India - Industrial Export (Engineering Products) Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 15589 PERFORMANCE AUDIT REPORT INDIA INDUSTRIAL EXPORT PROJECT - ENGINEERING PRODUCTS (LOANS 2629-IN AND 2630-IN) April 30, 1996 Operations Evaluation Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. Currency Equivalents (annual averages) Currency Unit = Country Currency ($$) 1990 US$1.00 Rs l7.504 1991 US$1.00 Rs22.742 1992 US$1.00 Rs25.918 1993 US$1.00 Rs30.493 1994 US$1.00 Rs3l.374 1995 (September) US$1.00 Rs33.263 Abbreviations and Acronyms AIEI Association of Indian Engineering Industries EMF Export Marketing Fund EXIM Export Import Bank of India GOI Government of India ICICI Industrial Credit and Investment Corporation of India OED Operations Evaluation Department PCB Participating Commercial Banks PF Productivity Fund Fiscal Year Government: April 1 - March 31 FOR OFFICIAL USE ONLY The World Bank Washington, D.C. 20433 U.SA. Office of the Director-General Operations Evaluation April 30, 1996 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: INDIA: Industrial Export Project - Engineering Products (Loans 2629-IN and 2630-IN) Attached is the Performance Audit Report on India - Industrial Export Project, Engineering Products (Loans 2629-IN and 2630-IN, approved in FY86 and closed in FY92) prepared by the Operations Evaluation Department. The principal objective of this project was to support and bolster the policy measures and trade reforms taken and planned by the Government of India in the mid-1980s, by providing credit to exporters and grant assistance to facilitate firm export development efforts. The reform measures were designed to increase the competitiveness and export orientation of both the engineering good sub-sector, as well as manufactured products in general. In addition to the term finance component of the project, a major goal was to shift the focus of export promotion toward direct support of strategic marketing measures by individual companies. In this regard, the project was designed to improve the institutional arrangements and capacities of those Indian agencies involved in export promotion. Initial implementation of the project was sluggish. There were a number of reasons for this, including overly restrictive "targeting" of potential beneficiaries, institutional constraints within the implementing agencies and a cumbersome foreign exchange control regime. These constraints were remedied, and as a result the demand for sub-loans climbed rapidly, and disbursements proceeded expeditiously. Despite the slow start, the objectives of the loan and project were achieved, and the boost to India's exports was realized. Manufacturing exports growth during the period 1987 to 1992 exceeded the growth of India's exports in general. Furthermore, the project together with parallel sector work and a follow-up Export Development Project, created a firm foundation for the bold trade reform measures that were embarked upon in March 1992. A total of 439 sub-loans were made, with many firms engaging in export activity for the first time. In addition, 292 firms benefited from the grant component of the project, which assisted the development of viable export marketing strategies. Over 50 percent of recipients were first time exporters, and export sales as a proportion of total sales increased in all but 10 cases. The overall outcome of the project is rated as satisfactory. Moreover, the institutional capabilities of all the implementing agencies involved improved, thus the institutional development impact is rated as substantial. All these agencies, have continued to lend for export projects, using resources raised in the domestic financial markets and the export policy environment has continued to improve. Hence the sustainability of this project is rated as likely. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  FOR OFFICIAL USE ONLY Contents Preface ......................................................... 3 Basic Data Sheet................................................... 5 Evaluation Summary................................................. 9 1. Background............................................. 17 2. Project Objectives and Design ................................... 20 3. Project Implementation ........................................ 22 4. Outcome and Overall Assessment .................................... 24 5. Project Sustainability............................................ 29 6. Lessons From the Project . .......................... ............... 30 Box ............................................ ....... 27 Some Firm Case Studies of Beneficiaries of the Productivity Fund and Export Marketing Fund ........................ ...................... 27 Tables India's Share in World Exports (%)..........1.8............. .. s Productivity Fund - Export Orientation Over Time .......................... 26 Annexes I. Table 1A: Selected Indicators of Grant Achievements.. .................. 33 Table IB: Activities Funded by Grant Programs (% of Total) .................. 33 I. Unweighted Mean Nominal Tariff Rates for Manufacturing Industries (% ad valorem) .................................................. 34 III. Selected Indicator's of India's Export Growth (US$ in constant 1981 prices).... 35 IV. Comments from the Implementing Agencies ................ .............. 36 This report was prepared by Roger J. Robinson (Task Manager) who audited the project in November 1995. Eneshi Irene K. Davis provided administrative assistance. The report was issued by the Country Policy, Industry and Finance Division, Manuel Pefialver, Chief, of the Operations Evaluation Department, Francisco Aguirre-Sacasa, Director. This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed wiLhout World Bank authorization.  3 Preface 1. This is a Performance Audit Report (PAR) on the Industrial Export Project - Engineering Products loan for an amount of US$250 million. The loan was approved on January 21, 1986, and closed in June 1992. 2. The PAR is based on the Project Completion Report (PCR) prepared by the South Asia Regional Office and issued in January 1994, the President's Report for the project, the legal documents, a summary of the Board discussion, project files, related economic and sector work and discussions with Bank staff. The PAR proved of considerable value addition, insofar as the Performance Audit provided further insight into the extent of project achievements and the benefits that have occurred in India!s export sector. There were no differences between the PAR and the PCR in terms of project ratings. 3. An OED mission visited India in November 1995 and discussed the effectiveness of the Bank's assistance with public sector officials, the participating commercial banks, representatives and members of the business community and private sector. Their kind cooperation and assistance in the preparation of this report is gratefully acknowledged. 4. The draft PAR was sent to the Borrowers. Comments received have been incorporated in Annex IV.  5 Basic Data Sheet INDUSTRIAL EXPORT PROJECT - ENGINEERING PRODUCTS (LOANS 2629-IN AND 2630-IN) Key Project Data (amounts in US million) As ofMay 31, 1995 Loan Original Disbursed Cancelled Repaid Outstanding 2629-IN 90.0 90.0 - 2630-IN 160.0 154.8 5.2 Cumulative Estimated and Actual Disbursements FY86 FY87 FY88 FY89 FY90 FY91 FY92 FY93 Appraisal estimate (USSM) 5.0 77.6 203.9 250.0 250.0 250.0 250.0 250.0 Actual (USSM) 0.0 7.9 19.3 72.3 128.9 201.2 233.8 244.8 Actual as % of appraisal 0.0 10.2 9.5 28.9 51.6 80.5 93.5 97.9 Date of final disbursement: October 31, 1992 Project Dates Original Actual Initiating memorandum N/A N/A Negotiations 03/85 10/29/85 Letters of Development Policy N/A N/A Board approval 04/85 10/85 Loan Agreement 01/21/86 Effectiveness 04/21/86 06/23/86 Closing date 12/31/89 06/30/92 6 Staff Inputs (staff weeks) Total Preappraisal - Appraisal 69.7 Negotiations 73.3 Supervision 107.2 Other - Total 250.2 Mission Data Date No. of No. of Weeks (month/year) persons Appraisal I 08/84 5 2 Appraisal II 01/85 3 1 Supervision I 02/86 2 2 Supervision II 10/86 3 2 Supervision III 02/87 2 1 Supervision IV 08/87 3 2 Supervision V 06/88 5 2 Supervision VI 11/88 3 4 Supervision VII 01/90 2 2 Supervision VIII 01/91 3 2 Supervision IX 07/91 1 2 Supervision X 01/92 1 2 Supervision XI 07/92 2 2 Supervision XII 12/92 1 2 7 Other Project Data Borrower/Executing Agency: Government of India FOLLOW-ON OPERMONS Operation Loan nos. Amount Board date (US$ million) Export Development Project 3058-3059 120.00 05/12/88  9 Evaluation Summary Background 1. Since independence in 1948, India has pursued an economic development policy that placed a high priority on economic diversification and self sufficiency. To this end, India has sought to develop a broad industrial and manufacturing sector, covering the full range of capital, intermediate and consumer goods. The policy framework focused upon substantial investment by the public sector in heavy and medium manufacturing. In addition, industry was protected and directed by a system of elaborate controls over capacity utilization and expansion, imports, investments in certain sub-sectors and operational practices. 2. The policies used were various. Certain sub-sectors were exclusively reserved for the public sector. There was an extensive system of investment licensing and regulation for those sub- sectors not considered the exclusive preserve of the public sector. These industrial regulations were often coupled with a complex array of incentives and/or exemptions designed to promote locational choice, labor/capital mix, technology employed, product pricing and distribution and financial structure. The largely publicly owned financial system provided directed credit for so- called "priority sectors" at subsidized interest rates. Specific rules were defined for the operation of foreign owned enterprises which imposed limits on their growth, diversification and financial management. New foreign investment was vigorously vetted, and only allowed within a system of ownership guidelines and technology transfer agreements. 3. Over time, there developed a system of employment legislation designed to protect labor from dismissal or redundancy, and a complex and opaque tax system, with high rates and numerous exemptions and allowances. The final overlay on this network of control and protection was a trade and tariff system, with import licensing, quantitative restrictions, export controls and import tariffs which, by the mid eighties, was one of the most protectionist in the world. 4. The results of these policies were disappointing. By the mid to late seventies, India's manufacturing sector had fallen behind many other developing countries, with export growth lower than that achieved by developing countries overall. There was a diversified industrial base, but this tended to be high cost, with a powerful anti-export bias inculcated by the trade and tariff regime. Furthermore the relative isolation in which the various sub-sectors evolved, impeded access to technology advancements in both product and process, with the result that by the early eighties much of India's industry was technologically backward. 5. By the early eighties, it was apparent that something had to be done. In 1983 and 1984, the Government of India undertook a serious review of the industrial policy framework, with a specific objective of determining the institutional and policy measures needed to improve the competitiveness and export performance of the manufacturing sector. And, in the Budget presented to Parliament in March 1985, significant changes in policy and strategy were announced. These measures included a partial liberalization of the industrial regulatory regime, a reduction in taxes and tariffs on capital good imports, institutional changes to the import licensing system and a stated commitment to replace all quantitative restrictions with tariffs over a period of time. In retrospect, however, these reforms were not comprehensive enough, and implementation of the 10 trade reform agenda was deficient. It was only in 1992 that a more comprehensive reform effort was designed and subsequently implemented. For further details on this see the Performance Audit Report on India, Structural Adjustment Loan/Credit (Loan 3421-IN, Credits 2316-IN and 2316- IN). Project Objectives and Design 6. The principal objective of this Industrial Export Project was to support and bolster the policy measures and trade reforms taken and planned by the Government of India in the mid-1980s by providing credit to exporters and grant assistance to assist in export development efforts. The reform measures, together with the targeted efforts of key financial institutions and export promotion agencies supported by the project, were designed to increase the competitiveness and export orientation of both the engineering good sub-sector, as well as manufactured products in general. 7. In addition to the term finance component of the project, a major goal was to shift the focus of export promotion from general market information and trade trips sponsored by the government and quasi government agencies, to direct support of strategic marketing measures by individual companies. In the project design it was explicitly recognized that the "software" components of export marketing and export initiatives was a necessary adjunct to the changes in the incentive structure and the availability of term finance for machinery and production modernization. Finally, the project was designed to improve the institutional arrangements and capacities of those agencies involved in export promotion. 8. The project was designed around two loans; one to the Government of India of US$70 million for onlending by commercial banks and one to Industrial Credit and Investment Corporation of India (ICICI) of US$160 million for onlending by ICICI, for a total loan size of $250 million. The remaining $20 million was earmarked for the creation of two funds, the Export Marketing Fund and the Productivity Fund, to provide grant support to individual firms for the export marketing and product adaptation needed to enter export markets. 9. An important element of the project design was the inclusion of some of the publicly owned commercial banks in the export development effort for the first time in India. Under this component, the commercial banks extended sub-loans to eligible companies, which were refinanced by the Government of India in the form of equity out of the proceeds of the Bank loan. 10. While the project was designed to support and complement the Government of India's initial reforms designed to improve the competitiveness of Indian manufacturing and the competitiveness of her engineering good exports, it was recognized that much more needed to be done, if this project was to achieve its maximum long term impact. In the project documents presented to the Executive Directors, the Bank explicitly noted the risks to the project's enduring success, if a sustained reform of the trade regime and the industrial regulatory system was not forthcoming. 11 Project Implementation 11. The project was identified and appraised in 1984, negotiated during August and September 1985, and approved by the Executive Directors in October, 1985. The project was signed on January 21, 1986 and both loans became effective five months later on June 23, 1986. 12. Initial Implementation of the project was sluggish. Three years after Board approval, loan commitments were only 29 percent of the estimated amounts at the time of Board presentation, and loan disbursements only 13 percent of the appraisal estimate. There were a number of reasons for this, including the onlending terms of the sub-loans, the overly restrictive "targeting" of beneficiaries, as well as institutional constraints and cumbersome foreign exchange controls. 13. Firstly, sub-loan interest rates, as initially set, were not attractive to potential borrowers because of the foreign exchange risk component that was incorporated in the interest rate, and the inability of the borrower to hedge against this risk. To remedy this situation, the Government of India, in consultation with the Bank, agreed in February 1988 to assume the foreign exchange risk and to denominate the sub-loans in Rupees. This was acceptable and the interest rates charged were positive in real terms. Secondly, the project design which targetted only eligible firms in the so-called "thrust product areas" was overly restrictive, while there was a considerable demand from a wide range of non engineering products with significant export promise. This was made less restrictive in February 1988. Similarly, the Productivity Fund administered by ICICI was broadened to include a wider range of eligible activities. Thirdly, there were some institutional constraints in the various implementing agencies. Given their relative unfamiliarity with export term finance, and the innovative nature of the two grant Funds, this was readily understandable. The implementing agencies, quite correctly, were initially cautious to ensure that individual grant requests properly formulated a strategic and credible export development strategy. As staff gained experience, however, this institutional constraint disappeared. Finally, Government of India foreign currency procedures required case by case clearance for many of the eligible activities covered by the Export Marketing Fund and the Productivity Fund. This was time consuming and proved a considerable deterrent given the small sums involved. Following representations from the World Bank, in mid 1987, the Government of India agreed to give the steering committees for both funds blanket government permits for approved activities. 14. As might be expected given the difficulties described above, disbursements were also delayed. This was further aggravated during 1990 and 1991, by the Government of India imposing tight import controls in order to improve the country's difficult balance of payments position. This made the opening of new letters of credit difficult, even for the sub-loans already approved for Bank funding. 15. As a result of the slower than anticipated project disbursement rate, the Closing Date for the project was extended three times to June, 1992, two and a half years after the Closing Date stated in the loan documents. This extension was appropriate given that once the design constraints were identified and remedied, the demand for sub-loans under the project climbed rapidly. 12 Outcome and Overall Assessment 16. Despite a slow start, the objectives of the loan and project were achieved, and the boost to India's exports was realized. From 1987 to 1992, manufactured good exports increased by nearly 10 percent per annum in real terms, which exceeded the growth of India's exports in general. While it is impossible to apportion how much of this improvement may be directly attributable to the project, it is clear that the loan supported an increasing awareness within the Government of India of the need to improve export competitiveness and establish an enabling export policy environment. Parallel sector work by the World Bank, and a follow up Export Development Project in FY89, created a firm foundation for the bold trade reform measures that were embarked upon in March 1992. Furthermore, ICICI and the Participating Commercial Banks (PCBs) felt strongly that the availability of the World Bank line of credit was critical in enabling firms to import capital goods during a period of emergency import restrictions imposed during the balance of payments crisis of 1990 and 1991. 17. The project financing plan projected that the World Bank funds of $250 million would mobilize a further $750 million from other sources, for a total project funding of $1 billion. A review of sub loan data suggests that this target was exceeded by a significant margin, with total project funding of nearly $1.2 billion. A total of 439 sub loans were made, with a Bank disbursement of nearly $230 million. The list of beneficiary firms includes well known and established Indian companies that already had an export presence. But many of the recipients of sub-loans were engaging in export activity for the first time. Two of the PCBs reported that over half their loans were for new export projects. The financial performance of sub-loans varied across sub-sectors and institutions, with financial rates of return ranging from 14 to 40 percent. Repayment performance has been satisfactory, and was consistent with each implementing agencies' overall portfolio performance. 18. A notable feature and result of the line of credit component of the World bank loan was the institutional strengthening that occurred in the PCBs. All of the commercial banks involved experienced an improvement in their project appraisal capabilities, and all created specialized units to deal with export finance. 19. The two Funds established to promote export awareness and orientation and help firms in the development of viable export marketing strategies, disbursed $15.6 million consisting of 359 grants to 292 firms. Despite early administrative and design constraints, commitments and disbursements proceeded expeditiously once the constraints were rectified. These Funds had a highly positive impact. Incremental exports generated by assisted firms over a five year period were 37 times the amount of the grant support in U.S. dollar terms for the Productivity Fund and 60 times for the Export Marketing Fund. In all sub-sector categories, annual growth rates of exports for firms receiving assistance from either of the two Funds exceeded the growth rate for the overall sub-sector. Over 50 percent of recipients were first time exporters, and export sales as a proportion of total sales increased in all but 10 cases. During the course of this Performance Audit Review, OED met with a sample of 14 beneficiaries, and all indicated that the provision of these grants, together with the support and guidance of ICICI and the Export-Import Bank of India, were crucial in their entry or development of export markets. 20. A positive externality of the project, both the sub-loan and grant components, was the in- depth review of a company's export strategy which accompanied each loan or grant request. The mere process of undertaking the preparation of a comprehensive export agenda, served to 13 crystallize and focus corporate attention on improving production efficiency and meeting the needs of overseas customers. Furthermore the institutional capabilities of both implementing agencies improved, and the experience gained in guiding the export efforts of one company were used for guiding other companies. Both agencies created separate cells to implement the two Funds, and both took a very pro-active role in encouraging companies to improve their export orientation. 21. All implementing agencies expressed satisfaction with the World Bank's implementation performance. Review and approval of individual sub-loan and grant applications was timely, with responses being received from the Bank in four to ten days. Supervision missions (approximately two per year) were considered adequate and productive, all agencies commented favorably on the Bank's flexibility in adjusting project parameters and covenants when it was clear that initial design features were imposing unnecessary constraints on commitments and disbursements. 22. Overall, the project had relevant objectives and an appropriate design, with some novel features adequate to the Indian macroeconomic environment. There were some initial design constraints which artificially and needlessly constrained project implementation, but once rectified, the project proceeded smoothly, and its objectives were achieved. Thus outcome is rated as satisfactory, and the Bank's and Borrower's performance is also rated as satisfactory. It is noteworthy, however, that during the life of this project, the staff inputs necessary for supervision were high (107.2 staff weeks), reflecting the initial design deficiencies. 23. The success of the project, however, did depend crucially on a continued process of investment liberalization and deregulation and trade reform, which only accelerated towards the end of the project's life. When the project was conceived in 1984, the Government of India did initiate some promising reform measures with the stated intent to continue. Progress in the last five years of the eighties, particularly in trade reform, was slow however. While manufactured export performance was good, it could have been better with more appropriate macro-economics policies and a more aggressive and bold approach to economic liberalization. The impressive response to the reform measures taken between mid 1991 and mid 1995 provide a graphic illustration of what could have been done, and how both the domestic and world economy would have responded as this project was being implemented. Institutional Development 24. In the context of this project, the Productivity Fund and Export Marketing Fund, clearly provided an impetus and initiation into the export market for many firms who might have found it too daunting a task, even in a more liberal economic and trade regime. Furthermore, the human resource and institutional strengthening that occurred in the area of export development was highly beneficial, and will have had wider, positive externalities for the whole economy. This project, together with the wide range of sector work undertaken by the World Bank in the second half of the eighties, contributed to a firmer understanding by the Government of India of the appropriate and necessary economic reform agenda that had to be followed. It is noteworthy that the comments on this PAR received from the implementing agencies, both expressed their ongoing efforts to improve their export development effectiveness. One also suggested that a future Productivity Fund should be on a soft loan, revolving fund basis to ensure that assistance can be maintained in the long term. Thus institutional development impact is rated as substantial. 14 Project Sustainability 25. Both the grant and sub-loan activities under this project were sustained via a follow-up project (Export Development Project; Loan 3058-In and 3059-In) approved in 1989. All implementing agencies and the PCBs have continued to lend for export projects, using resources raised in the domestic financial markets. And, given the freer policy environment currently existing, all institutions have been able to capitalize on their experience under this project and continue to provide support to firms wishing to undertake export development activities. Furthermore the Government of India recently approved (November 1995) a $35 million "Brand Promotion Fund" for exports, with the express mandate of assisting Indian firms in marketing their products abroad. Given these developments, the project's sustainability is rated as likely. Lessons From The Project 26. A number of lessons can be learned from this project and will be useful in guiding future World Bank export development projects. These are discussed below. 27. Macro-economics and Trade Regime Framework. This project was designed, appraised and implemented to support a Government of India reform effort and boost India's exports. Initial policy reform measures were encouraging, but the necessary reform momentum was not sustained. Ideally, a line of credit project such as this, targeted toward providing finance for export development, would have its maximum impact within the framework of a rapidly reforming trade regime. Thus, good policies, supported if necessary by an adjustment operation, or a sequence thereof, should be a prerequisite for such export development projects, providing a conducive framework of less distortionary price signals. Firms that have been sheltered over a long period of time by a highly protectionist trade regime, may need some time and assistance to adjust to a changing incentive structure. This is precisely how an export development project can be most effective. 28. The Hardware and Software of Export Development. The availability of adequate credit and foreign currency to provide capital inputs necessary for firms to improve productivity and product quality is a crucial rationale for an export development project. But as has been shown in other countries, and in the experience of this project, it is often not enough. Assistance is often needed in a range of other areas such as marketing, product adaptation, market knowledge, export procedures and shipping and legal frameworks. This project recognized that, and incorporated a component to assist and finance these efforts, with highly successful results. 29. Institutional Strengthening. For all implementing agencies there was learning as they dealt with relatively new and unusual activities. All recognized this and sought to adjust their institutional structures and improve their human resource base in export development. Inevitably this took time, and perhaps the project, in its initial design, underestimated the time necessary. In future projects in other countries, it would be useful to identify and specify at the outset, the needed institutional changes and staff development efforts necessary for export development finance activity and design the project accordingly. 30. Disadvantages of Sector and Sub-Sector Targeting. The early project parameters that focussed upon so-called product "thrust areas" was too restrictive, and impeded early implementation of the project. The lesson is clear that sub-sector export development should be 15 determined at the firm level and project design should recognise this, incorporating the maximum degree of flexibility in implementation. 31. Financial Sector Conditions. In all line of credit projects such as this, the market should be left to decide onlending interest rates, and implementing financial institutions need to be granted discretion to set interest rates according to the perceived risk in each sub-loan.  17 1. Background 1.1 Since independence in 1948, India has pursued an economic development policy that placed a high priority on economic diversification and self sufficiency. To this end, India has sought to develop a broad industrial and manufacturing sector, covering the full range of capital, intermediate and consumer goods. The policy framework focussed upon substantial investment by the public sector in heavy and medium manufacturing. In addition, industry was protected and directed by a system of elaborate controls over capacity utilization and expansion, imports, investments in certain sub-sectors and operational practices. Finally, there was a strategy of protection for small scale industry through exclusive production reservation in the belief that this would serve to promote more equitable wealth distribution and generate large amounts of non agricultural employment. 1.2 The policies of industrial development and protection for domestic manufacturing output were initially couched in terms of the need to encourage and nurture infant industries. The mix of policies used, and their method of implementation, however, did not yield the desired results in industrial, export or employment growth. 1.3 The policies used were various. Certain sub-sectors were exclusively reserved for the public sector, whether it be at the National or State levels. There was an extensive system of investment licensing and regulation for those sub-sectors not deemed the exclusive preserve of the public sector. These industrial regulations were often coupled with a complex array of incentives and/or exemptions designed to promote locational choice, labor/capital mix, technology employed, product pricing and distribution and financial structure. The largely publicly owned financial system provided directed credit for so-called "priority sectors" at subsidized interest rates. Specific rules were defined for the operations of foreign owned entities which imposed limits on their growth, diversification and financial management. New foreign investment was vigorously vetted, and only allowed within a system of ownership guidelines and technology transfer agreements . 1.4 Over time, there developed a system of employment legislation designed to protect labor from dismissal or redundancy, administered at both the Central and State levels of government. During the same period a complex and opaque tax system evolved, with high rates and numerous exemptions and allowances. This system of direct and indirect taxation not only distorted resource allocation decisions, but had a direct bearing on intermediate good input decisions at the firm level, which in turn affected the entire industrial structure. The final overlay on this network of control and protection was a trade and tariff system, with import licensing, quantitative restrictions, export controls and import tariffs which, by the mid eighties, was one of the most protectionist in the world. 1.5 As noted above, the results of these policies have been disappointing. In 1955, India's manufacturing sector was second only to China in the developing world. By the mid seventies, India's rank had slipped to fifteenth. Manufactured exports followed a similar trend, with export growth lower than that achieved by developing countries overall. The objective of a diversified For a detailed description of the entire regulatory structure in India and how it evolved see World Bank, India: Industria RegulatoY Reform, Report No. 9264-IN, May, 1991. 18 and broad industrial base had been achieved by the early eighties, but at a high cost. The industrial structure was characterized by high firm concentration ratios in many sub-sectors, a large number of which were monopolistic or oligopolistic. On the other hand, other sub-sectors were characterized by large numbers of very small manufacturing units, the majority of which operated below an efficient minimum economic scale. The development of a vibrant, medium scale manufacturing base in the country was retarded. 1.6 The diversified industrial base that had been developed by the mid eighties, was generally high cost, with a powerful anti-export bias inculcated by the trade and tariff regime2. Furthermore the relative isolation in which the various sub sectors evolved, impeded access to technology advancements, in both product and process, with the result that by the early eighties much of India's industry was technologically backward. During this whole period good progress was made in developing the human resource base relevant for the engineering product industry. The irony however was that a significant number of engineers and technicians migrated, to both developing and developed countries that were experiencing more rapid growth in manufacturing, and in consequence were able to offer better returns for skilled labor inputs. 1.7 The comprehensive range of industrial policies followed, while creating a degree of self sufficiency, did not allow India to exploit it's areas of comparative advantage (as they evolved over the first three decades following independence) with the result that export opportunities were missed. This was particularly true for light industrial product lines, an area in which India should have had a strong competitive advantage, at a time when world trade in these items was growing rapidly. The major beneficiaries were other newly industrializing developing countries, most notably in Asia, but also in other regions of the world. Table 1: India's Share in World Exports (%) 1970 1979 1981 1980 1982 1983 Leather, Leather Manufacture 11.4 9.0 5.3 6.8 5.9 5.2 Woven Textiles 5.3 2.2 1.85 2.3 1.7 1.65 Clothing 0.7 1.9 2.4 1.8 2.3 2.1 Iron and Steel 0.9 0.25 0.13 0.17 0.12 0.12 Metal Products 0.5 0.74 0.71 0.58 0.67 0.70 Non-Electrical Machinery 0.1 0.13 0.13 0.13 0.12 0.11 Electrical Machinery 0.1 0.11 0.08 0.13 0.08 0.07 Transport Equipment 0.1 0.10 0.05 0.14 0.05 0.04 Chemicals and Related Products 0.2 0.20 0.12 0.26 0.12 0.12 Average All Manufactures 0.54 0.46 0.37 0.44 0.35 0.33 Source: UN Statistical Year Book, various years. 1.8 Despite a good resource endowment, and a pool of skilled manpower, industrial growth in India has been sluggish. The growth rate in manufacturing has declined in each decade since 1950, 2 See Annex II for a table showing a selection of nominal tariff rates for manufacturing industries for a selection of 15 countries. Of this group, India's was the highest. 19 and averaged only 3.8 percent per annum in real terms from 1971 to 1980. During the same period, industry's contribution to GDP increased only marginally, reaching about 16 percent in 1981. While Indian manufactured exports grew at a more rapid rate than output, the 6.8 percent annual average export growth rate achieved was much lower than the nearly 12 percent annual average growth in manufactured exports achieved by the developing countries in the 1970s and early 1980s. It is noteworthy that between 1978/79 to 1984/85, the real effective exchange rate appreciated and the range of export subsidies declined; with the clear stagnation of manufactured exports3 1.9 In 1983 and 1984, the Government of India undertook a serious review of the industrial policy framework, with a specific objective of determining the policy and institutional measures needed to improve the competitiveness and export performance of the manufacturing sector. In the Budget presented to Parliament in March 1985, and in subsequent announcements, significant changes in strategy and policy were announced. The measures taken included the following: * The definition of companies falling under the restricted growth provisions of the Monopoly and Restrictive Trade Practices Act (MRTP) was adjusted, with the result that the number of engineering and metal product firms falling under MRTP fell from over 100 to 20. This adjustment meant that firms could expand or enter any product line rather than being constrained to a "priority" list and take advantage of existing automatic expansion provisions. * Industrial approval procedures were liberalized and 25 industries delicensed. Furthermore, special protection and incentives for small scale industry were diluted. * The Government of India introduced greater flexibility in the use of licensed capacity, resulting in greater firm discretion to determine the product mix. * Corporate and income tax levels were reduced, with a 50 percent tax exemption on profits from export sales. Since profits from domestic versus export sales are difficult to determine, exports as a percentage of sales was used as a proxy. This reduced the anti-export bias and represented a strong incentive to export. * Provisions were made to allow manufacturer exporters to obtain duty free imports of inputs and components without requiring a firm order. This facility eliminated the financing costs and delays in the duty drawback system. * Import duties on capital goods were reduced from a minimum of 65 percent to duty levels of 0 percent to 40 percent. * Institutional measures to improve the administration of import licensing, with many items being placed in an "Open General License" category. * Finally in the 1986 Budget, the Ministry of Finance announced the government's intent to replace all quantitative restrictions with tariffs over time. The volume index of manufactured exports was as follows: 100.0 (80/81); 105.1 (81/82); 95.3 (82/83); 95.6 (83/84); 108.1 (84/85); and 106.2 (85/86). 20 1.10 Sustained implementation of the initial reform momentum was disappointing in the last four years of the eighties. While industrial approval procedures were liberalized, administrative inertia still inhibited development of a freer investment climate and ongoing trade reform was modest. In 1988, the average nominal tariff was 141.2 percent, the trade weighted average was 85.5 percent and the average total collection rate was 61.9 percent. By 1990/91, the average nominal tariff was 128.0 percent, the trade weighted average was 77 percent and the collection rate was 41.6 percent. A balance of payments crisis came to a head by mid-1991 (international reserves had fallen to a level equivalent to two weeks of imports) and the country was on the verge of default on its external payment obligations. Following a period of emergency macroeconomic stabilization, a major and broad structural reform program was initiated. Tariffs were lowered with the removal of all licensing requirements for capital and intermediate good imports. As a result of these trade reforms, average collection rates fell to 28 percent by 1993/94 (more details on this trade reform effort, are included in the forthcoming Performance Audit Report on India - External Sector and Investment Regime Liberalization (Loan 3627-IN). 2. Project Objectives and Design 2.1 The prime objective of this Industrial Export Project was to support and bolster the policy measures and trade reforms taken and planned by the Government of India (GOI). These reform measures, together with the targeted efforts of key financial institutions and export promotional agencies supported by the project, were designed to increase the competitiveness and export orientation of both the engineering good sub-sector, as well as manufactured products in general. It was recognised that to improve the cost and quality of Indian engineering goods, pervasive structural change was necessary. As discussed in the previous section, the Government of India embarked upon a program of liberalization and change in the structure of import and export incentives. It was also recognised that term finance would be necessary, geared toward efficiency (including technology enhancements) and scale improvements within engineering firms and their auxiliaries. 2.2 In addition to the term finance component of the project, a major goal was to shift the focus of export promotion from general market information and trade trips sponsored by the government and quasi-government agencies to direct support of strategic marketing measures by individual companies. In the project design, it was explicitly recognised that the "software" components of export marketing and export initiatives was a necessary adjunct to the changes in the incentive structure and the availability of term finance for machinery and production modernization. Under this component, the Export-Import Bank of India (EXIM) and ICICI would fund firm level market research and development activities by individual firms in collaboration with their respective industry associations. This project objective would have the additional bonus of improving the institutional arrangements and capacities of all these agencies involved in export promotion. And, these improving institutional capabilities would catalyze awareness among private manufacturing companies in India of the profitability of exporting and the necessary steps to achieve this. 2.3 The project was designed around two loans: one to the Government of India and one to ICICI. The loan to the Government of India (Loan No. 2629-IN) was itself divided into three components: (a) US$70 million to be passed on to four government-owned participating commercial banks (PCBs) for financing term sub-loans to private auxiliary engineering firms; (b) US$10 million to be provided as matching grants by EXIM to engineering companies for export 21 marketing activities; and (c) USS10 million to be provided as matching grants by ICICI to engineering companies for productivity improvements necessary to compete internationally. The second loan (Loan No. 2630-IN) of US$160 million was provided directly to ICICI, guaranteed by the Government of India, for financing term sub-loans for export oriented projects, of which US$100 million was earmarked exclusively for engineering products. 2.4 An important element of the project design was to include the commercial banks in the export development effort, and increase their orientation toward explicit export financing activity. Under this component, the commercial banks extended sub-loans to eligible companies, which were refinanced by the Government of India in the form of equity out of the proceeds of the Bank loan. In order to target so called auxiliary engineering firms, limits were initially placed on maximum sub-loan size (US$500,000) and the maximum size of companies supported (US$2 million in fixed assets). Repayment was denominated in Rupees, with sub-loan interest rates set at the prevailing non-subsidized commercial bank term rate. The ICICI sub-loan component also included certain restrictions in the initial project design. Initially, repayment by the sub-borrower was denominated using the World Bank's variable currency pool and interest rate plus a 2 percent intermediary spread to ICICI. This proved to be a constraint during initial project implementation and was subsequently adjusted (see para 3.2 below). 2.5 As noted above, an innovative and important aspect of this project was the inclusion of funding to provide highly targeted and focussed assistance to the export market development efforts of individual firms. The Export Marketing Fund (EMF) was administered by the Export Import Bank which extended grants to private companies covering up to 50 percent of eligible activities. The remaining portion was to come from internal company accruals. Eligible activities included desk and overseas research, travel to and from India, staff training, minor product adaptation, quality certification, and establishment of overseas operations. Grants up to USS50,000 were vetted and approved by EXIM, with larger amounts requiring approval from a steering committee composed of government and financial institution representatives. An initial project design restriction limited eligibility to eleven product groups (engineering products and computer software), but this was subsequently eased during implementation (see para 3.2 below). A separate administrative unit was established in EXIM to oversee implementation of the EMF. 2.6 The so-called Productivity Fund (PF) was administered by ICICI. As with the EMF, grants were to be extended under the PF to private companies covering up to 50 percent of eligible activities. These activities included hiring productivity consultants, staff training, product adaptation, and exposure trips to see foreign operating systems. This eligible range of activities was subsequently expanded (see para 3.2 below). ICICI could approve grants up to US$100,000 in consultation with the Association of Indian Engineering Industries (AIEI), with larger grants subject to approval by a steering committee of government and financial institution representatives. An initial project design restriction focussed eligibility on so called "thrust" engineering products. As with the EMF, the product eligibility project design restrictions were subsequently eased (see para 3.2 below). Finally, as with EXIM, a separate administrative unit was established within ICICI to implement the PF. 2.7 The project documents (the President's Report and the Staff Appraisal Report) explicitly noted that this Industrial Export Project was designed to support and complement the Government of India's initial reforms designed to improve the competitiveness of Indian manufacturing and the competitiveness of her engineering good exports. The reforms to industrial and trade policies that occurred in 1984 and early 1985, certainly indicated a willingness by the authorities to address the 22 policy induced distortions that hithertofore had contributed to a loss of competitiveness in Indian manufacturing. However, as sector work undertaken prior to, and following agreement on this project indicated, much needed to be done. At the time of Board presentation, India's trade regime was one of most restrictive in the world and its industrial sector one of the most regulated. While a targeted export development financing effort would help to overcome some of the shortcomings of the policy milieu, by itself, it would not generate a self sustaining, dynamic export drive. This would require a bold and sustained reform of the trade regime and the industrial regulatory system. In the absence of this reform effort, projects such as this Industrial Export Project would have little, long term impact. 2.8 In it's presentation to the Board, the Bank explicitly noted this risk to the project's enduring success. In the Staff Appraisal Report (para 86, page 27) and the President's Report (para 7.05, page 42), explicit mention was made of the need to sustain the policy initiatives taken prior to Board presentation and to ensure that procedural and administrative difficulties (i.e. bureaucratic inertia) would not undermine the impact of the policy changes. Furthermore, strong emphasis was given to the need to ensure an appropriate macro-economic environment (in particular the maintenance of a real exchange rate conducive to providing adequate incentives for manufactured exports relative to production for the domestic market) throughout the life of the project. In the absence of a sequence of adjustment operations however, these crucial and vital policy steps could not be ensured nor guaranteed. At the time (mid 1985), the Government of India was adamant in its desire to streamline bureaucratic procedures and continue a policy of industrial and trade deregulation. Furthermore, a host of committees, task forces, and ministries had developed proposals for further decontrol of the industrial sector and a general economic liberalization. As discussed later in this report (paras 4.15 and 4.16), the boldness and pace of economic liberalization, industrial decontrol and trade reform undertaken between 1991 and 1994, relative to what occurred between 1985 and 1990, suggests what might have been done during the life of this project. More importantly, the impact and contribution of the project would have been all the greater if the policy reform measures advocated in the Board documents had been carried out expeditiously. 3. Project Implementation 3.1 The project was identified and appraised in 1984, negotiated during August and September 1985, and approved by the Executive Directors in October 1985. The project was signed on January 21, 1986, and both loans became effective five months later on June 23, 1986. ICICI and one of the PCBs, began to commit sub-loans in August 1986; EXIM and another PCB began to commit funds in the first half of 1987 and the other PCBs in 1988. 3.2 Initial implementation of the project was sluggish. Three years after Board approval, loan commitments were only 29 percent of the estimated amounts at the time of Board presentation, and loan disbursements only 13 percent of the appraisal estimate. There were a variety of reasons for this: (a) there was a long delay of five months between loan signing and effectiveness; (b) sub-loan interest rates, as initially set for both ICICI and the commercial banks, were not attractive to potential borrowers. ICICI sub-loan interest rates, initially set at the World Bank currency pool rate plus 2 percent, proved unattractive to 23 potential borrowers who were not familiar with the currency pool and quite naturally were reluctant to assume an exchange rate risk, with limited possibility to hedge this risk. A period of rapid nominal devaluation of the Rupee did not help potential borrower confidence. To remedy this situation, the Government of India, in consultation with the Bank, agreed in February 1988 to assume the foreign exchange risk and to denominate ICICI sub-loans in Rupees carrying an interest rate of 14 percent. This rate reflected the prevailing market term lending rates and was positive in real terms (inflation in 1987, as measured by the Consumer Price Index, was 8.8 percent). Under this revised scheme, for each sub- loan, ICICI agreed to pay the Government of India the difference between the World Bank interest rate and the sub-loan interest rate, less a retained spread. In return, the Government of India agreed to compensate ICICI for the foreign exchange risk on servicing the World Bank loan. To improve the attractiveness of PCB sub-loans, agreement was reached in November 1988 to bring them into conformity with ICICI rates; (c) institutional constraints in the various implementing agencies also contributed to the early delays in project implementation. For the PCBs, there was a need for each bank to develop internal structures and procedures consistent with the project objectives, obtain the permission of the Government of India on those procedures, and adequately publicize and promote the export development project to their client base (this was also an initial problem encountered by ICICI); (d) the EMF and PF were innovative new funds requiring unfamiliar tasks. EXIM and ICICI, quite correctly, were initially cautious to ensure that individual grant requests properly formulated a strategic export development strategy. As their staff gained experience and the especially established units became more efficient, this institutional constraint disappeared. In fact, this should be counted as an important contribution of the project, as the institutional capabilities built up and established, greatly improved the export development capabilities of both institutions. Furthermore, as the project proceeded, the experience gained in assisting early beneficiaries with their export development plans and strategies, provided a rapidly expanding data and knowledge base of the most cost effective and efficient marketing strategies, which proved of great benefit to new beneficiaries later in the project, and in subsequent projects. In terms of project design, there was perhaps a little too much optimism on the part of the Bank in gauging institutional capability to deal with complex export marketing issues, and the speed with which this expertise could be established; (e) an additional factor contributing to the slow start of the EMF and PF was that many of the eligible activities used foreign currency (for example overseas travel, technology imports and for licensing agreements on hiring foreign consultants) which required governmental clearances. This was time consuming and proved a considerable deterrent given the relatively small sums involved. Following representations from the Bank, in mid 1987, the Government of India agreed to give the steering committees for both funds blanket government permits for approved activities. This blanket permission was not envisaged or foreseen in the initial design. Ironically, once granted, the lack of onerous bureaucratic procedures proved to be an important attraction of both programs; 24 (f) after the first two years of the project, it became readily apparent that the project design included a number of restrictive procedures and covenants which slowed commitments. By 1988, when action was taken, it was apparent that the sole focus on certain industrial sub-sectors, and so called "thrust product areas" was overly restrictive. There was considerable demand from a wide range of non- engineering product sub-sectors which held significant export promise. At the request of the Government of India, the Bank agreed in February 1988, to reduce the allocation for engineering products for ICICI loans from US$100 million to US$60 million, and eliminate restrictions for commercial bank sub-loans. In addition, the Bank agreed that ICICI sub-loans could cover Rupee costs as well as foreign currency costs, up to 80 percent of each sub-project. With regard to the commercial banks, the Bank agreed to increase the maximum size of sub-loans from US$500,00 to US$1 million and the maximum asset size of eligible companies from US$2 million to US$4 million; and (g) finally, during the first two years of the project, it was found that the PF was too narrowly defined as to eligible activities, and as a result was broadened to include all export marketing activities in a manner similar to the EMF. 3.3 As might be expected given the difficulties described above which slowed commitments, disbursements were also delayed. Besides these difficulties, two additional factors slowed disbursements. First, during the 1990 to 1991 period, the Government of India, in order to improve the country's balance of payments position, imposed tight import controls. This made the opening of new letters of credit difficult, even for those sub-loans already approved for Bank funding. Second, there were often long delays (up to six months) between the submission of a claim for reimbursement by the implementing agencies to the Government of India and the submission of these claims by the Government of India to the Bank. 3.4 As a result of the slower than anticipated project disbursement rate, the closing date for the project was extended three times to June 1992, two and a half years after the planned Closing Date in the Loan Documents. This extension was appropriate given that once the design constraints were identified and remedied, the demand for sub-loans under the project climbed rapidly. 4. Outcome and Overall Assessment 4.1 Despite a slow start, the goal and objectives of the loan and project were achieved, and the boost to Indian exports was realized. From 1987 to 1992, manufactured good exports increased nearly 10 percent per annum in real terms, with the engineering products sub-sector increasing somewhat faster at 11 percent per annum. Both annual average growth rates exceeded the growth of Indian exports in general. How instrumental the World Bank loan was in improving export performance is not entirely clear, however. What is clear is that the loan supported an increasing awareness within the Government of India of the need to improve export competitiveness and have an enabling export policy environment to foster this. From OED field discussions with the various implementing agencies and a sample of beneficiaries, it is also apparent that all those associated with the project deemed it to be a successful operation. In particular, ICICI and the PCBs felt that the availability of the World Bank line of credit was critical in enabling firms to import capital goods during a period of Government of India emergency import restrictions on these goods to protect a deteriorating foreign exchange reserve position (1990 and 1991). 25 4.2 The project financing plan projected that the World Bank funds of US$250 million would mobilize a further US$750 million from other sources (both domestic and foreign), for a total project funding of US$1 billion. A review of sub-loan data suggests that this target was exceeded by a significant margin, with total project funding of nearly US$1.2 billion. Foreign commercial borrowings did not materialize as anticipated, but this may have been due more to other macro- economic and policy environment factors, than any intrinsic difficulties with the project and the range of sub-loans supported. 4.3 A total of 439 sub-loans were made, with a Bank disbursement of nearly US$230 million. For ICICI, the sub-loans averaged about US$1 million, and for the PCBs about US$250,000. The funds were used to improve the productivity of the manufacturing process and the quality and price competitiveness of the product. While the initial project design focussed upon engineering firms, this was found to be overly restrictive. Once the restriction was lifted, commitments and disbursements accelerated, with the result that beneficiary firms ranged across all sub-sectors in the manufacturing sector. The list of beneficiary firms included well known and established Indian companies that already had an export presence. But it is noticeable, however, that many recipients of sub-loans were engaging in exports for the first time. Two PCBs, for example, (Bank of Baroda and Canara Bank), reported that over half their loans were for new export projects, and, in the case of Bank of Baroda, 40 percent of sub-loans extended were to firms that had not previously been a client of the Bank. 4.4 The financial performance of sub-loans varied across sub-sectors and institutions, with financial rates of return ranging from 14 to 40 percent. Repayment performance has been satisfactory, and was consistent with each implementing agency's overall portfolio performance [in the case of Canara Bank, the loan repayment performance was better than their overall portfolio performance, and with respect to the Punjab National Bank, of 18 firms assisted, 6 repaid the entire term loan prior to the due date]. 4.5 A notable feature and result of the line of credit component of the World Bank loan was the institutional strengthening and focus that occurred in the PCBs. The Bank of Baroda reported an improvement in their own project appraisal capability, with an increased emphasis on Domestic Resource Cost and Economic Rates of Return calculations to determine the viability of a particular project proposal. The need to ensure competitiveness in an international environment, ensured an optimal benchmark for resource allocation that was more consistent with the country's comparative advantage. In the case of Canara Bank, a specialized internal unit was established in 1993 after the loan was closed to focus exclusively on export credit [both term loan and working capital] and develop the Bank's client base in this area. In addition, the bank founded in 1992 an "Industrial Advisory Division" comprising technical and engineering specialists and financial expertise to assist firms in project appraisal and export market development strategies. While this institutional strengthening was not touted as a major component in the appraisal documents, it undoubtedly has been an important benefit of the project. 4.6 As noted earlier, an innovative and novel feature of this World Bank loan was the establishment of the Productivity and Export Marketing Funds to promote export awareness and orientation and help firms in the development of viable export marketing strategies. These two funds disbursed about US$15.6 million consisting of 359 grants to 292 firms (63 firms obtained more than one grant), with an average grant size of about US$50,000. Selected indicators of the two funds activities and achievements is shown in Table in the Annexes. 26 4.7 Despite early administrative and design constraints, commitments and disbursements of both Funds proceeded expeditiously once the constraints were rectified. By any performance measure, both the PF and EMF had a highly positive impact. Incremental exports generated by assisted firms over a five year period were 37 and 60 times respectively the amount of grant support in US dollar terms. In all sub-sector categories, compound annual growth rates of exports for firms receiving assistance from either of the two funds exceeded the growth rate for the overall sub-sector. Of the 180 firms receiving assistance from the EDF, 52 percent were first time exporters. With regard to the PF, the table below clearly illustrates the improved export orientation of the assisted companies. In 1987/88, 47 firms had exports of more than 5 percent of total sales, whereas by 1991/92 70 firms had exports more than 5 percent of total sales. Furthermore, there are indicators that assisted firms improved their internal competitiveness and organizational efficiency. In 1987/88 40 firms had a capacity utilization lower than 50 percent, whereas by 1991/92 this number had fallen to 16. Table 2: Productivity Fund - Export Orientation Over Time 1987/88 1991/92 Export Sales As % of Total Sales Number of Firms Number of Firms < 10 percent 69 48 10-25 percent 14 18 > 25 percent 17 34 4.8 It is noteworthy, that in the context of the PF, the implementing agency, ICICI, undertook a comprehensive survey of beneficiary companies to ascertain the full impact of the fund. The results are revealing. The motivations for exporting reflected a clear change. In 1987/88, the main motivations reflected the more inward looking, domestic market orientation, with factors such as export incentives and export obligations (following import duty concessions) being most frequently cited. By 1991/92, these same firms expressed the view that export activity was lucrative and an opportunity for business growth, with a variety of beneficial externalities. For example, many firms expressed the view that as their export orientation increased, their organizations became more dynamic, top management was became responsive with less decision making layers, problem solving capabilities improved, product development and quality was improved and the confidence to enter new markets enhanced. 4.9 During the field mission as part of this project audit, OED staff met with a sample of 14 beneficiary firms. Without exception, they noted that the provision of grants funds under the PF and EMF, together with the support and guidance of ICICI and EXIM, were crucial in their entry or development of export markets. Some noted a change in their focus and corporate attitude from production driven exports (i.e. viewing exports as a residual activity) toward an approach of market driven exports. Not all companies were successful, but the success rate was very high. Of 190 companies assisted under the EMF, 10 expressed their inability to execute the approved export development strategy or plan. 27 Some Firm Case Studies of Beneficiaries of the Productivity Fund and Export Marketing Fund. During the course of the field mission in India undertaken to complete this performance audit, the mission met with fourteen firms that had benefited from the Productivity Fund and the Export Marketing Fund. A brief synopsis of some of these firms is shown below. It is also noteworthy that EXIM has published a book in 1996 showing detailed case studies for six beneficiaries of the Export Marketing Fund (Achieving Excellence, Tarjani Vakil (Ed), EXIM Bank of India, New Delhi, 1996). This book is now lodged with the Joint Bank-Fund Library. Firm 1. A large agrochemical and chemical firm (sales of over $100 million) in existence for 26 years. Exports in 1989/90 were US$2.5 million. Assistance was received from the Fund to find markets abroad. Export sales in 1994/95 were US$24.2 million with customers in over 100 countries. Firm 2. A very small producer of X-Ray screens with sales in 1986 a mere USS50,000. The firm was dying with poor quality and outdated technology. In early 1988, the firm received assistance from ICICI in the form of a grant of about USS6000 to upgrade technology, fund quality control instruments and develop contacts overseas. Sales in 1995/96 estimated at USS2 million, of which 50 percent was from export sales. Firm 3. A small electronics firm producing "hard ferode magnets" for loudspeakers. Funds from the Productivity Fund were used to hire the assistance of specialist consultants, and fund visits to trade shows. Prior to this the firm did not export; in 1994/95 exports accounted for 25 percent of total sales of US$3.2 million. Firm 4. A producer of "vinyl leather cloth", in existence for 40 years. Exported to the Soviet Union under the bilateral treaty trade with India. The market in the former Soviet Union collapsed. Funds from the Productivity Fund were used to develop alternative export markets for the company's coated fabrics and improve quality standards. Export sales were US$4 million in 1994/95 compared to USS900,000 in 1988/89. The company now employs a full time German sales manager. Firm S. An engineering firm started in 1989 producing gear systems for bicycles. Received assistance from the Productivity Fund for export market development. Sales now about US$2.5 million, over 60 percent to export markets. Firm 6. A producer of hand tools used a grant from the Productivity Fund to obtain technical advice from abroad and to participate in trade shows. All output is exported, with sales growing from USS600,000 in 1987 to US$3.5 million in 1995. The owner of the firm states that the availability of the grant funds initiated the export effort. Firm 7. An engineering company formed in 1972, started exporting to the Middle East in 1977, but experienced difficulty in expanding further. Working with EXIM, and with funds from the EMF, by 1989 the company had managed to enter the European and U.S. Markets, and by 1994 had received ISO 9002 quality certification for its products. Exports in 1993/94 were nearly US$10 million from a level of US$I million in 1987/88. Firm 8. An auto auxiliary company, formed in 1971, produced clutch plates and brake pads. By 1985, the company was in severe difficulties, and by 1988 was involved in a rehabilitation program with the financial institutions. By 1991, this had succeeded, and the company was now firmly established in the domestic market. With support from EXIM and the EMF, the company developed an export strategy, including ISO 9000 quality certification, and utilized foreign technical expertise to upgrade quality. Exports have grown from about US$500,000 in 1990/91 to about US$3 million in 1993/94. 28 4.10 A positive externality of the project, from both the sub-loan and grant components, was the in-depth review of a company's export strategy which accompanied each loan or grant request. The mere process of undertaking a comprehensive export agenda, served to crystallize and focus corporate attention on improving production efficiency and meeting the needs of overseas customers. Furthermore, as the project proceeded the institutional capabilities of ICICI and EXIM improved. The success or otherwise, of assisted companies was used as an additional input while appraising other proposals falling under the same sub-sectors. This ensured that mistakes either in the conception of plans or implementation were not repeated in future cases. The experience gained in guiding the export efforts of one company were used for guiding other companies. 4.11 Both ICICI and EXIM created separate cells to implement the two funds. EXIM developed a comprehensive software system for on line monitoring of sanctions, company and EMF progress and export performance of assisted companies. The half yearly repprts submitted to the World Bank also formed part of this software system. The human resource capability of both institutions (as well as the PCBs) was also improved. EXIM product officers were required to spend a major proportion of their time outside the office at company offices or factories guiding formulation of market entry plans as well as monitoring the implementation. 4.12 Both implementing agencies took a very pro-active role in encouraging companies to improve their export orientation. ICICI undertook a strong marketing effort for the PF in the initial stages of the project, making 500 audio visual presentations and meeting with nearly 3,000 firms. This graphically illustrates the need for a good implementing agency and the long lead times necessary in such export development programs. It is also noteworthy that with a "hit rate" of only 6 to 7 percent, the implementing agency must be prepared to undertake a wide promotional effort and be selective and uncompromising in its assessment of export development strategies and plans. In part, this also reflects the lack of export orientation in many Indian companies at the start of the project and the difficulties in overcoming management perceptions in firms that have enjoyed excessive protection over a long period of time. 4.13 All implementing agencies expressed satisfaction with the World Bank's implementation performance. Review and approval of individual sub-loan and grant applications was timely, with responses being received from the Bank in four to ten days. Supervisory missions (approximately 2 per year) were considered adequate and productive. ICICI, EXIM and the PCBs commented favourably on the Bank's flexibility in adjusting project parameters and covenants when it was clear that initial design features were imposing unnecessary constraints on commitments and disbursements. On the India side, there were some initial administrative problems encountered by all the implementing agencies involved. This may be readily understandable given the relatively new activities involved. But these difficulties were gradually overcome, and specific implementing units were created in all agencies with appropriate personnel. As this staff gained expertise, commitments accelerated rapidly. 4.14 From an overall perspective, this was a satisfactory project and was rated as such, with some novel features suitable in the context of the Indian macroeconomic environment. There were some initial design features which artificially and needlessly constrained project implementation. Defining project parameters (i.e. interest rate, so called "thrust" sub-sectors, firm size) which should more correctly be left to the market to decide is never a good approach. If there are considerable policy induced market distortions, it is better to remove the inappropriate policies 29 rather than add to the distortion and the uncertainties of doing business, by seeking project parameters that somehow seek to compensate for or alleviate the perceived market failings. Despite some of the initial design deficiencies the Bank and the Borrower displayed flexibility and adapted some of the earlier project parameters with beneficial results. Bank and Borrower performance is rated as satisfactory. It is noteworthy, however, that the initial design problems resulted in a much higher staff input during supervision of 107.2 staff weeks, compared to 69.7 staff weeks through appraisal. The Borrower was in compliance with all loan convenants. 4.15 This was not an adjustment operation, however, the full success of the project did depend crucially on a continued process of investment liberation and deregulation and trade reform. When the project was conceived in 1984, the Government of India at the time did initiate some promising reform measures with the stated intent to continue. Progress in the last five years of the eighties, particularly in trade reform, was slow however, with the result that by 1990 the balance of payments was approaching a serious crisis. While manufactured export performance was good, it could have been better with more appropriate macro-economic policies and a more aggressive and bold approach to economic liberalization. The impressive reform measures taken between mid- 1991 to mid-1995 provide a graphic illustration of what could have been done, and how both the domestic and world economy would have responded as this project was being implemented. 4.16 At the time this project was appraised and presented to the Board, India had one of the most restrictive trade regimes in the world. In order to overcome the anti-export bias inherent in the policy framework, a host of special dispensations, exemptions and incentives existed making for a highly complex, bureaucratic and unevenly discretionary business environment. As has been shown in many other economically developing countries, and most recently in India, the need for specific, targeted development finance projects diminishes significantly in a more liberalized economic environment as private, commercial sources of finance become more readily available. This is not to deny that market failures do not occur, even in highly market oriented economies. However, addressing clearly identified and ad hoc market failures as and when they occur is a preferred policy approach. In the context of this project, the PF and EMF clearly provided an impetus and initiation into the export market for many firms who might have found it too daunting a task, even in a more liberal economic and trade regime. Furthermore, the human resource and institutional strengthening that occurred in the area of export development was highly beneficial, and will have had wider, positive externalities for the whole economy. Institutional Development is rated as substantial. The fact that the Indian economy of 1995 is much more open and export oriented is a testament to the bold economic reform measures taken in the early nineties, but this project certainly contributed toward an increased export orientation and awareness on the part of policy markers, as well as the financing institutions and the manufacturing sector. This project, together with the wide range of relevant sector work undertaken by the World Bank in the second half of the eighties, contributed toward a firmer understanding by the Government of India of the appropriate and necessary economic reform agenda that had to be followed. 5. Project Sustainability 5.1 Both the grant and sub-loan activities financed under this project were sustained via a follow-up project (Export Development Project; Loans 3058-IN and 3059-IN) approved in 1989. This follow-up project provided funding for the same activities, and in addition, included a technical assistance component to further improve the managerial capabilities of the implementing agencies in evaluating export projects. Both ICICI and EXIM have continued to lend for export 30 projects using resources raised in the domestic financial markets. And, given the freer policy environment currently existing, both institutions have been able to capitalize on their experience under this project and continue to provide support to firms wishing to undertake export development activities. 5.2 Commercial banks have also played an expanding role in financing export activity. From 1991 to 1993, commercial banks increased their short term export finance by almost 50 percent, with generous refinance facilities provided by the Resource Bank of India. The Government of India has also issued a directive to the commercial banks to provide at least 10 percent of their credit for export finance, which many have surpassed. Furthermore, commercial banks have increased their term lending for both export and domestic projects, and for the PCBs in this project, term loans currently account for about 30 percent of their total credit portfolio. 5.3 A key element of this project has been the PF and EMF components for export promotion. Given the grant funding nature of this component, a question arises whether ICICI and EXIM can sustain this activity. Fortunately, the Central Government has recently approved (November 15, 1995) a US$35 million "Brand Promotion Fund" for exports, with the express mandate of assisting Indian firms in marketing their products abroad. While it is not clear at this stage how this fund will be administered and operated, it is a very encouraging sign that this export assistance activity will continue. Also both ICICI and EXIM have been looking into the possibility of providing innovative loan financing for export promotion activities. Furthermore, with the economic liberalization that has occurred in recent years, and the increased foreign business interest in India, a wider range of experienced market research and marketing advisory companies have expanded their presence in the country. Hence, professional export marketing assistance is now much more readily available on a commercial basis. Given all of the above, the project's sustainability is rated as likely. 6. Lessons From The Project 6.1 As noted above, this project should be deemed successful and satisfactory, from which some lessons can be learned which should be useful in guiding future Bank export development projects. These are discussed below. 6.2 Macro-economic and trade regime framework. This project was designed, appraised and implemented to support a Government of India reform effort and boost Indian exports. Initial policy reform measures were encouraging, but the necessary reform momentum was not sustained, particularly with regard to the trade regime. Ideally, a line of credit project such as this, targeted toward providing finance for export development, would have its maximum positive impact within the framework of a rapidly reforming trade regime. Thus, good policies, supported if necessary by an adjustment operation, or a sequence thereof, should be a pre-requisite for such export development projects, providing a conducive framework of less distortionary price signals. While encouraging firms to be more export oriented may include a degree of public relations promotion, and firm level marketing assistance, it is also encouraged by ensuring that export profitability is on a par with the returns made by catering solely to domestic markets. Firms that have been sheltered over a long period by a highly protectionist trade regime, may need some time and assistance to adjust to a changing incentive structure. This is precisely how an export development project can be most effective. 31 6.3 The "hardware" and "software" of export development. The availability of adequate credit and foreign currency to provide capital inputs necessary for firms to improve productivity and product quality is a crucial rationale of an export development project. But, as has been shown in other countries, and in the experience of this project, it is often not enough (a necessary but not sufficient requirement). Assistance is often needed in a range of other areas such as marketing, product adaptation, market knowledge, export procedures and shipping and legal frameworks. This project recognised that and incorporated a component to assist and finance these efforts, with highly successful results. Many countries have developed governmental or quasi- governmental agencies to support export development. However, often times these agencies are not as successful or useful in providing relevant and specific assistance at the firm level where it is most needed. This project shows what can be achieved in a complex and time consuming activity, provided the institutional framework is put in place. Furthermore, as these institutions gain experience, the quality of the firm level guidance and assistance can improve dramatically, provided the services are demand driven and not defined arbitrarily by a bureaucratic promotion agency. 6.4 Institutional strengthening. For both implementing agencies and the PCBs there was a learning curve as they dealt with relatively new and unusual activities. All recognised this, and sort to adjust their institutional structures and improve their human resource base in export development. Inevitably, this took time, and perhaps the project in its initial design underestimated the time necessary. This design anomaly was remedied in the subsequent export development project, with inclusion of a TA component to improve sub-project appraisal capabilities. In future projects in other countries, it would be useful to identify and specify at the outset, the needed institutional changes and staff development efforts necessary for export development finance activity and design the project accordingly. 6.5 Coordination of the "hardware" and "software" elements of export development. The PCR noted some deficiencies in this area which were remedied in the follow-up project. Coordination of both elements reduces documentation and the approval process. 6.6 Disadvantages of Sector and Sub-Sector Targeting. On the basis of earlier sector work by the Bank, and Government of India objectives, the initial focus of the project was to support certain manufacturing sub-sectors (i.e. engineering goods). This was found to be needlessly restrictive, impeded early implementation and was subsequently adjusted. The lesson is clear that sub-sector export development, should be determined at the firm level. Detailed comparative advantage studies are complex and can be misleading. Furthermore, comparative advantage is a dynamic concept, that is continually changing both in a specific country and in the world market. Project design should recognise this and incorporate the maximum degree of flexibility in implementation. 6.7 Financial Sector Conditions. Setting, A priori, interest rates for sub-loans proved an initial constraint. In all line of credit projects such as this, the market should be left to decide on- lending rates, and implementing financial institutions need to be granted discretion to set interest rates according to the perceived risk in each sub-loan.  33 Annex I Table 1A: Selected Indicators of Grant Achievements EXIM Bank ICICI EMF PF Amount Committed ($ m) 10 12 Amount disbursed (S m) 8.1 7.5 No. of Grants 207 152 No. of Companies 180 112 Av. Size of Commitments ($) 48,000 76,000 Av. Size of Grants Disbursed (S) 39,00 49,00 Av. Sales of Companies (Rs m) 261 205 Av. Incremental Export/Grants 60 37 Av. Ann. Exp. Growth in Co. 68 48 No. of Cancellations 12 0 a Average Disbursement Time (months) 15 (excl. ex-post funding) 18 Av. Cost Underrun (undis. bal.) ($) 9,000 27,000 % To Engineering Firms 71 61 a Ten grants were fully undisbursed but had not been formally cancelled. Table IB: Activities Funded By Grant Programs (% of Total) EXIM BANK ICICI Consultingffraining/Know-How 21 38 Business Promotional Travel 23 13 Product Certification/Adaption 31 10 Attending Trade Fairs 8 6 Staff Training 2 10 Production Equipment/Sampling - 18 Advertising 10 4 Establishing Overseas Offices 4 - Travel to India Buyers 1 1 Total 100 100 Unweighted Mean Nominal Tariff Rates for Manufacturing Industries (% ad valorem) Country Food, Textiles, Wood Paper, Chemicals, Non- Basic Machinery, Other All Beverages, Apparel, Products, Pulp, Rubber, Metallic Metals Metal Manufac- Manufac- Tobacco Leather, Furniture Printing, Plastic Mineral Products, turing turing Footwear Publishing Products, Products Transport Petroleum Equipment Argentina 21.9 36.7 34.1 27.2 13.6 27.3 27.7 25.6 22.0 22.9 Costa Rica 48.1 56.3 48.4 31.8 20.1 55.8 14.7 26.1 40.1 32.6 Ecuador 81.8 75.5 69.4 49.4 18.1 57.7 23.0 39.1 73.2 41.8 Egypt* 37.0 59.7 47.4 34.6 20.8 40.8 15.7 27.3 42.9 31.5 Hungary 29.7 16.2 10.5 8.5 12.6 9.6 4.9 22.3 11.5 12.6 India 140.2 135.8 118.2 125.6 147.3 128.5 217.2 124.3 137.8 137.7 Kenya 40.5 68.6 49.3 35.1 30.6 37.3 34.0 32.4 47.4 40.1 Mexico 29.9 31.6 36.7 26.7 18.1 29.3 18.8 22.7 31.1 22.4 Morocco, 74.2 74.0 70.0 67.8 52.3 64.8 40.9 57.0 75.6 62.1 Pakistan 97.5 108.9 119.7 66.0 72.4 94.1 69.1 66.2 100.7 80.9 Philippines 34.5 39.8 36.9 30.0 20.5 34.6 17.0 24.9 36.1 28.0 Sri Lanka 59.2 53.5 47.7 39.8 20.8 45.5 9.4 23.6 39.6 33.0 Thailand 59.4 49.1 46.6 35.1 29.2 53.3 20.4 34.5 45.4 38.3 Turkey 51.4 61.6 51.1 23.9 24.4 63.7 17.2 38.6 59.9 37.9 Yugoslavia 17.7 22.6 18.5 18.8 16.3 20.3 16.8 20.9 23.3 19.2 India (with 127.9 130.0 110.0 113.2 124.9 128.6 123.6 110.9 131.3 121.7 all-user exemptions) 1986 or most recent year includes import duties and flat duties (if any) but not excise taxes or the equivalent (e.g., India's additional duties). 4 Excluding (1) 21 items with tariff rates ranging from 160 to 3,000 percent, (2) customs consumption tax. b Includes 19 percent protection from neutral VAT. Notes: Computations are generally preliminary and subject to corrections. Other averages for all manufacturing are 48.9 for Madagascar and 44.7 for Senegal. Source: World Bank Sector Report, India: Export Development: A Proposed Strategy, Report No. 6663-IN, March 3, 1987. 35 Annex III Selected Indicator's Of India's Export Growth (USS in constant 1981 prices) Average Annual Growth Year Ending Year Ending Year Ending in Real Terms Mar. 31, 82 Mar. 31, 87 Mar. 31, 92 82-87 87-92 (SM) (SM) (SM) (%) (%) Total Exports 8522 10029 14915 3.3 8.3 Manufactured Goods 5240 6654 10607 4.9 9.8 of which Engineering 1048 907 1504 -2.9 10.6 Non-manufactured Goods 3278 3375 4367 0.6 5.3 Sources: Ministry of Commerce and Reserve Bank of India. Note: Deflated using export unit value deflators. 36 Annex (a) EXPORT- IMPORT BANK OF INDIA T.C. Venkat Subramanian -- al w rf Gnerzal Managr fi V fRd1CVIWB/120/96 it / Dare April 11, 1996 Mr. Manuel Penalver Division Chief Country Policy, Industry and Finance Division erations Evaluation Department The World Bank International Bank for Reconstruction and Development International Development Association 1818 H Street, N.W. Washington D-C. 20433 U.S.A. Dear Sir, India : Industrial Export Projc,t - Enmineering Products aLan 29 TN) May we refer to your leter dated March 14, 1996 enclosing a copy of the draft Performance Audit Report (PAR) for our comments. We have gone through the draft report and concur with all the comments made with reference to Exim Bank and Export Marketing Fund (EMF) component that was implemented by our Bank. 2. We wish to submit for your consideration and inclusion in the report the following new initiatives of our Bank that could be covered in paragraph 5-3 on Page 30 of the report. "As part of Exim Bank's onoing commitment to promoting excellence, the bank has been supplementing fmance with export related servccs. The crent mission of Exim Bank is to develop commercially viable relationsiip with target set of externally oriented companies by offering them a comprehensive mne of products and services, aimed at enhancing their intemationalisation efforts. Exim Bank has set up for visiting business delegations from oversegs, a display centre at its headquarters in Bombay, to showcase products supported under EME programmes that have successfully entered industrialised country markets. The bank has also established state-of-the-art training centre at Bangalore for imparting professional knowledge to export executives of Indian companies through focussed seminars and workshops on international trade and mvesanent related subjects.' ftas: 1s100, 214*e-w, rresqu,wt, gt.eo cas 21ssays.21ssseenvit toness,ar ingren2 ss Postaag : 18100, Canve0mptur21. waistree Canus. CarsPt. M.m,aginac00OL Pio.e:2185272.3182288CamaMu atinelol 5531390MINMar:2ta075 37 Annex (a) continued Continuation 3. We feel that inclusion of above points will reflect the real benefits that Exim Bank has derived from its experience as the implementation agency for EMF programme under World Bank's guidance- Thanking you, Yours faithfully, (T. C. VENKAT SUBRAMANIAN) 38 Annex (b) fg Omae: jes ascamllawfamann. The Industrial Credit and Investment Corporation of India Umited 1Ta.: Managemes 20251 I5 cm. ofice- 2022535 CR= P soemomr Tomes 011-8502 ICIC IN ed Fim 2041582 PAX MESSAGE TO MR.MANUEL PENALVER DIVISION CHIEF, COUNTRY POLICY, INDUSTRY AND FINANCE DIVISION, OPERATIONS EVALUATION DEPARTMENT, Tm iti n nua i 11 SR.VICE PRESIDENT ICICI, BOMBAY FAX NO 202-522 3124 DATE :APRIL 15.1996 Dear Sir, Re:Draft of the Performance Audit Report (PAR) Industrial Export Proiects - (Loans 2625 and 2630 IN) We refer to your communication dated March 14,1996 enciosng a copy of the draft Performance Audit Report (PAR) In respect of the above lines of credit for our comments. At the outset, we would like to thank the Bank for providing us an opportunity to manage the above lines. We would like to appreciate the efforts that have gone into preparing the aforesaid PAR. The report is fairty exhaustive and comprehensive, focussing on various aspects related to the lines (including the objectives, structure and implementation), the benefits accruing therefrom and the hurdles in the implementation thereof. We would also like to add that if the assistance had been provided by way of say, a revolving soft loan in lieu of a grant, it would haw supported in leveraging the benefits, particularly in respect of the Productivity Fund on a long term basis. Kind regards Annex (c) U afts Bank of Baroda (VWR 501-8 : W1v*, 116M (Heed offie : Mandvi. BARODA) qWvm Rm fgm CENTRAL OFFICE: qAqvft qkqt f4rfka, 3 ;ft S Project Finance Division P ftManeckji Wadia Bldg., 3rd Fir., Nanik Motwane Marg. SqOpp. Bombay University, WZqt 400023.Fort, Bombay-400 023. '~, tut-40023.Tel.: 2470250, 2t0205 J%if4 : 270250, 270205 : 22 52t2 */No. fAW/Date: REF:CO:PFD:88//cg 22.4..96 Mr.Manuel Penalver Division Chief Country Policy, Industry & Fin. Operations Evaluation Dept. The World Bank 1818 H.Street Washington DC 20433 U.S.A. Dear Mr.Manuel Penalver, Re : industrial Export Project - Engineering Products (Loan 2629-IN and 2630- IN ). We refer to your letter dated March 14,1996, on the captioned subproject forwarding therewith a draft Performance Audit Report prepared by your Evaluation department and inviting our comments on the subject issue. We also note that the matters related to our Bank are mentioned in the project on the lines of Project Completion Report submitted by us. The aggressive marketing and the inbuilt project appraisal capabilities of this division has enabled to support -69- cases under the said scheme in such a short time. This however, was possible with the support extended by the World Bank in quickly approving the projects. Though there may be shortfall in achieving the projection vis-a- vis the planned one, in overall we concur with your views that the objectives of the scheme were achieved and the line of credit has helped the industry to import the equipments, when there was foreign exchange crunch.We have to further inform you that with the promotion of the scheme, our Bank in particular has widened the scope of operations and certain practical skills were achieved through training opportunities provided under the World Bank assistance. With regards, Yrs sincerely, V. AL SEKSENA ASST.GENERAL MANAGER (PROJECT FINANCE)   IMAGING Report No: 15589 Type: PPAR