesale price index for manufactures grew during the same time by 50%. Thus, the annual growth rate of this sector, when calculated in constant prices, was only 2.1 p.a., practically the same as GNP growth. On the whole, trends for almost a decade show that loan approvals of all financial institutions were progressing at the same pace as those of ICICI. In real terms, when deflated by the price index for machinery, the growth of approvals was about h% p.a. ICICI's disbursements were proceeding at a somewhat slower pace, this mainly because in the years following the devaluation of the rupee the decline in foreign currency disbursements was more pronounced than decline in domestic currency loans, which were made by other financial institutions. The above picture reflects only a part of the situation and, at that, quite imperfectly. Statistics are not available for evaluation of the trend in private sector investment in manufacturing and in particular in investment in modern branches, to which ICICI loans were mainly channeled. Also, the trend in-unit prices of imported machinery, the type of purchases ICICI loans were mainly used for, is not available. Government controls were the last element with which ICICI lending activity has been more closely related. At least two such basic controls were influencing entrepreneurial decisions to invest and to borrow from the ICICI. The first was the Government capacity - and its willingness - to issue capital goods licenses. In absolute terms, this capacity has been fluctuating markedly over time: Table 2: Dependence of ICIgI Operations on Import Controls Capital Goods Import License,-La ICICI Operations Growth Foreign Currency Relation of 3:1 (in m1n. rs.) P.a. Approvals (in mln. rs.) (in %) /b (1) (2) (3) (4y 1966/67 1,890 - 105 5.5 1967/68 836 -56 65 7.8 1968/69 354 -58 206 58.2 1969/70 492 38 187 38.0 1970/71 750 52 224 29.9 1971/72 1,078 44 202 18.7 1972/73 1,139 6 330 29.0 1973/74 1,311 15 338 25.8 /a Both for the public and the private sector. A This relation is not lagged. As TCICI approvals follow the granting of the caDital goods clearance by the Government but r.recede the issuance of an import license, a one-year lag covariation might have been a more correct reflection of reality. Even in such case, however, with one or two minor exceptions, the results in column 4 would not change. - 6 - The above shows that, in the years of massive issue of import licenses, during the rather short-lived liberalization of imports, related to 1966 devaluation of the rupee, the importance of ICICI loans for purchases of imported capital goods was not large. However, the recession, which followed the devaluation, might have simply discouraged the holders of import licenses from using them, and the amount of ICICI loans used to finance purchases under the effectively implemented import licenses was probably much more important than the above table conveys. From 1968/69 onwards, foreign currency loans approved by ICICI cover, on the average, 29% of the value of capital goods licenses. Considering that about one-half of investment - and consequently of capital goods licenses - is undertaken by the public sector to which ICICI does not lend, it could be concluded that ICICI lending is used to finance about three- fifths of import licenses issued to the private manufacturing sector. As the capital goods clearance, necessary for obtaining import license, has to be given by the Government before ICICI approves the loan, ICICI operations depend directly and fully on the Government licensing system. Another important relation between the ICICI operations and the Government control system depends on the Government attitude toward the so- called large houses - a euphemism for a monopoly or oligopoly enterprise. The concentration of Indian industry is quite high. In 1971, according to the Indian Department of Company Affairs, 25 of the largest private industrial companies held total net assets worth about $5.5 billion. The activity of these companies was quite closely monitored by the Government, especially with a view to protect smaller enterprises from being affectel/by competition. Thus, starting from February 1970, large business houses- were required to apply for special permission to enter new manufacturing activity except for that in the so-called "core" sector, which includes industries producing agricultural inputs, iron and steel, non-ferrous metals, petroleum, coking coal, heavy industrial machinery, shipbuilding, newsprint, and electronics.2/ This somewhat limited entries to new fields and possibilities for product diversification. Also the large companies became very reluctant to apply for licenses for investment in "permitted" areas, mainly because the processing of these licenses became wide open to political and often partisan pressure and scrutiny and investment intentions became therefore a widely discussed issue. As a sizeable part of ICICI loans - in value, but not in number of loans - goes to larger industrial companies, a part of ICICI's lending activity unavoidably depends on the Government's posture vis-a-vis the investment inten- tions of "large houses". The whole problem is a thorny one. Thus, during its initial decade (1955-66) ICICI disbursed 50% of its total assistance to the 73 large and 1/ Defined at first as those holding assets valued at $47 million or more, but reduced later to $27 million per enterprise. 2/ This list was, in 1971, expanded and included also steam generating plants, industrial turbines, equipment for transmission and distribution of electricity, commercial vehicles, earthmoving equipment, drugs and phar- maceuticals. - 7 - larger houses,1/ compared with 36% loaned by IDBI, 34% by IFCI and 48% by other financial institutions (SFCs, SIDCs, LIC, UTI, SBI and Direct Govern- ment Assistance). / Since 1966 ICICI share has been declining and amounted to 40% during 1967-71. These percentages do not shed any light on the problems of economy of scale, social desirability or creation of new entre- preneurs. For instance, considering that ICICI lends basically to "modern" industries, and that the optimum scale of production in such industries is often quite substantial, ICICI assistance goes predominantly to "large" projects. Thus, during 1967-71, 90% of ICI loans went to projects with assets exceeding $1.4 million. A significant proportion of these projects is unavoidably initiated by large enterprises (houses). Furthermore, one could assume that, to the extent to which such investment has been thoroughly reviewed by various Government instances, it has been found socially desirable. Finally, to what extent an increasing percentage of lending to "other enter- prises" reflects a contribution to market competition is a moot question, considering that many "other entrepreneurs" are large independent or foreign- controlled companies, whose competitive effect in the Indian market is minimal. II. TARGETS, RECOMMENDATIONS AND EXPECTATIONS Unlike the appraisals of many other DFCs, the appraisals of the ICICI were quite clear on what improvements the Bank expected the ICICI to achieve. The Bank missions to ICICI were frequent and the level of economic and financial analysis they performed was clearly far above the average. Furthermore, the Bank analysts acquired - and used - a knowledge of rather difficult to grasp, complex Indian economic policies, which represented often a web of constraints, limiting aspirations common for other DFCs. Such constraints tend to hamper in particular all initiatives which would require a quick reaction on the part of the entrepreneur or which would call for special incentives to make them financially feasible. The former would normally be impeded by a long and awkward bureaucratic procedure, whereby all permissions pertaining to imports or to investment are, or were until recently, decided sequentially by Ministries in New Delhi, the latter would call for material incentives to the private sector, and those, more often than not, were considered a sensi- tive issue, to w ich answers were sought in the realm of politics rather than economics./ 1/ The criterion for identifying large and larger houses is that given by the Industrial Licensing Policy Inquiry Committee's Report (July 1969). There were 53 large houses and 20 larger houses listed by the Committee. 2/ It is noteworthy that the share of all 73 large houses in total assets of the private sector varies between 49 and 54, depending on the year. Con- sequently, lending of financial institutions to these houses was propor- tionate, or even less than proportionate, to their share in the private corporate sector. / For a more extensive analysis of these and related problems, refer to Chapter TV of the OED Performance Audit Report on India: Four Industrial Imports Projects, SecM75-704 of October 3, 1975. - 8 - At the time the Sixth Loan to ICICI was appraised (mid-1965), the following objectives and expectations were set forth: a. As far as the allocation of ICICI resources is concerned, they were to be guided by policies established by its Board of Directors. These policies stipulate that ICICI was expected to direct its assistance mainly to the newer sectors of industry, keeping to the minimum financing of industries long existing in India, such as jute and other textiles. To avoid excessive concentration in financing, ICICI policies set a limit of Rs 10 million for all types of finance to any one company and Rs 30 million for foreign currency loans to any group of companies. Finally, and this at the Bank's suggestion, ICICI has considered how to make itself more accessible to entrepreneurs in other parts of India, so as to diversify its lending away from the Bombay area. b. In the institution-building field, three principal points were brought forward. The first was the existence of excessive lags between ICICI's approval of loans and its commitment of funds in formal loan agree- ments, and between the commitment and disbursement of funds. Each of these lags were estimated to have been about 18 months in the past. They were reduced to 15 months each by 1965, but this was still considered excessive. The second point was that of a certain weakness detected in the market analysis, carried by ICICI staff appraising projects. The Bank considered that ICICI could do more here by undertaking analysis of industries related to the project, especially on the forward-linkages side, so as to check whether the activity in buyers' industries could be expected to remain buoyant. Thirdly, the number of follow-up visits was found to be inadequate. Although ICICI was found to have a well-conceived system for monitoring projects, because it was collecting financial and production statements from all borrowers, the number of visits to borrowers, made by members of the Follow-up Section of ICICI, was considered insufficient. c. As a part of its financial projections, ICICI worked out a certain tentative program of resource mobilization. It intended to replenish its rupee resources - projected at some Rs 650 million during 1965-70 partly from repay- ments of past loans (Rs 190 million), partly from an increase in share capital (additional Rs 25 million), partly from a loan from the Government (Rs 100 million), partly from floating rupee debentures, and the remainder from newly available refinance facilities of IDBI. ICICI intended to maintain the distri- bution of its operations between loans (foreign currency and rupee), under- writing and equity investment within a pattern similar to that of the past few years. The distribution between these activities was, during 1962-64, 49% in foreign currency loans, 27% in rupee loans, 20% in underwriting of shares and debentures and 4% in direct equity investment. These shares were expected to become, during 1965-70, 55%, 25%, 18% and 2%, respectively. The Seventh Loan to ICICI was appraised only two years later, in August 1967. The objectives and expectations formulated at that time were not basically different from those for the Sixth Loan spelled out above. These were: a. In the field of resource allocation, it was admitted that ICICI had a lasting impact on many Indian industrialists, but that, on the other hand, ICICI had developed little business on its own initiative, mainly acting on referrals from the Government. The appraisal mission expected ICICI to do more to identify and develop projects on its own. On a broader plane, the mission underscored the need for Indian industry to become a greater foreign exchange earner and to enhance its competitive position in the world markets and at home. The mission also stressed the need for a greater liberalization of controls over imported capital goods. b. As far as institution-building was concerned, the appraisal mission admitted, firstly, that lags between loan approvals and commitment of funds and between commitments and disbursements had been further shortened to 9-10 months for the former and 5 months for the latter, but found that these gaps were still considerable. Secondly, while the market analysis for project appraisals did actually improve, the mission still perceived a need for wider checking of assumptions underlying market forecasts, with a greater emphasis on the competitiveness of clients in the changing industrial structure of India and of the world market. Thirdly, project supervision was found to be undertaken with less energy and thoroughness than appraisals. The progress reports required from clients were found to lay stress on physical implementa- tion of projects, with not enough attention given to assessment of the clients' financial situation and relative position in their respective industries. c. Resource mobilization problems were not commented on, with one exception, namely that the debt limitation on ICICI was found to be too stringent and restrictive to ICICI long-term borrowings. The arrangements restricted ICICI borrowing to four times its capital, reserves and the out- standing balance of the first Government loan. The appraisal considered that a relaxation of these conditions was warranted and recommended a revised definition of "indebtedness". The Eighth Loan to ICICI was appraised in May 1970, three years after the appraisal of the preceding loan. The focus of the appraisal and the objectives and expectations related to it had somewhat changed, under the quadruple impact of the growing sophistication of the Indian industrial scene, increased maturity of the ICICI, improved appraisal techniques of the Bank and also the Bank's shift in emphasis in appraising DFCs. a. As far as the resource allocation is concerned, the Bank acknow- ledged, firstly, as a positive element, the setting up of branch offices in Calcutta and Madras and expressed hope that these offices should help ICICI to find new business and to appraise small projects. It found that, so far, they were found to have served mainly to relieve the Bombay headquarters in its follow-up functions. It was stressed in the appraisal that only the future could tell whether these branches would spruce up ICICI's image as an all-Indian institution. Secondly, it was emphasized in the appraisal that ICICI will have to deal soon with the criticism that it does not do enough for small-scale enterprises; this criticism was voiced by both the Government and the enterprises. Thirdly, somewhat related to it was the fact that ICICI decided to start financing partnerships and private concerns, while previously - 10 - only (public and private) companies were accepted as clients. Some reserva- tions were expressed with respect to this new form of financing, whose impact on the volume of ICICI's business was judged negligible. Also, it was considered too early to judge ICICI's efforts to attract small business. b. In the institution-building field, the mission found that the ICICI project appraisals, although they had considerably improved both in terms of engineering and of market analysis, suffered from some weaknesses stemming from working traditions formed when the economy was buoyant, and from the lack of exposure to industrial developments abroad. The mission's recommendations were therefore that, firstly, ICICI judgments have to become more trenchant on the abilities of client companies to adapt to changing conditions and especially to withstand difficult periods; and that, secondly, the ICICI should place more emphasis on using its leverage to promote the use of modern management techniques among its customers. Thirdly, the mission found that while the focus of ICICI marketing work was primarily on prospec- tive Indian sales, ICICI should put more effort in collection and analysis of data from which the clients' export prospects could be judged. Discus- sions were held on methodologies to improve ICICI's assessments of its client companies' competitive strength. c. In respect of resource mobilization, the most important finding was that ICICI's interest rate on foreign currency loans, and even on local currency loans, may have been low in relation to the economic cost of scarce resources in India, although the report candidly admits that this cannot be accurately established. An increase in interest rates, at least on foreign currency loans, was deemed necessary before long to prevent a drop in ICICI's profitability and to keep industrial projects which depend on relatively cheap resources for commercial viability away from ICICI. Also the problem of a need for replenishment of rupee resources was found to be persistent. It was found that while repayments, retained earnings, and proceeds from investment sales were likely to contribute about Rs 530 million, ICICI will have to make a considerable effort, during 1971-74, to borrow another Rs 400 million. An increase in the share capital by Rs 25 million, planned for 1971, was to contribute only a fraction of this amount. - 11 - III. ACHIEVEMENTS To relate the achievement of objectives to each loan separately would be irrelevant, especially because it would split some interrelated issues and obfuscate a historical progress in ICICI achievements. Thus, while the review of issues, which follows, provides answers to questions with regard to implementation of Bank suggestions or realization of ICICI expectations, it is not organized along the expectation-realization scheme, used in audits reviewing other, less complex cases. A. Resource Allocation 1. Industry-wise Orientation. ICICI tended, to a larger extent than other term-lending institutions, to concentrate on the modern sector of manufacturing. Table 3 attempts, to the extent to which statistics are available, to compare industrial breakdown of loan portfolios of each of the principal term-lending institutions of India. ICICI's share of lending going to such well-established and traditional industries as food or textiles is below that of other term- lending institutions, as well as below the relative share of productive capital installed in these industries. Its share of lending to chemicals is roughly at par with other lending institutions and with industrial assets, while its share of lending to machinery and transport equipment industries is above that of other lending institutions. Overall, capital goods indus- tries, including steel and building materials, absorbed 52% of ICICI loans. It is worth mentioning that capital goods industries were, during the last decade, considered as the "growth industries" of India, and that their rate of growth was by one-half higher than that of the entire manufacturing industry. This, of course, should not be considered as a proof of their efficiency, which was often meagre, but simply of the existing market demand. 2. Regional Distribution of Loans. Industry in India is concentrated mainly in its western regions, which contribute 40% of industrial value added. Outside the West, only the states of West Bengal and neighboring Bihar, and Karnataka in the extreme South contribute, each, about 5% of the industrial value added. In this situation, it was almost natural to see the IICI, which is situated in the heart of Western India, directing as much as 50% of its loans to the States in this region, and about 7% each to the Western Bengal, Bihar and Karnataka States. The agglomeration effect of existing entrepreneurs and easier access to know-how in more industrialized States is compounded, in the Indian situation, with the fact that, comparing to other regions, industrial labor in Western India is perhaps less prone to stage frequent strikes, which were plaguing in particular the North-Eastern regions. It is not, however, so much the regional distribution of lending which matters for social equality, as the direction of lending to support activity in poor districts. The table below shows that backward districts are rather evenly spread in each region and throughout the Indian territory, - 12 - Table 3: Distribution of Long-term Lending by Recipient Manufacturing Industries All India Distribution of product ve IDBI IFCI ICICI Capitaly (Approvals) Approvals / Approvals Industries Rs. m1n. % Rs. m1n. Rs. m1n. 71Rs. m1n. Food and beverages 6,001 9.2 233 5.7 997 22.7 14h 3.1 Textiles & clothing, footwear 7,947 12.1 1,110 26.9 527 12.0 399 8.7 Wood, paper, rubber, leather 3,981 6.1 270 6.5 433 9.9 510 11.1 Chemicals, fertilizers, petroleum, petro- chemicals 13,925 21.3 972 23.5 807 18.2 983 21.4 Building materials 2,723 4.2 82 2.0 204 4.6 342 7.4 Steel, nonferrous, metal products 17,496 26.7 600 14.5 657 15.0 851 18.5 Machinery (elec. & nonelec.) 7,523 11.5 746 18.0 359 8.1 759 16.5 Transport equipment 5,340 8.2 121 2.9 152 3.4 4h 9.5 Precise instruments & optical goods 370 0.5 n.a. n.a. n.a.) ) 6.1 160 3.8 Miscellaneous 156 0.2 n.a. n.a. n.a.) Total Manufacturing 65,502 100.0 LL13h 100.0 4,100.0 4592 100.0 a/ Annual Survey of Industries, 1969. Excludes electricity, gas, steam, etc. D/ Annual Reports 1968-1974. Includes direct project assistance, refinance and rediscounting. c/ Annual Reports. c/ Annual Reports, 1955-1974. Note: As long-term lending institutions reviewed above were created at different points in time, it was not possible to make a comparison reflecting their lending patterns during an identical time period. - 13 - Table 4 Regional Underdevelopment and ICICI Assistance to Backward Areas All India , ,ICICI Lendin-af Iidustryacy % of of which to backward districts Backward Share in all India Total Noor share of lend- aDistricts _/(N) back- ing to DacK- aln. No. As % of Productive Value ward ward areas in state capital Added -districts Loans total ICICI _ population 7eled Czin.rs.) 1endine Western India 119*7 21.9 2 1 20- 4*.1 9.6 18 26 Gujarat 26.7 4.9 10 49 6.3 8.1 12.4 6 59 1.1 Madhya Pradesh 1.7 7.6 36 83 6.5 3.3 1.8 5 be 0.9 Maharashtra 50.4 9.2 13 L2 17.3 28.7 3.3 6 149 2.9 Goa 0.9 0.2 3 100 n.8. na. 1.1 1 70 1.4 South India 91.8 16.7 ?. 16.9 1 19. 20 282 L Karnataka 29.3 5.3 11 63 5.1 5.3 6.6 8 165 3.2 Kerala 21.3 3.9 5 50 2.4 3.2 1.7 4 7 Tamil Nadu 41.2 7.5 8 60 9.4 9.1 11.0 8 110 2.3 East India 654 11.9 22 O_ 9 8 1A 1.8 Andhra Pradesh 43.5 7.9 IL 59 5.2 3.9 3.3 6 47 0.9 Orissa 21.9 4.0 8 48 4.6 1.8 2.1 2 3 0.9 North India !LU 2. 61 18.0 U 11 211 L 7-7 Haryana 10.0 1.8 4 39 2.5 1.9 2.8 1 3 Punjab 13.5 2.5 h 35 2.5 1.8 0.3 2 12 3.2 Rajasthan 25.8 4.7 16 S4 2.7 1.7 2.1 4 [3 0.8 Uttar Pradesh 88.3 16.1 37 62 9.1 6.9 5.0 6 29 0.7 Union Territory (Chandigarh and New Delhi) 4.4 0.8 n.a. n.a. 1.2 1.6 1.0 1 n.a. North-East India 1 21.1 _ 62 23.2 21.8 1 Z 6 Assan 14.6 2.7 7 76 2.1 1.3 1.0 3 49 1.1 Bihar 56.4 10.3 9 55 7,7 5.6 6.7 2 - West Rengal h.3 8.1 13 68 13.h 14.9 6.8 4 96 1.8 Smaller states 13.8 2.5 43 n.a. n.a. n.a. 11 13 0.2 All India 548.0 100.0 24-1 18 100.0- 100.0 100.0 z 2 11 18. (5,.381 mr. rs / Approvals basis - as of December 31, 1974. g/ 1971. As per "Guidelines for Industries", New Delhi, 1974. These districts are considered as industrially backward. d/ Annual Survey of Industries, 1969. - 14 - and that even in regions whose share in the total industrial value added exceeds their share in total population, as in Maharashtra, almost one-half of population is still located in backward districts. Bearing this in mind, the ICICI efforts to increase the regional distribution of its lending should be viewed in a different, more positive, light, because even lending within the state of Maharashtra could be considered as an effort to eradicate poverty through industrialization entailing increase in employment. Another noteworthy fact is the gradual increase in importance of ICICI lending to backward regions. The efforts in this direction began to accentuate in the late 1960s, but the really tangible results were obtained in 1972 and 1973: Table 5: ICICI Assistance to Backward Regions 1965-1973 (in Ra million) 1965 1966 1967 1968 1969 1970 1971 1972 1973 1. Total assistance to backward areas 19.1 19.9 23.1 15.3 42.5 29.6 47.9 94.1 187.8 2. Total approvals 275.6 191.6 217.0 305.3 297.9 340.1 405.0 523.5 592.7 3. Share of assist- ance to backward regions in the total (%) 6.9 10.4 10.6 5.0 14.3 8.7 11.8 18.0 31.7 In a broader sense, it was the system of incentives provided by the Government, by financial institutions and by the States, which was largely instrumental to this process. This system comprises various developmental measures, including provi- sion of concessional finance, initiated by All-India financial institutions, the capital subsidy and the tax benefits offered by the Central Government and the supporting infrastructure facilities and a variety of incentives provided by the State Governments. It is worth mentioning that States which have been in a position to provide more adequate infrastructure facilities have generally been able to secure a larger share of the assistance extended to the backward areas. Furthermore, the State Industrial Investment Corpora- tions were set up in a number of States in the late 1960s and, based on a share capital received from the Government, undertook financing of investment in backward regions, jointly with term-lending institutions, including the ICICI. There is, however, also little doubt that several concrete steps, undertaken by the ICICI, were conducive to this institution having stepped up its assistance to the backward regions. The first step was to set up regional offices in 1969. ICICI has now fully operating offices in Madras and Calcutta, fully staffed with project officers, and assuming the - 15 - responsibility for all loan applications up to Rs 1 million. Assistance of the Bombay headquarters, mainly in the form of technical advice, is some- times solicited. Regional offices appear to entertain not only excellent contacts with local business circles but also with local consulting firms, research institutions, state agencies and commercial banks, all useful sources of project ideas. The second step consisted of an arrangement to undertake studies of regional growth potential. Such studies were first undertaken in mid-1970, within Joint Institutional Study Teams, set up in collaboration with other term-lending institutions. All in all, 18 indus- trial surveys were carried out, and 15 reports have by now been printed and distributed. Independently from this joint effort, ICICI sent also its own teams to three States - Orissa, Tamil Nadu and Karnataka - to investigate project possibilities there. The third step in the ICICI effort to finance industrialization of the backward districts of India is that of taking project ideas, identi- fied through a regional survey, and making them feasible. This step has been broken into a few components, such as the prima facie feasibility assessment of the project idea, identification of entrepreneurs, prepara- tion of feasibility studies and, finally, a collection of information on the subsequent stages of various projects. Tasks under each of these functions have been distributed among ICICI, IDBI and IFCI, with each of these lending institutions having been allocated a certain number of regions. After the Joint Institutional Study Teams had drawn attentioi: to a number of possibilities for industrial development, these possibili- ties were made feasible and projects for Rs 1.7 billion ($225 million) are now either implemented or are under implementation by banks, State organi- zations and corporations. 3. Lending to Small-Scale Industry. ICICI assistance to small- scale industries has been marginal, with only 0.4% of its total approvals attributable to such loans as of 1974. In retrospect, the suggestion of the Bank and the Government of India that ICICI do more small-scale lending was probably misplaced, because ICICI was not geared up to handle this type of lending, unlike the SFMs (State Financial Corporations) which have a much greater expertise in this field and are much better situated, because of their location in the heart of each State, to cater to needs of the small-scale sector. IDA has recently made a credit to the State Financial Corporations (through IDBI) specifically for this purpose. 4. Promotion of New Projects. In the situation of India, an independent promotion of a project by a term-lending institution of the ICICI type has to be viewed in a somewhat different light than that in other countries. To begin with, the influence of the system of economic controls is all- pervasive. Two of the principal control instruments operate in a way which does not leave much room for initiative to a potential new entrepreneur of a respectable size, wishing to enter into an industrial field. The size of a new entrepreneur, in terms of a project he wishes to invest into, is here of importance, because industrial licenses are not obligatory only for - 16 - small entrepreneurs, the only ones whose freedom of entry is unlimited.l/ But the size is also directly related to the type of industry, and in modern industries, which ICICI was created to support, there is little room for small projects. The first of the control instruments is the system of industrial licenses, issue to new investors above a certain level. These industrial licenses are issued for investment in industries which are considered as useful for the national econopW either by the Planning Commission, if such industry has emerged from its long-term projections, or by the Development Wing of the WAnistry of Industry, whenever the current analysis carried out by this institution shows that some bottlenecks in inter-industry relation- ships have arisen or are likely to occur. These new activities are given a practically unlimited protection, not only against imports, but also against domestic production, the latter mainly because the volume of invest- ment is permitted to satisfy only what is calculated to be the existing or the immediately foreseeable demand. For these reasons, they carry with them a promise of profitability and, therefore, tend to attract the attention of potential investors, usually those who are already established in this or in an adjacent field of industry and are sufficiently well introduced in the ongoing procedures to be aware early enough that such capital goods licenses will be issued./ The second instrument is that of import licenses issued to indus- trial users. About one-fourth of inputs into industry is imported. Those entrepreneurs who are already operating as "established users" could prove that they had used in their past production a certain well-defined quantity of inputs from imports, and enjoy, therefore, a quasi-automatic right to reapply each year for a new import license. This is not the case for new entrants who, although theoretically enjoying such right, may encounter difficulties in seeing it quickly and fully implemented. Such are the laws of bureaucracy, and not only of the Indian one, that they tend to favor more the verified and established claimants. A question remains, however, to what extent there is an urgency for the promotional effort to be undertaken. Contrary to most other develop- ing countries, where new entrepreneurs emerge from merchant and landowner classes, Indian industrial entrepreneurship was born over a hundred years ago. The cotton industry, the first entrant into the world scene, has been, 1/ The limit, below which no license is needed, has been raised in 1975 by some 30%, to $1.3 million. 2/ The Government can either invite applications or wait for the applicants to come forth. In 1972 there were only 187 industrial licenses issued to new undertakings (but not necessarily new entrepreneurs) out of a totaof 563 new licenses issued. - 17 - from its beginnings in 1853, financed, managed and controlled mostly by Indians. The growth of a steel industry in India is another tribute to the indigenous entrepreneurship, with a first steel mill having been founded in 1907 and with domestic steel industry supplying, by 1934., almost three-quarters of the domestic demand. By 1922, domestic produc- tion of coal attained 19 million tons.! This spirit of Indian entrepreneur- ship remains very much alive today. It is the outlets, where this spirit of entrepreneurship could be realized, which are constrained by a number of factors - scarce resources, sluggish demand, and the limitative role of the administrative mechanisms. Nevertheless, the promotional efforts of ICICI were not altogether passive. Firstly, some projects are discussed between ICICI and the poten- tial borrowers even before the project idea is submitted to the Capital Goods Committee. Thus, out of 139 projects assisted under the Sixth Loan, 21 were formulated as a result of discussions with ICICI and then submitted to the Government's Capital Goods Committee for approval, and one project was entirely due to ICICI initiative. Out of 59 new projects under the Seventh Loan, 11 were formulated in discussions with ICICI and two were entirely due to ICICI initiative. Finally, out of 71 new projects under the Eighth Loan, 7 were formulated as a result of discussions with ICICI. Secondly, when the project idea is approved by the Capital Goods Committee (which issues industrial licenses), ICII has a chance to consoli- date the project, to "mould" it, before the entrepreneur applies for an import license - the next step on the way toward the finalization of the project. Thirdly, ICICI can start its promotional effort from point zero, namely from the idea of a project. In late 1973, ICICI established to this effect a Project Promotion Department, which is expected to focus on the identification of projects which would have linkages with existing industrial units, would fill identifiable gaps in the industrial sector, would be located in a backward area and would be conceived by a yet-not-too-well established entrepreneur. Several project ideas were generated by this Department during 1974. 5. Lending Strateg. ICICI did not have any clear strategr of its own as to the fields in whch its own expertise should be strengthened and the industries to which a more careful attention should be given. It considered, since its inception, that in the capacity of a key lending 1/ Fbr what the figures are worth, calculations of the League of Nations show that India's manufacturing production was equal, during 1870-85, to about 12% of total world manufacturing output, almost equal to that of Germany, exceeding that of France, and yielding to the United States and United Kingdom. League of Nations, Industrialization and World Trade- Geneva, 1945, p. 13. - 18 - institution to the private sector of manufacturing, its strategy should rather reflect a broader strategy of industrial development, which is designed by the Government and that, therefore, it should include the following main lines of activity:1/ (a) export industries and supporting activities; (b) industries supporting coal, power and transport sectors; (c) industries related to agricultural inputs and outputs; (d) industries serving a wide spectrum of uses, such as caustic soda, soda ash, alloy and special steels and machine tools; (e) mass consumption goods; and (f) balancing and modernization programs. It is certainly true that these industries were of importance to the Indian econonW. A brief review of ICICI lending in recent years shows that 81% of its lending has been channeled into these groups. Table 6: ICICI Lendinga According to Its "Broad Strategy" (in Rs million) Total Total A/B (a) (b) (c) (d) (e) (f) "Strategy" Lending (%) A B "Strategy" lending 247 375 5 241 52 167 1,137 1,401 81 /a Loans approved during 1973 and 1974. Columns (a) to (f) correspond. to the main lines of strategy, specified above. The above "broad strategy" lending corresponds to priorities reflected in Government policies. In a way, this could have hardly been expected to have been otherwise in view of the strict investment control system, by the Government, based on a notion of priorities. The so-called "priority 1/ Such strategy has been incorporated as a part of the Appraisal Report for the last (eleventh) loan to ICICI - Report 637a-IN of March 14., 1975, Annex 32, p. 2. - 19 - industries " account now in India for as much as 84% of the output of Indian manufacturing sector, a figure remarkably close to the share of "strategic- ally important" sectors in ICICI lending.i/ It is furthermore also true that in conditions of a widely spread scarcity of resources in a model of closed econon of India, with well- developed input-output relationships between industries and sectors, any shortfall in supply produces a ripple effect throughout the econoay and creates a situation in which practically all production flows acquire, in one point of time or another, a priority aspect. This, however, should not preclude a major financial institution, such as ICICI, from "gearing" a certain part of its lending program to a specific subsector of manufac- turing which is found particularly worth developing in the Indian context. Such choice will have to entail a concentration of skills and of time of a small group of people, to be chosen within ICICI to work on such subsector. If, as a result of such concentration, a well documented and convincing lending strategy could be formulated, this would lead to a more decisive promotional effort by ICICI. It is worth mentioning, in this connection, that ICICI always maintained solid and continuous relations with the Capital Goods Committee of the Government, which decides on industrial licenses. This committee refers projects to ICICI for financing, and, since 1973, ICICI has been even formally invited to sit in on meetings of this committee. However, ICICI served only in the capacity of an active advisor, offering views of dissent or reservation with regard to certain types of investment, rather than initiating or suggesting new types. Also, except for a few cases signalled above, ICII acted as a screener, rather than a promoter of new project concepts. With a certain, even though narrow, but thoroughly researched, area of strategy and specialization, these voids could be filled and the type of the relationship of ICICI with Government and the business world could change from that of a,counsellor to that of an initiator. This change may also help in remoulding the Bank's work related to industrial import credits, because, then, ICICI lending strategy could offer new possi- bilities for a "directed" Bank lending to industry. Industries considered as promising or stategically significant could benefit from capital loans by ICICI and, at the same time, their import needs could be satisfied from an industrial import credit, a part of which could be specifically earmarked for such purpose. 6. Exports. Exports of ICICI-assisted companies were quite impressive, reaching about W1o million in 1973. To compare, the overall manufacturing exports of India reached $1.5 billion in the same year, 78% of this representing 1/ Such similarity reflects only the order of magnitude. Other conclusions would be spurious, as these shares are, for obvious reasons, statistically not comparable. - 20 - jute, leather and coir manufactures, cotton yarn and textiles and handi- crafts, all these from industries to which ICICI lending is scant. This explains why the ICICI sample of companies accounts for a large portion of national exports in several non-traditional commodity groups. During the year 1973, this share was about 48% in transport equipment, 38% in rubber products, 35% in metal products, 32% in electrical machinery, and 23% in chemicals. It is, however, also true that the dynamics of exports from the ICICI-assisted companies are not much different from the overall export dynamics in manufactured goods. The share of exports in production of all ICICI-assisted enterprises, while still quite amall, is increasing. It has grown from 4.2% in 1972 to 4.8% in 1973 and to 5.8% in 1974. The share of exports in total sales of only eorting companiesis somewhat more impressive, amounting to 6.2% in 1973 and to 7.6% in 1974. Table 7: Exports of Manufactures from ICICI-Assisted Companies a. Dynamics Number of Total Companies Exports of ICICI- Indian Exports for which Number of Percentage Assisted Companies of Textiles and Information Companies of Exporting .b. Engineering Goods Year is Available Exporting Companies 2+1 $million Index $ million Inde a 1967 143 114 80 54 100 131 100 1968 141 128 91 93 171 184 140 1969 278 210 75 150 277 212 161 1970 498 270 54 157 289 256 195 1971 58k 342 58 187 345 265 200 1972 581 330 57 210 388 319 243 1973 434 245 56 150 276 406 31/2 1974 0. 26k .. 177 328 481 367 b. Sectcral Distribution (1972) - Exporting Companies Only Exports as % of Total Sales Commodity Group 1971/72 1972/73 1973/74 Chemicals 1.8 6.0 6.5 Electrical machinery, apparatus and appliances 4.3 4.4 4.8 achinery (other than electrical) 2.2 4.l 6.7 ?1nufactures of metal 4.7 10.1 11.8 Non-metallic mineral manufactures 1.k 1.6 2.0 Rubber manufactures 3.9 6.7 8.6 Textiles 7.6 7.6 8.0 Transport equipment 3.8 3.2 3.6 Other commodities k.1 .. 4.2 6.2 7.6 /a Cotton textiles have been incorporated in the index, because about 9% of ICICI- assisted companies are in this field. Without cotton textiles, this index would have been at k55 in 1973 (1967 = 100). - 21 - The Sixth, Seventh and Eighth Bank loans contributed considerably to export performance of ICICI-financed companies. Their contribution was as follows: Table 8: Contribution of Sixth, Seventh, and Eighth IBRD Credits to Export Performance (1973) Total Number Number of Total of Companies Companies Exports /b Assisted /a Exporting ($ millioT Sixth Loan (414-IN) 118 69 77 Seventh Loan (515-IN) 61 33 47 Eighth Loan (683-IN) 68 33 50 /a Those for which information is available. /b Some of the companies overlap between loans. The analysis of export performance relates to exports of companies, not projects. The task of developing in India enterprises and types of productions, which could compete in the foreign market is a national task of utmost importance. ICICI's contribution to this task has been important, judging by the number of enterprises it supported which are capable of exporting. The problem remains, that exports are still insignificant. There are two possible answers to the question why is it so. The first is that these enterprises may not be internationally competitive, but that they have to export either because they need some free foreign exchange to import restricted items, and they would be entitled to such exchange if they become exporters,:V or because they are obliged to export.Z Another answer is that these companies are capableof exporting more, but that the material incentives to export are too weak and they find it, therefore, much more profitable to sell their output on the internal market. Whether it 1/ Through a system of import replenishment licenses - REPs. 2/ There is a general obligation imposed on all units operating in selected industries to export 5% of their output - a percentage remarkably close to the share of exports in output of ICICI-assisted companies. - 22 - is really so could be e8tablished through application of a correct economic analysis to ICICI projects. Practically all methods of economic analysis applied to DFC projects - economic rate of return, effective rate of protection and domestic resource cost methods - rely on comparisons between domestic and international unit prices.S Thus, if the difference between these two prices is large, indicating a negative comparative advantage in producing a good domestically, economic indicators which the analytical method would yield would show that the project is not attractive.g/ It is responding to the Bank's suggestions that ICICI launched in 1972 a broad study aimed at finding the answer to a question as to whether the companies it financed would remain viable in a hypothetical situation where inter- nati6nal goods would be freely admitted to India to compete with Indian industry. But even the economic analysis cannot provide an answer to an important problem, namely that of quality of Indian manufactures. The economic analysis carried out by the ICICI indicates that about 60% of ICICI-assisted companies do export, but only a small fraction of their output. This may indicate, prima facie that the quality of these goods is acceptable for export. Nonetheless, a more thorough analysis is needed to find whether the quality and the finishing standards of these exported goods are not significantly higher than the quality of goods sold domestically by the same producer, and whether the unit cost of exported goods is not, therefore, much higher than the unit cost of goods sold domestically. If it is so, the results of the economic rate of return calculation, which uses average unit cost, representative rather for domestically sold goods, but at the same time uses If The ICICI had tried to obviate the difficulty in choosing the appropriate analytical method, difficulty usually encountered by other DFCs. It decided to apply in each appraisal most of the known major methods. Thus, beside the standard Economic Rate of Return and Financial Rate of Return, ICICI applies also two versions of the Effective Rate of Protection - one proposed by Mac Corden, and the other by Bela Balassa. It also applies a Domestic Resource Cost calculation, proposed by Michael Bruno. In a number of cases, indications of these methods differ (Annex Table 2). It is rather difficult to ascertain whether ICICI is using all these methods in order to forestall possible queries or whether it just has abundant, well-trained economic staff to use for this purpose. Thus, the ICICI Chairman stated officially that "an examination of all these indicators together would contribute to a better understanding of the appropriateness of such methods of economic appraisal to developing countries." The ICICI management also makes it clear that the results of these methods are uncertain and it there- fore tends to avoid using them for categorical either-or lending decisions. Again, to quote the ICICI Chairman, "given the sensitivity of calculations...to international prices of both output and inputs.. .the current behavior of prices and their unpredictability have only compounded the difficulties in putting this methodology to any meaningful operational use" (both quotations from the publi- cation Economic Rate of Return: ICICI Projects, Bombay, May 1975). Nonetheless, the use of these methods is considered useful by the ICICI management, especially because in cases where the results are striking, a more thorough inquiry into the project appraisal is usually undertaken, to pinpoint the exact reasons under- lying such results. 2/ Unless the data used for such calculations or the method itself are incorrect. OED has drawn attention to this probability in its Project Performance Audit Report on Turkey, Eighth DFC Loan, SecM75-582, August 6, 1975. - 23 - international prices applicable to the exportable (and therefore quality- competitive) goods, may point to erroneous conclusions. ICICI undertook recently an export study, covering a large sample of enterprises, the results of which should be helpful in pinpointing both the reasons behind these companies' decisions to export and the differences between production costs and quality of products sold domestically as compared to those sold in international markets. 7. Economic Analysis of ICICI Projects. The study of the develop- mental impact of ICICI was undertaken partly in fulfillment of one of the objectives of the Eighth,Loan, stipulating the need to "improve ICICI's assessment of its client companies' competitive strength" (see above), partly because a broader effort was undertaken by the Bank to evaluate dwneopmntal impact of DFCs.!/ The study was completed in mid-1973 and the results show, after a large pharmaceutical project with a high negative economic rate of return is excluded, a weighted economic rate of return (ERR) of 19.3% and a weighted financial rate of return of 17.5%, calculated for a sample of 42 projects, completed during 1967-70. A certain number (12 out of 42) of projects analyzed in this study (in 1972) were financed out of the Sixth Bank Loan. There was none financed from the Seventh or Eighth Loan, as the study was focussing an already operating projects. The economic results of these 12 projects were highly positive in nine cases and barely - but still - acceptable in the remaining three cases. Table 9: Economic and Financial Results of Projects, Financed out of the Sixth Loan Amount of Loan Committed Rates of Return Project ($ million) Financial EConomc Mafatlal Fine 0.7 14.2 21.2 Kirloskar Pneumatic 0.4 22.7 32.2 Indian Link Chain 0.3 14.1 9.6 Cable Corporation 0.3 19.8 24.1 C.T.R. Mg. 0.5 7.0 23.4 Usha Telehoist 0.2 19.1 18.3 Semi Conductors 0.1 29.6 8.4 Kamani Engineering 0.3 13.5 27.9 Prem Nath Monga 0.1 93.1 88.7 Nippon Electric 0.1 28.5 61.1 Agricultural discs 0.1 33.8 6.8 Geep flashlight o. 24.2 38.3 3.5 1/ Of the special studies then undertaken, one, the OED Report on DECs, Secm74-529 of July 26, 1974, was published and circulated in final version; two (Korea: KDIU Special Study, Report 109-KO of March 29, 1973 and India: ICICI Special Study, Report 320-IN of Januay 25, 1974) were circulated in final draft form; two (Turkey: TSKB; and Nigeria: NIDB) did not go beyond the preliminary drafts; and one (Colombia: Financieras) is now in preparation. - 24 - These results are derived from an ex post economic analysis, applied to projects in full operation in 1972. Anex ante economic analysis started being applied regularly somewhat later, around973, only after the Eighth Loan was committed by ICICI. This is why nothing could be said about the economic rate of return of projects financed from the Seventh and Eighth Loans. The review of ex ante calculations applied to 39 projects which were approved from loans subsequent to the Seventh and Eighth Loan, shows that the economic rate of return remains generally on the 20% level (see Annex Table 2). The analysis prepared by ICICI-/ yields the weighted Economic Rate of Return (ERR) of 20.3% and the weighted Financial Rate of Return (FRR) of 14.0%. There is hardly any instance where the return falls below 8%. The number of projects with relatively low economic returns (those below 10% but above 8%) was not more than 5 in all, while those yielding a high return (over 15%) number 29. A great majority df the 39 projects have either negative or low rates of Effective Protectibn. All except seven have shown a Domestic Resources Cost of Ra 9 or less for one US dollar, compared to the no ' exchange rate of Rs 7.50 per one US dollar prevail- ing until mid-197h. In a majority of cases the domestic prices of these projects' products were below or not far in excess of world prices, indicating prima facie their export competitiveness. The goods high on the top of the list were metal, sugar, and cotton products, while those ranking lowest were automotive ancillaries, tires, and man-made fibers. 1/ It is being prepared for all projects where ICICI assistance exceeds Rs 5 million ($660,000). 2/ The rupee, de-linked recently from the pound sterling, is floating. Its rate is now close to Rs 9 per one US dollar. - 25 - Table 10: Economic and Financial Rate of Return Calculated for ICICI Projects (based on appraisals of projects, main3y during 1974, where ICICI assistance exceeded Ra 5 million) No. of Economic Return Financial Return Industy Projects Average Weighted Average Weighted --------- M( -------------- Chemicals and petrochemicals 11 15.9 15.6 14.1 12.8 Machinery manufactures 1 16.8 - 15.0 - Electrical equipment 2 26.1 22.7 13.5 13.4 Glass products 1 30.0 - 13.5 - Metal products (ferrous) 10 29.8 29.4 16.4 16.2 Metal products (non-ferrous) 1 31.3 - 12.1 - Sugar 2 38.2 33.2 21.0 19.7 Rubber products 3 11.5 11.1 14.1 13.1 Textiles 5 31.2 29.1 19.8 18.3 Paper 2 16.9 17.0 12.0 12.3 Miscellaneous 1 19.7 - 15.5 All Industries 39 23.9 20.3 15.7 14.0 While the above results may come as a surprise to an uninitiated reader, liable to think of Indian industry as being somewhat inefficient, they would be accepted by those more familiar with the Indian industry. There are important segments of Indian industry which are truly inefficient, each for a specific reason.-V One segment consists of many public enterprises which suffered for a long time from bad management, an aspect which appears to be now improving, and which were often afflicted by a mixed blessing of tied aid depriving them of a choice of appropriate equipment; another segment comprises important sectors of private industry, such as textiles, suffering from obsolete equipment, modernization of which has been for a long time prevented because it could have led to a reduction in employment; many smaller enterprises, found to be at a below-optimum level of production compared to the technologically justifiable one in their specific industries; and finally some enterprises producing heavy equipment, which counted upon 1/ The Bank has drawn the attention to "considerable differences in performance between units producing the same type of product," and to the fact that "large enterprises on average out-perform small and medium sized units." India: Review of Trends in Manufacturing Industry, April 1, 1970, SA-9a. - 26 - a higher public sector demand for capital goods than had actually materialized and whose capacities are turning idle. However, many enterprises in India could be considered as efficient by general standards. This includes a large segment of middle-to-large private enterprises in non-traditional industries and these are precisely the enterprises ICICI focusses its financial assistance upon. These enterprises are, therefore, often competitive enough to be able to export more than they do. The lack of marketing arrangements abroad, more exacting quality require- ments and weak long-term export credit facilities make it certainly easier, if not more profitable - given costliness of export efforts - to sell products in the domestic market. Moreover, had these enterprises been operating at a less than full capacity, exports at a marginal cost might have materialized. This, however, does not seem to be the case. Data on capacity utilization during 1970-71 for 109 ICICI-assisted projects (76 new projects and 33 expansions) show that about one-third of these projects were working near capacity (80% or more), another one-third were operating within the 60-80% range of capacity utilization, and only one-fifth of these projects had a capacity utilization ratio of less than 40%. Many of these projects had been completed only a year or two earlier, and this level of capacity utilization could be considered fairly satisfactory.12 8. ICICI's Influence on Projects. ICICI was capable of introducing relatively important modifications in a number of projects referred to it by the Capital Goods Committee. It is noteworthy that the amount and type of modifications depends largely on whether the project benefits or not from foreign collaboration, the fact determining often the need for suggestions on technical improvement, or whether the project is new or is an expansion, which may determine the need for suggestions related to market. These relevant project determinants are therefore listed below, alongside with the ICICI contribution to projects' design and structure. In a few cases, ICICI intervention was of a triple nature, such as market research, cost analysis, and technical improvements. This tends to increase artificially the number of interventions compared to the number of projects, and therefore the table also shows the number of projects where there has been no ICICI influence whatsoever. In as much as 60% of projects, ICICI played no advisory role. This could be explained by the fact that [0% of all projects consisted only of relatively minor expansions, and that 14% of projects had technical and financial foreign collaboration, leaving little room for additional advice. 1/ It should be also borne in mind that capacity utilization figures in India are not necessarily a reflection of market conditions and/or of the efficiency of the firm. A number of external factors, such as availability of essential raw materials, power shortages and inter- ruptions, transport bottlenecks and disturbed industrial relations are sometimes strongly responsible for variations in capacity utili- zation. - 27 - Table 11: ICICI Influence on Projects Fbreign Nature of Projects Collaboration TCICI Contribution Expansion Major Minor No. of Moderni- or Tech- None Market Projects zation Balan- nical %of Survey Product and and cing Tech- and all Cost and Mix Finan- No. of Diversi- Equip- nical Finan- Proj- Revi- Market- and. cial Time Companies fication ment New O cial Number ects sion Output Matters Phasing Sixth Loan 150 (139) 69 49 21 23 15 86 62 3 6 20 22 35 Seventh Loan Bo"(59) 23 29 7 12 10 38 64 - 1 2 11 13 Eighth Loan /c 74- (71) 36 20 25 14 14 44 62 6 16 4 13 11 Total (Three loans) 304 (269) 128 98 43 49 39 168 62 9 23 26 46 59 /a Of which 31 projects were cancelled. /b Of which 21 projects either overlap with the Sixth Loan or represent loans to the same enterprise from the Seventh Loan, or were cancelled. Analysis applies, therefore, to 59 loans only. /c Of which 3 projects overlapping with previous lines or cancelled. Therefore, analysis applies to 71 loans. It is noteworthy that the relative role of market research supplied by ICICI is increasing over time. In only 0.4% of the cases under the Sixth Loan did ICICI provide market advice, while under the Eighth Loan this percentage increased to 22% (Table 11). This change could be attributed to the Bank having in timely fashion discerned the need for such advice and having formulated it as an objective attached to the Sixth Loan, reiterated when the Seventh Loan was negotiated. Also the Bank's suggestion to ICICI to adopt an industry approach instead of a product approach in appraising the future markets proved to be pertinent and valuable and was accepted. Finally, the apprehension that market demand may not become as buoyant as the Government Plans were predicting has unfortunately proved justifiable. These plans are not adopted as a framework for market projections any more. - 28 - B. Institution-Building 1. Lags and Delays in Project Processing. The lags between approvals, commitments and disbursements of projects have increased in terms of money. Thus, the gap between foreign currency loan approvals, commitments, and disbursements were as follows: Table 12: Leads and Lags in Loan Processing 1965 1967 1969 1971 1973 (in Rs million) 1. Approvals 167 65 187 202 339 2. Commitments 200 73 250 236 435 3. Disbursements 173 102 108 205 271 (ratios in %) Approvals 83 89 75 86 78 Commitments Commitments 115 71 231 115 160 Disbursements Increase in gaps finds partly its justification in the dynamics of lending, with loan approvals having increased 2.0 times, loan commitments 2.2 times and disbursements only 1.6 times, during 1965-73, each having its own growth function, related to the past behavior of the variable it depends on. More- over, with increasing project costs it is to be expected that approvals during a given year would be larger than disbursements, as disbursements relate to approvals of earlier periods. A lag between approvals and commit- ments is, however, more difficult to justify. It is attributable, to a large extent, to ICICI being eager to sanction its assistance early and, as a consequence, running out of funds for approvals well before it receives a new loan from the Bank. ICICI's performance regarding the timeliness of project implementa- tion is generally stable and satisfactory. Projects concluded on time or with less than one year delay were 80% of all projects in 1968, 77% in 1969, 70% in 1971, 59% in 1972, and 82% in 1973. Slippages in punctuality of completion were mainly due to import license delays, changes in project design and late delivery of machinery. 2. Follow-up Procedure and the Problem Comanies. Improvement of follow-up procedure has been parallel to the stall increase in the Follow-up Department of ICICI, from five persons in January 1966 to 26 persons in January 1975, considerably quicker than the number of companies assisted, - 29 - which increased from 425 in 1966 to some 900 in 1979.1/ Members of the Follow-up Department are presently visiting altogether some 160-170 companies annually. What matters, however, more than the number of companies, is the frequency of these visits to enterprises where problems were discovered. At present, there are 4O such companies, which are subjected to practically the day-to-day monitoring by a special group of analysts, created for that pur- pose within the Follow-up Department. A certain number of problem companies were financed from the Sixth, Seventh and Eighth Bank loans. - Under the Sixth Loan: Eight out of 139 companies can be considered to be facing difficulties of long-term nature. These include projects in various industries - an enamel factory, a cotton mill, a truck plant, a polymers mill, a firebrick plant, a forge, a steel company, and a transport equipment compo- nent factory. Thus their problems were not of sectoral nature. The major problem facing all these eight companies was that of management. In almost all cases steps have been taken following ICICIts initiative, to strengthen this aspect. Six of these projects, as well as three other projects, are in arrears, either in the repayment of the principal or in the payment of interest on the foreign currency loans. The total foreign currency assistance which went to these projects was relatively small, Rs 18.3 million ($2.4 mil- lion, or 5% of the Sixth Loan). The principal amount in arrears was, in mid- 1974, Rs 12.0 million, plus Rs 7.3 million in intereat. - Under the Seventh Loan: Four out of 65 companies can be considered as weak. Two of these projects are foreign-owned (Japanese ownership). Their difficulties appear to be temporary. Two of these projects are in arrears. Total foreign currency assistance made to projects in arrears amounted to only $0.6 million, one-third of this sum is outstanding in arrears in repay- ment of principal,and arrears in interest payment are below $0.1 million. - Under the Eighth Loan: Two out of 68 companies face long-term difficulties. The operation of one of those, an aluminum company, had been affected by labor trouble. The other suffers from inadequate management and an unsatisfactory market for filament wires. Six companies are in arrears, which amount to Rs 3.2 million in principal and Rs 1.3 million in interest. 1/ It is somewhat difficult to establish the number of companies assisted by ICICI, as many of its loans are repeater loans, going to the same company. It is calculated that 1,506 projects financed by ICICI until mid-1974 were distributed among 888 enterprises. - 30 - Table 13: Problem Cases Under Sixth, Seventh, and Eighth Bank Loans Type of Production Problem Solution Envisaged and Results Aluminum Raw material shortage, Improved lately (end 1974). labor strife. Carbon (electrodes) Financial lossesand heavy Recently earned profits. borrowing; power cuts. Forge Adverse market. Improved lately (end 1974). Chemicals (caustic Slow project implementa- Revised amortization. soda) tion; power cuts. Tools Management shortcoming; Management will be changed. labor strife; power cuts. Semi-conductors Delay in sales to public Debt rescheduled. Situation sector; liquidity problem. improved. Lamps Decline in demand. Improvement expected shortly. Lamps Management, technical Management strengthened. Tech- problems, labor strife, nical problems removed. market. Tillers Rural market not prepared Financial break-even achieved. to receive products. Enamel Management, labor. Marketing, labor problem solved. Additional credits necessary. Trucks Organization, management. Improved recently (early 1975). Plastic polysterene Cost overrun, implemen- Management and technical prob- tation delays, technical lems solved, but market and difficulties, weak manage- cost problems remain. ment, increased input cost. Firebricks Cost overrun, weak market Plant closed, but will be re- and management; delay opened under new management. in execution of orders. Rubber Delays in imports of Reached profit earning stage. equipment and financing (project delayed by seven years). Steel High cost of raw Location of a furnace changed. materials; power cut. The above review of problem projects suggests that ICICI, in response to Bank missions' prodding and, probably even more, reacting to the nature of problems encountered, succeeded in providing an appropriate type of advice and assistance. Most of the advice offered at present relates to financial or managerial problems. 3. IBRD Comments and Advice on ICICI-assisted Projects. The Bank prior approval (free limit) margin was gradually increased, from $2 million for the Sixth and Seventh loan to $4 million for the Eighth Loan. Under these limits, eight projects from the Sixth Loan, five projects from the - 31 - Seventh Loan and four projects from the Eighth Loan were submitted to the Bank for approval. The issues raised by the Bank related to a wide number of problems, and are presented in a tabular form which follows (Table 14): Table 14: Bank Comments on ICICI-assisted Projects C any Product Loan Bank Comments Actual Development Sixth Loan ($ mln.) 1)Goodyear Tires 3.95 a. Rejection rate high a. Solved before the issue was raised; b. Effect of foreign b. No problem; control; c. Relative share of c. Taken into account markets for new & retreaded tires 2 )Ashok Leland Chassis 2.45 a. Cost-price rela- a. Decline in profit- tionship; ability but still b. Reliability of good; suppliers questioned;b. Proved reliable c. Indigenisation of c. 88%; product; d. Good (78% capacity d. Market; utilization); e. Scale e. No diseconomy of scale 3) Ahmedabad Calico Manufacturing Printing 2.56 a. Reservation as to a. Consumption has future PVC demand grown 22% p.a. 1968-73 LOTata Iron & Ingot Steel Steel 2.62 a. Manpower rational- a. Company began such ization (1967) scheme in 1965 5) Nirloin nylon yarn tire cord 3.00 None recorded 6) Scindia Shipping 3.00 a. Foreign exchange a. Incre-ased 114.5% earnings; p.a. 1967-73; b. Fuel consumption b. Increased more than propor- tionally to tonnage 7)Madras Rubber Tires 2.00 a. Demand-supply- a. Appraisal demand price relations; 5.6 mln. b. Replacement norms Actual demand in tire industry; 5.5 min. c. Profitability Production 4.8 mln4 b. 87% replacement; c. Good - 11.9% of sales 16.8% on capital - 32 - Table l (Continued) Company Product Loan Bank Comments Actual Development (s mln.7 8)Great Eastern Shipping 2.37 a. Long-term cash a. Liquidity position flow consistently good Seventh Loan 9)Goodyear As above (line 1) 10)India Steamship Shipping 3.00 a. Why purchase second- a. Large number of hand ship, neglect- small consignments; ing containerisation containerisation premature in India ll)Gwalior Rayon silk 2.17 a. Doubts about diacal- a. Plant dropped Silk cium phosphate plant;b. Operating 15% above b. Doubts about caustic designed capacity; soda unit; c. No such process c. Chlorine utilization foreseen 12)Tata Iron & Steel As above (line 4) 13)Tata Engin- Heavy eering & engineering 4.23 Locomotive Eighth Loan 14)Gujarat State Fer- tilizer Fertilizer 4.00 a. Choice of caprolac- a. Market demand tam capacity (ammo- higher than ammo- nia availability, not nia supply but market demand); neither import nor b. Quality control & add. production marketing; advantageous; c. Domestic price high b. Guarantee provided compared with cif by supplier of equip- ment; c. Prices reduced when full capacity attained. 15)Scindia Shipping 4.10 As above (line 6) 16)Tata Iron & Steel Steel 6.00 As above (line 4) 17)Tata Engineer- Heavy ing Engineering As above (line 13) TOTAL 45-45 - 33 - The Bank's comments were usually of three different kinds. The first were the "consistency and completeness" type of comments; by making them the Bank experts intended to draw the attention of ICICI to elements of the appraisal which either appeared to have been insufficiently investigated or were out- rightly missing from the appraisal. In making these comments the Bank experts usually have in mind a complete list of issues that a project analysis is supposed to take into account. Such type of comments is highly useful in the first stages of development of a DFC, when there still exists a danger that, due to inexperience, an element vital to the future success of a project may escape the lender's attention. The likelihood of this to occur in a DFC of the ICICI type, with 20 years and over one thousand projects behind it, is not large, however. The proof of it could be found in Table 14, where the comparison of "Bank Comments" with the "Actual Development" tends to dissipate any apprehension the Bank might have had with regard to pricing, markets, cash flow or the scale of production. The second type of comments are those pertaining to technology and the third type relates to international prices. Both these were useful to ICICI and were highly valued by its project appraisal staff. It is note- worthy that the first type of comments, while it possesses a "drill" value in the first stages and continues to have some educative value later, cannot be fully relevant to the DFC without Bank experts being able to familiarize themselves with local conditions, especially because fitting a large project into the national economic framework as specific as that of India's is a complex analytical task. The second and third type of comments, however, require mainly a good knowledge of the international scene and particularly of the trends in modern technology and in foreign trade, and this is where the Bank's knowledge is superior to that of a mature DFC of the ICICI class. 4. Predictive Capacity of ICICI Projections - Structure and Dynamics of Its Operations, Investment Cost Overruns. A DFC's - or for that matter any institution's - capacity to forecast reasonably correctly its own operations represents an important index, showing the degree of maturity it reached in understanding mechanisms hidden behind the national and inter- national economic scene. Nonetheless, the Bank appraisal missions rarely enquired ex post into DFCs' predictive capacity, which they could do by checking how the real evolution deviated from projections and trying to explain, conjointly with a DFC, the reasons for these deviations, sometimes residing not so much in unforeseeable events having happened as in projections having been prepared without a solid factual basis and without having reviewed a variety of possibilities. This, however, was not the case of ICICI whose forecasts appear, ex post, to have been sound and thoughtful. These forecasts were usually discussed in detail with the Bank appraisal missions, which some- times led to changes and adjustments. A predictive capacity of ICICI could be measured on two planes. The first is its ability to predict correctly the volume of its future operations - approvals, commitments and disbursements. The second is its ability to assess the correctness of its clients' forecasts, especially those bearing on project investment costs. a. Forecast of Operations: As forecasted during the appraisal of the Sixth Loan,ICICI planned to maintain - during 1965-70 - the distribution - 34 - between the foreign currency loans, rupee loans, underwriting of shares and debentures and direct equity investment at 55, 25, 18 and 2%, respectively, calculated on the basis of approvals. The actual shares during 1965-70, became 58, 17, 23 and 2%. The relative decline - compared to predictions - of the share of rupee loans could be partly explained by difficulties ICICI was encountering in mobilizing domestic currency resources and partly by the fact that a new powerful development banking institution - the Industrial Development Bank of India (IDBI) - lending exclusively rupee resources and benefiting from Government budgetary funds, came into full operation during 1965-70./ From the point of view of domestic resource lending, the fact that underwriting of shares and debentures had largely substituted itself for direct rupee lending somewhat lessens the effect of apparent non-achievement of the TCICI target. But most importantly, this shortfall has been evened out in the subsequent period of 1971-73, when the proportion between foreign currency loans, rupee loans, underwriting and direct equity became 57, 29, 7 and 7%, respectively. Thus, when the whole 1965-73 period is taken into consideration, the breakdown between those four forms of financial assistance becomes 58, 23, 15 and 4%, almost exactly as predicted and as intended. Another test could consist in checking the predictability of the dynamics of ICICI operations. This could be done by calculating the deviations of actual figures from what has been forecasted by ICICI. Table 15: ICICI Degree of Achievement of Forecasted Operations (forecast = 100; deviation from forecasts in ) 1965 1966 1967 1968 1969 1970 1971 1972 1973 1965-73 Approvals 4.7 -30.8 -21.8 - 7.5 -30.8 - 5.5 0.0 17.9 18.5 - 4.3 Commitments 30.4 -34.4 4.3 -33.2 - 8.9 -17.8 -14.0 -18.0 21.4 - 7.1 Disbursements 5.2 - 1.8 -15.5 -34.8 -46.7 5.0 - 7.7 - 0.8 -13.4 -11.2 On the whole, correctness of ICICI forecasts for mid-1960s suffered mostly from the recession. ICICI forecasts for the early 1970s, probably influenced by past experience, were overly cautious. Actual operations have then over- taken the forecasts, helping to even out the trend, and the final result was that of rather small deviations between forecasted and actual operations for the entire period. The largest discrepancy appears between actual and fore- casted disbursements. It is surmised that this indicates not so much a weak ICICI processing capacity as frequent delays on the part of ICICI clients, who draw on their accounts only when all the clearance formalities, unduly lengthy in India,are completed. b. Project Cost Forecast: The last test is that of correctness of ICICI assessments of the estimate of capital cost of projects. The record on this score is as follows: 1/ IDBI was established in 1964. -35 - Table 16: Capital Cost Overruns and Delays in Completing ICICI-Financed Projects Cost Time Delays iin Completion (in number of projects) Number of Number of projects for projects for Overrun which time which cost Capital Cost Over- less More scheduling information (Rs. m1n.) run On than 6-12 12-2L than information Available Estimated Actual Schedule 6 mos. mos. mos. 24 mos. is ayqilabLe Sixth Loan 93 918 1,031 12.3 l 13 16 28 l4 85 Seventh Loan 37 390 397 2.1 6 15 8 8 5 42 Eighth Loan 62 1,59h 1,981 24.3 10 15 11 17 6 59 Total 192 2,902 3,409 17.5 30 43 35 53 25 186 /aa_ /a /a_ In $ or in % ($387 mln.) ($454 mln.) 16. a 23.1-a 18.8-/a 28.5- 13.5La 100.0 /a As % of the entire number of projects for which information is available (= 100). The record appears to be quite good with respect to cost overruns. Cost information was available for 192 projects, representing 70% of all projects financed under the three Bank loans. For this large sample, the total cost overrun was kept below 20%. Most of the overruns occurred in the last few years, when price inflation became rampant. The overruns were worse with respect to time delays. Only 58% of the sample projects were completed on schedule or with less than 12 months delays. This, however, will have to be viewed against the backdrop of the general situation in India, where con- siderable construction delays, mainly attributable to slowly turning wheels in administrative mechanisms, are a common phenomenon. 5. Use of Management Techniques by ICICI Clients and Spread of Managerial Knowledge. Following Bank recommendations, ICICI has successfully persuaded many of its clients to adopt project scheduling techniques, such as PERT and Critical Path Analysis, to help the sponsors keep track of project implementation. These measures have proved to be valuable cost and time saving devices, particularly in the context of a variety of environmental uncertainties conditioning project implementation activities in India. ICICI has also introduced the discounted cash flow analysis (DCF) as a normal part of its project exercise for establishing the internal rate of return calcula- tion. It has also introduced sensitivity and break-even analyses to measure - 36 - uncertainty and risk. ICICI clients, exposed to these exercises have dis- played their keenness to adopt them also in other situations than that of project appraisal. ICICI has taken the initiative in setting up the Institute for Financial Management and Research with the sole objective of providing specialized training facilities in financial management, monetary and capital market fields, among others, to the staff of industrial estab- lishments, banking and finance institutions in the country. The programs of the Institute are partly based on case studies provided by-the -IC-ICI. From time to time the ICICI has also been organizing seminars and conferences on specific topics. For example, in 1962, it organized the first Regional Conference of Development Banks in Asia. In 1964, a conference of ICICI clients was organized where a mutual appreciation of the points of view of the ICICI staff and the clients was made possible. In 1970 a seminar on Technological Research and Development took place, where ICICI clients together with representatives of research and development organizations in the country took stock of developments and deliberated on new areas and directions for future research efforts. Again in 1972, a seminar on Con- sultancy Facilities available in the country was convened to facilitate a dialogue between consultancy organizations and those who utilized their services. C. Resource Mobilization The task of resource mobilization is a rather difficult one in the situation of India, with institutionalized sources of credit and with a capital market on decline. Thus, while still in 1957 the commercial banking system had remained private and the capital market provided over Rs 1 billion or 17% of the net domestic savings, by 1972 the banking system had been entirely nationalized and the afflount of Rs 1.3 billion providl9 by the capital market was equivalent to only 3% of the net domestic savings.- Additionally, a new Government regulation was introduced in July 1974 (amended in May 1975), limiting dividend payments, which depressed the capital market even more. 1. Mobilization of Rupee Resources. When the Sixth Loan was negotiated, ICICI's virtually sole outside source of domestic resources, besides increases of its own share capital, was Government loans. A new possibility opened shortly afterwards, namely, that of borrowing from the IDBI. IDBI relied on large loans from the Government of India, from the DAF (Development Assistance Fund) and from the Reserve Bank of India, at varying rates of interest.P/ Finally, the last possibility open to ICICI was that of floating its own debentures. 1/ Capital market figures calculated as a sum of shares and debentures. 2/ During the first 10 years of its existence, 1964-73, IDBI borrowed about Rs 1.6 billion from the Government (at interest rates ranging from 0 to 5.5%) and another Rs 1.6 billion from the Reserve Bank of India at some- what higher rates, hovering around 6%. - 37 - The importance of debenture issues, which accounted, as of December 31, 1974, for 34% of ICICI's domestic resources, was gradually growing. Other sources of domestic resources were GOI and IDBI loans (39%), share capital (12%) and internal cash generation (15%). A little over one-half of all the debenture issues have been taken up by commercial banks, about one-third by financial institutions and the remainder (14%) by private institutions and individuals, mostly ICICI clients. Though ICICI's efforts in helping develop the financial markets by floating debentures are laudable, little actual mobilization of primary savings is generated in this process. ICICI, like other long-term financial institutions, is-mostly tapping secondary resources which have already been mobilized by commercial banks and other institutions, primarily insurance companies. This is the result partly of traditional investment habits and partly of the lack of secondary markets for debentures, a major obstacle to attracting funds directly from the public. Finally, ICICI finds it increasingly difficult to obtain subscriptions for its debenture issues from commercial banks and institutional investors, because its debentures are not classified as trustee securities under the Indian Trust Act of 1882, and therefore the commercial banks and institutional investors are not permitted to include their investments in ICICI debentures to meet their reserve ratio requirements. ICICI has asked the Government to reclassify its debentures as trustee securities and the last debenture issue was granted this status. ICICI used all three sources of domestic financing whenever the need arose. Table 17: Domestic Resource Mobilization by ICICI Source of Finance Maturity or Redemp- and Date (Month Amount tion Period (Grace and Year) (Rs m1n.) Period) Rate of Interest (%) Government 7765 100 15 (5) 5.05 7/66 50 15 (5) 5.5 Total 150 IDBI TT/66 50 15 (5) 5.6 10/67 30 1 (5) 5.6 11/68 25 15 (6) 5.6 6/69 18 15 (6) 5.6 2/71 18 15 (6) 6.25 3/72 18 15 (6) 6.25 11/73 28.5 l4 (5) 6.75 9/74 19.0 li (i) 7.75 Total 206.5 Debentures 10/67 60 10 6 12/69 50 11 6 6/72 70 12 6 3/73 80 12 6 6/74 90 12 6.25 Total 350 Grand Total (001, iP. IDBI, Debentures) ($94 m1n.) - 38 - As the above table shows, ICICI had almost met - with barely a 13% shortfall - the domestic resource borrowing expectations formulated in the appraisals of the Sixth and Eighth Loans (expectations of the Sixth Loan were for ICICI to borrow about Rs 435 million during 1965-70, and expectations of the Eighth Loan were that ICICI would borrow about Rs 375 million during 1971-74). This shortfall is consistent with a much smaller shortfall in achieving the lending targets and with maintenance of the relation between foreign and rupee lending. Both were discussed in preceding sections of this report. A question remains whether, given the gradual increase in the degree of import substitution for capital goods in India, ICICI should not have increased proportionately its lendings in domestic currency - and consequently its rupee borrowings. Had ICICI been a sole or principal long-term lender in India, the answer to this question should have been clearly in the affirma- tive. This, however, is not the case. Starting from 1966, following the strong expansion of other term-lending institutions and an increase in the average size of industrial projects, an Interbank Consortium was created in India, which includes ICICI, IDBI, IFCI, Life Insurance of India and the Unit Trust of India. The Consortium convenes normally once a month, to discuss new project applications. For each project, one chosen member of the Consortium becomes a "lead" institution and undertakes to prepare and to submit the appraisal for joint financing. In recent years, the cooperation between the members of the Consortium was extended to joint analysis of industrial develop- ment possibilities of backward areas. According to IDBI, practically all viable project proposals received from the Consortium all necessary financing, except for 1975 when the credit squeeze became a binding condition. Further- more, ICICI affirms that on no occasion in the past had a loan application for a good project been turned down because of this institution's shortage of domestic resources. If supply of domestic resources, at a given interest rate, was adequate, additional borrowing on the part of ICICI would have implied simply a shift in relative shares between the members of the Consortium, rather than a provision of new resources to satisfy financial requirements for new investment. This is especially true because additional rupee borrowing would have involved either borrowing from IDBI or placing debentures with the Life Insurance or the Mutual Fund (Unit Trust of India), all those being also members of the Consortium. A related question concerns the need for mobilization of domestic resources by ICICI in the future. The continued advance of the import substitution process in India into increasingly complex areas of industry permits a guess that the share of supply of equipment from domestic sources in the value of projects will continue to grow. Therefore, if ICICI wants to maintain its share in term lending, it will have to think in terms of a higher proportion of rupee lending. As the commercial banks could be considered as the most effective collectors of primary savings and providers of such savings to the term-lending institutions, the question is at what cost ICICI should borrow these funds, in the future. This, in turn, brings into focus the attractiveness of commercial banks' term deposits to the primary savers. It is an important question which, while not treated adequately in the past, calls for an urgent solution, on which the success of ICICI efforts to mobilize domestic resources may depend. - 39 - Finally, a much wider use of domestic resources in the future could be made by ICICI, to a larger extent than hitherto, for seed capital, through equity investment and underwriting. The Bank was inclined to caution ICICI in the past, especially with respect to its underwriting activity, because ICICI had to take up the unsubscribed portion of public issues, a move which was difficult to avoid in depressed market conditions. As a result, ICICI largely shifted from underwriting to direct subscription. 2. Capital Market Operations and Equity Investment. According to Government regulations, companies with annual volume of sales exceeding Rs 2.5 million ($0.3 million) have to become public. Also, given India's tax structure and limitations on intercorporate investment, it is practically impossible to set up a family-owned enterprise. Thus, the normal difficulty, which DFCs in most countries seem to encounter in persuading their clients to acquire statute of public enterprises, does not apply to India. The Bombay Stock Exchange alone lists about 500 companies. The demand for shares originates in four sources: (a) small investors searching for marginal profits; their part in transactions is rather negligible; (b) larger savers, who ca.ider the capital market as a.possibility to preserve value of their financial assets; (c) large speculators, dealing in shares of widely held companies, among them Scindia Steamship Company, whose expansion was financed from the Seventh Loan to ICICI (see above); and (d) institutional investors. The tendency of potential investors is toward fixed-term securities because, except for occasional short-lived peaks the long-term tendency of the market was rather disappointing. The index nwqber of security prices was rising, on the average, by 3% annually, since 1965.1/ In these circumstances, ICICI's equity invest- ment operations could be considered as particularly successful. Its portfolio has been increasing at the rate of about 6.5% annually. ICICI adopted the principle of keeping shares for at least five years, and then selling them back to the market. It managed to rotate about 10% of its share portfolio annually, an activity rather few DFCs have been successfully engaged in, and, despite the depressed market conditions, enjoyed a capital gain of 28% on sales or 5.1% annually.!/ 1/ With 1961/62 taken as 100, this index was at 76.7 in 1965/66 and remained practically unchanged until 1968/69. It rose by 10% both in 1969/70 and 1970/71, and declined again to 94.4 in 1971/72 and 1972/73. 2/ If shares are kept for about five years on the average, this implies an annual capital gain of about 5.1%, almost twice the annual progression of the All-India security index. - 40 - Table 18: EAuity Portfolio and Capital Gains Sales Proceeds Average Market As Net Capital Gains Market Value W of As % Number Book Value Vqlue as % of Market in of Sales Year of Companies (Rs. mn.) (S.- mln.) Book Value (Rs. mln.) Value (Rs. mln.) Proceeds 1965 66 56.7 48.7 86 2.0 4.1 0.6 30 1966 87 71.2 65.1 91 2.7 4.1 0.h 15 1967 95 80.5 72.8 90 8.1 11.1 0.6 7 1968 97 79.5 75.9 95 5.0 6.6 0.7 1b 1969 102 78.0 89.4 114 12.0 13.L 2.9 24 1970 124 82.5 108.0 131 10.2 9.4 4.2 41 1971 1h2 86.8 105.0 121 10.3 9.8 5.5 53 1972 161 86.8 106.9 123 20.6 19.3 6.8 33 1973 173 89.1 122.1 137 20.5 16.8 7.6 37 197h 175 97.0 116.9 120 n.a. n.a. n.a. n.a. Average 3.8% p.a. 9.5 28 3. Foreign Resource Mobilization. The bulk of ICICI's foreign currency resources comes from IBRD. Of total foreign exchange resources of $242 million as of December 31, 1974, 10 BRD loans account for $201 million or 83%.!/ Thirteen KfNW lines of credit account for 10% and five UK lines of credit for 6%; the balance of 1% was provided by one AID line of credit, and a recent Swiss bond issue. In addition, a loan of DM 7 million from KfW has recently been sanctioned and is expected to become effective shortly. The Swiss bond issue for SF 8 million ($2.1 million) was floated during 1973 at a fixed rate of 8% and was the first of its kind for ICICI. Though the amount was modest, it represented an important step in diversifying ICICI's sources of foreign exchange. ICICI had also envisaged obtaining a $15 million aro-currency loan which was not finalized because of rising borrowing costs and increasing uncertainties in the Euro-dollar market. ICICI was keen to diversify its sources of foreign currency funds but, in view of the difficult monetary situation worldwide, it was unable, in the short term, to mobilize new foreign commercial funds at a cost acceptable, both to 00I and to its borrowers. ICICI is now negotiating a loan of about $15-25 million in foreign exchange resources from Kuwait. 001 is strongly backing ICICI in its attempt to tap the Middle Eastern market. 4. Profitability. ICICI's profitability in nominal terms remains satisfactory. On the income side, as ICICI's major sources of revenues and expenses come from foreign currency operations, and as ICICI lends at a positive spread, inflation does not pose too much of a threat. On the other hand, from the point of view of ICICI's capital structure, inflation adversely affects the growth in share capital and retained earnings vis-a-vis the foreign currency assets and liabilities. 1/ The Eleventh Loan for ICICI was approved in April 1975. - 41 - Table 19: Profitability of ICICI Operations Net Profit Dividend as Dividend (in % of Interest % of Equity Payout Ratio/a share value) Rate Spread 196 10.6 47.0 4.17 n.a. 1966 13.0 51.0 6.75 n.a. 1967 12.4 48.0 6.75 n.a. 1968 12.2 46.0 6.75 n.a. 1969 12.6 36.4 6.75 3.3 1970 14.1 36.1 7.50 3.1 1971 13.3 3h.2 7.81 3.1 1972 11.7 42.9 10.00 2.8 1973 10.7 40.9 10.21 2.8 1974 10.1 33.3 /b 8.87 2.9 /a This represents the share of dividends in net profits. The remainder is added to reserves. /b This reflects already a. new dividend policy of the Government, whereby the maximum payout is limited to 1/3 of profits. The rate of net profit to equity was decreasing mainly as a result of the Rs 25 million increase in share capital in 1973 and in 1974. ICICI adminis- trative expenses remain quite low, at 0.5% of average total assets, one of the lowest ratios among 41 DFCs reviewed, for which the median value of this ratio is 1.5. This is undoubtedly due to ICICI's capacity to keep its costs under control, but - undeniably and to a larger degree - also to low salaries paid to qualified personnel in India. In this situation, a hiring of addi- tional personnel to apply multiple versions of economic analysis or to strengthen the follow-up procedures presents less of a drain on resources to ICICI than is the case with other DFCs, situated in countries where skills are more expensive. 5. Interest Rate. The question as to what level of interest rate is correct is a difficult one in India. The Bank mission appraising the Eighth Loan early in 1970 set forth a rather simply worded recommendation that the ICICI interest rate should be increased, because otherwise ICICI profitability may decline. To a large extent, this argument was justifiable, especially since the Eighth Loan to ICICI carried a higher interest rate than the pre- ceding ones. ICICI's on-lending rate was increased, by one-half percentage point, one month after the Bank loan was signed. However, the decision to increase an interest rate is usually a complex one. It is clear that, as a private sector institution, ICICI had little option but to increase its foreign currency rates commensurately with the increasing cost of borrowing and of its own administration. Also, in a way, as ICICI enjoys a virtual monopoly situation in the long-term foreign exchange market, it could have raised this rate without great dangers of losing its clients to a competing institution. The problem here is what should have been the appropriate - 42 - interest rate level, so as to enable ICICI at the same time to: (a) raise domestic resources from commercial banks (see above) but also (b) avoid a situation where the borrower will assume an excessively heavy debt repayment burden. ICICI passes the foreign exchange risk on to the borrower. The rupee is not strong; during 1975 alone, the value of the rupee, which is floating, depreciated 11% vis-a-vis the dollar, which added to the debt service burden of ICICI borrowers. In similar situations in other countries, the borrowers usually could easily pass such increased cost to the buyers of their products, but in India this may not be easy because many industrial prices are con- trolled, demand is sluggish and often highly price-elastic, and delivery terms for capital and many intermediate goods are signed long in advance. Questions on how the change in interest rate influences the debt burden of the ICICI borrowers should have probably been asked but were not. Bank missions appraising DFC loans are not usually well staffed in analysts con- versant with such problems; nor do they have enough time to enquire satis- factorily into the interest rate problem which, beside its aspect of immediate profitability to the DFC, has many important implications which should not be neglected. This is also why in such cases, particularly in countries like India, where a number of other important financial intermediaries,are active in the term-credit market, a more thorough, although brief and practical, study of the interest rate problem, leading to specific proposals of a desirable level and structure of these rates, should have - as a rule - preceded any recommendation affecting the interest rate in one institution. Table 20: ICICI Interest Rates Interest Rates on TCTCI Lending ICICI Borrowing from the Bank Date from Date which begins Interest Rate of Loan Interest Rate August 1962 8% May 1965 5*5% Arct 1962 8Sentember 1967 variable March 1965 *8un.17%7 July 1970 9.0%(IBRD only) June 197 7.% December 1970 9.0 IKW, U.K.) October 1971 7.25% November 1972 9*5% June 1973 7.25 August 197 10.00 April 1975 8.% - 43 - IV. CONCLUSIONS ICICI is a mature, efficiently run development finance company. It achieved probably most of what could have been achieved within the frame- work of difficult circumstances of Indian economic development. The decade analyzed in this report was not an altogether happy or fruitful one for the Indian economy. During this period, out of nine years for which statistics exist, four years were those of negative industrial growth. Stringent Government economic controls over investment and imported material supplies were not relaxed, the capital market remained practically stagnant, important term-lending institutions supported by relatively cheap Government funds developed, protection against foreign imports remained practically absolute and balance-of-payments deficit increased, with infla- tion bursting out at the end of the period. Despite these adverse circumstances, ICICI managed to steer a clear, independent and steady course. Its rate of loan approvals grew in current terms by over 10% p.a. and in real terms by over 4% annually. Its share in total disbursement of all term-lending institutions, some of which were lending extensively to the quickly expanding public sector while ICICI continued to finance exclusively the private sector, was maintained at a respectable level of almost 15% throughout the period. It supported, as it originally intended, modern industries, of which more than one-half were producing capital goods. Within these industries, it was supporting economically viable enterprises, whose economic rate of return hovered around 20% and of which more than one- half was engaged in exports. ICICI succeeded, during the period, in developing two important internal Departments, an Economic Service which analyzes all medium and large loans from the economic point of view, and a Follow-up Department, which is keeping actively abreast with developments in most of the client enterprises and is focusing particularly on problem enterprises whose number remained comfortably low. A third Department, which is in charge of project promotion, has been created recently but the time for it to acquire a full importance it deserves is still too short to assess its successes or failures. Resource mobilization efforts remained well within the limits that ICICI had cautiously traced for itself. It kept the proportion of direct domestic resource lending on an unchanged level of about 23%, leaving this activity to other development banks, originally created for this purpose. It has therefore kept its mobilization of domestic resources within these modest proportions. Its equity participation activity was well designed and implemented, and the capital gains that ICICI has reaped on equity sales were, for Indian conditions, unexpectedly high. The Bank's appraisals of ICICI were of a professionally high standard and did often venture into areas of broader economic policies, which appraisal missions to other DFCs regrettably rarely touch upon. Also, the degree of refinement of these appraisals was becoming higher over time. It is noteworthy that, unlike in the case of appraisals of other DFCs, the Bank's assessments of ICICI were relatively free of pontificating aspects and the appraisal missions did not attempt to impose upon ICICI any unfeasible requirements, based on wishful thinking or on a belief in "general appropriateness" of such requirements. The Bank was, at least implicitly, considering ICICI as an equal partner, and this made its often useful suggestions more palatable to ICICI. This is not unrelated to the fact that, for a number of years, the Bank considered ICICI as the main, if not sole, torch-bearer in the field of term financing in India. This is also why the Bank suggested that ICICI should assume additionally such functions as lending to small-scale enterprises or that it should increase domestic currency lending. But other financial institu- tions in India were specifically created for these purposes and there was little reason for ICICI to transgress into their territory. The Bank realized that it is the cooperation of ICICI with these institutions which is more advisable and had begun to support such cooperation. The fact that ICICI did not have any clear, even implicit, lending strategy and considered that it had to follow closely the lead of the Govern- ment, needs to be noted but is, at least in this case, of secondary importance, especially because the Bank's views on this subject matured only quite recently and the ICICI espoused this view rather promptly. All these points should in no sense mar the picture of a generally very positive and effective use made by ICICI of the proceeds of the Sixth, Seventh, and Eighth Bank Loans. Å-ex_Table. TS x KIMSTRIA. ICDT 4D IW7ET1ET ~ P=ATIff & mDu LIKTAD B6enry of 0rktionm - and F~oeat <1965 - 19ft 196§ 19619_ 1960 1969 1979 1971 1972 19m Actual Foras Latala Forcs AEs ore t Atu Foramt Actua Foreat Agtuslå frect Atala Fr~ Ag tlaForggast Actual.s Forecat Foreign Curency Ioans 166.6 175.5 105.4 182.2 65.5 157.5 206.2 180.0 186.6 240.0 224.8 200.0 202.5 240.0 550.4 260.0 558.7 500.0 Rp0e 1oan 55.7 50.0 50.8 52.5 49.0 72.0 24.7 90.0 59.8 114.0 58.8 50.0 158.5 120.0 115.5 118.0 174.5 105.0 Guaranto.a - - - - 52.0 - 15.6 - 0.8 - 9.0 10.0 -10.0 - 2.5 - 1.5 10.0 Underwriting of shareo/debentures 50.2 56.0 33.1 57.8 68.5 45.0 59.0 57.0 69.9 75.0 57.1 968.0 24.5 22.0 45.7 48.0 44.0 48.0 Direot subsoription to shares/ 5.1 4.0 2.5 4.2 2.0 5.0 1.8 5.0 0.8 5.0 10.4 2.0 29.7 24.0 55.4 18.0 54.2 39.0 debentures Total 275.6 25.5 191.8 276.7 217.0 277.5 50 .3 550.0 297.9 450.0 540.1 560.0 405.0 406.0 525.5 444.0 592.7 500.0 Foreign cuwrency loans 200.6 160.5 88.0 175.5 72.9 129.0 92. f 1,2.5 250.0 190.5 146.9 200.4 256.0 271.5 214.6 285.0 455.0 525.0 Rupee loa 68.9 45.8 54.4 51.8 76.8 57.6 19.9 75.3 28.4 95.4 53.9 40.7 91.4 101.9 88.9 95.8 154.6 100.0 Guarantees - - - - 52.5 - - - 0.8 - 11.5 10.0 - - - - 1.5 10.0 Undervrting of sha rs/debentureo 52.9 40.5 50.1 87.3 54.5 59.1 75.9 51.0 42.5 65.0 58.9 85.8 21.6 22.1 45.1 46.5 52.6 44.5 Direct subcriptin to are/ 4.5 4.0 2.5 4.2 2.0 2.9 1.0 5.0 0.8 5.0 7.4 2.0 8.9 20.8 15.7 14.5 25.0 56.5 dobenturo Total 526.7 250.6 174.8 266.4 258.5 2=8.O 188.2 281.6 322.5 555.9 27.8 558.9 357.9 416.5 562.5 441.4 628.7 518.0 Diaburcemnte Foreign urreny loane 175.1 159.0 145.2 165.0 102.0 145.5 72.2 142.5 108.5 151.5 202.4 177.9 204.7 211.2 265.8 242.1 271.3 212.6 Rupe loana 44.0 55.5 50.8 46.9 50.7 55.6 59.7 67.2 58.5 87.5 40.2 56.5 83.1 86.5 75.8 94.4 106.1 115.0 Guarantecs - - - - - - - - - - - - - - - - 2.0 - Underwriting of saores/debontureo 34.8 26.4 55.6 21.9 47.2 35.7 50.9 59.6 51.8 45.5 26.9 46.6 8.9 12.0 18.2 26.2 14.4 17.5 Direct subcription to shares/ 5.5 3.8 2.2 4.2 2.5 2.a 1.T 3.0 1.9 5.0 6.7 2.0 9.0 21.5 15.1 15.0 22.5 37.5 debentures Total 255.4 242.7 252.8 258.0 202.4 259.6 124.5 252.5 180.5 285.5 278.2 265.0 305.7 531.0 374.9 277.7 416.1 480.6 Annex Table II The Industrial Credit and Investment Corporation of India Limited onomic Indicators for Pro ects ICICI Assistance Above Rs 5 million) (Ranked according to returns at world prices) DRC New/ Fconomic Rate Financial Rate Effective Rate (Rs per Ecpansion Product of Return (%) of Return (%) of Protection ($) U.S.S saved) Balassa Corden Ecpansion Sugar 50.1 24.1 36.5 12.0 6.1 Pxpansion Cotton Ducks 50.0 35.5 -4.0 -2.6 6.2 Exparvion Steel Wires 50.0 20.0 -41.0 -31.0 5.7 New Steel Billets 44.3 17.0 -24.0 -17.0 5.3 New Steel Dillets 42.0 13.0 -26.0 -17.0 6.4 New Laminations/Stampings 41.4 13.7 -48.9 -43.8 5.3 New Ferro-silicon 41.2 15.3 -28.2 -15.9 5.4 Expanbion Biended Fabrics 37.3 15.9 15.3 9.1 8.8 New H.T. Nuts/Bolts 31.5 16.5 26.o 15.3 7.1 hcpanmion Aluminium Ingots 31.3 12.1 -37.0 -29.6 5.9 New Castings 30.1 19.2 0.5 0.3 6.2 New Glass Containers 30.0 13.5 4.3 2.2 6.8 New Polypropylene Fibre 29.6 13.5 1.3 0.9 8.3 New Finished Leather 28.6 14.1 -6.3 -4.3 6.6 New Sugar 26.3 17.9 -5.1 -1.7 6.7 New Industrial Fabrics/ 25.1 15.1 -2.1 -1.6 7.1 Conveyor Belting Exrpansion Cotton Textiles 24.0 17.0 -3.0 -2.7 5.3 New Caustic Soda 23.8 15.8 33.1 16.8 7.3 Now Tufted Carpets 19.7 15.5 45.1 23.5 6.5 Calcium Carbide 19.3 20.7 280.0 78.0 8.6 Expansion Gears 19.2 13.3 23.0 17.5 8.3 New Polyester Film 18.0 21.1 104.0 62.5 7.6 New Sodium Hydro-sulphite 17.3 9.4 28.4 20.5 7.5 New Caustic Soda 17.0 10.9 34.0 16.0 7.4 New Paper 17.0 12.6 36.0 - 8.0 New Hydraulic Excavators 16.8 15.0 62.8 43.7 8.9 Expansion Special Paper 16.8 11.4 14.2 7.8 8.0 New Castings 16.7 13.2 33.0 23.0 7.5 New Caustic Soda 14.3 11.3 29.0 16.0 7.2 New Tyres 14.0 12.8 66.0 41.o 9.5 Expansion Bearings 13.2 21.2 123.0, 82.0 9.5 New lyres 12.6 20.0 58.4 41.3 8.9 New Storage Batteries 10.8 13.2 1".0 84.0 10.9 New Alloy Steel 10.0 15.0 176.0 93.0 8.6 New Urea Formaldehyde 9.0 10.0 78.0 37.0 12.1 New Nylon Tyre Cord 9.0 15.0 113.7 70.0 11.1 New CPc 8.6 15.2 52.0 35.0 9.3 New Nylon Filament arn 8.6 13.5 153.0 101.0 12.0 New Tyres 8.0 11.2 57.0 37.0 9.0 Source: ICICI appraisal reports, prepared during 1973 and 1974