India - Industrial Imports Project

RESTRICTED Report No. P-376 This report was prepared for use within the Bank and its affiliated organizations. They do not accept responsibility for its accuracy or completeness. The report may not be published nor may it be quoted as representing their views. INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED DEVELOPMENT CREDIT FOR AN INDUSTRIAL IMPORTS PROJECT INDIA May 28, 1964 INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMNDATIONS CF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO INDIA FOR INDUSTRIAL IMPORTS 1. I submit the following report and recommendations on a proposed develop- ment credit to the Government of India in an amount in various currencies equivalent to $90 million. The proposed credit would assist the construction industry and selected sectors of capital goods manufacturing by providing foreign exchange to pay for a portion of the imports of components, materials and balancing equipment required to fulfill a program of expanded production and investment in these industries. I. BACKGROUND 2. A year ago in my proposals on Bank financial policy, I recommended that, in appropriate cases, we should be prepared to make available long-term financing for the import of components and spare parts required to maintain or to increase industrial production, and I cited the situation in India as one possible case in point. Subsequent analysis has confirmed the economic benefit of this form of lending for India in the present context. The pro- posal I now submit for your approval would help in providing the foreign exchange necessary to support and expand the production of capital goods in the form of trucks, buses and component parts, heavy construction eouipment, machine tools and cutting tools, and electric motors, transformers and switch- gear. In addition, the proposed credit would make possible a better rate of utilization of earth-moving and construction equipment (i) by making replace- ment parts more readily available to service equipment imported in recent years in connection with the construction of major development projects and (ii) by enabling civil works contractors to obtain larger supplies of such equipment. 3. The present proposal would represent a further evolution in Bank/IDA lending policy. In the past in India loans such as those to the Railways have financed materials, parts, components and sub-assemblies for incorpora- tion in capital goods required for the development of rail transport, and the Bank Loan of August 9, 1961, provided a flow of equipment and spare parts for the expansion of production in the private coal industry. The proposed credit, by making materials, components and a limited amount of balancing equipment available to three key sectors of manufacturing, would substantially increase the availability of road transport equipment, machine tools and heavy electrical apparatus to a broader segment of the Indian economy. 4. A request for IDA assistance of this type was first put forward a year ago. A preliminary mission discussed the project in Delhi in June of 1963, and an appraisal mission was in India from mid-October to mid-December. Negotiations began in Washington on May 4 and were concluded on May 22. - 2 - 5. The proposed credit would increase the total amount of IDA assistance to India to $390 million -- the sum pledged under the Aid-India Consortium for the first three years (1961/62 - 1963/64) of the current Five-Year Plan. All past credits are now effective; and as of April 30, 196k, $118.2 million had been disbursed. There have been delays in some projects -- notably in the case of National Highways; but the rate of disbursement has increased recently and, as far as the roads project is concerned, contracts have been let for the full amount and more than half the total credit has now been withdrawn. These credits are as follows: Amount Credit No. Purpose ($ Million) 3-IN National Highways 60.0 8-i Tubewell Irrigation 6.0 13-IN Shetrunji Irrigation 4.5 14-nm Salandi Irrigation 8.0 15-IN Punjab Drainage and Flood Protection 10.0 19-IN1 Fourth DVC 18.5 21-rI Sone Irrigation 15.0 23-IN Purna Irrigation 13.0 2k-IN Second Koyna Power 17.5 27-IN Bombay Port 18.0 28-IN Telecommunications 42.0 36-IN Seventh Railways 67.5 37-IN Kothagudem Power 20.0 Total 300.0 6. The Bank has now made 31 loans in India, totalling $847.1 million (net of cancellations), of which $720.5 million has been disbursed. All loans are now effective. Further details as of April 30, 1964 are as follows: ($ Million) Total loans, net of cancellations 847.1 of which has been repaid 165A- Total now outstanding 681.7 Amount sold 89.6 of which has been repaid 61.0 28.5 Net amount held by Bank 653.2 - 3 - II. DESCRIPTIO1t OF THE CREDIT 7. The main features of the proposed credit are as follows: PURPOSE: To provide a portion of the foreign exchange required for the purchase of components, materials, spare parts and miscellaneous items of manufacturing and construc- tion equipment, in order to achieve a higher rate of utilization of existing capacity for the productive purposes specified in the proposed Credit Agreement. In accordance with its regular foreign exchange licensing procedures, the Government of India would sell the pro- ceeds of the credit for rupees to firms and agencies on an agreed list of (i) manufacturing industries producing selected types of capital equipment, (ii) civil works contractors and (iii) authorized representatives of foreign manufacturers of spare parts for heavy earth- moving and construction equipment. DORROWER: India, acting by its President. AOUNT: 090 million. SERVICE CHARGE: 3/4 of 1% per annum. TERUIMS: The term of the credit would be for a period of 50 years. Commencing November 15, 1974, one-half of 13 of the principal amount would be repayable semi-annually for 10 years; and commencing November 15, 1981, and ending May 15, 201, 1-1/254 of such principal amount would be repayable semi-annually. PAYNENT DATES: May 15 and November 15. 8. The central purpose of this credit would be to achieve a higher rate of utilization of existing capacity for the production of capital goods. Three-Quarte of the total credit would be for components and materials re- quired by manufacturers, as the following table indicates: ($ Million) Components, materials and spare parts for manufacturers of specified capital goods 68.6 Balancing equipment for manufacturers 6.2 Heavy construction equipment and spare parts for such equipment 15.1 Consultant's services 0.1 Total 90.0 9. The Government of India has estimated that the total amount of imported components, materials and spare parts required during 1964/65 would be roughly twice what is proposed for financing under this credit if the manufacturing industries selected for the project are to operate at levels approaching their presently installed capacity in accordance with production targets summarized in paragraphs 3(a) and 3(b) of Schedule 1 to the proposed Development Credit Agreement (No. 1). The Government has agreed to provide the balance of these industries' foreign exchange require- ments from other sources, such as export earnings and bilateral credits. Imports at the proposed level would make possible in 1964/65 an average increase in production of 30 percent and would also provide a basis for additional increases during 1965/66. In these industries the total value of production in 1964/65 is expected to be five or six times the amount of components and materials imported under the IDA credit. The project would also include $4.5 million for commercial vehicle spare parts to provide replacements for parts that are not yet produced by indigenous manufacturers. 10. In addition to components and materials the proposed credit would include approximately $6 million for miscellaneous industrial equipment required to balance existing manufacturing facilities in the selected in- dustries. The Government has indicated that additional balancing equipment and modest expansion projects will require another $12 million or more in foreign exchange, which will be supplied primarily from various sources of bilateral assistance under the consortium. 11. Approximately $21 million worth of imported spare parts will be required to help achieve a satisfactory rate of utilization of the heavy earthmoving and construction equipment that is already in India. Roughly half this amount would be provided in the proposed credit. This portion of the project would also support a major reorientation of the Government's import licensing system, so that in the future the authorized representatives of foreign parts manufacturers will be in a position to undertake the primary responsibility for importing and stocking replacement parts and spares. Formerly, a large percentage of import licenses for construction equipment spare parts were issued to users of equipment only after a specific need had been identified; therefore, equipment was often idle for some months, while parts were being delivered from sources overseas. Because of the high cost of such delays and a rapid growth in the number of projects re- quiring spare parts service, the Government no longer considers this "actual user" approach to import licensing efficient, and it is felt that dealers should be put into a position to maintain adequate stocks in India and to fill orders promptly. The credit also provides slightly more than $5 million for construction equipment to be purchased by medium-sized contractors, and for transporters to expedite the movement of equipment from one project site to another. III. APPRAISAL OF TE PROPOSED CREDIT 12. "An Appraisal of the Industrial Imports Project" (Report No. 41ha, dated May 28, 1964) is attached (No. 2). This appraisal report was prepared by a technical team, consisting of six members of the Association's pro- fessional staff assisted by three consultants from Production Engineering Ltd. of London, which last October/December visited a large number of manufacturing enterprises in India as well as construction firms, State public works depart- ments and construction sites. The mission studied each of the sectors that would benefit under the proposed credit. Manufacturing and Construction Industries 13. On the basis of its field survey and subsequent analysis of data collected in the field, the appraisal mission is satisfied (a) that production in the industries concerned is currently being held back by shortages of imported materials, components and spares, (b) that firms and agencies par- ticipating in the project are reasonably efficient in their operations and have the other resources needed to make good use of foreign exchange made available under the proposed credit, and (c) that products manufactured in these industries are important to development in India, already find ample markets and can reasonably be expected to be in increasing demand in future. Despite numerous difficulties and shortages most of these industries have been growing very rapidly in recent years -- in some cases by as much as 20 or 30 percent per annura. Generally, growth has been combined with a steady increase in the indigenous content of end-products. Order books are full -- generally for one year ahead and in some cases for two or three years. The mission also noted a wide variety of collaboration agreements, under which foreign firms are providing valuable designs, technical know-how and quality control, and it observed a large number of young, well-trained engineers working effectively and enthusiastically in these industries. 14. An exact coparison between local production costs and the costs of imported products is difficult, partly because many products have been modified somewhat for the Indian market and are therefore not strictly comparable to imported items, but also because of various taxes included in the ex-factory prices quoted by Indian firms. However, the 30-h0 percent differential in the ex-factory price of Indian trucks relative to c.i.f. prices of nearly comparable imported trucks seems to be accounted for largely by special taxes. The prices of electric equipment appear to be only mar- ginally higher than comparable imports. The prices of most cutting tools and many machine tools are fully competitive. In those few cases where production costs are at present substantially higher than abroad (e.g., some types of heavy construction equipment), production in India is of very recent origin, and there are indications that costs will be reduced substantially within a very few years when current expansion plans have been fully implemented. - 6 - 15. In India the demand for machine tools and cutting tools has been growing rapidly, and there is ample scope for further expansion. The pace of future growth will probably depend more on the development of satisfactory collaboration arrangements between Indian firms and experienced machine tool manufacturers from abroad than on any other single factor, and the Government is presently studying ways to assist this development. The training of skilled labor is another factor that is critical for future growth, and intensive efforts are being made to improve various training programs. In the electric equipment sector, market forecasts and present efficiency provide ample justi- fication for the selective expansion of some producers. In other firms the movement toward two-shift operations should be completed. In addition, some modification in product designs may offer scope for producing electrical equipment that is less costly in terms of materials and would help reduce the multiplicity of specifications used by various State Electricity Boards. 16. With respect to commercial vehicles it has for some time seemed appro- priate to us to encourage the trend toward road transport, which is so important for short and medium hauls or when high value goods are to be moved. A major purpose of the first IDA credit to India, three years ago, was to improve the national highway network. To service a growing road traffic, the Government in recent months has approved applications to import capital equipment that will enable Indian manufacturers of commercial vehicles to produce in 1967 or 1968 roughly twice as many trucks and buses as were manu- factured in India during 1963; furthermore, since the market has shown some resistance to one engine for trucks, which is of relatively low horsepower, steps have been taken to provide a more powerful unit. Although rapid expansion of the vehicle fleet is desirable from the point of view of transport, it would now appear prudent for the Government to see how the market will respond to the greater availability of vehicles before scheduling further investments in this sector. 17. Several recent end-use missions concerned with Bank/IDA assistance for the constructicn of highways, irrigation facilities, ports and power plants have confirmed the urgent need for additional heavy construction and earthmoving equipment if development projects are to be completed expedi- tiously and in accordance with satisfactory quality standards. Within the last few years manufacturing facilities have been established in India for road rollers, shovels, cranes and similar equipment, and these units show promise of rapid expansion. In exploring the needsfor types of equipment not yet manufactured in India, the appraisal mission was struck by the low rate of utilization of equipment already on site -- much of it imported under individual project agreements. It was therefore agreed with the Government that first priority under this project be given to improving the availability of spare parts and complementary maintenance facilities rather than importing new equipment. Provision would, however, be made for the import of equipment needed to strengthen a group of medium-size contracting firms. The Government is aware that continuing efforts will be necessary to obtain a higher rate of utilization of all equipment, to provide parts dealers with satisfactory assurances regarding future pro- vision for imported spare parts and to strengthen the role of contractors. - 7 - 18. Duiring negotiations there has been a frank and cordial exchange of views regarding the future development of manufacturing and construction industries in India. We are satisfied that the Government is giving thoughtful attention to problems connected with future expansion, and that when planning further investments, it will give due consideration to views expressed in the appraisal report and at the time of negotiations. Import Licensing 19. In its efforts to conserve foreign exchange the Government operates a complex foreign exchange allocation and import licensing system. The Association is satisfied that the import licensing system has been successful in keeping India's total import bill within the limits set by the availability of foreign exchange, in encouraging firms to import goods from the most competitive international source of supply, and, on the whole, in channeling scarce foreign exchange into high priority sectors of economic activity. However, the system involves a number of time-consuming procedures and allows firms very little flexibility, since even within the total value of each half-yearly allocation, many import licenses specify the amount to be spent on each item. 20. In the recent past the prospects for simplifying import licensing procedures or reducing controls have been limited by the severe overall shortage of foreign exchange and continuing pressure on the balance of payments. One illustration of the consequences of this pressure is the reduction of foreign exchange allocations for what the Government calls "commercial imports" - a concept which includes most of the materials and components required by industry. From the half-year April/September 1960 to the same period of 1963 foreign exchange allocations for commercial imports were reduced from approximately $410 million to barely $320 million. Hore- over, these totals mask an even sharper reduction in free foreign exchange (from roughly $400 million to $240 million in the same period), the balance being covered to an increasing extent with bilateral credits made available primarily from consortium countries. Imports of steel, which are accounted for separately, have also been held in check. In the engineering sector, a major part of which consists of industries that would benefit under this project, total allocations have not been reduced quite so severely, but the tendency to rely increasingly on bilateral aid arrangements has been very strong; free foreign exchange licenses covered 85 percent of components and materials (other than steel and non-ferrous metals) in 1961/62 but only 65 percent in 1963/64. 21. Consortium assistance in non-project form has helped prevent further reductions, and the proposed IDA credit would enable recent trends to be reversed. If the credit is approved, the Goverment proposes a 10-12 percent increase '*n three years. Considering other aspects of the balance of pay- ments and especially the recent increase in export earnings, the Government also prop es significant increases in other imports required to maintain -8 - and expand production; for example, increases totaling more than $60 million per annum are contemplated for steel, fertilizer and petroleum imports. 22. The mission was concerned to study how the import licensing system might affect the implementation of this project and has discussed with government officials a number of mbdifications that would appear to be advisable as soon as foreign exchange becomes more freely available for industrial components and materials. In recent months the Government has taken significant steps to simplify procedures and expedite the issuance of licenses. In 1964 the Government aims to release foreign exchange alloca- tions to industries six and possibly eight weeks earlier than has been the practice in recent years; authorized representatives of foreign manufacturers of spare parts for heavy construction equipment are to be given substan- tially higher allocations than in the past; and whenever possible, licenses will indicate the items eligible for import and the total value of imports allowed but will avoid a detailed listing of the amount allowed for individual items. The Government is also proposing to review and evaluate its existing data gathering procedures, so that in estimating foreign exchange requirements more effective use can be made of statistical information avail- able from manufacturing establishments. During negotiations the Government has proposed various further measures to simplify and expedite the pro- cessing of import license applications from firms in industries covered by the project and has indicated that insofar as these measures are found to be useful in the limited range of industries covered by the project every effort will be made to apply them more broadly to other industries in the future. The Economy 23. A report on the "Current Economic Position and Prospects of India" (Report No. AS-105a) was circulated to the Executive Directors on May 12, 1964 (R6k-55). It is clear from this report, and others which have preceded it, that in recent years one severe restraint on the growth of industry - and on the economy as a whole - has been the limited availability of imported components and materials. The report stresses the importance of aid which can be used quickly to finance additional imports of materials and components and the close relationship between such aid and the prospects for relaxing controls on industry (see especially paragraphs 8k and 91). PART IV. LEGAL INSTRUKENTS AND AUTHORITY 2k. Attached is a draft Development Credit Agreement (No. 1) between India and the Association, which substantially conforms to the usual pattern of Development Credit Agreements. Attention is drawn to Section 4.01 (b) of the draft Development Credit Agreement which contains commitments of the Borrower with respect to the issuance of licenses, the availability of foreign exchange and the allocation of local materials. These commitments are supplemented by two letters which are also attached, one entitled "Foreign Exchange" (No. 3) and the other one entitled "Import Licensing Arrangements" (No. 4). - 9 - 25. The recommendations of the Committee provided for in Article V, Section 1 (d) of the Articles of Agreement of the Association are attached (No. 5). PART V. COMPLIANCE WITH ARTICLES OF AGREEMENT 26. I am satisfied that the Borrower can fulfill his obligations under the Agreement and that the proposed development credit would comply with the Articles of Agreement of the Association. PART VI. RECOMMENDATIONS 27. I recommend that the Association make available a Development Credit to India in an amount in various currencies equivalent to $90 million for a total term of 50 years with service charge of 3/4 of 1 percent per annum and on such other terms as are specified in the draft Development Credit Agree- ment, and that the Executive Directors adopt a resolution to that effect in the form attached (No. 6). George D. Woods President Washington, D.C. May 28, 1964