India - National Bank For Agriculture and Rural Development (NABARD) Credit Project

Document of The World Bank FOR OMCIL USE ONLY Report No. P-4225-IN REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$375 MILLION TO INDIA FOR THE NABARD CREDIT PROJECT February 3, 1986 tI documuent h a oLctd dllsbrlosn anid miay be ued by reripiets only in the perfeome of their eical duties. Ift esumtni mey not otherwise be discloseed without World Bbli 'ntenmb-  CURRENCY EQUIVALENTS (as of January 24, 1986) US$1.00 = Rs. 12.44 Rs 1.00 = US$ 0.08 Rs 1 million = US$ 80,376 The US Dollar/Rupee exchange rate is subject to change. Conversions in the Staff Appraisal Report were, except as otherwise noted, made at the rate of US$1 to Rs 12.0, which represents the projected exchange rate over the disbursement period. FISCAL YEAR COI April 1 - March 31 NABARD July 1 - June 30 Commercial Banks January 1 - December 31 ABBREVIATIONS AND ACRONYMS ARDC - Agricultural Refinance and Development Corporation GOI - Government of India CB - Commercial Banks DCCB - District Central Cooperative Banks ERR - Economic Rate of Return HYV - High Yielding Variety ERDP - Integrated Rural Development Program LDB - Land Development Bank PACS - Primary Agricultural Credit Society PLDB - Primary Land Development Bank NABARD - National Bank for Agriculture and Rural Development NREP - National Rural Employment Program PCR - Project Completion Report Credit Review - Agricultural Credit Review to be financed under proposed project RBI - Reserve Bank of India RRB - Regional Rural Bank SCB - State Cooperative Bank SEC - Senior Experts Croup  FOR OMCIAL USE ONLY INDIA PALARD CREDIT PROJECT Loan and Project Summary Borrower: India, acting by its President. Beneficiaries: NABARD, for onlending to farmers for on-farm investments through participating banks. Amownt: US$375 million (equivalent) Terms: Repayment over 20 years, including 5 years' grace at the standard, variable rate. Onlending Terms: (i) COI to NABARD: Interest would be 6.51 (after a reduction of 0.25Z for prompt repayment) per annum in respect of NABARD refinancing of term loans of up to nine years' duration and 7.0X (after a reduction of 0.25Z for prompt repayment) in respect of NABARD refinancing of term loans of up to 15 years' duration. Repayment of principal in lump sums at the end of 9 or 15 -years, respectively. (ii) NABARD to Participating Banks: (a) For small farmers, 1/ IRDP loans, and all loans for minor irrigation and land development, not less tJ'an 6.5Z. (b) All others, not less than 8.0S. Repayments to coincide approzimately with collections from ultimate borrowers but not to exceed two years beyond initial amortization schedules specified in loans to ultimate borrowers refinanced by NABARD. (iii) Participating Banks to Ultimate Borrowers: (a) For small farmers, IRDP loans, and all loans for minor irrigation and land development, not less than 10.OZ. (b) All others, not less than 12.51. Repayments are based on borrowers' repayment capacity and types of investments financed. 11 "Small farmers" are defined, in GOI terminology, as those cultivating land that provides a yearly pre- development net return to the farmer and his family of not more than Rs 2,000 based on 1972 prices. This document has asriced ditibjtion and may be used by recimsonso in Xt perfonnne of thi offdci duties. Its coens my not orwime be diodned wihout Wodd Bnk authiutoiL  -ii- Project Descripeion: The purpose of the project is to help increase agricultural production through participation in NABARD's ongoing loan refinancing program for investments on agriculture, and to strengthen the agricultural credit system. The project includes a component for extending the existing pilot scheme for branch-level training and farm-level credit delivery systems, along with the an extensive training program component for the management and operational staff of NABARD, the Land Development Banks (LDBs), commercial banks (CBs), and Regional Rural Banks (RRBs). A thorough review of the workings of the credit system would also be financed under the project. There is a risk that the more strict criteria governing branch access to NABARD refinance may not necessarily induce such branches to take the measures required to improve credit discipline. A series of covenants are designed to have NABARD take a more active_role in the rehabilitation of branches to minimize this risk. Secondly, there is a risk of continued general deteriora- tion of loan recoveries in the agriculture credit system. However, the project is designed to progressively reduce NABARD refinancing of poor-performing branches and, under either of the above risk scenarios, IBRD funds would not be at risk, as repayments by participating banks to NABARD are generally made on time and NABARD's own finan- cial position remains very sound.  Estimated Cost: 1/ (US$ millions) Item Local Foreign Total I. NABARD Refinancing (a) Schematic Loans: - Minor irrigation/ land development 1,413.3 157.0 1,570.4 - Farm mechanization 667.4 117.8 785.2 - IRDP and other schemes 1,522.3 97.2 1,619.4 - Other (including dairy livestock, plantations, fisheries, forestry) 885.8 46.6 932.4 Subtotal 4,488.8 418.6 4,907.4 (b) Nonschematic Loans 2/ 330.6 82.6 413.2 (c) Pilot Scheme 22.5 2.5 25.0 (d) Agricultural Credit Review 1.6 1.9 3.5 (e) NABARD's Training Programs 5.2 1.3 6.5 Total Project Cost 4,848.7 506.9 5,355.6 Financing Plan: IBRD _ 375.0 375.0 Dutch Government - 5.5 5.5 KFW - 21.2 21.2 Ultimate Borrowers' equity 426.8 105.2 3/ 532.0 NABARD and COI resources 3,464.2 - 3,464.2 Participating Banks' contributions 957.7 - 957.7 Total 4,848.7 506.9 5,355.6 1/ Excluding taxes and duties (which are estimated to be small). 2/ Comprising loans for crop storage, input stocks, and rural electrification. 31 Estimated indirect foreign exchange cost of purchased goods, of which India is a net importer.  -iv- Estimated Disbursements: (USS millions) FY87 FY88 FY89 FY90 (a) Refinancing First Tranche 100.0 - - - Second Tranche - 80.0 - - Third Tranche - 80.0 - Fourth Tranche - - - 80.0 (b) Other Disbursements 9.0 15.0 9.5 1.5 Cumulative Total 109.0 204.0 293.5 375.0 Rate of Return: Not applicable. Appraisal Report: No. 5594-IN, dated January 24, 1986.  INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO INDIA FOR THE NABARD CREDIT PROJECT 1. I submit the 'ollowing report and recommendation on a proposed Loan to India in an amount of US$375 million equivalent to support NABARD in its activities of providing credit to borrowers for agricultural investments. The Bank loan would be 20 years, including 5 years' grace at the standard, variable interest rate. The Government of India (GOI) would: (i) onlend US$340 million equivalent through NABARD to cooperative and commercial banks to be made available as loaLis to farmers; (ii) provide NABARD with US$25.0 million equivalent for the pilot scheme for strengthening credit delivery and US$6.5 million equivalent for training programs as a grant; and (iii) use the remaining US$3.5 million equivalent to cover the costs of the proposed Agricultural Credit Review. The interest and exchange risks would be borne by GOI. PART I - THE ECONOMY 11 2. An economic report, "India: Structural Change and Development Perspectives" (5593-IN, dated April 24, 1985), was distributed to the Executive DIrectors on May 1, 1985. Country data sheets are actached as Annex I. Background 3. India is a large and diverse country with a population of about 760 million (in mid-1985) and an average per capita income of about US$260. Agriculture con- tinues to dominate the economy, accounting for 36% of GDP, 23% of exports and about two-thirds of employment. The steady increase in population, which continues at a rate of 2.2% a year, has put increasing pressure on natural resources, in par- ticular cultivable land. By the mid-1960s, nearly all productive land had been brought under cultivation. While irrigation continues to increase total cultivable area, an increasing share of the labor force will have to be absorbed in non- agricultural activities. Industrial developrmnt has not progressed rapidly enough to provide employment opportunities for the growing labor force, or to bring about a rapid economic transformation, with significantly higher productivity and income levels. As a result the long-term growth of per capita income has only averaged about 1.4Z p.a. and close to one-half of India's population continues to live below the poverty line. The pervasiveness and intensity of poverty is such that its alleviation has been and remains at the core of India's development strategy. 4. During the 1950s and 1960s, India's economic performance was generally characterized by slow economic growth, moderate inflation and a sustainable exter- nal position. GDP rose at about 3.5%, with agriculture and industry growing at 1.82 and 4.8% respectively; imports increased by 4.6% and exports by 5.8% a year. India was able to reduce its dependence on foodgrain imports from a peak of 14% of total foodgrain consumption in 1966/67 to 4.5% by 1969/70 through improvements in agricultural production, but progress in poverty alleviation was slow mainly because of continued high population growth. 1/ Parts I and II of the report are similar to Parts I and II of the President's Report for the Gujarat Urban Development Project (No.P-4187-IN), dated November 20, 1985.  -2- 5. In the early to mid-1970s, in response to a sharp deterioration in India's terms of Lrade, the Government introduced various policy measures designed to stimulate exports. This resulted in a large increase in export growth to about 7.3% per annum in the 1970s compared with only 2.2% per annum between 1950/51 and 1969/70. While expanding world markets, particularly in the Middle East, con- tributed to this growth, liberalized access to imported inputs and more effective export incentives played a major role. The success in the export expansion effort coupled with continued import substitution, particularly of foodgrains resulted in a surplus on current account between 1976/77 and 1978/79, which was further enhanced by increased concessional aid flows. India was thus in a relatively favorable position to deal with the increases in international oil prices, the sharp deterioration in the terms of trade and a series of poor harvests. The comfortable foreign exchange position also played a major role in the Government's decision to initiate import liberalization. 6. Towards the end of the 1970s, India again faced considerable domestic difficulties. In 1979/80 it experienced one of the country's worst droughts which caused a large reduction in agricultural production. In addition, industrial production, plagued by labor unrest and a vicious circle of supply shortages (coal, power and transportation), failed to expand. These events coincided with a second round of incernational oil price increases. As a result, the curfent account reverted to a deficit position and the remarkable price stability that the Indian economy enjoyed after 1975 came to an abrupt end. The Government responded by mounting an adjustment program, which was embodied in the Sixth Five Year Plan (1980/81 - 1984/85). The program aimed at raising the GDP growth rate from its historical level of 3.6% to 5.2% per annum while adjusting the country's external balance to the adverse price developments in world markets. The major elements of the program -were alleviation of infrastructure and supply constraints, increased energy independence, improved efficiency in resource use, promotion of exports and efficient import substitution. Economic Performance Under the Sixth Plan 7. Overall the Government's adjustment program has been effective despite the severe drought in 1982/83 and a worsening of the external environment in the earLy 1980s. During the Sixth Plan period, GDP grew by 5.1Z per annum, 1/ well above India's long-term growth rate of 3.6%. However, overall growth during the first half of the 1980s has not been steady, mainly because of the effect of uneven rainfall on agricultural production. In 1980/81 and 1981/82, the economy substan- tially recovered from the 1979 drought, with real GDP growing by 7.6Z and 5.3%, respectively. The recovery was particularly robust in agriculture where normaL weather helped output to rise by more than 15% in 1980/81 and 5.5% in 1981/82. A severe drought in mid-1982 brought the economic recovery to a halt. Agricultural output declined by 42, which in turn reduced GDP growth to only 1.8%, and put further strains on the balance of payments and domestic resource situation. The timely implementation of various economic policies relating to foodgrain imports, procurement and distribution, and the increased allocation of power to irrigation pumps mitigated the adverse effects of the poor monsoon. An excellent monsoon combined with satisfactory performance of the infrastructure sectors, in particular 1/ Actual CDP growth rate during the 1979/80-1984/85 period was 5.1% per annum. However, this figure overstates the trend in recent years because of the rela- tively low base year (1979/80). The 4.5% GDP growth per annum and 3.3Z annual agricultural growth between 1980/81-1983/84 (two "normal" years) are more repr2sentative of the growth rates during the period.  -3- coal and transport, led to a recovery of the economy in 1983/84. Agricultural output rose by 92, industrial output by 4.5% and overall CDP by 7.42. The power sector, however, emerged again as a constraint on higher growth, especially in industry. In 1984/85, despite a mediocre monsoon and difficult political circumstances, the aggregate growth of the economy is likely to range between 4 and 4.52. 8. During the Sixth Plan period, foodgrain production continued to grow at an average annual rate of 2.6% a year-sufficient to maintain a broad balance between supply and steadily increasing domestic demand. The progress achieved is an indication of the effectiveness of programs to expand irrigation, strengthen exten- sion and encourage efficient use of other agricultural inputs which are being implemented. Bountiful harvests have led to record foodgrain stocks in recent years. Over the past year, Government held stocks have increased by more than 40S. Maintenance of ample, balanced operating stocks to ensure smooth operation and even expansion of the public distribution system remains a top priority of Indian agricultural policy. Yet, the financial cost of foodgrain storage and subsidies represent a rapidly growing burden on the budget. 9. Growth of the industrial sector during the Sixth Plan period was slow and uneven. Industrial growth averaged about 3.42 a year-below the growth rates achieved in the 1960s and 1970s. An inadequate policy environment, coupled with depressed domestic demand, power and raw material shortages, as well as labor unrest are the main causes for the slower than anticipated growth of the industrial sector. After the severe drought in 1979/80, manufacturing output grew at 1.7Z in 1980/81 and 3.32 1981/82. The drought in 1982/83, which led to widespread short- falls of agro-based raw materials and a sharp drop in the demand for consumer durables, combined with a prolonged textile strike in Bombay, reduced the growth of industrial output to 1.7% in that year. Following the excellent monsoon in 1983184, industrial output gained-momentum and grew by 5.02. Preliminary estimates place the growth of the manufacturing sector at about 5.5Z in 1984/85. 10. The performance of the infrastructure sectors was mixed under the Sixth Plan. While electric power generation, coal production and railway traffic grew by 8.72, 6% and 2.52 a year respectively, oil and gas production increased by 22.6Z. The rapid expansion of domestic oil production is largely the result of India's oil development program. Backed by substantial financial commitment, performance under the program has been excellent with real investment and oil production levels running well ahead of Plan targets. In 1984/85 domestic oil productinn is estimated to have reached 29.4 million tons. While the gap between domestic con- sumption of petroleum and production remains large, India's dependence on oil imports dropped from 63% of consumption in 1979/80 to 30% in 1984/85. About two- thirds of current output comes from offshore fields around Bombay High. As most of these fields have now reached their mature stage, further increases in domestic oil production will have to come mainly from new discoveries. 11. India's economy has reverted from a situation of a resource surplus in the late 1970s to an aggregate resource deficit during the Sixth Plan period. The gap between gross investment and national savings increased from negligibLe levels to an average of 2.1Z of CDP in 1980-85. Gross domestic capital formation increased from an average of 22.62 of GDP in 1975-80 to 24.7% in 1980-85 while gross national savings remained constant at an average of 22.6Z of CDP in both periods. The increase in capital formation mainly resulted from an increase in the public investment rate, but it was largely a financial rather than a real phenomenon since prices of investment goods increased considerably faster than the general price level.  -4- 12. The basic thrust of fiscal policy during the Sixth Plan was to provide sufiicie-t resources for growth and planned investment while maintaining inflation under control. However, the Sixth Plan period was characterized by significant budgetary resource constraints. Despite massive additional resource mobilization efforts, public sector deficits exceeded 7% of GDP as compared to only 4-5S of CDP during the mid-1970s. The shortfall was met by additional market borrolLaigs, both domestically and from abroad and by deficit financing. Major reasons behind the large deficits were continued losses by most departmentally-run undertakings, unsatisfactory performance of the two major non-departmental undertakings of the States (the State Electricity Boards and the State Road Transport Corporations), and the increasing importance of subsidies which are estimated to have reached 2.8Z of CDP in 1984/85. Of these, fertilizer accounted for more than 0.8% of CDP, and food subsidies nearly 0.5Z of CDP. 13. Developments in the savings-investment balances were mirrored in the balance of payments. Thus, India's current account balance, which had recorded surpluses between 1976/77 and 1978/79, reverted to deficits averaging US$3.5 billion and 2.1% of CDP during 1980-85. Several developments contributed to these relatively large deficits. First, the terms of trade deteriorated sharply in 1979/80 due to the second round of oil price increases and continued to move against India during the first three years of the 1980s. Second,-a more liberal import policy towards industrial inputs was pursued. Third, net invisibles declined as travel receipts fell off, workers' remittances stagnated (reflecting slower development activity in the Middle East), and payment of interest on higher levels of foreign debt increased. Fourth, export growth was sluggish partly due to growing domestic demand, and, perhaps most significantly, due to depressed foreign markets and prices. Faced with a growing need for external capital inflows and stagnation in the availability of concessional assistance, India drew SDR 3.9 billion from che Extended-Fund Facility of the IMF and borrowed significant amounts on commercial terms from the Euro-dollar market snd increased the use of suppliers' and export credits. 14. Price performance during the Sixth Plan period has been mixed. The overall improvement in economic performance in the early 1980s, combined with more restric- tive monetary policies in 1981/82 and 1982/83, resulted in a sharp decline in the rate of inflation. The growth rate of wholesale prices declined from 18Z in 1980/81 to only 2.62 in 1982/83. The lagged effects of shortages of foodgrains in 1982/83 and of other agricultural products and industrial goods in 1983/84 coupled with a rise in the domestic cost of imports and rapid liquidity growth, gave a boost to inflationary pressures towards the end of 1983/84. The annual average growth of wholesale prices rose to over 9% in 1983/84, and the rate of growth of consumer prices exceeded 12%. In September 1984, the Government took a number of measures to dampen pressure on prices including increased imports of important agricultural commodiEies (sugar, jute, coconut oil and others), releases of sugar stocks for distribution through fair price shops, and a reduction in wheat prices for flour mills. These measures, together with a decline in cereal prices as a result of the bumper crop in 1983/84 and a generally restrictive budgetary policy, led to a slowdown in the rate of increase of wholesale prices to about 7.1% in 1984/85. 15. Developments in the Indian economy during the Sixth Plan underscore the progress that has been made in recent years towards acceLerated CDP growth, exter- nal adjustment, and increased investment. The experience of recent years illustrates that India i.as the capacity to grow and develop at a more rapid pace. It is a tribute both to the fundamental soundness of key policies and programs,  -5- particularly in agriculture, and to the strength and effectiveness of public administration, that neither the serious political disturbances in Punjab, nor the assassination of Prime Minister Indira Candhi, resulted in significant disruptions to the performance of the economy in the last year of the Sixth Plan. But the results during the Plan period also highlight the disappointing performance of industry, the continuing shortfalls in electric power generation, the rising public sector deficits, the importance of regaining and sustaining momentum in export growth and the need for continued prudent economic management so as to avoid a resurgence of inflation thile generating adequate resources for development. This mixture of achievements and challenges provides the context for an assessment of development prospects and policies. Development Prospects and Policies 16. To deal effectively with its dual challenges of alleviating pervasive poverty and expanding employment opportunities for a growing labor force, the Seventh Plan is expected to aim at sustaining an annual rate of growth of GDP of at least 5. The Seventh Plan which will lay down the development strategy for 1985/86-1989/90 is also likely to continue the emphasis on agriculture, energy development, export promotion, domestic import substitution where economically justifiable and the removal of infrastructural bottlenecks. 17. Achieving a GDP growth of around 5 a year will place heavy demands on policy adjustment and entail major challenges. India will need to: (a) maintain the recent higher rate of expansion of agricultural prodiction; (b) accelerate industrial production and export growth through policy changes which enhance com- petition and efficiency; (c) expand supply capacities in the econcmy by improving basic infrastructure services and the availability of energy; {d) improve the efficiency with which resources are used, including particularly the elisting capital stock in infrastructure and industry; and Ce) furtber improve the already high resource mobilization effort. 18. Agriculture. Despite an impressive performance under the Sixth Plan, Indian agriculture faces many challenges in the second half of the decade. As possibilities for extending cultivated acreage shrink, agricultural growth will depend on finding new ways of increasing the productivity of land through further development of irrigation, better water management, more intensive use of new technology, efficient delivery of inputs and services, and appropriate pricing policies. High priority must be given to the expansion of the country's irrigable area through coupletion of ongoing irrigation projects, as well as selective investment in new undertakifigs. Besides creating new irrigation potential, the efficiency of irrigated farming will have to be enhanced through the improvement of water management practices in existing irrigation systems. Greater emphasis should also be given to obtaining higher yields under rainfed and dryland farming conditions. Finally, even greater efforts must be made to build and strengthen institutions to ensure the efficient delivery of agricuLtural services, input supplies, credit and technology. 19. Industry and Trade. Prospects for raising India's GDP growth rate wiLL, to a large extent, depend on more rapid industrial production and export growth to be attained through improved productivity and efficiency. A key requirement will be greater competitive pressure on industry than has been the case in the past. The size and domestic orientation of the Indian economy make it necessary that this competitive pressure come mainly from within the domestic economy. An important complement, however, will be greater exposure to foreign trade to stimulate domes- tic competition as well as to induce technological innovation and modernization.  20. To increase domestic competition, domestic policies will need to allow freer entry and exit of firms in the industrial sector and greater reliance on market price signals. While the Government has taken various initiatives in the above directions during the past several years, the most significant were announced in the context of the 1985/86 Budget. These include the broadening of licensing categories for certain industries, delicensing for others, increases in the size limits for MRTP 1/ and small-scale industries, reductions in the incentive for small-scale industries to stay small and various initiatives to stimulate efficient indigenization of 'sunrise' industries (energy exploration equipment, computers, telecommunication equipment, motor vehicles and parts, general electronics). These are significant advances that need to be sustained in future years. 21. Changes in external trade policy will also be required to stimulate export growth which is essential not only for current financing of imports, but to enhance borrowing capacity, to service debt, to provide an impetus to the economy from the demand side, and to expose entrepreneurs to the quality-consciousness of competi- tive external markets. While some changes have been recently introduced, there remains a need to: (a) provide greater access to imported inputs and capital goods through continued import liberalization (b) review tariffs, eliminating anomalies and lowering their overall level; and (c) modify trade policies in such a way that the net impact of incentives is more neutral between exports and Import substitution. 22. Infrastructure Sectors. Investments in these sectors currently constitute about one-third of total investment in India, and the efficiency with which these investments are managed has an important bearing on the efficiency of total invest- ment and the growth rate of the entire economy. There is substantial evidence that better planning and management of public investments in power, coal, railways and irrigation could improve returns and lower the current capital-output ratios. For example, more efficient use of investment could be achieved by better water manage- ment in irrigation projects, improved load factors in thermal power generation, better capacity utilization in the fertilizer industry and improved efficiency in railway transport. 23. Resource Mobilization. India's gross national savings rate (22.6Z in 1980-85) is already high for a country at India's level of income. Nevertheless, the investment required to sustain the relatively high CDP growth rates realized during the Sixrh Plan period--while holding foreign savings as a share of CDP at prudent levels--will require some further increase in the aggregate savings rate especially in public savings. Because there will continue to be well-founded demands for expansion of current and capital expenditures in the public sector, the burden for a reduction in the savings investment gap has to be put on the revenue side. Increasing tax rates beyond their current high levels would be counter productive. Thus, economically efficient pricing policies in public enterprises, supported by improvements in their operational efficiency, are to be preferred over tax increases as vehicles for increased public resource mobilization. The sheer size of past and present public enterprise investment indicates that if proper returns were made even only a part of them, an increase in revenues of about 3% of GDP would be attainable. In a number of sectors, e.g. thermal power, railways, and fertilizer, concerted efforts are being made--with Bank assistance--to increase I/ Monopolies and Restrictive Trade Practices Act, 1969.  -7- efficiency and reduce costs. These efforts need to be improved and expanded into new areas. 24. Balance of Payments. A policy of sustained CDP growth of 52 per annum will need to be complemented by measures which assure a viable balance of payments position. Acceleration of industrial growth vill lead to a substantial increase in import requirements, even after allowing for continued import sub_titution of key bulk commodity items. Bank staff estimates place the export volume growth neces- sary to support these growing import requirements without excessive increases in external borrowing at about 8Z a year over the Seventh Plan period. Prospects for India to attain the needed higher export growth rates appear to be reasonably good because India's share in total world exports in value terms is only about 0.4Z, leaving ample room for growth. Furthermore, India's exports are relatively less sensitive to fluctuations in demand in the OECD industrial countries because exports are well diversified with respect to both products and markets. Nevertheless, success in India's export drive will depend heavily on changes in domestic policy to improve the supply and profitability of exports. 25. Even assuming favorable export performance, India will continue to need substantial external capital flows to augment its own resources for the foreseeable future. Even with 8Z export growth, the 52 CDP growth implies an increase in gross capital inflows from US$17.5 billion to US$34.5 billion between the Sixth and Seventh Plan periods. In the past, the bulk of this financing was provided in the form of official development assistance. In more recent years the availability of concessional assistance to India has declined. Total bilateral grants and conces- sional loans declined from a level of about US$1.3 billion per annum over the years 1979180-1981/82 to US$1 billion in 1983184. Moreover, there was a large deteriora- tion in the terms of aid from multilateral sources. For example, while total lending from the Bank Croup continued to increase in nominal terms, the grant element declined from 712 to 412 as new commitments of IDA declined from a peak of $1,535 million in FYBO to $673 million in FY85. 26. In the event that official development assistance does not increase sig- nificantly from recent levels, nearly the full additional financing required would have to be provided from additional non-concessional borrowing from official and commercial sources. This will increase India's debt service ratio from the present level of 15.5% to 21.6% by 1989/90. Provided India can in fact, expand export earnings along the lines described earlier, and provided India's past record of prudent borrowi-ng and debt management continues, the country should be able to raise the projected amounts. While its foreign resource requirements would be manageable, the increase in its external debt exposure would leave it with little cushion to deal with unfavorable eventualities and with the risks of policy change. 27. In the short term, a relatively large level of external borrowing, includ- ing an increased emphasis on commercial borrowing, will be necessary to cope with the balance of payments consequences of the growth strategy described earlier. Although India is currently in a position to increase borrowing on commercial terms frGm the very low levels of the past, there are, of course, limits beyond which India will choose to sacrifice growth objectives rather than accept debt on unfavorable or unmanageable terms. While therefore a greater volume of both offi- cial concessional and non-concessional assistance is warranced, concessional assistance, in particular, will be invaluable in moderating the build-up in India's debt service burden. Apart from the quantitative arguments for concessional aid, there remains the imperative to assist India in addressing the problems of per- vasive poverty. While India is now better placed than other poor countries to tackle its development problems, the mobilization of additional resources to  -8- address poverty problems is heavily constrained. Concessional assistance can also play a very important role in relieving this constraint. 28. Summary. India has demonstrated that it can sustain a rate of growth closer to 5.0% per annum than to the long-run trend of 3.6Z per annum. If the rate of population growth can be brought to below 2.0% per annum, a 5.0 growth rate would mean a doubling of the trend rate of growth of per capita income of 1.4% per annum. Success in these efforts would make a significant difference to the prospects of easing poverty in India. Development prospects over the next few years will hinge on the extent to which the economy can be brought into both inter- nal and external balance, while at the same time achieving more rapid growth than in the past. This will require the continuation of the current development strategy which assigns high priority to export promotion, public finance discipline, improvement of economic efficiency, and investment in infrastructure, supported by adequate flows of external borrowing and aid. PART II - BANK GROUP OPERATIONS IN INDIA 29. Since 1949, the Bank Group has made 91 loans and 182 development credits to India totalling US$8,487 million and US$13,753 million (both net of cancellation), respectively. Of these amounts, US$1,544 million has been repaid, and US$7,360 million was still undisbursed as of September 30, 1985. -Bank Group dis- bursements to India in the current fiscal year through September 30, 1985 totalled US$179 million, representing an increase of about 5 percent over the same period last year. Annex II contains a summary statement of disbursements as of September 30, 1985. 30. Since 1959, IFC has made 35 commitments in India totalling US$301 million, of which a total of US$168 million has been repaid, sold, terminated or cancelled. Of the balance of US$133 million,-US$126 million represents loans and US$7 million equity. A summary statement of IFC disbursements as of September 30, 1985, is also included in Annex II (page 5). 31. The thrust of Bank Group assistance to India has been consistent with the country's development objectives in its support of agriculture, energy and infrastructure. Of particular importance have been investments in irrigation, extension and on-farm development designed to increase agricuLtural productivity, and efforts to improve the availability of basic agricultural inputs to farmers through credit, fertilizer, marketing, storage, and seed projects. Major elements of the lending program have also been directed at helping to meet the energy needs of the economy while curbing the growth of oil imports, and to ease the infrastruc- ture bottlenecks which have hampered economic growth in India, particularly through power generation and distribution, and railways and telecommunications projects. The Bank Group has also provided financing for a broad range of medium- and small- scale industrial enterprises, primarily in the private sector, through its support of development finance institutions. Recognizing che importance of improving the ability to satisfy the essential needs of urban and rural populations, the Bank Group has supported nutrition and family planning programs, a rural roads project, as well as water suppLy and sewerage and other urban infrastructure projects. 32. This pattern of assistance remains highly reLevant, and consonant with Government priorities, as reflected in the the Se,enth Plan. First, high priority will continue to be given to GOI's agricultural program. While India has made significant progress in agriculture, productivity growth will have to be sustained to improve the balance between food demand and supply and to contribute to poverty alleviation and employment. Thus, the Bank Group will continue to support  -9- irrigation, fertilizer production and distribution, and agricultural extension and credit. Second, alongside COI's efforts in promoting greater efficiency and faster development of the industrial sector, increased assistance will be provided for industrial development. Third, in line with the stress which the Seventh Plan gives to the expansion and more efficient use of basic infrastructure capacity and to the development of India's indigenous hydrocarbon resources, the Bank Group will continue to provide substantial support to the development of the energy, transport and telecommunications sectors to alleviate critical shortages which constrain output in both the agricultural and industrial sectors. Fourth, support of urban development and other GOI basic social services programs for the poor will also continue in light of the growth in population which, despite successes in lowering birth and death rates, still increases by about 16 million each year. 33. The need for a substantial net transfer of external resources in support of the development of India's economy has been a recurrent theme of Bank economic reports and of the discussions within the India Consortium. Thanks in part to the response of the aid community, India successfully adjusted to the changed world price situation of the mid-1970s. However, India continues to require a substan- tial level of foreign assistance both to offset the overall deterioration in the world trade environment, and to sustain the relatively higher investment and growth rates achieved during the Sixth Plan period. As in the past, Bank Group assistance for project- in India should aim to include the financing of local expenditures. India imports relatively few capital goods because of the capacity and competitive- ness of the domestic capital goods industry. Consequently, the foreign exchange component tends to be small in most projects. This is particularly the case in such high-priority sectors as agriculture and irrigation. 34. India's poverty and needs are such that whenever possible, external capital requirements should be provided on concessional terms. Accordingly, the bulk of the Bank Group assistance to India in the past was provided from IDA. However, IDA lending to India is declining from a peak of US$1.5 billion in FY80, mostly due to funding constraints related to IDA. The amount of IDA funds available to India is likely to remain small in relation to India's needs for external support. Thus, this requirement for additional assistance will have to be met, in part, through larger Bank lending. Given its development prospects and policies, India is judged creditworthy for Bank lending to supplement IDA assistance. A continuation of efforts already underway to achieve growth in productive capacity, trade expansion, higher levels of savings, foodgrains self-sufficiency and a reduction in the rate of population growth should result in continued economic growth and improvement in the balance of payments. India's debt service ratio is estimated at about 15.2% in 1954185. This ratio is projected to rise to around 20% by 1989/90, mainly due to the hardening structure of India's debt; and to increase slightly over this level through the mid-1990's. Although the projected debt service ratios are considerably above historical levels, they are still manageable and will not adver- sely affect India's creditworthiness. 35. Of the external assistance received by India, the proportion contributed by the Bank Group has grown significantly. In 1970/71, the Bank Group accounted for 22Z of total commitments, 11% of gross disbursements, and 10% of net disbursements as compared with 68Z, 38% and 47%, respectiveLy, in 1984/85. In 1984/85, about 26.3% of India's total debt service payments were to the Bank Group. On March 31, 1985, India's outstanding and disbursed external public debt was estimated to be about US$26.5 billion, of which the Bank Group's share was US$11.1 billion or 42Z (IDL.'s US$8.9 billion and IBRD's US$2.2 billion). As of September 30, 1985 out- standing loans and credits to India heLd by the Bank totalled US$20,696 million, of which US$7,360 million remain to be disbursed, leaving a net amount outstanding of US$13,336 million.  -10- PART III - THE AGRICULTURE SECTOR General Overview 36. Agriculture remains the mainstay of the Indian economy. Farming and related activities currently account for 35Z of India's Gross Domestic Product (GDP) and 29% of its exports, and the agricultural sector employs about 70% of the total labor force. Sustained agricultural growth, especially in the output of cereals, has made it possible for food supplies to expand roughly in step with the rising domestic demand, and has enabled India to eliminate grain imports in recent years. The volume of agricultural output has risen by about 2.6X-2.8Z since the late 1960s, the rate of growth being closer to 2.8% in the early 1980s. 37. The principal objective of GOI's agricultural policies during the past 15 years has been to achieve self-sufficiency in foodgrains and to increase farm incomes in an equitable manner. Significant progress has been made, as attested by the remarkable increase in foodgrain production that has enabled India to attain self-sufficiency, although a shortage of edible oils persists. Nevertheless, continuing efforts to improve agricultural productivity are essential to meet the increasing demand for food by a population that is growing by some 15 million, or 2.2Z, per annum. Moreover, in recent years, the rate of yield increases has been falling, and parts of the country have shown little growth in agricultural production. The projected demand for foodgrain by 1990, the last year of the Seventh Five-Year Plan, is about 168-179 million tons annually, compared with the actual production of about 151 million tons in 1983/84. 'This means that projected levels will not be reached unless production increases at an annual rate of about 2.7Z-2.8Z; in shert, historical growth rates must continue, suggesting that the recent slowing of yield increases will need to be reversed. 38. India's agricultural gains over the last 15 years are due, in large part, to the widespread use of high-yielding hybrid cereal varieties (HYVs) and to the more extensive application of fertilizers and other-inputs in cultivation, all of which have been made possible by a large-scale investment program in irrigation facilities and agricultural extension efforts. By 1983/84, fertilizer-responsive HYVs, which were initially introduced in India in the iaid-1960s, were used in over half the area devoted to cereal production. Fertilizer consumption, which totaled-1.8 million tons in 1968169, rose to 7.8 million tons by 1983/84. 39. In addition to the increased expenditures on yield-enhancing inputs, the agricultural sector has also benefitted from high levels of capital investments by both public agencies and by private sources over the last 15 years. The irrigation potential created through publicly funded dams and canals rose from 18 million hectares in 1968/69 to more than 30 million hectares in 1983/84, and there has been a concomitant and substantial private farm-level investment program in land leveling, soil conservation, and the construction of field channels to make use of the irrigation capacity created through these major public-funded schemes. Private investment has also  -1l- supported "minor" irrigation schemes involving the installation of tubewells, dugwells, and pumpsets that will make it possible to access India's considerable groundwater potential. Private agricultural capital formation in India also encompasses construction of farm-based storage and marketing structures, the acquisition of tractors and other mechanical aids, and the purchase of livestock. Overall, gross agricultural capital formation is estimated to have risen, in real terms, from Rs 13 billion to Rs 21 billion over the decade ending 1981/82, the last year for which data are available. 40. As agricultural development in India has become more capital intensive, Indian authorities have sought to enhance the magnitude and quality of both public and private investment in agriculture. COI's efforts in the public investment program have been concerned witb major irrigation works and expanded agricultural extension and research, and its initiatives within the private sector have centered on the evolution and expansion of the agricultural credit system so that farmers at all income levels can have ready access to investment capital. Attempts to widen the coverage of India's rural banking system and to enlarge the volume of funds channeled through institutional means date back to the early 1900s; these efforts became increasingly effective in the last two decades with the creation of a number of institutions designed to provide credit and with the-development of a loan-refinancing capability, initially within the Reserve Bank of India (RBI) and, later, within a separate organization, the Agricultural Refinance and Development Corporation (ARDC), which in 1982, was renamed NABARD and which took over most of the functions previously performed by RBI in agricultural credit. Agricultural Credit - An Overview 41. Historically, the cash-needs of India's millions of rural households were met entirely by the traditional system of family financing and village money lending, normally at usurious interest rates and for short periods. But these sources were not well suited to the investment needs of modern agriculturalists nor to the growth objectives of the nation. Therefore, in recent years, specialized agricultural institutions have come to play a crucial role in facilitating and accelerating private agricultural investments. These institutions have several important characteristics: they are able to appraise projects and lend for them on the basis of their anticipated productivity; they have access to funds outside the rural sector; and they can fulfill farmers' needs for production credit at a reasonable cost. 42. Institutional agricultural credit was introduced in India under the Cooperative Credit Societies Act of 1904. By the early 1950s, institutional credit still financed less than 5% of the financial needs of the rural population. Since then, however, the share of institutional finance has been growing rapidly and now accounts for approximately 50Z of total credit. The rec2nt growth in institutional financing can be attributed not only to social pressures and to borrower protection legislation, but also to the lower cost of financing and the growing access-bility of credit institution outlets. By 1984, the agricultural banking system had more than 130,000 outlets, and virtually all of India's 5,000 administrative blocks contained at least one outlet of an institutional credit facility. Annual institutional  -12- agricultural credit to farmers increased from Rs 6 billion in 1968/69 to about Rs 58 billion in 1984/85, and estimates for COI's Seventh Five-Year Plan (1985-1993) suggest a figure of Rs 125 billion per year by 1989/90 for short, medium- and long-term loans. 43. Agriculture credit operations are guided and regulated by rhe RBI. NABARD (formerly ARDC) was created as an apex institution to provide refinancing, tu develop lending policies that would guide the financial intermediaries, and to act as the policy vehicle for RBI's regulatory activities in the sector. At present, the main institutions to offer medium- and long-term lending 1/ are the cooperative banks and the commercial banks, with the latter providing more than half of the total financing. Since 1975, the Regional Rural Banks (RRBs) have also entered into agricultural lending and currently provide about 10% of the total funds. Under NABARD guidance, all these banking windows offer similar terms and conditions to the farmers. The Cooperative Banks are organized by individual States into two independent groups of institutions: (a) Land Development Banks (LDBs) for long-term credit, and (b) State Cooperative Banks (SCBs) for short- and medium-term credit. There are 19 LDBs, each consisting of a State Land Development Bank that lends either through its own branches or by refinancing affiliated Primary Land Development Banks (PLDBs). LDBs do not take deposits, make seasonal loans, or lend for non-agricultural purposes. The SCB structure is much larger and more diversified. In 1984, 24 SCBs provided funds for 337 District Central Cooperative Banks (DCCBs), which, in turn, onlent funds to about 94,000 Primary Agricultural Credit Societies (PACS). These PACS, which specialize in production and medium-term credit, also provide a variety of other services to their members, including facilities for savings, input supply, staple consumer goods supply, and crop marketing. The participation of SCBs and their affiliated DCCBs and PACS in long-term lending has been insignificant. 44. The involvement of Commercial Banks (CBs) in agricultural lending is relatively recent and accounts for only a modest proportion of their total business. Even so, CB lending to the agricultural sector increased from 5% of their total loan portfolio in 1968/69 to about 15% today. The CBs' ability to provide both short-term (production) and medium- to long-term (investment) loans and their correspondingly greater flexibility with regard to taking collateral, have given them an advantage over the LDBs; the CB share of rural lending has therefore increased at the expense of the LDBs. Since 1975, the Regional Rural Banks have been increasing their activities in agricultural lending,-and their share is now about 10% of India's institutional rural credit. RRBs were created specifically to lend to the weakest section of the population having minimal access to other institutions. Each RRB is sponsored by a local commercial bank and by the State Government. 1/ By convention, short-term credits are seasonal production loans to farmers for a period of up to 18 months; medium- and long-term (over 3 years) credits are classified as investment or term loans.  -13- National Bank for Agriculture and Rural Development (NABARD) 45. NABARD was established by an Act of Parliament in 1982. NABARD's primary objective is to promote increased availability of credit for agricultural investments, and, as noted earlier, it is the vehicle for formulating agricultural credit policy and monitoring the implementation of thcse policies. NABARD makes funds available to the various banks participating in the supply of rural credit by refinancing loans made on agricultural schemes 1/ that are judged by NABARD to be economically and technically sound. NABARD normally approves schemes submitted to it by participating banks, but it also assists in formulating schemes in less developed States. Although its legal mandate for enforcing agricultural credit policy should enable NABARD to influence the lending policies and procedures of the participating banks, political considerations often limit enforcement. Nevertheless, NABARD has contributed to the development of agricultural credit institutions throughout India. For the year ending June 30, 1985, NABARD's refinancing activity was split as follows: to CBs, Rs 5.7 billion (representing 54% of total refinancing); to LDBs, Rs 3.1 billion (30Z); to RRBs, Rs 1.4 billion (13%); and to SCBs, Rs 370 million (3%). 46. NABARD has a staff of about 2,700 of which 1,600 are professionally qualified. About half are located at the Head Office in Bombay and the rest work in the 21 regional offices. NABARD is governed by a 14-member Board of Directors. The Chairman is a Deputy Governor of the Reserve Bank of India (RBI), and the Managing Director, who is the Chief Executive Officer, is also appointed by RBI. NABARD's sharehold3rs include RBI, the state LDBs, SCBs, the Life Insurance Corporation of India, CBs and investment companies. It derives its operating funds through borrowings from GOI, annual allocation of quasi-equity funds from RBI, augmented by issue of bonds in the market, as well as retained profits. For the year ending June 30, 1985, NABARD's sources of funds were as follows: share capital, quasi-equity funds from RBI, and retained earnings, US$2.4 billion; COI and RBI borrowings, US$2.0 billion; other borrowings, US$458 million. NABARD's 2/ after-tax profit increased frem US$4.8 million in 1975/76 to US$154 million in 1984/85. The Integrated Rural Development Program (IRDP) 47. In 1978, the Government of India (GOI) established the IRDP as an amalgamation of many ongoing rural poverty-alleviation programs. It, along with the National Rural Employment Program (NREP), has consistently been l/ "Schemes" are a series of individual on-farm investments grouped together to simplify the administration of the loan application, disbursement, and subsequent debt servicing. 2/ Throughout chis report, reference to NABARD, which was created by Act of Parliament in 1982, includes reference to NABARD's organizational predecessor--the Agricultural Refinance and Development Corporation (ARDC), which itself was created as a separate entity from the RBI in July 1963.  -14- accorded high priority in GOI's national development plans. IRDP's objective is to identify, each year, about 600 families with incomes of less than Rs 3,500 per year (US$292) from all sources in each of India's more than 5,000 blocks (a block is a subdivision of a district), and to provide those families with productive investments through a subsidized loan program. The program uses staff from the commercial and cooperative banks, from NABARD, and from State Covernment planning agencies to review farmers' needs in a selected block, identify investment opportunities, and prepare block development plans and associated requirements for financing by the participating banks. NABARD can and does refinance the resultant loans made by the banks to individuals within the context of the block development plan and this component of NABARD's operations has been growing rapidly--from 1% of total disbursements in FY79/80 to 33% in FY84/85. Previous Bank Experience in Agricultural Credit 48. The Bank Group involvement dates back to the formulation of ten State-based agricultural credit projects approved between 1969 and 1973. They were implemented through ARDC, and are fully disbursed. Subsequently, ARDC was entrusted with four general lines of credit--ARDC I (Cr. 540-IN of April 1975), ARDC II (Cr. 715-IN of June 1977), ARDC III (Cr. 947-IN of August 1979), and ARDC IV (Cr. 1209-IN/Ln. 2095-IN of February-1982)--which have all been fully disbursed. In addition, ARDC/NABARD has also been indirectly involved in the implementation of another 25 projects financed by the Bank Group in irrigation, tree crop development, marketing, horticultural processing, inland and marine fisheries, seed production, and sericulture--all of which relied, among other sources, on long-term financing from ARDC/NABARD to supplement Bank Group funds. Bank Group disbursement7s to GOI for onlending under the four completed ARDC general iines of credit totalled US$875 million. - 49. The State-based projects were designed mainly to support lending programs to farmers by LDBs and, to a lesser extent the CBs, for investments in minor irrigation (representing more than 80% of the total refinancing program), land leveling and, in six States, farm mechanization. Most of the projects also required the State Governments concerned to establish or strengthen a groundwater agency responsible for monitoring the scale of groundwater investments financed through institutional credit to protect against over utilization of the groundwater potential. Each project required participating banks to adopt specific loan appraisal procedures that were based on incremental income calculations rather than on security-oriented factors, to observe uniform lending terms and, in several cases,to implement improvements in management and staffing methods. Physical targets for the minor irrigation components were achieved or surpassed. Farm mechanization targets were also reached in most cases, but land development loans were somewhat delayed by organizational or legaL difficulties but they were eventually completed. Groundwater resource evaluation techniques and practices improved in all project States. However, the spacing and density criteria used for siting minor irrigation investments were not applicable to privately financed investments and were therefore only partly effective in regulating groundwater abstraction.  -15- 50. With the improving capability of ARDC to appraise and supervise lending schemes independently of IDA and with the growing experience of participating banks in development lending, IDA agreed in 1975 to change the concept of its agricultural credit projects to a general line of credit to support lending approved by ARDC throughout India. This move was expected to bring better coverage of the nation and allow more flexibility in the type of lending, since ARDC could appraise schemes that would be too small for IDA to approve individually. All four of these general ARDC projects were completed on or ahead of schedule. 51. An ex-post review of the ten State-based and three general line-of-credit projects completed through 1982 indicates that about US$2.4 billion investments were made in tubewells, dugwells, and pumpsets, which placed an estimated 3 million hectares of incremental irrigated area under production. According to evaluation studies by NABARD, this incremental irrigation has enabled India to produce an additional 4.8 million tons of foodgrain per year. Additional employment resulting from the projects was estimated at about 2 million man-years. The projects also played a part in diversifying the pattern of refinancing by ARDC, the result of which was the development of 110,000 hectares of plantations or orchards, the financing of about 4,600 motorized fishing boats, the construction of 5 million tons of grain storage, and miscellaneous animal husbandry investments. 52. Project Performance Audit Reports (PPARs) have been prepared by the Operations Evaluation Department for all but the one most recent ARDC projects. All PPARs concluded that the projects met objectives, but consistently questioned the adequacy of lending margins and financial viability of some of the smaller branches, and the limited availability of groundwater in some areas. Increasing attention is paid to worsening loan recoveries and, in the ARDC I and II reports, the inadequacy of ARDC supervision and staff shortages were noted in a discussion on lending quality-versus-growth options. In addition, in 1981 the Operations Evaluation Department prepared a report ll on the results obtained in the State-based projects and in the first ARDC credit project. The review confirmed the important contribution of the credit projects to agricultural development in India. The review found that, although project benefits may have been somewhat overestimated (mainly because of methodological shortcomings), "there is sufficient evidence to conclude that this set of projects was very timely, generally received strong institutional support, and achieved an impressive measure of success." The review concluded that the change from State-based projects to ARDC line-of-credit projects was timely and justified, despite the loss of influence by the Bank Group on State-based institutions. In the ARDC III project, which disbursed over the two-year period 1980/81, although virtually all physical targets were achieved as planned, serious problems emerged prior to and during the project 1/ Report No. 3415-IN, "Agricultural Credit Projects: A Review of Recent Experience in India," April 8, 1981.  -16- period, especially on the increasing level of loan overdues 1/ and the inability of the various institutions, including ARDC, to control the rapid growth of agricultural credit. A Project Completion Report is under preparation for ARDC IV project. 53. The continuing problem of poor loan recoveries from farmers was addressed more directly in successive ARDC projects--largely by restraining ARDC from refinancing those bank branches with already high levels of overdues. This was done by introducing branch overdues limits or "eligibility criteria" that, at some predetermined point, restricted or cut off refinancing. During ARDC III and IV, these criteria were augmented with specific rehabilitation measures designed to improve the institutional performance of weak LDB branches. Eligibility criteria developed in these projects, however, typically allowed even the weakest primary lending institutions to obtain almost unlimited refinancing from ARDC with the exception, during the 1978-81 interval, of LDB branches with recoveries of less than 35Z, which were denied access to further refinancing during that period. Various rehabilitation programs comprising financial, and procedural measures, were introduced, but all fell short of expectations because they did not seek out and address the basic financial and institutional weaknesses of the participating banks and of NABARD itself. Branch staff performance incentives during this period were based almost solely on voluiie criteria, rather than on the quality of loans and/or recoveries. The effectiveness of the rehabilitation efforts was further reduced by ARDC/NABARD's poor control and guidance of the system. 54. The most recent analysis of the performance of the credit system over the past three years (1982-85) suggests that continued rapid growth in the volume of loans outstanding has not been accompanied by a commensurate growth in the management and operational capabilities of the many institutions providing such credit. In a review of the system discussed with GOI during preparation of the proposed project, it was agreed that a number of fundamental problems must be resolved if the credit intermediation function is to operate efficiently. Specifically: (i) the expected role of credit in the agricultural sector must be examined and measures developed to make the overall credit delivery system more efficient and responsive to farmers' needs; (ii) the respective roles and modus operandi of hABARD, the SCBs and their associated cooperative banks, LDBs, CBs, and RRBs must be clarified, along with staffing and training requirements; (iii) lending units should be allowed sufficient margins to enable efficient and profitable credit intermediation function to be performed by all components of the system; and 1/ ARDC did not bear the financial burden of these unrecovered loans: the burden was absorbed either by the parent commercial banks or, in the case of LDBs, by the State Government budget.  -17- (iv) appropriate monitoring and control mechanisms and staff training programs must be designed and implemented to ensure that the growing system is efficiently managed. GOI is fully committed to a high leveL of agricultural development since, without it, neither its macro-economic nor its poverty alleviation objectives can be achieved. The challenge facing the Government is how this continued growth is to be matched by concomitant improvements in the many institutions charged with the responsibility for implementing the Government's credit policies and managing the accompanying growth in agricultural credit. PART IV - The Project 55. In late 1983, GOI asked the Bank to provide a fifth general line of credit to fund NABARD's refinancing activities. The project was prepared by the Bank with the assistance of staff from NABARD and the Ministry of Finance. It was appraised in December 1984, and a report entitled "Staff Appraisal Report - National Bank for Agriculture and Rural Development (NABARD) Project" (Report No. 5594-IN, dated January 24, 1986) is being circulated separately to the Executive Directors. Negotiations were held in Washington, D.C., in November 1985. The Government of India and NABARD were represented by a delegation coordinated by Mr. P. Singh of the Department of Economic Affairs, Ministry of Finance. A Supplementary Project Data Sheet is attached as Annex III. Project Objectives and Rationale for Bank Involvement 56. While experience with previous agricultural credit operations in India suggests that the production objectives were largely achieved, the achievements in strengthening the capacity of the financial intermediation system were much less than desired. In particular, the poor loan collection performance of many of the participating banks has required major infusions of public capital to them. The modernization of Indian agriculture is of major importance to the national economy and will clearLy require growing amountq of producer credit. The option, therefore, of having the operations of the credit system held back until institutional performance is fully satisfactory is not one which the Government can afford to take. Equally, it cannot afford to delay major improvements to the system. 57. Within GOI and NABARD, there is now a general consensus that a major overhaul of the agricultural credit system is overdue and that the Bank's involvement in this overhaul process could be extremely fruitful. The magnitude and scope of the task--achievement of reforms will take a minimum of five years, and may well take more-strongly suggests that close involvement by the Bank in each step of the review is highly desirable. Such an involvement can best be orchestrated in the context of a project that supports, in a meaningful way, NABARD's ongoing refinancing requirements, and that can, at the same time, support key initiatives to rehabilitate the system. These efforts would include in the short term the introduction of more stringent eligibility criteria for access to NABARD refinance facilities; intensified NABARD technical assistance to weak onlending agencies; and a broadened piLot effort to improve the quality of branch bank  -18- financing services and collection performance. These steps, plus a series of major studies to review systematically the issues in the rural finance sector and specific further changes needed, should set in place over the medium term the actions for needed reforms. 58. In sum, the project would serve as the vehicle for initiacing measures that would strengthen the agricultural credit system while continuing Bank assistance to NABARD in its program of refinancing medium- to long-term credit. Through its association with NABARD's ongoing refinancing of rural credit, the project would also help to increase agricultural production, rural income, and employment; in particular, it would emphasize assistance to small farmers. These objectives are fundamental to India's growth and poverty alleviation program. Project Description 59. The project would help finance NABARD's medium- and long-term refinancing program with participating credit institutions (CBs, LDBs, RRBs, and SCBs) over the three-year period from mid-1986 to mid-1989. The project would also finance the execution of the Agriculture Credit Review (hereafter referred to as the Credit Review), the extension of pilot schemes to 20 districts, and training required for strengthening credit delivery at the farm level. - 60. The Refinancing Pro3ram. Most of the funds (US$340 million) provided under the project would be used by NABARD for its loan-refinancing program with participating banks. The refinancing program for each of the next three years (FY87, B8, and 89) would show sectoral allocations and would be furnished to the Bank for its review and comments by the June 30 prior to the start of each of these years. The refinancing program would include investments in minor irrigation (both groundwater and surface water development), and in electric pumpsets, dugwells, and tubewells. To avoid excessive exploitation of groundwater potential through over-investment in minor irrigation systems, NABARD would, on June 30 each year, beginning June 30, 1986, provide an assessment of the lending potential for minor irriga.ion schemes (to be provided by the State Groundwater Organizations), including an analysis of the compatibility of its refinancing program with this lending potential. The refinancing program would also include allocations for dryland farm development, land leveling and soil conservation, livestock, plantations and horticulture, forestry, fisheries, storage markets, and farm mechanization. The rates of interest charged by the various institutions and the loan repayment terms are summarized in the Loan and Project Suimmary on page (i) above. The amount of refinance made available by NABARD to branches would be determined according to agreed criteria that are discussed below. 61. Eligibility Criteria. Beginning July 1, 1986, the amount of NABARD refinance available to participating bank branches (except those in Special  -19- Assistance States 1/) will be determined according to criteria tied to the loan recovery performance of that branch in the previous year. Only branches with recoveries of 75% or more of their annual demand will be eligible for unlimited access to NABARD refinancing. Refinance to branches with recoveries of between 60% and 74Z (increased to 65% to 74Z with effect from January 1, 1988) will be limited to the highest amount lent in any of the last five years; those branches with recoveries of between 36X and 59% (increased to 41% to 64% wich effect from January 1, 1988) will be limited to the amount actually recovered from the borrowers in the previous year, or the average amount recovered in the past three years, whichever is greater. Branches with recoveries of 35% or less (increased to 40% or less with effect from January 1, 1988), will be entitled to no more than 75% of the amount recovered in the previous year. Furthermore, unless such branch demonstrates an improvement of at least 7 percentage points in its level of total recoveries, such branch's entitlement will be further reduced (to 50% and 25: of the amount recovered from borrowers, in the second and third years, respectively). Unlike the calculations used in earlier Bank projects, calculations of recoveries will be based solely on actual cash recoveries from borrowers, and such recoveries would include those related to special schemes such as IRDP. Recovery calculations would exclude recoveries on short-term loans of CBs and any subsidies, interest remissions, or other payments or measures by state governments which may artificially inflate recovery performance statistics. 62. Assistance to Weaker LDBsIPLDBs. Application of the above criteria, and the tougher definition of recoveries used, is expected to result in several LDB branches and PLDBs falling in the lowest category (i.e., those with recoveries less than 35Z-40%). NABARD has a critical role in assisting these branches to analyze their overall financial status, recommend corrective measures, and implement appropriate rehabilitation programs in order to maintain the financial soundness of the LDBs/PLDBs and improve their overall performance. As a first step in this exercise, NABARD has issued guidelines under which branches are reviewing, case-by-case, their long overdue loans to identify some of the reasons for overdues (e.g., insufficient grace periods allowed, repayment terms inconsistent with returns on investment, or relief measures where these were evidently justified). Corrective measures, essentially rescheduling of loans in accordance with guidelines by NABARD, are being taken. To this end, NABARD would continue to take steps to (i) assess the financial position of the weaker branches (including potential bad debts, adequacy of provisions, reserves and equity); and (ii) make appropriate recommendations for strengthening the financial position of such branches. To the extent that additional staff are required for this work, NABARD would staff its regional offices with institutional development specialists and provide other temporary sta