world bank document of the world bank ... idbi - industrial development bank of india iep ... terms...

Document of

The World Bank

FOR OFFICIAL USE ONLY

-~ 3 D sq _ aJ Report No. 7603-IN

STAFF APPRAISAL REPORT

INDIA

EXpORT DEVELOPMENT PROJECT

APRIL 2(,, 1989

Industry and Finance DivisionAsia Country Department IV

ThIs doemsent has a resticted di oibudin and may be used by e nt y In Ihe per_omae oftheir officfl duties. ls contents may not otherwise be disclWosd Bak autdd hoao

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CURRENCY EOUIVALSNTS

Rs 1 - US$0.071Rs 14 = US$1.00

FISCAL YEARS

Government of India = April 1 - March 31ICICI - April 1 - March 31Eximbank - January 1 - December 31Bank of Baroda - January X, - December 31Canara Bank = January 1 - December 31

PRINCIPAL ABBREVIATIONS AND ACRONYMS USED

AL - Advance LicenseCCS - Cash Compensatory SupportDD - Duty DrawbackDFI - Development Finance InstitutionEDF - Export Development FundEMF - Export Marketing FundERAS - Exchange Risk Administration SchemeEximbank - Export-Import Bank of IndiaFERA - Foreign Exchange Regulation ActGIC - General Insurance Corporation of IndiaGOI - Government of IndiaICICI - The Industrial Credit and Investment Corporation

of India, LimitedIDBI - Industrial Development Bank of IndiaIEP - Industrial Export ProjectIFCI - Industrial Finance Corporation of IndiaIRBI - Industrial Reconstruction Bank of IndiaLIC - Life Insurance Corporation of IndiaMRTP - Monopolies and Restrictive Trade Practices ActOGL - Open General LicensePCB - Participating Commercial BankPF - Productivity FundRBI - Reserve Bank of IndiaSFC - State Financial CorporationSIDC - State Industrial Development CorporationTA - Technical AssistanceUTI - Unit Trust of India

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INDIA

EXPORT DEVELOPMENT PROJECT


Table of Contents

Page No.

LOAN AND PROJECT SUMMARY ....... ............................ i

I. INTRODUCTION .......... ............................ ** ........ 1

II. SECTOR BACKGROUND .......................... ... ..... 2A. Industrial Policy Environment ........................ 2B. Export Policies and Administration ..... ................. 5C. The Financial System ........................... 8D. Exchange Risk Administration Scheme (ERAS) ... .......... 12

III. THE BANK'S ROLE IN INDUSTRY ............. ....... . .. ..... 14A. Previous Bank Lending to Industry ....................... 14B. The Bank's Future Lending Strategy .......... ............ 16

IV. THE PROPOSED EXPORT DEVELOPMENT PROJECT ..................... 18A. Objectives and Project Components ... 8.................... iB. Export Development Fund (EDF) Components . . . 21C. Technical Assistance Fund (TAF) Components 22D. Term-Lending Components . ................... ... ......... . 23E. Project Costs ............... ... .. . 24F. Financing Plan . .......................... ...... 24

V. THE PARTICIPATING FINANCIAL INSTITUTIONS .................... 26A. The Industrial Credit and Investment Corporation

of India, Limited (ICICI) ............................... 26B. Export-Import Bank of India (Eximbank) ......... ......... 27C. Bank of Baroda ... ....................................... 28D. Canara Bank ............................................. 28

VI. THE PROPOSED LOAN . .................................. . 30A. Terms and Conditions ....... ............................. 30B. Administrative Procedures ...... ......................... 32C. Project Benefits and Risks ...... ........................ 35

VII. AGREEMENTS AND RECOMHENDATIONS .............................. 36

This report was prepared by Messrs. Ataman Aksoy and A. Olawale Edun (AS4IF),and Mr. Andrew Singer (Consultant). It is based on a mission led by Mr. MichaelGould (AS4IF) in November-December 1988.

This documeit h a restricted distribution and may be used by recipients only in the pefonceof their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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ANNEXES

I. The Industrial Credit and Investment Corporation of India, Limited (ICICI)

Table 1.1: Actual and Projected Income SheetsTable 1.2: Actual and Projected Balance SheetsTable 1.3: Actual and Projected Cash Flow StatementsTable 1.4t Collection Performance Before ReschedulingTable 1.5: Arrears of Principal Before ReschedulingTable 1.6: Average SpreadsTable 1.7: Resource Position as at December 31, 1988

1I. The Export-Import Bank of India (Eximbank)

Table 2.1: Audited Income StatementsTable 2.2: Audited Balance Sheets

III. Bank of Baroda

Table 3.1: Audited Prr,fit and Loss StatementsTable 3.2: Audited Balance SheetsTable 3.3: Spread Analysis

IV. Canara Bank

Table 4.1: Audited Profit and Loss StatementsTable 4.2: Audited Balance SheetsTable 4.3: Spread Analysis

V. The Export Development Funds - Draft Statement of Policies andOperating Procedures

VI. The Technical Assistance Funds - Draft Statement of Policies andOperating Procedures

Table 6.1: Technical Assistance Component

TABLES

Export Structure and Performance

Table A.ls Merchandise Exports, 1980181-1987/88 - Current PricesTable A.2: Merchandise Erports, 1980/81-1987/88 - Constant 80/81 Prices

The Financial System

Table B.l: Commercial Bank SpreadsTable B.2: Structure of Industrial Finance for the Private Corporate

Sector in India

INDIA

EXPORT DEVELOPME?IT PROJECT

LOAN AND PROJECT SUMMARY

Borrower s (a) India, acting by its President; and

(b) Industrial Credit and Investment Corporation ofIndia, Limited (ICICI)

Guarantor of the s India, acting by its PresidentLoan to 'CICI

Beneficiaries s ICICI; Export-Import Bank of India (Eximbank); Bankof Baroda; and C Onk

Amount s US$120 million to India, Acting by its President; andUS$175 million to ICICI

Terms s The proposed loans would be made at the Bank'sstandard variable interest rate and would haveterms of 20 years including 5 years of grace.

Relending Terms : ICICI Credit Component. The Bank loan to ICICI wouldeither be relent to subborrowers in foreign exchangeat the Bank's standard variable interest rate plus 2Zor in rupees at the prevailing rate under theExchange Risk Administration Scheme (ERAS) (presently152 with a cap rate of 182). Under this arrangement,the differential spread between the interest rate onthe Bank loan and the ERAS rate less 22 for ICICI'sspread, would accrue to the ERAS Fund to cover therisk of interest and exchange rate fluctuations. TheERAS rate would be adjusted every six months toensure that the interest rate and foreign exchangerisks are adequately covered.

Eximbank and PCBs Credit Component. US$100 millionof the US$120 million loan to the Government would bepassed on to these financial intermediaries asequity. Their clients will be small and medium sizefirns and the final interest rates to subborrowerswould be consistent with the Reserve Bank of Indiainterest rate structure for term lending to thesesectors: 13.52 p.a. for small firms and 142 p.a. formedium size firms. These rates are highly positivein real terms given current and projected inflationrates of 8Z. The Government would bear the foreignexchange and interest rate risks.

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Export Development Fund acnd Technical Assistance FundComponents. US$20 million and US$2.7 million wouldbe allocated to the Export Development Funds andTechnical Assistsnce Funds, respectively. The ExportDevelopment Funds would be administered by the finan-cial institutions on behalf of the Government. TheGovernment would pass on the Technical AssistanceFunds to the institutions on a non-reimbursablebasis. It is expected that the Technical AssistanceFund would be financed by the Japanese GrantFacility.

Proiect The proposed project would assist the Government toDescription carry out its strategy of promoting the growth of

manufactured exports. The project would assist keyfinancial institutions through: (i) an ExportDevelopment Fund (EDF) to finance part of the costsof consultant fees and Zoreign travel associated withthe preparation and implementatiohn of their clientfirms' export development programs; (ii) a TechnicalAssistance Fund to help strengthen the institutions'capacity to appraise export projects and advise firmson export strategy issues; and (iii) a line of creditfor term lending to finance export investmentprojects.

Benefits and : The proposed project would build up institutionalRisks capabilities, within the Indian financial system, for

supporting manufacturing exporters. The creditcomponent would provide long term finance to about350 subprojects, resulting in total investments ofabout US$730 million. On the basis of the perienceunder the Bank's previous export project, ..eprojects financed under the Export Development Fundscan be expected to generate exports many times thevalue of the initial EDF investment. The projectwould also have positive effects on the environmentas ICICI, in particular, has incorporated strongenvironmental objectives in its strategy statement.

There is a risk that subprojects financed under theproject may not be internationally competitive. Tomitigate this risk, the Exp.rt Duvelopment Fundcomponent would help firms develop coherent exportplans while the Technical Assistance Fund componentwould help the financial institutions to improveabilities to assess export projects. The ERASarrangement for relending the Bank loan to ICICI isnew and it would be closely monitored by theGovernment, the financial institutions and the Bankto ensure that the adjustable rate covers the cost offoreign borrowings and provides greater financialpredictability for both the financial institutionsand their subborrowers.

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Estimated Costs : Local Foreign Total------ USS Million)--

Credit Component 411.7 27b.0 686.7Export Development Fund (ICICI) 7.0 7.0 14.0Export Development Fund (Eximbank) 7.0 7.0 14.0Export Development Fund

(Commercial Banks) 6.0 6.0 12.0Technical Assistance for ICICI 0.4 1.2 1.6Technical Assistance for Eximbank 0.3 0.7 1.0Technical Assistance

for Commercial Banks 0.3 0.8 1.1

Total 432.7 297.5 730.4

Financing Plan

Bank -- 295.0 295.0ICICI 45.0 -- 45.0Eximbank 8.0 -- 8.0Commercial Banks 47.6 -- 47.6Subproject Sponsors 212.0 - 212.0Other Capital Market Sources 120.1 -- 12X.IGovernment of Japan 2.7 2.7

Total 432.7 297.5 730.4

Estimated Bank FY 89 90 91 92 93 94 95Disbursements

Annual 0.4 33.0 60.0 77.0 86.0 24.0 8.6Cumulative 0.4 33.4 99.4 176.4 262.4 286.4 295.0

Economic Rateof Return : Subprojects financed by the Financial Intenmediaries

would have a minimum economic rate of return of 12Z.

INDIA

EXPORT DEVELOPMENT PROJECT


I. INTRODUCTION

1.01 After several decades of following restrictive industrial regulatorypolicies and an inward looking trade regime the Government has, in recentyears, embarkeC upon a broad reform program. The reform program consists ofliberalizing the regulatory framework, streamlining export policies andadministration and libiraliziag the trade regime. These changes have alreadyled to significantly higher growth in industrial output nnd exports. Thesustainability of further reforms, especially in import liberalization willdepend crucially on IndJa's ability to continue increasing its export growthto meet its increased imports.

1.02 The proposed Export Development Project will assist the Government inits efforts to sustain, and build upon, the current success in manufacturingexport growth. The project is designed to achieve this goal by supporting thework of key development finance institutions and commercial banks, which haverecently developed strategic plans for assisting firms to increase theirexport volumes. The project would complement the institutions' work in twoimportant areas. First, it would help them build up their institutionalcapabilities for providing direction and advice to their clients on exportissues and markets. Second, it would help them to improve their own abilitiesto assess export projects as well as to mobilize the additional resourcesneeded to support such projects. The project would also provide a basis forthe continuation of the very active dialogue between the Government and theBank on export policy.

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IT. SECTOR BACKOGOUND

A. Industrial Policy Environmer..

2.01 The Indian industrial sector has achieved considerable success inattaining the post-Independence goal of self-sufficiency. and has developedproduction capability across virtually the whole spectrum of industrialactivity. This success has not been without considerable cost. The indus-trial growth rates have consistently been below Plan targets and substan-tially lower than in many other industrializing nations. Growth inmanufacturing output which averaged about 4Z p.a. between FY74 and FY81only increased to 5.7Z in FY81-FY85 period. The policy of investmentlicensing and controls on output and technology acquisition led to a stateof product shortages that inhibited competitive behavior. Furthermore, thehigh import barriers created by widespread quantitative restrictions andthe very high tariffs effectively delinked many Indian industries from thetechnological developraents in the rest of the world. The heavy indirecttaxes on all stages of production had a cascading effect that, whilereducing the degree of overall effective protection, increased itsvariability and raised domestic prices making it difficult to expandmarkets and achieve economies of scale. The rigidities created by theregulatory system not only constrained firms' ability to enter new marketsand expand, but also limited their ability to restructure and/or closedown. In many sectors, continued production by financially sick firms viasubsidies, undermined the viability of the remaining more efficient units.As a result of these policies, Indian firms in many industrial subsectorsare below international standards in terms of technology, scale andefficiency, and offer products at high prices and variable quality. Thisenvironment has also contributed to India's disappointing export perform-ance. Lack of incentives for export activities and the appreciation of therupee during the first half of 19809 led to an environment where manufac-tured exports (which account for about 702 of India's total exports) grewon average at less than 3Z p.a. in real terms over the period PY80 to FY86,and represented a small and declining share of industrial output (less than52 in FY85).

2.02 The Seventh Plan (1984/85-1989/90), annual budgets, the Long-TermFiscal Policy (LTFP) and recent official policy statements have set out aspries of policy reform objectives designed to address some of the majorproblems indicated above. Since 1985, GOI has initiated a series ofdiscrete policy actions which although individually incremental when takentogether have already made significant improvements in the industrialpolicy environment. The reforms in industrial policies have been comple-mented by some liberalization of the financial sector especially in thecapital markets (paras. 2.21-2.23). The policy reforms implemented sinceFY85 can be grouped under four broad areas. The first is the liberaliza-tion of the domestic regulatory system bys (a) delicensing investmentsfirst up to about US$4 million and more recently up to US$ll million indeveloped areas, and up to US$37 million in backward areas, as well asreducing bignificantly the number of industry groups that require alicense; (b) giving firms much more flexibility to adjust both output mixand capacity; (c) allowing greater import of capital goods and technology

by moving capital goods into open general license (OGL) and easing restric-tions on technology imports; (d) reducing the number of products reservedfor production by small scale industriest and (e) easing the monopolyreg1ulations by increasing the threshold level and expanding the productareas in which firms classified as monopolistic can invest.

2.03 The changes in the regulatory framework have been complemented bya policy of licensing more capacity (relative to estimated domestic demand)compared to earlier practice, to induce greater domestic competition andexportable surpluses. Minimum import cor.tent of 15? for projects whichrequired a license has been increased to 302. The phased manufacturingprograms have been modified to reduce the targeted domestit content from902 to 70Z. Minimum economic scales have been established in many productgroups to reduce inefficient import substitution. Licensing for foreigntechnology collaborations was also eased to allow Indian industry to catchup with the rest of the world. The number of foreign collaborationapprovals, which averaged around 350 p.a. between 1975 to 1982, jumped toabout 1,000 p.a. after 1985.

2.04 The second area of reform is a series of measures to improve thetax system includings (a) reduction and simplification of income andcorporate taxes; (b) implementation of a modified value added tax (MODVAT)that eliminates the cascading effect of indirect taxes for most productsand facilitate indirect tax deduction for exports; and tc) rationalizationof tax incentives for small scale industries.

2.05 The third area of reform has been attempts to deal more construc-tively with the increasing problems of sick firms and industries, espe-cially after deregulation and increased ease of entry. Until recently,financial institutions and state governments had been constrained tomaintain "sick" industrial enterprises functioning through differentschemes thus burdening their portfolios. To deal more effectively withobstacles to closure, restructuring and rehabilitation of firms, the SickIndustrial Companies (Special Provisions) Act, 1985, established proceduresfor identifying and resolving the worst cases of financial difficulties.The Act established the Board for Industrial and Financial Reconstruction(BIFR), with quasi-judicial powers to order and speed closures, mergers,and other changes, including the power to override some other industriallegislation. The current obligation of a company with completely erodednet worth to report to the BIFR, and of the subsequently appointedoperating agency to coordinate all involved parties and rapidly recommend arehabilitation or closure scheme, should rationalize and quicken thedecision-making process on the rehabilitation or closure of sick units.While the creation of the BIFR was a major step forward, its ability to actefficiently was being constrained by the fact that its activities wereconfined to firms where net worth is already fully eroded. In recognitionof this problem, in 1989, firms were required to report to BIfR when 502 oftheir net worth is eroded.

2.06 The last area of reforms is export policies and administrationwhere the most fundamental and consistent changes have been made. The mostimportant change has been the adoption of a flexible and realistic exchangerate policy conducive to export growth. The real effective exchange ratehas depreciated more than 302 since the end of 1985. At the same time the

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Government has introduced and st,eamlined the duty exemption schemes forimports used in export production, and now almost all inputs are importableby exporters without restrictions and payment of duties. Fcr firms usingduty paid and domestic inputs, the Governmeat has streamlined the adminis-tration of the the duty drawback and refund of excise taxes on domesticallyproduced inputs to reflect actual tax incidence.

2.07 As a result of these policies and an expansionary macroeconomicpolicy, industrial growth has accelerated to an average of 9? p.a. over thelast three years (FY85-FY88) compared _.o about 5S over the preceding fiveyears. This rapid growth, which has been achieved despite drought inducedcontraction in agricultural output of almost 7Z, is partially in responseto the improved policy environment which has enabled firms to adapt tomar.ket conditions by adjusting the volume and composition of their output.According to Bank estimates, t'his growth has not come just from addedinvestments, but also from more efficient use of existing resources. Thecapital-output ratios for manufacturing had been consistently increasingfrom 4.3 in FY74 to 5.0 in FY81. Since then it has decreased to 4.2 inFY87. The labor productivity has also been increasing much faster in the1980s. The response of exports to improvements in policy has been slowerthan that of domestic output. The depreciat'on of the rupee, which startedin 1986 and accelerated in 1987, together with increased domesticcompetition, has significantly increased the relative profitability ofexporting compared to production for the domestic market. Furthermore, thepolicy and administrative reforms gradually implemented over the last fewyears (see paras. 2.09-2.19) have eliminated many bottlenecks thatinhibited export growth. Thus after growing by less than 31 p.a. in theearly 1980s, exports have started growing rapidly in FY87 sand FY88.Manufactured exports grew about 13? in real terms in FY87 and 25Z in FY68.The proportion of manufacturing exports in total exports has increasedsteadily in recent years to 74z in FY88, reflecting the fast growt'n of thissegment (See Table A). At present, the main product groups are gems andjewelry (22.4Z), textiles (18.8?), garments (15.5X) and leather manufacture(1OZ). The share of engineering goods (12.22) has started to rise again,after falling slightly in previous years. Total real exports in the firstnine months of FY89 are up by about 12?, compared to the same period in theprevious year. At the same time, there has been a structural shift in thecomposition and destination of exports. Exports to industrializedcountries have increased their share from 54? in FY82 to 672 in FY87. Thisstructural change has come about due to the decline in traditional exportareas of COMECON, African and Middle Eastern markets and expansion ofexports to industrialized countries.

2.08 While recent policy improvements have been far reaching andimpressive, more remains to be done to increase the competitiveness ofIndian industry. With the exception of export policy, where fundamentalchanges have been made, the incremental nature of the other reforms havecreated pockets of improved competition coexisting with subsectors wherethere has been little improvement. Import liberalization has beenprimarily in capital goods. some intermediate products and all inputs forexports. Severe constraints on public resources and foreign exchangeavailability, the complicated structure of existing industrial policies andvery strong political sensitivities have necessitated a gradual and incre-mental approach to liberalization in India. Rapid growth of exports as well

as industrial restructuring caused by greater competition can be expectedto reduce these constraints significantly over the next few years and allowthe Government to accelerate its reform program, especially in the moredifficult areas of greater import liberalization and industrial exitpolicies.

B. Export Policies and Administration

2.09 A Bank report outlining the problems in expanding industrialexports and recommendations to overcome these problems has been preparedand discussed with the Government (India - Export Development: A ProposedStrategy, March 3, 1987). The export sector report identified as majorproblems, the high profitability of production for the domestic marketrelative to production for export, Lnd high cost of Indian productscompared to their competitors. The major cause of the profitabilitydifferential has been strict regulations inhibiting domestic competition,the orervalued exchange rates, and high tariffs coupled with QRs whichprovide substantial protection to domestic producers. The lack of competi-tiveness is primarily due to high cost of intermediate inputs caused par. Iyby high tariffs and/or high excise taxes and partly by production ineffi-ciencies. Although India had a full set of schemes intended to supportexports and compensate for the effects of protection and indirect taxes,they were probably the most complex in the world and were unsatisfactory intheir administrative implementation and procedures. The only successfulexports were in a few product lines that either had easy and duty freeaccess to imported inputs (e.g., diamonds) or relied heavily on domesticinputs that are abundant and priced close to world prices (e.g., cottongarments and leather products). On the basis of these findings, the exportstrategy report strongly recommended, as the minirum necessary conditionfor the rapid expansion of exports, the development of an efficient dutyand domestic indirect tax exemption scheme that would allow both direct andindirect exporters quick access to all (domestic and imported) inputs atworld quality and prices. In addition, maintenance of a realistic exchangerate, and freeing the exporters from domestic regulations that curtailtheir ability to change their output, technology, labor force and locationwere recommended to improve the competitiveness of exports. The reportalso stressed the need for gradual liberalization of the import regime tofoster increased competition and to reduce the artificially high profitsobtained in the domestic market.

2.10 In FY86 and more effectively in FY87, the Government started aprogram to address the issues of export policy. 1/ These reforms have beenfurther extended under the new Import and Export Policy for the next threeyears (FY89-FY91) announced in April 1988. A major change has been in the

1/ Details of all recent policy improvements have been summarized inD. B. Keesing's 'Recent Improvements in Indian Export Policies andTheir ImplementationO (December 1987), and "An Evaluation of ExportMeasures in India's 1988-91 Import and Export Policy' (May 1988),available in the project file.

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design and administration of the duty exemptLon scheme (advance licensesand passbook for imported inputs). In February 1987, the duty exemptionsystem (Advance Licenses) was extended to cover all imported inputs(including raw materials, components, mandatory spare parts and packingmaterials) for both direct and indirect exporters, based either on a speci-fic export order or past export performance. To facilitate the granting ofAdvance Licenses (AL), central and regional committees with decision-makingpowers have been set up and meet weekly or biweekly. In May 1987, the"passbook' scheme was made operational for firms that have exported for theprevious three years and would like to import their inputs for a longerperiod (e.g., 18 months). In April 1988, the passbook scheme was extendedto all firms with sales of more than Rs 150 million, even if they had notexported previously.

2.11 For firms using domestic and/or duty paid inputs, Duty Drawback(DD) and Cash Compensatory Support (CCS) systems have also beenstreamlined. The Duty Drawback, which co-ipensates the exporters forcustcms and Central excise duties, has been considerably simplified andrationalized by the establishment of all industry rates and fasterreimbursements. These rates have also been increased to approximate theactual duties and excise taxes paid. For CCS, which compensates theexporters for indirect taxes of all types not covered by duty drawback, therates have been increased considerably to reflect the actual cost ofindirect taxes. In 1987, firms that use duty exemption schemes were alsobrought under CCS to compensate them for the indirect taxes on localinputs, which allows these firms greater flexibility.

2.12 The Government has also tried to compensate the exporters, espe-cially smaller units that cannot import directly, for the high cost ofuniversal inputs produced in India by supplying these inputs to exportersat international prices. Currently basic iron and steel, special alloys,special steels, rubber, aluminum and aluminum products, and basic petro-chemicals such as benzene, naptha, methanol, etc., are included in thisscheme.

2.13 Another area of improvement has been in preshipment export creditwhere the strict lending norms have been relaxed for the credit needs ofexporters. To assist exporters in their marketing efforts, the ReserveBank of India (RBI) has allowed exporters to retain up to 10 of theirforeign exchange receipts to fund their marketing efforts abroad under anew blanket permit.

2.14 The 1988-91 Import and Export Policy announced in April 1988 hasbrought further reforms and changes. Important changes were made to thescheme for replenishment (REP) licenses. Now almost all exporters areentitled to receive REP licenses which are a proportion of their exports.With these licenses the firms can import any canalized and restricteditems, and can sell these in the domestic market. This policy change, inaddition to increasing the incentives for exporting, also contributessignificantly to the liberalization of the import regime by making the QRsless binding. The Policy also includes major initiatives to extend exportincentives to indirect exporters, i.e., to firms supplying raw materialsand components to direct exporters. Before April 1988, dutv free importsof raw materials two stages back from the export was permitted only for a

limited list of products. The new policy allows first, any direct andindirect exporter to jointly apply for a new Intermediate Advance License,which permits duty free import of raw materials and componeuts by theindirect exporter. Second, every exporter with a duty free import licensecan buy instead from a local firm. On the basis of this, the local firmcan obtain "deemed export" status. As a deemed exporter it can then obtainduty drawback on its raw materials and components and is eligible for CCSavailable to deemed exports and for REP licenses.

2.15 The new Import and Export Policy has made important revisions tothe rules and facilities for export and trading houses. The previousextremely complex qualifying rules have been replaced by much simpler rulesrelated to the fob value of exports and net foreign exchange earnings. Inparticular, these houses will now have full access to the advance licenseand passbook schemes for duty free materials; receive a more generoul.allowance to import and stock raw materials for resale to other firms; willbe able to import capital goods and otherwise restricted raw materialsunder 'additional' import licenses and sell them in the domestic market.

2.16 A number of measures bave been introduced to make importedmachinery and equipment needed by exporters more easily available and atlower cost. First, as discussed below, the machinery and equipment neededby some export oriented industries and industries believed to have exportpotential was put on the OGL list and the corresponding import tariffs werereduced usually to about the 25Z to 35? range. Second, for licenses toimport restricted capital goods, a new provision introduced in April 1988gives nspecial consideration' to manufacturerlexporters exporting more than252 of their output or with exports in excess of US$7.7 million in that theimport may be allowed on the basis of price and delivery considerationseven if the capital goods are indigenously available. Third, the greaterflexibility allowed in REP and additional licenses among other thingsapplies to imports of capital goods, and should benefit all users ofcapital equipment including exporters.

2.17 The income tax deduction for exports has been substantiallyincreased by allowing all profit from exports to be deducted from taxableincome. This should significantly increase the profitability of exportingversus production for the domestic market.

2.18 The reforms implemented over the last few years have improved theprofitability of exports and have eliminated some other impediments tosustained export growth. However, more remains to be done in policies andinstitutions to put exporters on an equal footing with their competitorsabroad. The remaining problems can be grouped into two categories. Firstis the streamlining of the export administration system to efficientlyimplement the duty and restriction free importe for exports. Through theexpansion of the advance license and the passbook schemes, Indian exportadministration is moving from a system which approximately compensatesdirect exporters for the higher prices of domestically produced or dutypaid intermediate inputs with limited imports, to a system that allowsdirect exporters free choice between domestic and imported inputs andex ante access to them without paying duties. In the transition, bothsystems will have to be utilized and even in the long-run, it is desirableto give exporters the choice between alternative compensation schemes. For

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the new export administration to operate efficiently, a system that estab-lishes input coefficients systematically is an essential requirement.Based on these coefficients, close coordination among different agenciessuch as Directorate of Technical Development (DGTD), Chief Controller ofImports and Exports (CCIE), CCS administration in Ministry of Commerce andDuty Drawback Department in the Ministry of Finance is needed to administ.:existing compensation schemes in a complementary manner. The Bank has madea proposal to support the needed streamlining process through a compo-entof a UNDP Technical Assistance Project. Under the project, a combined teamof officials responsible for implementing export policies would visit othercountries, such as Korea, to study their export administration systemu.This would provide the officials with cross-country experience and ideasfor improving the Indian system. The project proposal, for which the Bankwill be the Executing Agency, has been submitted to the Government and isawaiting further processing. Furthermore, sustained export growth willdepend on being able to extend value-added derived from the exportingactivity back to the suppliers of inputs to exporters and, eventually, evenfurther back. The principle of ext ling free trade status to indirectexporters has commendably been acceptc-. in the 1988-91 Import-ExportPolicy. However, the actual system appears to be having some initialimplementation problems, which will require the continuing attention ofGovernment. The second category includes policy changes that are needed tocompensate exporters for higher cost capital goods in India and relievethem of some of the labor and location restrictions that are placed on allfirms. The Government is in a continuous process of evaluating the prob-lems still faced by exporters and has been very flexible in adjusting thepolicies to eliminate the bottlenecks. So far, improvements in administra-tive streamlining and reduction in the costs of capital goods have beenimplemented as a response to short-run problems. However, after che newImport and Export Policy, GOI has been evaluating alternative proposals forboth administrative streamlining and has already experimented with alter-native methods of reducing the tariffs on capital goods for exporters.

2.19 Given the continued improvements on the export policies, theresponse of exports to these incentives depend on firms' ability to enternew and more demanding markets and restructure their products and processesto be competitive. In this area, despite the existence of various tradepromotion organizations in India, there is very little effective institu-tional support, especially for new exporters, to assist in their marketingand technological upgrading efforts. The proposed project aims to helpestablish programs in key financial institutions to assist exporters toincrease the supply response of firms to the improved policy environment.

C. The Financial System 2/

2.20 Historically, India has followed relatively conservative monetaryand financial policies. The main objectives have been to mobilize domesticsavings on a large scale, contain inflationary pressures and achieve apattern of investment conforming to the Government's economic and socialpriorities. These objectives have been pursued through several mechanisms.

2/ World Bank, India: Credit and Capital Markets Study, ReportNo. 6661-IN (February 27, 1987), provides a comprehensive analysis ofthe Indian financial sector.

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First, interest rates have been administered through the Reserve Bank; andthe interest rates paid on commercial bank deposits and other savingsinstruments as well as the lending rates hzve been kept positive in realterms. Second, the commercial banking system's scope for credit creationhas been tightly circumscribed. Third, a system of quite rigid creditallocation guidelines has been used to direct funds to earmarked industriesand social sectors. Within this policy framework, the financial system hasgrown rapidly over several decades and the nation's traditionally highsavings rates have been accompanied by significant financial deepening.Savings rates have risen steadily from about 16S of GDP in the late sixtiesto an average of 231 since 1980. Likewise the ratios of M2 and credit toGDP have risen significantly. M2 to GDP has risen to about 451 in 1985from 261 in 1975. These levels are more usually found in a typical middleincome country than a low-income one such as India. However, this successon the resource mobilization side contrasts with the more mixed results ofresource allocation policies both in terms of their impact on economicefficiency and the financial condition of lending institutions. Theevidence suggests that in conjunction with restrictive industrial policies,the credit allocation policies encouraged inefficient patterns ofinvestment in industry. As of December 1986, commercial bank credits of Rs49 billion were officially classified as being extended to "sickindustries' which have negative net worth. Outstanding credit to sickindustries alone are about 15.72 of commercial banks' credit to industryand 8.12 of their total outstanding credit. The situation in the DFIs issimilar; in 1985 IDBI's outstanding loans to sick industries were about 111of itr portfolio. In addition to the sick industry problem, the collectionratios on other industrial and agricultural lending have been decreasing.The problems are being further exacerbated by increased competition facedby many industries resulting from the ongoing industrial liberalization.Together with deteriorating portfolio quality, the operating spreads offinancial institutions have narrowed as recent interest rate adjustmentshave resulted in lower average lending rates and higher funding costs.Thus there is a need to rationalize the system of financial sector controlsand improve the institutions' operational flexibility and profitability.In recognition of these problems the Government has since 1985 set upseveral committees to study the various financial markets and recommendways of improving the working of the financial sector and their reports areproviding a basis for an ongoing process of reform. 31

2.21 In the last few years, the Government has encouraged the develop-ment of new and more appropriate funding instruments and markets to financeindustry; thus, it has encouraged a shift away from bank loans to morecapital market funding of both private and public sector industrial firms.

2.22 First, restrictions on the purposes for which companies couldissue securities were progressively relaxed to allow flotation of deben-tures to fund new companies, mergers/acquisitions and working capital.

3/ These are the Chakravarthy Committee to Review the Working of theMonetary System (1986); the Patel Committee on the Operations of theStock Exchange (1986); the Vaghul Working Group on the Money Markets(1987) and the Hussain Committee on the Capital Markets (1988).

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Second, the quantitative limit for issues exempt from capital issuescontrols was doubled to Rs 10 million and listing requirements were eased.Third, in an effort to encourage public sector firms to raise funds on thecapital markets, these fims were given the freedom to undertake publicdebenture issues even though their shares may not be listed. Measures todiversify the markets and improve the attractiveness of issues by start-upfirms have included the introduction of new instruments such as CumulativeConvertible Preference Shares (CCPS). These securities count as equity,carry a 102 dividend and are convertible into straight equity after threeto five years. Also liquidity has increased--particularly in the debtmarkets--with the major public sector investment institutions playing animportant role in maintaining secondary markets. Finally, the Governmenthas introduced legislation to protect investors and boost confidence in themarkets and new institutions such as a stock holding corporation have beenset up to simplify the purchase of securities. The introduction of furthercapital market reforms is expected soon. In response to the variouschanges in regulations and fiscal incentives the capital markets have grownrapidly in the 19808, and particularly since 1985. The equity market tookoff in 1980181 as a result of legislation which led to the indigenizationof ownership of many foreign firms. Since then, the primary market hasgrown fast. The volume of equity issued (including rights and preferenceshares) quintupled to Rs 8.8 billion in 1986 from Rs 1.77 billion in 1982.The debenture market also grew significantly from 1982 to 1986. Amountissued more than doubled to Rs 5.9 billion from Rs 2.4 billion. Volumes inboth the equity and debenture markets fell sharply in 1987 as the overalleconomy slowed due to the effects of the drought. In general, therelaxation of guidelines controlling debenture issues brought downfinancing costs to companies, especially the cost of working capital, incomparison to bank loans. At the same time the yields to investors onthese securities were higher than those paid on comparable bank deposits.

2.23 These capital market developments have encouraged financialinstitutions to expand their activities to lessing, mutual funds, creditcards and other higher income earning activities to compensate for thedeclining margins on their basic lending activities.

2.24 The Banking System. The Indian financial system is highly seg-mented with different roles clearly earmarked for the various institutions.The Reserve Bank of India (RBI) has a wide-reaching role in the system. Inaddition to traditional central banking functions, it has broad regulatoryand policy implementation functions. The financial system is overwhelm-ingly in the public sector. The development banks are state-owned andcontrolled ai-d the commercial banking system has been progressivelynationalized over time. The most recent nationalizations came in 1969 withthe government take-over of 14 private commercial banks, followed byanother 6 in 1980. There are currently about 30 private sector Indianbanks and about 20 foreign banks which together comprise the private bank-ing system. However, these banks are dwarfed by the huge public sectorones, both in terms of size and geograthical spread. The private sectorbanks and foreign banks account for only about 4.3S and 4.5Z respectivelyof total commercial bank assets. The remaining 91.2Z is almost whollyaccounted for by 28 public sector commercial banks.

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2.25 In spite of the increased role of the capital markets, the finan-cial sector is still dominated by the banking system. In terms of resourcemobilization, the commercial banks have the lead role and these banks,together with the Development Banks, are the biggest source of funding forindustrial investments. As of June 1987, the Scheduled Commercial Bankshad total deposits of over Rs 1 trillion.

2.26 The commercial banks' scope for creating credit is strictlylimited by reserve and liquidity ratio requirements which currently channelabout 51? deposits into compulsory investments in the securities of Govern-ment and public sector institutions at below-market rates. Furthermorethey have limited discretion over the direction of their lending as RBIcredit allocation guidelines account for about 77Z of total deposits.

2.27 Under this system, the commercial banks are a major source offunds for the public sector through their purchases of securities issued bythe central and state governments, public sector companies and all Indiafinancial institutions in order to satisfy Statutory Liquidity Ratio (SLR)stipulations. The strict control of bank operations has had someunintended effects. Apart from promoting inefficient resource allocationand fostering rigidities, the system also has a negative impact on commer-cial banks' profitability as the net interest income they receive is onlyslightly more than their administrative costs. In fact, the commercialbanks' profits are largely derived from unfunded items such as fee incomeon international trade, foreign exchange commissions and gains on portfoliotrading activities.

2.28 The commercial banks have been given greater flexibility as aresult of reforms announced in October and November 1988. These reformshave: (a) removed the interest rate ceiling on working capital loans;(b) given customers the freedom to change banks; and (c) removed the priorRBI approval requirement on the working capital lending limits of thecommercial banks. As a result of the new freedom to set interest rates,the banks have been able to lower the interest cost to the mostcreditworthy customers to 162, while slightly increasing the rates chargedrelatively weaker credits.

2.29 As a consequence of the Chakravarthy Committee recommendations,RBI has been adjusting the long term interest rate structure by increasingthe interest rates paid on public sector bonds held by commercial banks asSLR requirements to bring public sector borrowing rates closer to marketrates. While this rationalization does not appreciably affect theprofitability of the commercial banks, it significantly increases the costsof the development banks which raise resources through selling their bondsto the commercial banks. Given this, and for other reasons, it would beappropriate to extend the same flexibility to set rupee lending rates,which has been given to the commercial banks, to the development banks.

2.30 The Indian development finance system comprises nationalstate-level development banks and investment institutions. At the nationallevel the predominant development banks are Industrial Development Bank ofIndia (IDBI), The Industrial Credit and Investment Corporation of IndiaLimited (ICICI) and Industrial Finance Corporation of India (IFCI). Inaddition, the Export-Import Bank of India (Eximbank) was set up in 1982 to

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take over the export finance operations of IDBI and, in 1984, theIndustrial Reconstruction Bank of India (IRBI) was established to replacethe Industrial Reconstruction Corporation of India and take overresponsibility for rehabilitating sick units. The national or All-Indiainvestment institutions are Life Insurance Corporation of India (LIC), UnitTrust of India (UTI) and General Insurance Corporation of India (GIC). Atthe state level, funding is provided by the State Industrial DevelopmentCorporations and State Financial Corporations (SFCs). These developmentfinance institutions are the major source of term lending to industrialfirms. Furthermore, the vast majority of their leading is to privatesector firms. As at March 1981, these institutions 4/ had disbursed aboutRs 290 billion, 75Z of which was to the private sector. Annual sanctionsand disbursements were Rs 81 billion and Rs 56 billion, respectively, upfrom Rs 66 billion and Rs 49 billion in the previous year. The three maindevelopment banks IDBI, ICICI and IFCI accounted for 752 of totaldisbursements by the development finance institutions in 1986187. The termlending institutions have, in recent years, been faced with an increasinglyriskier lending and investment environment. These adverse developmentshave been partially offset by the leasing business and other higher-yielding e=tivities undertaken by these institutions, so that so far theirprofitability has been maintained.

D. Exchange Risk Administration Scheme (ERAS)

2.31 The DFIs previously on-lent their foreign currency borrowings, ona back-to-back basis, with a mark-up of 1.5Z to cover costs of adminis-tration and risks, with the interest rate and foreign exchange risks borneby the sub-borrowers. Given the steady depreciation of the rupee andvolatility of foreign exchange rates in the last few yeazs, sub-borrowershave borne extremely high, and often highly unpredictable, effectiverepayment rates. The absence of a well developed foreign exchange currencymarket in India has meant that private sector borrowers have limited meansto protect themselves against such risks. As a consequence, these firms'debt-servicing capacities have been impaired, which in turn has negativelyaffected the foreign currency loan portfolios of the lending institutions.By 1987, the demand for foreign currency loans had fallen dramatically;foreign currency sanctions by ICICI fell an estimated 34Z in that year.

2.32 The Government, in conjunction with the major DFIs (IDBI, ICICI,and IFCI), has responded to the situation with the development of anExchange Risk Administration Scheme (ERAS), which was introduced in April1989. Under ERAS, the DFIs will move to a currency pooling system fortheir foreign commercial borrowings. Sub-borrowers will pay a rupee-denominated rate made up of: (a) the weighted average interest cost of theDFIs foreign borrowings; (b) a premium in respect of the estimated foreignexchange risk; and (c) the DFI's intermediation spread of 2.OZ. Accordingto the present plan, the scheme will commence with an initial rate of 15Z,1Z above the present term lending rate of the DFIs. The rate will bereviewed every 6 months and adjusted as necessary to cover the foreign andinterest rate costs, based on international interest rate and currencymovements, subject to an initial cap rate of 18Z on existing loars. Thus,each sub-borrower would have a floating rate subloan, subject to the cap.

4/ Eximbank data not included.

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The actual ERAS rate and the cap rate will be adjusted semi-annually. ERASwill be optional and sub-borrowers will also have the right to borrow in agiven foreign currency and assume the attendant foreign exchange risks.The Government has agreed that the ERAS rate will be adjusted as necessaryto cover the foreign exchange and interest rate risks. It has also beenagreed that if due to large interest rate or exchange rate fluctuations thefund runs into a deficit in the short run. the Government will makeadvances into the fund and be repaid when the fund is in surplus.

2.33 Potentially the benefits of ERAS include the followings

(a) the floating rate mechanism and adjustable cap will allow forthe assumption of the interest rate and foreign exchange risksby sub-borrowers, but with a limit on the interest rate andexchange rate liability on each individual loan;

(b) in principle, the mechanism would imply appropriate pricing ofthe foreign exchange and interest rate risks and thus avoidsubsidies to the private sector;

(c) all foreign loans to the DFIs would be covered under thescheme; and

(d) the DFIs will have the flexibility to manage actively theirforeign currency liabilities in line with international marketopportunities; they will be able to use short and long termhedging instruments, such as currency futures and interest rateand currency swaps, to minimize interest rate and foreignexchange risks on their borrowings. They will also activelymanage and invest the rupee premium funds. All this will serveto minimize the ultimate cost of borrowing to their clients andso help reduce the credit risks to the DPIs.

The ERAS scheme will apply to the proposed loan to ICICI in this project.

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III. THE BANK'S ROLE IN INDUSTRY

A. Previous Bank Lending to Industry

3.01 The Bank has made 19 development finance loans amountinig to US$1.4billion through financial intermediaries (maitnly ICICI and IDBI), to pri-vate firms engaged in all aspects of industry. The Bank has also madeloans amounting to US$3.2 billion for it-vestment to enterprises in specificsubsectors such as cement, fertilizers and petrochemicals, either directlyor through financial intermediaries.

3.02 An earlier Bank loan of US$250 million was for the IndustrialExport (Engineering Products) Project (IEP) (Loan No. 2629130-IN), which isbeing implemented through ICICI, Eximbank of India and four participatingcommercial banks (PCBs). This loan, which is a precursor of this proposedproject, became effective on June 23, 1986 and includeds (a) a relendingcomponent through ICICI to support investments in exportable engineeringproducts and through four PCBs to support investments in ancillaryengineering enterprises; and (b) a productivity fund (PP) in ICICI and anExport Marketing Fund (EMF) in Eximbank for financing of operationalupgrading and export marketing activities of engineering enterprises. TheGovernment of India undertook to absorb the foreign exchange risk on thesubloans to ancillary firms but not on the others. Initial project imple-mentation and utilization of the Bank loan initially progressed slower thanexpected.

3.03 Initial commitment of the ICICI loan was slow because of thereluctance of sub-borrowers to assume the foreign exchange risk. InFebruary 1988, the project was modified to allow the Government to bear theforeign exchange risk and commitments have picked up since that time. TheICICI loan is about 662 committed and 262 disbursed. However, ICICI hasinternally sanctioned sub-loans totalling about US$140 million, or 88S oftotal, which will be submitted to the Bank soon. The ICICI loan isexpected to be fully committed by the time the proposed loan becomeseffective.

3.04 Initially, there was relatively slow utilization of the PCB compo-nent for several reasons. Since IEP was the first loan to be channeledthrough the PCBs, some tims was required for these banks to adjust theiroperations to meet project requirements. The area of engineering ancil-laries was probably too limited and was effectively narrowed down evenfurther due to availability of other funds for small scale industries atlower interest rates. In March 1988, this line was expanded to includeother export oriented subsectors. As a result of the modification, thedisbursement of this line accelerated significantly. Also in Vovember1988, the interest rate structure of the PCB component was adjusted tobring it in line with the prevailing stru'ture for commercial banks.Nevertheless, it is anticipated that the PCB component will only be about802 committed by the time the EDP loan becomes effective.

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3.05 The Export Marketing Fund (EMF) administered by Eximbank vas setup with US$10 million for 50? cost sharing of the export marketing programsof individual companies. It is available only for convertible currencycountries and is limited to eleven subsectors of engineering products. TheProductivity Fund (PF), managed by ICIC1 with US$10 million in foreignexchange, provides cost-sharing support to engineering product and compo-nent (ancillary) firms with identified export prospects mainly for consul-tancy, technical support, some imports of tools and products, and super-visor training. The PF covers up to 50 of eligiblc expenditures notexceeding US$400,000 with a sublimit of US$125,000 on hardware for anysingle subproject. Both these funds have had very slow starts for a varietyof reasons. First, for activities that are covered urder these funds, theclearances required turned out to be too numerous and complicated. About ayear ago, the steering committees for both the funds were given blanketGovernment permits that have significantly facilitated the processing ofthe projects. Second is the relative lack of experience in both ICICI andEximbank in evaluating and assisting the specific needs of exporters. Withblanket permits and more exposure of the staff, the operation of theseschemes has improved and about 80 of the marketing and about 502 of theproductivity funds are already committed and the remaining amounts areexpected to be fully committed by the June 1989.

3.06 It is two and a half years since the IEP became effective.Despite the problems mentioned above, there are already some identifiablegains from the project. The PF has supported about 62, mainly medium andlarge firms in the engineering sector, with 17S of assistance providedgoing to electronics and computer software firms. The EOF has supportedabout 142 firms, mainly in the engineering sector with the major productgroups beings softi^are (24Z); auto ancillaries (21X) and commercialvehicles, diesel engines and machines tools (8? each). While it isextremely early to make serious long term projections, the indications arethat the grant funds will be highly cost-effective when measured in termsof incremental exports. Furthermore, the investments appear to be having abroad impact on inculcating a mentality of efficiency and export-orienta-tion. In the case of the PF, some firms which were severely weakened bydomestic competition have been motivated to invest in improving productiv-ity to regain competitiveness. With regard to the EMF, nearly half of thefirms had not actively exported to developed countries before and the grantsupport was used mainly for market exploration, product adaptation andproduct testing. The other 50? of firms supported were already exportingin a limited way and the grants helped their efforts to extend theirmarkets, mainly through market surveys, travel to set up initial businesscontacts and some testing and inspection. It is estimated that the twofunds will each return a yield many times their value by way of incrementalexports, over a five year period. Furthermore, the few results availablefrom the earliest grant recipients are running ahead of projections.

3.07 The term lending components of the IEP have also made an importantcontribution. Bank of Baroda and Canara Bank have now gained familiaritywith the use of economic analysis, which is a requirement of the IEP loanagreement. They have indicated its usefulness for them and their intentionto gradually extend the concept to their general investment lending opera-tions. In the case of ICICI, the export-orientation that has developed inthe staff of the PF cell has not yet had the chance to spread sufficiently

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to their operational staff who prepare export investment sub-projects forfinancing under the IEP. Under this project, ICICI has adopted the policyof joint appraisals of export projects between the operations staff and thePF cell.

3.08 The PCBs have supported about 62 sub-projects for a total of aboutUS$15 million, with a firm pipeline of another 49 sub-projects for aboutUS$16 million. As intended, they have mainly lent to small and medium sizefirms, particularly engineering ancillaries. With the broadening of theproject to other investment projects, they have begun to focus on a widerrange of export investment projects and assisting export-oriented units.About 602 of ICICI assistance has been to large firms with the balancegoing to medium firms. About 32Z of as3istance has been to engineeringfirms. It is currently estimated that firms in the IEP project portfoliowill export about 25Z of sales and this compares favorably with a figure ofabout 42 for the overall [CICI portfolio.

3.09 Thus the experience under IEP so far has been fairly satisfactory.However, operation of the ILP shows that there is a need to strengtheningboth the capabilities of firms and financial institutions in designing,implementing and appraising export development programs and export-orientedinvestments. In the proposed Export Development Project, these problemsare explicitly addressed through technical assistance which includes upfront training of key personnel in the institutions and modification of theoperation of the funds (Annexes V and VI). Furthermore, the TA isstructured in a way that will enable the institutions to have greateraccess to international expertise and information. Finally, there havebeen some delays in Government reimbursement of participating financialinstitutions; these claims were brought up to date prior to negotiationsand an understanding reached that claims would be reimbursed promptly underthe proposed project.

B. The Bank's Future Lending Strategy

3.10 The Bank has had an active industrial sector work program andprepared a number of sector reports on such subiects as industrial regula-tion, technology policy, export promotion, public enterprise management andcredit and capital markets and a number of subsector reports includingelectronics, automotive products, steel, capital goods and fertilizer. The1987 CEM, "India: An Industrializing Economy in Transition" also focusedon the development of the industrial sector and supplied the broad outlinesof a reform program. Many of the issues in these reports will continue tobe discussed with the Government in the context of futurie operations.

3.11 The future lending program for industry is primarily based on thesector work and will thus include:

(a) industrial finance projects which will serve as a focal point forevaluating and discussing with Government overall progress onindustrial and financial policy reform as well as addressingissues in the financial institutions;

(b) export, technology and industrial energy conservation projectswhich will serve as a focal point for evaluating and discussingwith Government overall progress and improve the policy, financialand institutional support for activities in these key areas; and

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(c) subsector projects which will provide policy, technical and finan-cial support for economic investments in areas where improvedefficiency will have implications for the growth of the wholeindustrial sector (e.g., petrochemicals, electronics, cement andcapital goods).

3.12 However, in all of these areas, loans are basically linked to thepolicy reforms that are being undertaken either in designated policy areassuch as exports, technology, etc. or in the policies that affect a specificsubsector. The basic criteria that determined the decision to go aheadwith a loan is whether the policy environment is conducive to efficientinvestments in the area or subsector that is being supported. Thus, thelending strategy involves supporting investments in areas where policyimprovements have already been undertaken, consistent with the conclusionsof the previous sector work.

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IV. THE PROPOSED EXPORT DEVELOPMENT PROJECT

A. Objectives and Project Cononents

4.01 The Export Development Project has two objectives. The firstobjective is the reform of the export policies and administration. In thecourse of proj3ct preparation, the Bank has worked closely with the Govern-ment in reforming the export policies and will continue to do so duringimplementation. The second objective is to assist GOI in its program ofincreasing the competitiveness and exports of manufactured products. Morespecifically, the objective of the proposed project is tos (i) help actualand potential exporters to identify, enter and maintain export marketsthrough assistance for export marketing. product and proce4s adaptationsand improvements; and (ii) complement this assistance with term lendingfunds for export-related investments. To achieve this objective, theproject will develop an integrated program in four financial institutions:ICICI, Eximbank, Bank of Baroda and Canara Bank. This integrated programin each institution will include the following three components:

(a) an Export Development Fund (EDF) to aid exporters by giving themassistance to improve marketing, product development andtechnological know-how on the basis of well developed exportdevelopment plans and programs;

(b) a Technical Assistance Fund (TAF) for improving the institutions'capabilities to piomote and appraise export development programsand export-oriented investments and assist exporters in theseareas; and

Cc) a term lending component to supply investment funds toexport-oriented subprojects for expanding exportable output.

4.02 While the policy environment faced by exporters has improved sig-nificantly over the last two years, the export growth has come mainly fromthe existing product lines. For long-term export growth and diversifica-tion, existing firms have to shift some of their output from domestic toexport markets, as well as create new capacities of exportable products.Given the lack of international exposure, obsolete products and processes,and four decades of closed domestic markets, most firms need some supportin finding foreign markets and upgrading their products and processes.Furthermore, the range of activities that is usually undertaken forrestructuring, such as hiring foreign marketing or design consultants, andimporting technology, other know-how, and specialized machine-y, requiresseparate permission from various government agencies, which is cumbersometo obtain. In addition, within the financial system, recurrentexpenditures for consultancy, know-how and technology development areusually not covered under established lending schemes and have to be fundedfrom firms' own resources. Firms that shift to the external market becauseof increased domestic competition and reduced profitability, usually havestrained internal financial resources. Currently, there are no agencies inIndia that offer comprehensive programs to assist exporters in theirmarketing and restructuring efforts. The project will try to support key

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financial institutions such as ICICI, Eximbank and two commercial banks inestablishing programs designed to assist exporters and help these institu-tions to develop centers of expertise in export-related activities. Amongthese institutions, Eximbank already has been involved in assistingexporters, but has focused primarily on supporting large, discrete invest-ment projects undertaken by Indian companies abroad, and would like toexpand its support to other export products. ICICI has been designated asthe lead development finance institution in charge of export development,but so far has limited experience in developing export-oriented projectsand/or assisting exporters. A nucleus of expertise has been developedunder the TEP, but it is very small and needs to be extended to be moreeffective. Some of the commercial banks with large overseas branch net-works do work with exporters on specific activities related to import andexport business, but they do not have the integrated programs or organiza-tional structure to meet the varied needs cf emerging exporters. The twocommercial banks are setting up export departments that will incorporatedifferent services offered to exporters under one unit, which will interactwith the selected branches that will administer the export developmentfunds.

4.03 The proposed Export Development Project, building on theexperience gained under the IEP, aims to modify and expand the originalproject in two main directions. First, it will attempt to integrate theactivities covered by the Productivity and Marketing Funds into singlemulti-purpose funds (Export Development Funds (EDFs)) and place them ineach participating institution. The experience gained under the existingFunds has shown that what is really needed is for firms to forAulate oneintegrated development plan which would normally include both marketing andproductivity improvement activities. In most cases, the plan would alsoneed to be complemented by term finance for technology upgradation, expan-sion or new investments for increasing the supply of exportable output.Second, the fact that the Funds have been implemented by two central insti-tutions, ICICI (Productivity Fund), and Eximbank (Export Marketing Fund),has meant that coverage has mainly been restricted to the larger firmswhich comprise the usual client base of these two institutions. However,there is substantial export potential in the small and medium-scale indus-try (SME) sector. Therefore the new project will utilize two leadingcommercial banks, Bank of Baroda and Canara Rank, to provide similarsupport to firms which will tend to be smaller and more geographicallydispersed. Given their day-to-day contact with smaller firms as well asthe wide reach provided by their br,nch networks, these commercial banksare in a strong position to identify and help develop the export capabil-ities of firms that would not normally be reached by centralized institu-tions such as ICICI and Eximbank. The commercial banks would initiallyfocus on a few targeted centers in which smaller firms with exportpotential are concentrated as detailed in Annex V.

4.04 In general, the participants for this project have been selectedon the basis of their perceived commitment to supporting manufacturedexports as well as their performance to-date under the ongoing IndustrialExport Project. ICICI provides almost half of the foreign currency loansmade by the term-lending institutions. As the regulatory and incentiveframework moves in fa%or of exporters, it will be called upon to sul-port anincreasing number of export investment projects. Eximbank has the tradi-

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tional role of assisting exporters and it has, in recent years, begun toplace more emphasis on financing investment projects in addition to projectfinance and post-shipment credits. The two commercial banks have alreadyadopted strategies to help their clients to start exporting or increasetheir exports. Thus the Bank will, through the EDP, be supporting andgiving direction to export development strategies that are already beingimplemented by these banks.

4.05 The total cost of the Export Development Project would be US$730million equivalent, with US$295 million in IBRD financing to coverprimarily the foreign exchange portion of the two components in each of thefour financial institutions. The TAP of US$2.7 million would be fundedthrough a grant from the Government of Japan.

(a) Export Development Funds. The four institutions would manage onbehalf of Government a total of US$20 million in exportdevelopment funds, which will help to finance eligible exportdevelopment activities of firms. The US$20 million will beallocated among the financial institutions as follows: ICICI -US$7 million; Eximbank - US$7 million; Bank of Baroda - US$3million; and Canara Bank - US$3 million. The Export DevelopmentFunds would finance part of the enterprises' costs of consultantsand foreign travel associated with the preparation andimplementation of their export development plans.

(b) Technical Assistance Funds. It is expected that a total of US$2.7million would be made available to the GOI, through a grant fromthe Government of Japan, to pass on to the four institutions on anon-reimbursable basis, to improve their capabilities to appraiseexport development programs and export-oriented inv_stments andassist exporters. More specifically, the TA funds would be usedfor training of staff to implement the EDFs, purchase of marketand technical information from international data banks and hiringof specialist consultants. The total of US$2.7 million would beallocated among the financial institutions as follows: ICICI -US$1,175,000; Eximbank - US$675,000; Bank of Baroda - US$425,000;and Canare. Bank - US$425,000. One component of the TAFs wouldfinance a joint international training program for the EDFoperators and other selected staff from each institution at thestart of the project. ICICI will be the coordinator for thetraining program in consultation with the other rarticipatingfinancial institutions.

(c) Te.m-Lending Components. A total of US$275 million would be madeavailable to the four institutions for term financing of non-governmental enterprises for export-oriented subprojects. Of thistotal, US$175 million would be lent directly to ICICI for relend-ing to large firms, US$100 million would be made available fromthe loan to Government to the remaining three institutions forrelending to small and medium size firms and would be allocated asfollows: Eximbank - US$40 million; Bank of Baroda - US$30million; and Canara Bank - US$30 million.

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B. Export Development Fund (EDF) Components 11

4.06 The experience under IEP has indicated that most firms in India donot have the expertise to evaluate external market conditions and developstrategic export development programs. Furthermore, such expertise isusually not available within India and the firms have been reluctant toemploy foreign experts due to tremendous cost differentials between localand foreign experts. The EDF is aimed to encourage the domestic firms topurchase foreign expertise and information and integrate them into anexport development program by giving the firms matching grants for selectedexport promotion activities. The EDFs in each institution will be designedto support individual firms to formulate export plans and to make thenecessary investments of time and money in order to achieve significantincreases in exports. Thus the EDFs will provide firms with: (i) grantsupport on a matching basis for a range of specific pre-investment promo-tion and marketing activities within a structured firm-level export devel-opment plans; (ii) one-window clearance through already establishedSteering Committees (para. 4.08) for the various GOI approvals required forexport marketing and product adaptation activities, within the context ofan export development plan; and (iii) direct linkage between these two EDPsupport measures and the provision of term finance and incremental workingcapital finance needed to implement such an export development plan. As inthe IEP, motivation of firms would also be greatly assisted by the advisoryservices provided by the participating institutions as an integral part ofthese measures. In effect firms would be offered substantial advice on howbest to formulate their export development plans. While the specific needsof individual firms will differ, they will all be encouraged to structuretheir export development plans in three distinct phases comprising marketexploration, product adaptation and sales promotion.

(a) Market Exploration. This would entail desk research to determineinitial market targets, followed by field research, includingface-to-face contact with potential buyers or specifiers, in orderto ascertain the basis of buying decisions and the type ofbarriers the firm's existing product would face. The results ofthis research would normally then form the basis for an analysisof the present constraints preventing the firm from fully exploit-ing the targeted export potential.

(b) Product Adaptation. From this point on the plan would usuallyconsist of a series of specific measures, designed to addressidentified constraints, in a determined order of priority, withthe emphasis on product or process improvements.

(c) Sales Promotion. It would only be after adequate progress hasbeen made in dealing with the key constraints that the plan wouldconcern itself with promotional activities, aimed directly atachieving export sales growth, e.g., setting up a field salesnetwork, creating brochures, direct mail and journal advertising.

I/ The operating principles and administrative procedures (SPOP) for theEDFs are given in Annex 1.

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4.07 Eligible Expenditures and Activities. Grant support would berestricted to expenditures on fees for marketing and technical services andtravel expenses, and would be matched by at least an equal contributionfrom the enterprise. It must be emphasized that EDP grant support is notintended to cover all "software" expenditures incurred in reepect of exportdevelopment. Rather the aim is to encourage specific export developmentactivities and the careful planning of export strategies, by supportingincremental costs incurred as a direct result of a firm's exportdevelopment plan activities.

4.08 Steering Committe3 Mechanism. At present, there are two SteeringCommittees in place for the approval and official clearing of qualified PFand EMF projects. Access to such single-window clearance, for all fourinstitutions involved, is an important pre-requisite for the relevantcomponents of the proposed EDP. Therefore the two existing SteeringCommittees will be maintained. It is felt that it would be appropriate forthe PCBs to be affiliated to the Ministry of Commerce Committees given thatthe EDFs will be carrying out activities more closely resembling those ofthe current EMF than the PF. It is envisaged that most of the EDFsubprojects supported by the PCBs will be relatively small and thus shouldfall under the free-limit. The provision of non-free limit grants by thePCBs would be regarded as exceptional and would be closely scrutinized bythe Steering Committee. The committee would be expected to provide reviewand guidance to the PCBs, which will make detailed quarterly reports to thecommittees to facilitate this process. The Steering Committees woulddelegate to ICICI and Eximbank the power to approve individual proposals upto US$100,000 of grant support. As firms would normally go through asequence of three approvals, corresponding to the three stages of a typicalexport development plan, and return for support of new plans, the SteeringCommittees would retain the power to approve any single proposal that takesa firm through a cumulative grant limit of US$200,000. For the commercialbanks, the single approval free limit delegated to them will be set atUS$50,000 with a cumulative grant limit of US$100,000.

4.09 The main administrative arrangements and staffing requirementshave been agreed with the participants and they are outlined in Annexes Vand VI. ICICI and Exim have already provided the Bank with their updatedadministrative strategies for implementing the project and completed theirstaffing. PCBs will establish their export units, approve the SPOP, andcomplete the staffing of them by June 30, 1989.

C. Technical Assistance Fund (TAF) Components 21

4.10 The appraisal of export programs and projects requires analyticalskills and information on factors such as external markets, distributionchannels, technical inputs, actual and potential competitors and technolo-gies. Therefore, the TAFs of the four institutions would support: (i) the

2/ Administrative arrangemerts for the four technical assistance programsare given in Annex VI.

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training of their staff to acquire the necessary skills; and (ii) thehiring of experts with specific technical skills, on a temporary basis, toassist staff in appraisals and advising exporters. Experience under theIEP has shown that few clients have skills internally to generate coherentexport development plans for grant assistance or term financing. Thus PFand EHF officers have spent considerable effort in helping firms developthese plans. In the proposed EDP, this advisory service function of thefinancial institutions' EDF cells would need to be explicitly budgeted forand strengthened. Thus, a portion of TA funding provided to the financialinstitutions would be used to support the advisory service activities oftheir respective EDF cells. Similar support also needs to be given toexport-oriented term finance subprojects, especially If they are undertakenindependently of EDF support.

4.11 Eligible Activities. Activities to be funded through the TAFwould include: (i) training abroad for staff, particularly those involvedwith management of the EDFs; (ii) purchase of information abroad, insupport of appraisal activities, where there is a requirement forassessment of overseas market potential; and (iii) fees and travel expensesfor technical experts, called in to augment internal skills wherenecessary.

D. Term-Lending Components

4.12 A total of US$275 million would be made to ICICI, Eximbank, Bankof Baroda and Canara Bank for onlending to non-governmental industrialenterprises for export-oriented subprojects. A Bank loan of US$175 millionwould be lent directly to ICICI and US$100 million of the US$120 millionloan to the Government would be made available to Eximbank, Bank of Barodaand Canara Bank through GOI under the terms of financing 'greements. Theseterm lending funds would be aimed at creating capacities to supplyexportable products. IBRD funds would be used to finance estimated foreignexchange cost of subloans for balancing, modernization, expansion and newinvestment of non-governmental enterprises that meet agreed financial,economic and export-orientation eligibility criteria. Although institu-tions will have the flexibility in choosing subprojects to support with theloan funds, the following differentiation is expected. ICICI willprimarily cater to investment needs of larger enterprises in sectors thatrequire major technological upgradation as well as large greenfieldprojects. Eximbank is focusing on giving term lending funds for smallerproduct upgradation projects with quicker turnaround time and is alsoassisting export and trading houses in developing export mark ts throughfinancing of their pre-investment activities. The commercial banks wouldlend for investment needs of smaller and medium-sized firms, often throughtheir branch offices in areas outside major metropolitan centers.

4.13 The eligibility criteria for export orientation of subprojectswould be the preparation of a satisfactory strategic export plan. Such aplan would take a firm, or a division, from its present exporting situationto a future situation representing a significant expansion in exportperformance. The normal characteristics of an export plan are described inpara. 13 of Annex V.

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E. Proiect Costs

4.14 The total cost of the project is estimated to be US$730 million,of which US$297.7 million is in foreign exchange. No contingencies havebeen calculated for the credit component because it is a line of creditfac'lity. In the event of escalation in the average cost of subprojects,the total number of subprojects would be reduced. The same approach wasapplied to the Export Development Funds, where the number of proposals tobe financed is also flexible. The cost estimates are summarized inTable 4.1. Detailed cost estimates for the technical assistance componentare given in Table 6.1.

Tabl- 4.1: PROJECT COST SUMMARY(in current prices)

ForeignLocal Foreign Total Local For isn Total Exchsne= - - =RU9rrion - - -- In-

Credit Component

IcicI 8,788.0 2,584.0 6,817.0 270.0 175.0 445.2 40.0Exlmbank 654.0 632.0 1,086.0 89.6 40.0 79.6 50.0Comercial Banks 1.427.0 784.0 2.211.0 101.9 60.0 161.9 85.0

Subtota1 61.0 9.S14.0 411.7 27S.0 666.7 40.0

ExPe° Dvle ht tOnFind Component

iCICI 98.0 98.0 196.0 7.0 7.0 14.0 50.0Eximbank 98.0 98.0 196.0 7.0 7.0 14.0 50.0Commercial Banks 84.0 84.0 168.0 6.0 6.0 12.0 60.0

Subtotal 280.0 280.0 560.0 20.0 20.0 40.0 50.0

Technical AssistanceComponent

ICiCI 6.8 16.8 22.6 0.4 1.2 1.6 75.0Eximbank 8.5 9.8 18.8 0.8 0.7 1.0 70.0Comercial Banks 4.7 11.2 16.9 0.8 0.8 1.1 72.0

Subtotal 14.0 87.8 61.6 1.0 2.7 8.7 78.0

TOTAL PROJECT COST c,468.0 8,780.0 9,286.0 482.7 297.7 780.4 40.8-==8= e= === r=

F. Financing Plan

4.15 The proposed Bank loan to ICICI of US$175 million would finance theforeign exchange component of its lending for eligible export projects andthe proposed Bank loan of US$120 million to the Government would finance theforeign exchange component of the term financing of Eximbank and the PCBsand of the Export Development Funds. The US$2.7 million technical assis-tance component would be funded by a Japanese Cofinancing Grant. Table 4.2shows the financing plan.

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Table 4.2: PROJECT FIUNNCING PLAN(in current prices)

Government FinancialBank , of Jacan Intormdlarles S etor 1Othi r Total

~~~~~~~~~M I I1 TIIon) -

ICICI 176.0 45.0 18U.8 63.9 445.2Eximbank 40.0 8.0 28.9 7.7 79.6Co mercial Banks 60.0 47.6 80.8 28.5 161.9

Subtotal 276.0 100.6 191.0 120.1 686.7

Export DovelopoentF-und COMpon nt

ICICI 7.0 7.0 14.0Eximbank 7.0 7.0 14.0Co"mercial Banks 6.0 6.0 12.0

Subtotal 20.0 20.0 40.0

Technical AssistancecomDonent

ICICI 1.2 0.4 1.6Eximbank 0.7 0.8 1.0Comercial Banks 0.8 0.8 1.1

Subtotal 2.7 1.0 8.7

TOTAL PROJECT COST 29. 2.7 101.6 211.0 120.1 780.4

4.16 Under the credit component for ICICI, the Bank would finance 40?of subproject costs representing the average foreign costs of medium andlarge subprojects in India. ICICI would financ: about 102 of the sub-project costs from their own rupee resources. Based on the financingpatterns for medium and large industrial projects in India, other capitaland credit market sources are expected to provide another 20Z while sub-project sponsors and other equity subscribers (the sector) would provideequity financing for the remaining 30?. Eximbank's term loan clients wouldnormally be those manufacturers specializing in exports such as hundredpercent export-oriented units (HEOUs). Such firms would normally have ahigher than average import content in their production processes. There-fore in the case of Eximbank subprojects, the Bank would finance 50? of theproject costs, corresponding to the foreign exchange requirement. Eximbankwould finance about 102 of the subproject costs with the remainder comingfrom the sponsors and equity sources. The PCBs would generally supportsmaller and less import-intensive export 4-cvia&tents. Thus for PCBsubprojects, the Bank would finance 352 of project costs while the PCBsthemselves would contribute 30? and sponsors and other equity sources(sector dnd others) would finance 35Z.

4.17 For EDF components, the Bank would finance up to 502 of costswhile the sponsors would finance the balance. For the technical assistancecomponents, the Japanese grant would finance the foreign exchange costs,which are estimated to be about 75Z of total costs.

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V. THE PARTICIPATING FINANCIAL INSTITUTIONS

5.01 As in the case of the IEP, the EDP funds will be passed throughIndian financial institutions, in the form of matching grants and loans, tonew and existing manufacturing exporters. The participating institutionswill be ICICI, Eximbank and two comaercial banks; Bank of Baroda and CanaraBank. All four institutions were involved in the IEP. 1/ These organiza-tions have been selected to participate in the project largely on the basisof their keen interest in supporting the growth of manufacturing exports.As part of project preparation, the Bank has worked closely with them andreached agreement on project implementation issues such as staffing andmanagement of EDP cells and type of firms, geographical regions and indus-try groups that specific institutions will emphasize.

A. The Industrial Credit and Investment Corporation of India, Limited (ICICI)

5.02 ICICI was established in 1955 to provide long term finance toprivate industry. Since then it has developed into one of the country'smajor financial institutions and it is the main provider of foreigncurrency term loans to Indian firms. The corporation offers a wide rangeof financial services and over the years it has diversified out of itstraditional functions into areas such as merchant banking, leasing, hirepurchase, venture capital and credit-rating services. In addition to itsoperational activities, ICICI plays an important developmental role. Itadvises the Government on industrial issues, carries out sector studies anddevelops new ideas and methods of improving the financial markets. ICICIis a profitible and well-managed institution. Over the last five years ithas grown at an annual rate of about 20t p.a and enjoyed rising profits.As at March 31, 1988, total assets had reached Rs 36 billion, while equitywas Rs 3.2 billion and net profits were Rs 770 million. The Bank has made16 previous loans to ICICI, including a US$160 million loan under the on-going IEP. The most recent is a US$105 million facility under theIndustrial Finance and Technical Assistance Project.

5.03 The latest ICICI Project Completion Report (PCR XIII) shows thatalthough project implementation went well, a number of the subprojects haveencountered repayment problems. One of the major reasons for the difficul-ties has been adverse foreign exchange rate movements which have resultedin Indian subborrowers bearing extremely high real rates of repayment.ICICI is also faced with a need to focus more on project appraisal and theinternational competitiveness of the investments it finances, given thetrend of deregulation and delicensing which ia creating a more competitiveenvironment. The new EDP will address these concerns. The relending ratewill be either the Bank's standard variable rate plus 2Z or the onedetermined under the new Exchange Risk Administration Scheme (ERAS). Underthe second option, the situation whereby subborrawers faced open foreignexchange risk will be replaced by a situation in which they pay a floating

it The detailed descriptions of these institutions are given inAnnexes I-IV.

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rate (in rupees) with a pre-determined upper limit (see paras. 2.31-2.33).Second the technical assistance component of the EDP is designed to supportfurther improvements in project appraisal capabilities within ICICI byproviding funds for training and purchase of information on foreignmarkets, production costs and prices.

5.04 Under the proposed Export Development Project, ICICI will adminis-ter a US$7 million Export Development Fund (EDF). The EDF will enableICICI to support the firms which have developed sound export developmentprograms for improving their export potential and performance. Thecorporation will also be able to use funds from a US$1,250,000 TechnicalAssistance Fund component to carry out its own analysis of export markets,hire export marketing specialists and assist firms in putting togethertheir expert development plans. The TAF funds will also be used to supportICICI's appraisals of export-oriented sub-projects under the term loancomponent. The cell established within ICICI under IEP will be expanded totake on the role of administering the EDP. At full strength, it will havea staff of five. Furthermore, ICICI has provided to the Bank its detailedadministrative arrangements for ensuring greater linkage between the EDFCell and the general lending staff of the institution.

5.05 The Project will support ICICI's lending to the large and medium-sized export-oriented firms. In the past, the institution has lent mainlyto import-substitution projects and the ratio of exports to sales of itspresent borrowers is only 4Z. However, it has been increasing its port-folio of export projects in line with the growth of export investmentsresulting from the recent shift in policies in favor of the export sectorthrough the subprojects financed under the Bank's Industrial Export(Engineering Products) Project. The EDF and TAF components will strengthenits institutional capabilities for advising its clients on, and analyzingthe international competitiveness of, export investment proposals while theterm lending component would continue ICICI's involvement in financingexport-oriented projects.

B. Export-Import Bank of India (Eximbaak)

5.06 Eximbank was established by an Act of Parliament in 1982, tofinance and promote India's international trade. At inception it took overthe Rs 1.7 billion export loans and guarantees portfolio of IDBI and becamethe central body for coordinating the activities of the banks and financialinstitutions engaged in the financing of imports and exports. Eximbankoperates out of its headquarters in Bombay, three regional offices inCalcutta, Madras and New Delhi and three overseas representative offices inWashington D.C., Abidjan and Singapore. Its primary function is providingmedium and long-term finance for pro3ject exports, directly and through therefinance of commercial banks' obligations. Exim is a well-managed insti-tution and it has maintained a sound financial condition, while expandingat a relatively fast rate. Between 1982 and 1987, it grew at an annualcompound rate of 29Z and, as at December 1987, total assets had reached Rs13 billion. Over she same period, net income has risen consistently to Rs199 million and equity has tripled to Rs 2.5 billion. Eximbank's partici-pation in the on-going IEP as administrator of the US$10 million ExportMarketing Fund represents its first involvement in a Bank project. It hascommitted about US$7.5 million to 120 firms under the project. Eximbank isalso the implementing agency for an on-going IFC project which was signedin 1986,

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5.07 Under the IEP, Eximbank has moved from project exports to support-ing product exporters by working closely with firms to help them developviable export marketing plans. The proposed Export Development Projectwill build on the existing gains. The term lending component will allowEximbank to provide a full financing package for export-oriented investmentprojects. Eximbank will make both small equipment loans in support ofexport plans and loans to support software expenditures undertaken by firmsto upgrade products and to enter foreign markets. The Technical Assistancecomponent of the EDP will provide relevant training for selected staff aswell as access to on-line data bases and a pool of internationalconsultants on export marketing. For the Export Development ProjectEximbank will maintain the cell which has been formed to execute the EMF.The staff complement of five, including one Deputy General Manager, anl thepresent regional coverage of having an EMF officer stationed in Calcutta,Madras and New Delhi is adequate. Eximbank has provided to the Bank, itsdetailed implementation strategy for the EDP.

C. Bank of Baroda

5.08 Bank of Baroda was set up in 1908 and nationalized in 1969. It iscurrently one of the top ten largest commercial banks in India with totalassets of Rs 101 billion. It operates nationwide with a network of over2,000 branches, and internationally, through 52 branch offices in 14countries. The bank has about 42,500 employees. Like the other majornationalized banks, Baroda has grown steadily in recent years and enjoyedrising profits. Compound asset growth was 11.5Z p.a. between 1983 and 1987and net profits rose 153Z to Rs 218 million over the same period. Networth currently stands at Rs 1.6 billion, or 1.6Z of assets. Bank ofBaroda is one of the Participating Commercial Banks under the IndustrialExport Project. Its performance under the project has been satisfactory.It has mtade commitments of about US$4.4 million to 14 subprojects to date.Furthennore the Bank's project appraisal skills and procedures have beendeveloped, to include economic analysis, as a result of its participationin the IEP. Bank of Baroda has made adequate preparations for partici-pating in the EDP and details of its administrative arrangements and imple-mentation strategy are given in Annex V.

D. Canara Bank

5.09 Established in 1906, Canara is currently the fifth largest commer-cial bank in India. It was one of the 14 commercial banks that werenationalized in 1969. As at December 31, 1987, it had total assets ofRs 109 billion and a staff of over 48,000. The bank has its head office inBangalore and its 1,864 branches are spread throughout India. It also hasa branch in London. Canara has in recent years developed a reputation as ahighly innovative, aggressively-managed and responsive bank and this isreflected in the rapid growth of its operations. Over the last five years,it has outstripped its competitors by a wide margin as measured byvirtually all the major performance indicators. Total assets have grown ata compound rate of 20Z p.a. and total deposits rose by 18Z p.a to Rs 79billion, or 6Z of the industry total, over the same period. For the lastfive years it has earned the highest profits of all nationalized banks andin 1987 its net profit of Rs 450 million was virtually equal to that ofState Bank, which is nearly five times larger. The bank expects to

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maintain the curreit momentum and pace of growth over the next few years.Such continued fast growth will pose challenging management issues for thebank's leadership. Given the more difficult operating environment faced byall lending institutions as a result of the ongoing industrialliberalization process, there will be a need for greater emphasis on thequality of additional assets booked. Canara's participation in theEngineering Ancillary Development component of the IEP represents the firsttime it has worked with the Bank and, as with the other ParticipatingCommercial Banks, the results to-date have been beneficial. Canara hasdeveloped the institutional capabilities to incorporate economic analyzesin its project appraisals. It has committed US$4.2 million to 22 sub-projects under the IEP. Satisfactory arrangements have been worked outwith Canara Bank for implementing the EDP.

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VI. THE PROPOSED LOANS

A. Terms and Conditions

6.01 Both the US$175 million loan to ICICI and US$120 million loan tothe Government would bear the Bank's standard variable interest rate andwould be repaid over 20 years, including 5 years of grace. US$100 millionof the US$120 million Bank loan to the Government would be passed on toEximbank and the two PCBs as equity and the balance of the loan of US$20million would be passed on to the Participating Financial Institutions asgrants for the Export Development Funds to be administered on behalf ofGovernment. It is expected that the US$2.7 million from the Japanese GrantFacility would be passed on to the Participating Financial Institutions tosupport their Technical Assistance Funds. These relending arrangementswould be set out in financing agreements with each of the financialinstitutions to be signed as a condition of effectiveness of the proposedloan.

Term Lending Component

6.02 The relending arrangements reflect the segmentation in the Indianfinancial system. In this system, the DFIs, including ICICI, providemainly term loans to larger industries and the commercial banks provideworking capital and some term loans to small and medium sized firms. Therelending arrangements for the foreign borrowings of the DFIs areGovernment by the ERAS Scheme and for the commercial banks and Eximbank by-the interest rate regulations of the Reserve Bank of India.

6.03 ICICI. The US$175 million Bank loan would be made directly toICICI on standard Bank terms. These funds would be relent to subborrowersin rupees at the prevailing ERAS rate (currently 152 with a cap rate of18Z) or relent in foreign exchange at the Bank rate plus a 2Z spread forthe DFIs (see paras. 2.31-2.33 for discussion of the ERAS scheme). Thesearrangements are consistent with the Governments broader policies of havingall foreign exchange loans of the DFIs passed on subborrowers either inforeign exchange or under the terms of ERAS.

6.04 ICICI requested the Bank to provide technical assistance in regardto management of its foreign borrowings and its participation in the ERASscheme. In response to this request, the Financial Technical AssistanceUnit of Financial Operations Department undertook an identification missionto India. On the basis of the mission's findings, a comprehensivedevelopment program for ICICI's liability management staff is expected tobe worked out soon.

6.05 Eximbank and PCBs. Of the US$120 million Bank loan to GOI, US$100million would be passed on to PCBs and Eximbank as equity to finance theirterm lending under the project. The interest rates charged by PCBs andEximbank would be 14Z for large and medium size enterprises and 13.5Z forsmall scale industries consistent with RBI guidelines and IDBI refinancingrates for term lending to small and medium-scale industry. The Governmentwould periodically review these relending rates in telation to chaniges in

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inflation and other market conditions and adjust these rates as necessaryto ensure that they remain positive in real terms and reflective of marketconditions and sufficient to provide a reasonable spread to the financialinstitutions.

6.06 Subproject Eligibility Criteria. An eligible enterprise isdefined as an industrial enterprise in the private, joint and cooperativesectors, which is engaged or intends to engage in manufacturing, processingor exporting. An eligible subproject would involve the establishment,expansion and/or balancing, modernization and replacement proposal of aneligible enterprise which meets minimum economic and financial viabilitycriteria and is export-oriented. An export-oriented subproject would con-tain a satisfactory strategic export plan as described in para 4.13. Allappraisals (in addition to an export plan) would include detailed sub-project analysis showing the economic and financial rates of return ofsubproject proposals, which to be acceptable to the Bank would generallyhave a minimum economic rate of return of 12Z and a financial rate ofreturn of 15Z. An enterprise should have an acceptable capital structuresuch that with the new subloan the debt:equity ratio of the enterprisewould not exceed normally 70:30.

6.07 Subloan Terms and Conditions. The relending terms and conditions,reflect the policies of the institutions and agreements reached with theBank as follows:

(a) all subloans would be denominated in rupees; except that ICICIwould also have the option to make foreign currency denominatedloans;

(b) subloan maturities would be at least 3 years and up to a maximumof 15, including a grace period of up to 3 years.

(c) all subloan proposals submitted to the Bank for authorization orapproval will include strategic export development plans,estimates of financial and internal economic rates of return anddomestic resource cost analyses.

For ICICI

(a) the final interest rate charged would be either the Bank'sstandard variable rate plus 2? (in the case of foreign currencydenominated loans), or a rate determined by the Exchange RiskAdministration Scheme (ERAS) (in the case of rupee denominatedloans). In either caee, the rate would be variable;

(b) the free limit will be US$8.0 million; and

(c) the amount of the Bank loan allocated to a single enterprise wouldnot exceed US$30 million.

For Eximbank

(a) the interest rate would be 13.5Z for small-scale enterprises and14? for all other subprojects or the applicable rates set afterreview of interest rates established under the earlier projects;

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(b) the maximum subloan would be US$1.0 million; and

(c) the free limit would be US$500,000 and since this would be thefirst Bank loan to finance Eximbank's lending operations, the Bankwould review the first 5 subproject proposals regardless of size.

(d) Eximbank will also make loans, strictly for software expenditures.to larger firms. Such loans will not be used to fund anyproduction assets and "he loan limit will be US$1 million, unlessotherwise agreed to by the Bank.

For PCBs

(a) the interest rate would be 13.5? for imall-scale enterprises and142 for all other subprojects, or the applicable interest ratesset after the interest rate review under this and earlierprojects;

(b) the maximum subloan would be US$1 million;

(c) the maximum size of the enterprise supported under this loan wouldbe US$4.0 million in fixed assets (excluding land and buildings)prior to the credit; and

(d) the free limit would be US$500,OOC.

Under these guidelines, 20? of subprojects by number and accounting for 302of the amount of the loan are expected to be above the free limits.

EDFs

6.08 Of the IBRD loan to GOI. US$20 million would be allocated toExport Development Funds; US$7 million through ICICI, US$7 million throughEximbank and US$3 million each through Bank of Baroda and Canara Bank. Thefinancial institutions would manage these funds on behalf of GOI. Satis-factory draft Statements of Policies and Operations Procedures have beendeveloped for these funds (paras. 4.06-4.09 and Annex V).

TAPs

6.09 It is expected that a Japanese Government Grant of US$2.7 millionwould be passed on to the four financial institutions as grants to financethe technical assistance programs. The structure, financing, operatingprocedures, and accounting and reporting requirements for the TAPs aregiven in Annex VI. In particular, these requirements provide that theInitial Training Program would be managed by ICICI and Terms of Referencefor the program would be issued and opened for bids immediately aftereffectiveness of the loan. The remaining portions of the TAFs would beused for hiring of consultants and purchase of information on externalmarkets.

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B. Administrative Procedures

6.10 Procurement. Under the ICICI credit component, for contractsexceeding US$8 million equivalent to be financed out of the proceeds of theBank loan, the financial institutions would i'.ist that sub-borrowersfollow international competitive bidding procedures in accordance with BankGuidelines. A preference of 152 or the level of customs duty, -hichever islower, would be afforded to domestic bidders. For other contracts,procurement would be done in accordance with ICICI's internal procedureswhich have been used on a number of previous Bank projects and areacceptable to t1e Bank. Presently, the financial institutions requiretheir borrowers to solicit three competitive and responsive quotations forall procurement. Under the PCBs and Eximbank's credit component, goodswill be purchased either directly from overseas or through local commercialsources for foreign goods. As required under the ongoing Industrial ExportProject, PCBs will need to establish that the goods and services purchasedare of competitive price and quality. For contracts of US$50,000 and over,PCBs would require subborrowers to evaluate quotations from at least threequalified suppliers. For each withdrawal application, the concernedfinancial institution would have to certify that the agreed procurementprocedures have been followed. The financial institutions would maintainrecords of the method of procurement, summarizing offers and awards foreach subproject. The Bank would periodically review these records on asample basis in the course of regular project supervision. Table 6.01shows a breakdown of the procuremsnt methods, by category.

Table 6.01: Procurement MethodsCUSS Million)

Procurement MethodProject Element ICB/LIB IS CON Total

Credit Component 35.0 652.0 687.0--Bank (25.0) (250.0) (275.0)

Export Development Funds 38.0 2.0 40.0--Bank (19.0) (1.0) (20.0)

Technical Assistance Funds 1.0 3.0 4.0--Japanese Government (0.7) (2.0) (2.7)

Total 35.0 691.0 5.0 731.0--Bank (25.0) (269.0) (1.0) (295.0)--Japanese Government (0.7) (2.0) (2.7)

Notes:

ICB means International Competitive BiddingIS means International ShoppingLIB means Limited International BiddingCON means in accordance with consultancy selection guidelines

Source: Staff estimates.

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6.11 For the technical assistance components, goods would be procuredunder contracts awarded on the basis of sound commercial practices, and theemployment of consultants by the financial institutions would be inaccordance with the Bank's Guidelines for the Use of Consultants by WorldBank Borrowers and by the World Bank as Executing Agency." Appointment ofall consultants and their terms of reference would be subject to the priorapproval of the Bank. '-ith the exception of small purchases of informationunder US$20,000, all expenditures would require prior approval by the Bank.

6.12 Disbursements. Under the credit component, the Bank loan wouldfinance 802 of the amount of subloans to eligible enterprises, or 100I ofthe foreign cost of imported equipment financed by the subloans. Thisprocedure has been adopted to allow for reimbursement for estimated averageforeign exchange costs of subprojects. However, there are a number ofcases where the institution finances only equipment imports, particularlywhere it is a minority partner under consortium arrangements and in thecase of simple balancing or modernization projects. In these cases, 1002financing of CIF imports would be appropriate. For the technicalassistance component, the proposed loan would finance foreign exchange costof consultants, training and information purchases, and the initial grouptraining program. For the EDF component, the loan would finance up to 502of actual expenditures.

6.13 In accordance with the Bank's current disbursement profiles fordevelopment finance projects and the Bank's experience in similar technicalassistance projects, it is expected that the Bank loans will be committedin three years and disbursed over six years.

6.14 Some disbursements by the Bank would be made on a reimbursementbasis through Special Account., one for the Government (US$10 million) andone for ICICI (US$15 million), which would be established for the projectwith a total authorized allocation of US$25.0 million. After loaneffectiveness, the Bank would deposit into the Special Accounts the statedamount, through the submission of the usual withdrawal application, whichwould scw"' as the revolving fund. The Bank would replenish the SpecialAccounts on the basis of requests for reimbursements on a quarterly basisor whenever the amount in each Special Account reaches 502 of the initialdeposit. Reimbursements to ICICI through the Special Account would be madeagainst Statement of Expenditures (SOE) for projects below the free limits.Supporting documentation under SOEs would be retained and would be subjectto review by Bank supervision missions, and to anuual audit by auditorsacceptable to the Bank, such audit is to be submitted within four monthsafter the close of each financial year. For all subloans in excess of freelimits having prior Bank approval, ICICI would fully document withdrawalapplications when requesting replenishments to its Special Account.

6.15 Reporting and Audits. ICICI would submit to the Bank quarterlyprogress reports on commitments, disbursements, collections and arrearsunder the project and for the institution as a whole, while Eximbank andthe PCBs would only report the same information for the project. ICICIwould also submit financial statements in conformity with the Bank'sstandard reporting requirements, incluaing the submission of auditedfinancial statements, prepared by independent auditors acceptable to theBank, within four months of the close of each financial year while the

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other participants would submit audited reports in respect of their projectaccounts within the same period. Audit of SOEs would be submitted fourmonths after the close of each financial year. After full disbursement ofa subloan, the financial institutions would prepare a subproject completionreport, comparing actual vs. projected costs and benefits of the sub-project. After closing of the Project the financial institutions wouldprepare and submit an overall operational audit report of the Project'sexperiences and results within six months of the closing date.

C. Project Benefits and Risks

6.16 Benefits. The increased efficiency and continued rapid growth ofindustry and, in particular, manufactured exports are essential elements ofthe Government's economic sLrategy. In support of these goals, the Govern-ment has implemented a gradual process of industrial and trade reform overthe last few years. The Bank has provided advice on key elements of thereform process through its sector work and preparation for this project.The proposed project would further support Government's efforts in two mainways. First, the project would support the strengthening of key financialinstitutions with the aim of helping them to better respond to the needs oftheir clients for advice on export marketing and production strategies andissues. Thus, the technical assistance component of the project providestraining for a nucleus of staff in each financial institution in exportmarketing and project appraisal, and also provides each institution withready acces. to international expertise and up-to-date information onexport markets. Ir. addition, the Export Development Fund component wouldencourage firms to prepare and implement coherent export development plansby providing them matching funds and technical assiatance in product devel-opment and market entry. Second, the project would help meet the needs forlong term funding of export investment projects through the provision ofterm loans under the credit component. Sub-projects would have a minimumfinancial rate of return of 152 and an economic rate of return of 12Z. Itis projected that the EDF component would support about 300 firms, whileabout 350 sub-projects would be assisted under the credit component. Theproject will also have positive environmental impact. ICICI has adoptedclear environmental guidelines in its policy statement to promoteinvestments required for cleaner processes in existing industries, and toabstain from financing new projects that do not meet the Government'senvironmental guidelines.

6.17 Risks. Given the historical emphasis of Indian industrial policyon developing productioa capabilities largely for the domestic market, thecommercial banks and development banks have had only limited experience inanalyzing export projects. It will be essential that the participatingfinancial institutions improve their capability to promote and appraiseinvestments for export production; the technical assistance and exportdevelopment funds are designed to ensure that they can do this effectively.The proposed Exchange Risk Administration Scheme is an important innovationlinking the relending rate to the cost of funds through floating rates.Since this scheme is new, the Government, ICICI and the Bank will monitordevelopments closely to ensure that the relending rate adjusts properly tocover the costs of foreign borrowings and meet the needs of the financialinstitutions and sub-borrowers for some predictability in their financialplanning.

- 36 -

VII. AGREEMENTS AND RECOMMENDATIONS

Agreements

7.01 Agreements were reached on:

(a) the contents of the Loan Agreement between IBRD and the Governmentand Financial Agreements between the Government, Eximbank and thePCBs, as they apply to financing of export-oriented subprojects;conditions of participationt disbursement; procurement; sub-project review and reporting requirements; arrangements forproceeds to be retained as equity by the institutions, in amountsequal to eligible disbursements of IBRD funds; onlending rates andGovernment assumption of foreign exchange risk and repaymentobligation to IBRD; provision for IBRD supervision of end use;reporting, accounting and auditing requirements for projectaccounts (paras. 5.07 (Eximbank), 5.08 (Baroda), 5.09 (Canara),6.01, 6.05, 6.06-6.07 and 6.10-6.15);

(b) the contents of the Loan Agreement between IBRD and ICICI; theprocedures for onlending on ERAS terms and spread; subprojecteligibility criteria; provisions for subproject review; pro-curement and disbursement procedures; debt to equity and debtservice coverage limits; staffing and organizational strategy; andreporting and auditing requirements (paras. 2.31-2.33, 5.04, 6.01,6.03-6.04, 6.06-6.07, and 6.10-6.15);

(c) the contents of the Financial Agreements for the Export Devel-opment Funds (EDFs); Statements of Policies and OperatingProcedures for the EDFs (Annexes V); Organization and imple-mentation strategies for the Funds; Steering Committeearrangements and delegations of powers to the participatinginstitutions; and Disbursement arrangements (paras. 4.06-4.11,6.01, 6.08-6.09 and 6.10-6.13).

7.02 The Signing of financial agreements between the Government andeach of the Participating Financial Institutions would be a condition ofeffectiveness of the proposed loan.

Recommendat.ons

7.03 The proposed Export Development Project constitutes a suitablebasis for a Bank loan of US$120 million to India and a Bank loan of US$175million to ICICI at the Bank's standard variable rate, and terms of20 years including 5 years of grace.

_37_ ANNEX IPage 1 of 6

THE INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA, LIMITED (ICICI)

1. ICICI was established in 1955 to provide term finance to privatesector industrial firms. Since then it has grown into one of India'sleading financial institutions and it now provides a broad range offinancial services including: term loans, equity, leasing, merchantbanking, export finance and venture capital finance. It advises Governmenton the promotion of industry and the financial markets and undertakes otherdevelopmental activities. From its head office in Bombay and threeregional offices in New Delhi, Madras and Calcutta, ICICI operatesnationwide. The company has grown rapidly and total assets stood at Rs 36billion and total equity was Rs 3.2 billion as at March 31, 1988. ICICI isresponsible for about 451 of all foreign currency loans made by thefinancial institutions to Indian firms. In keeping with its role as animportant source of foreign funds the organization has established itselfin tbe international financial markets. To date it has raised over US$1.5billion in multi-currency foreign loans and recent transactions haveinvolved complex capital market tecbniques and instruments such as interestand currency swaps. However, as discussed below the ongoing liberalizationof industry and recent monetary policy measures will have some negativeeffects on the institution, such as weakened portfolio quality and reducedlending spreads, at least in the short term. The Bank has made 15 loans toICICI, the latest one being a US$105 million facility under the recentlysigned Industrial Finance and Technical Assistance Project (US$360million). The recently completed Project Completion Report for the 13thloan to ICICI noted that the loan was committed and largely disbursedwithin two years of the effective date. It is too early to judge theProject's overall financial performance but results to-date are mixed,although a major negative factor has been the heavy burden on firms offoreign exchange and interest rate movements.

OwnershiP

2. At inception ICICI was privately owned. However, with 812 of itsshares held by public sector institutions, now it is classified as agovernment company under the Companies Act for certain purposes such asappointment of its auditors. The breakdown of shareholding is as follows:

Shareholder Proportion (2)

Public Institutions (including LIC, UTI 81.5and nationalized commercial banks)

Private Indian investors 9.2 (approx. 7,500)

Foreign investors (mainly commercial banks) 9.3

Total 100.0

ManaRement and Staff

3. ICICI's day-to-day operations are guided by the policies laid downby a 15-member Board Of Directors. One of the Board's operating functionsis to decide on individual projects involving exposure of over Rs 35

-38- ANNEX IPage 2 of 6

million. The Chairman and Managing Director, Mr. N. Vaghul, came to theinstitution in 1985 and has led it through a period of impressive growthand profitability. In recognition of the changed business climate, hiscurrent priorities involve finding new and cheaper sources of funds,developing new financial projects with better spread than loans, addressingportfolio quality issues, and collecting overdues.

4. ICICI has a strong management team which is consistently able toattract, motivate and retain highly competent staff. As at December 1988total ataff strength was about 805. The institution is divided into fiveadministrative groups: operations, planning, special operations, financeand administration.

5. The Operations Group consists of lending and rehabilitation. Theformer is headed by a General Manager. It is responsible for the lendingfunction including appraising new loans, monitoring existing ones andmaking collections. The regional offices report to the General Manager towhom market research department also report. Rehabilitation functionincluding coordination with the Board for Industrial Finance andReconstruction (BIFR) is headed by a Deputy General Manager.

6. Corporate Planning and Resources, headed by a Deputy GeneralManager, develops and coordinates the ovrerall strategy and direction of theCorporation. It is also responsible for funding the institution both indomestic and foreign currencies. The increased importance of this functionhas been reflected in the organization structure.

7. Special Operations is under a General Manager. This group'sresponsibilities include merchant banking and leasing. The IEP is handledby this group which will also be in charge of the EDP.

8. Finance, Accounts, Administration and Personnel are supervised bytwo separate General Managers.

Business Strategies

9. ICICI has continually expanded the range of financial instrumentsand services it offers in response to the perceived needs of the businesscommunity and Government's industrial development priorities. Theorganization's latest Policy Statement, which was drawn up against thebackground of the Seventh Plan projections, was adopted in 1987. Itidentified six priority areas for support: modernization and technologyupgradationt export promotion; eaerging industries such as electronics andcommunications; core industries; and energy conservation and pollutioncontrol equipment.

Appraisal of Proiects

10. ICICI's appraisal techniques are thorough and of a high standard.The economic and financial rate of return norms used are usually 12Z and15Z respectively. For projects of more than Rs 25 million or for which theICICI loan will exceed Rs 25 million, a domestic resource cost calculationis done. For appraisal of export-oriented projects, ICICI officers wouldbenefit from training programs aimed at increasing their awareness of


current practices and trends in the international environment. Thetechnical assistance component of the EDP will play an important part inaddressing this need. through provision of training and access to on-linedata bases and export marketing specialists.

Developmental Activities

11. In addition to its basic project financing functions ICICI alsoundertakes activities to help the overall development of Indian industryand financial markets. Thus the institution takes an active part in thedialogue on topical issues affecting industry and finance, throughmemoranda to policy makers and Government committees. It regularly carriesout suhsectoral studies and provides training and institutional developmentsupport to national and foreign financial institutions. ICICI's has set upa credit rating agency in conjunction with Unit Trust of India. Such aservice will provide support for any eventual move towards the developmentof a lending system based on variable interest rates which are determinedby the level of risk. ICICI has provided since 1986 venture capital-typefinancing through conditional loans. In order to improve and expand itsventure capital services it recently established a venture capital company--Technology Development and Investment Company of India (TDIC)--which willfocus on investments in high technology ventures. The new firm is expectedto receive support from the Bank under an upcoming proposed TechnologyDevelopment Project.

Financial Performance

12. ICICI's financial performance has been impressive, as the figuresin Table 1 show. It has ach'.eved rapid growth and rising profits over thelast five years. Total assets increased to Rs 36 billion at the end ofMarch 1988 from Rs 14.3 billion in 1983. This represents an annualcompound growth rate of about 25Z. During this period the loans andinvestments portfolio increased to Rs 32 billion from Rs 13 billion and netprofits almost quadrupled to Rs 770 million. Consequently return on equityaveraged 23Z p.a. during this period. However these impressive figureswill be difficult to sustain in future years unless problems of increasedborrowing costs, narrower spreads and deteriorating collections aresatisfactorily resolved. Gradual deregulation has meant increasedcompetition in the industrial sector and higher risk to financialinstitutions. Net spreads (before administrative expenses) on the rupeeloan portfolio have fallen from 3.48? in 1986 to 1.90? in 1987188 due toincreased borrowing costs in the domestic market and fixed lending rates.Spreads on foreign currency loans have been maintained. In recognition ofthese trends ICICI's management has already embarked on a strategy thatinvolvess (i) greater emphasis on finding new cheaper funding sources;(ii) increasing non-funded assets and fee income activities; (iii) pursuingnew and more profitable lines of business; and (iv) vigorously pursuingcollections of arrears.

Funding

13. ICICI funds its rupee assets largely through the public issue ofbonds and debentures and to a small extent, through increases in paid-upcapital. Like the other development banks it has historically benefited


from access to long term funds at concessional rates. However, it has seenthe average cost of its borrowed rupee funds rise dramatically, from 7.55Sin 1983 to 8.252 in 1986, to 9.32 in 1987188, for two main reasons. First,its lending growth rate of about 25Z p.a over the last five years faroutstripped the 10? official limit on increases in annual capital marketborrowings at concessional rates and the additional requirement has beenfunded at the prevailing non-concessional rates of 12.5Z-132. 11 In 1980,70S of rupee borrowings were at the concessional rate. By 1988 this figurehad fallen to about 54?. Second, the current concessional rate for issuesby the Development Banks increased from 7.5S-8.75Z p.a in 1983 to thepresent 1 p.a. (l1.5Z for 15-year bonds) along with rates on all bonds.ICICI's foreign funding operations have become increasingly sophisticateda; it has taken up the benefits of increased competitiveness andinnovations in financial engineering on the international capital markets,and the country's favorable credit status, to lower foreign funding costs.Recent transactions have established the institution in the Euro-Commercialpaper and interest ratelcurrency swap markets. However, the spread chargedon all foreign currency loans is set by GOI and is currently 1.52, and thusthe lower borrowing costs are passed on in full to Indian borrowers withonly indirect benefit to the institution. The Bank has been an importantsource of funds to ICICI and Bank loans currently account for 36? of allforeign currency borrowings and 14Z of total borrowings. The Bank's fundsunder the currently ongoing projects will be an important source of addedprofitability for ICICI. Under the terms of three ongoing Bank projectsthe institution was given a spread of 3S compared to 1.5? on other foreigncurrency loans. 2, ICICI will be one of the financial institutionsparticipating in the proposed Exchange Risk Administration System, (ERAS)which is being introduced to minimize the foreign exchange and interestrate risk, of Indian firms on commercial foreign currency loans, obtainedthrough the financial institutions. This will put even greater demands onits funding officers to skillfully manage its foreign currency liabilitiesand the Corporation is keen to maintain its current impressive performanceby strengthening its skill in this important area. ICICI recentlyrequested the Bank to assist it in developing its liability managementstrategies, systems and staff skills. In response, the Financial TechnicalAssistance Unit (FTA) of the Bank's Financial Operations Department visitedIndia in November 1988, to identify areas for supporting ICICI's liabilitymanagement efforts.

Loan Portfolio

14. As at March 31, 1988, ICICI had disbursed loans and madeinvestments in equities and debentures totaling Rs 46.3 billion, forpredominantly large and medium scale firms. Outstanding loans andinvestments were Rs 31.6 billion and the sub-sectoral distribution of loanswas as follows: engineering sector, including metal products, mechanical

1/ ICICI is allowed to issue government guaranteed bonds and debenturesfor up to 15 years at an administered rate of 11? and these securitiesqualify for SLR of commercial banks.

2/ The three projects under which ICICI Is able to make rupee-denominatedforeign currency loans are the IEP, the Cement Energy Saving Projectand the Industrial Finance and Technical Assistance Project.


and electrical machinery and transport equipment (24Z); chemical andpetrochemical industries (222); textiles (13Z); basic metal (9Z): cement(92); and pulp and paper (42). For project sizes up to Re 30 million ICICIwould normally provide the debt finance directly. Projects greater than Rs70 million are funded through the inter-institutional syndicate mechanisminvolving IDBI and IFCI as well as the all-India investment institutions,the State Financial Corporations and the commercial banks.

15. Portfolio quality has deteriorated in recent years as reflected infalling collections ratios from 1983-1986. However, collections beforerescheduling, improved slightly as at March 31, 1988, to 74.4Z (15 monthsfigure) as compared with 73.1Z in 1985, when the industrial liberalizationprocess gathered momentum. Total arrears stand at 3.1Z of portfolioalthough about 64Z of these are accounted for by firms in five industries:sugar, textiles, cement, jute and paper, which face long term structuralproblems. The difficuilties caused by the more competitive operatingenvironment have, in many cases, been exac,rbated by the depreciatingexchange rate which have increased effective interest rates to over 30Zp.a., for many firms with foreign exchange denominated loans.

Profitability

16. As a result of the interest rate squeeze, ICICI's spreads havedeteriorated to the extent that, at the margin, it's basic lending businessis barely profitable. At present 12.5Z of total assistance is atconcessionary rates averaging about 12.02 p.a which yields a negativespread, when marginal borrowing costs of 11.52 p.a, and administrativeexpenses and provisions are taken into account. Furthermore the overallsituation will become worse over time as the older and cheaper funds matureand are replaced with funds at prevailing higher rates. Given thesedevelopments, ICICI has used a three-point strategy to preserve itsfinancial profitability. First, it has concentrated on increasing volumesin its most profitable activities such as leasing and lines of credit forequipment suppliers. Second, it has successfully held down administrativecosts in the face of rapid growth from 0.4Z of total assets in 1983 to 0.3Zin 1987/88. Third it has placed increased emphasis on collections, throughthe adoption of a comprehensive collection strategy.

Future Prospects

17. Loans are expected to grow at an average rate of 152 p.a. over thenext five years, compared with about 202 p.a. for the 1983-88 period. Asthe projections in Table 2 show, following five years of steadily risingprofits, ICICI is expected to experience a slow down in profits growth withno change in current cost of funds and lending rates. Between 1983 and1988, there was an almost fourfold increase in profits and return on equityaveraged 23Z. Over the next five years, with no change in spreads. ROE isexpected to decline to about 14Z. Spreads will narrow due to higherborrowing costs as maturing cheap funds are replaced by higher cost fundsand weak collections squeeze profitability. Profit performance will alsobe influenced by the extent to which ICICI succeeds in its plans todiversify its funding sources (in order to tap cheaper funds), increase feeincome and successfully launch new higher yielding products and services.The debttequity ratio is expected to stay mostly below 10:1 and minimum


debt service coverage is projected to be 1.5. The key underlyingassumptions behind the projections are that: (i) there will be continuedrapid growth in high profit areas and non-funded business; and (ii) the newdebt collection strategy should improve the collection ratio, presently74.42 (15 months). The declining interest rate margins are a cause forconcern and should be kept under close review by the Government and ICICI.

Table 1.1: The Industrial Credit and Investment CorsOration of India Limited (KCMI)(Actual anO Projected Incom* Shees)

(Rs billions)

Flscal Year End March 31 / 1983 1964 16S6 1966 HE"- 99 1990 1991 1992 1998

Incoo

Interest on Loans and Debentures 1.80 1.64 1.98 2.61 8.82 8.37 4.09 5.00 5.97 7.11

Fee and Comission 0.06 0.07 0.14 0.27 0.80 0.84 0.62 0.74 0.97 1.28Other Income 0.01 0.01 0.01 0.15 0.40 0.48 0.44 0.62 0.63 0.66

TOTAL INCOME 1.88 1.62 2.11 2.98 4.a8 4.17 6.06 6.26 7.47 6.99

Exoxsm

Intr"et 0.90 1.16 1.44 1.62 8.08 2.94 8.87 4.44 5.41 6.56

Provisions/Write Off. b 0.08 0.00 0.00 0.16 0.00 0.00 0.00 0.00 0.00 0.00Salaries and Personnel 0.08 0.08 0.04 0.06 0.11 0.08 0.07 0.09 0.10 0.12Depreciation 0.02 0.02 0.02 0.11 0.16 0.19 0.28 0.42 0.64 O."6

Oter 0.04 0.05 0.07 0.07 0.04 0.05 0.06 0.07 0.08 0.09

TOTAL EXPIENSES 1.02 1.26 1.67 2.20 8.41 8.24 8.98 6.02 6.18 7.47

Profit Before Tax 0.84 0.86 0.64 0.78 0.92 0.98 1.07 1.24 1.84 1.42Tax 0.18 0.16 0.16 0.12 0.15 0.16 0.17 0.21 0.24 0.26Profit After Tax /c 0.21 0.26 0.88 0.81 0.77 0.78 0.90 1.08 1.10 1.17Dividends 0.04 0.08 0.08 0.09 0.16 0.14 0.15 0.17 0.19 0.21Reerves 0.17 0.22 0.80 0.52 0.81 0.64 0.75 0.66 0.91 0.96

Rati on:

ROE 21.2X 28.2x 24.6x 29.0x 27.1X 22.11 21.13 19.93 17.93 16.83

ROA 1.6 1. OX 1. 9X 2.4X 2.4X 2.03 2.03 2.0 1.6X 1.63

La Flscal Year End Is Deember 81 up to 1966 and March 81 from 196 onwards. March 1966 figures are for15 months.

1b Interest incom for 1984, 19865 is net of provisions and write-off.

tc The 1964 figure includes write back of Rs 70 million *rom doubtful debt reserve.

Source: ICICI.

Table 1.2: The Industrial Credit and Investment Cororatlon of India Limited (ICICI)(Actual and Projetewd Balanee Sheets)

(Re billions)

Fiscal Year End March 81 /a 1983 1984 1ess 198e Ig!s 1989 199o 1991 19 199e

Asoete

Cash and Bank Balances 0.88 0.42 1.47 1.51 0.75 2.10 2.60 2.60 2.60 2.50Other Assets and Advances 0.80 1.05 1.27 1.65 8.18 1.18 1.10 1.16 1.18 1.16Current Asset 1.18 1.47 2.74 8.04 8.98 1.42 2.10 2.92 3.87 5.02Loans (rupes) 7.70 9.40 11.40 14.12 19.00 22. Wi 27.02 84.11 41.66 60.28Loans (fx) 4.60 5.60 6.88 9.27 11.00 12.83 18.88 15.06 18.28 17.09

Investments 0.80 1.00 1.20 1.80 1.64 1.80 2.02 2.26 2.59 2.99Net Fixed Aseote 0.06 0.20 0.24 0.40 0.86 1.68 2.82 8.07 8.85 4.67

TOTAL ASSETS 14.88 17.67 22.41 28.18 36.48 48.00 51."6 01.07 71.76 84.59

Liabilteet and Net Worth

Current Liabilities 0.76 0.98 1.09 1.28 0.98 1.65 1.65 1.65 1.65 1.65

Rupe Debt 0.41 10.12 13.02 15.27 20.00 23.17 27.82 38.68 40.08 49.08Foreign Currency Debt 4.08 6.14 6.6B 9.16 18.22 14.84 17.48 20.19 28.48 26.18Not Long Term Debt 12.49 15.26 19.58 24.48 88.22 37.61 46.80 58.77 63.47 76.21

Share Capital 0.27 0.41 0.49 0.67 0.80 0.80 0.90 1.00 1.10 1.24Reserves 0.81 0.92 1.25 1.80 2.41 8.04 8.80 4.06 S.54 8.49

Total Equity 1.08 1.88 1.74 2.47 8.21 8.84 4.70 6.66 0.64 7.78

TOTAL LABIIUTIES 14.83 17.67 22.41 28.18 86.48 48.00 51.66 61.07 71.76 84.69AND NETWORTH

Ratios:

Dobt:Equity (time) /b 10.30 9.80 10.40 9.60 9.50 9.40 8.00 8.20 8.50 9.10

/a Fiscal Year End Is December 31 up to 1986 and March 81 from 1988 onwards. March 1988 figures are for 15 mnths.

Lb Debt: Equity as defined In World Dank Loan Agreement form 1988.

Source: ICICI.

Table 1.8: The Industrial Credit and Investment Coreoratlon of India Limited (ICICI)(Actual and Projed CFah Flow Statements)

(Rs bi l ions)

Fiscal er End Varch 81 / 19883 1984 1985 1998 1987 1986 1989 1990 1991 1992

-~~~~~ Il GT*-------ict*d-- --

Sources

Operations 0.88 0.5W 0.65 0.90 1.87 1.16 1.44 1.78 2.06 2.36

Share Capital 0.00 0.0? 0.09 0.16 0.18 0.00 0.10 0.10 0.10 0.14

Loan Drawdownn 2.28 8.18 4.69 4.64 18.48 5.82 9.37 10.8? 11.98 16.82

Repayments andDisposal of Investments 0.86 1.14 1.84 2 29 8.64 8.83 4.48 6.16 6.04 6.42

TOAL 8.47 4.87 6.85 0.09 18.67 10.80 15.39 17.40 20.18 24.74

Us"s

Fixed Assets 0.08 0.12 0.18 0.28 0.62 0.10 0.10 0.10 0.10 0.10

ODsburs_ents 8.09 8.67 4.18 5.77 8.66 9.66 12.06 18.94 16.09 18.80

Invostente 0.16 0.14 0.26 0.81 0.64 0.86 0.41 0.47 0.66 0.63

Repanymen 0.41 0.68 0.98 1.16 S.64 1.58 1.68 1.91 2.28 4.07

Dividends and Other 0.81 0.20 0.24 0.64 0.98 0.72 0.84 0.98 1. 6 1.14

Change In Cash undShort-term Invewteente -0.58 0.04 1.05 0.04 2.05 -1.4S 0.40 0.00 0.00 0.00

TOTAL 8.47 4.87 6.86 8.09 18.51 10.80 16.39 17.40 20.18 24.74

DSCR 1.60 1.60 1.60 1.70 1.80 1.40 1.70 1.60 1.50 1.40

L Fiscal Year End Is December 81 up to 1We -w4 March 81 from 1988 onwards. March 1988 flurs are for 15 months.

Source: ICICI.

Table 1.4: The Industrial Credit and Investment Corporation of India Limited (ICICI)Collection Performance Before Rescheduling

(Re billions)

Year 1983 1984 1985 1986 1987/1988 la

Amount Overdue at Beginning 0.27 0.31 0.37 0.56 0.83of the Year

Amount Falling Due 1.72 2.36 3.00 3.73 6.00During the Year

Amount Collected 1.49 1.96 2.46 3.10 5.08During the Year

COLLECTION RATIO: 74.92 73.42 73.0 72.3Z 74.42

Collection Performance After Rescheduling(Rs billions)

Year 1983 1984 1985 1986 198711988 /a

Amount Overdue at Beginning 0.27 0.31 0.37 0.56 0.83of the Year

Amount Falling Due 1.72 2.36 3.00 3.73 6.00During the Year

Amount Collected 1.49 1.96 2.46 3.10 5.08During the Year

Amount Reschedued 0.19 0.35 0.35 0.35 0.62During the Year

COLLECTION RATIO: 82.8? 84.5? 81.5? 78.7? 81.8?

/a Fifteen months.

Source: ICICI.

Table 1.5: The Industrial Credit and Investment Corporation of India Limited (ICICI)

Arrears of Principal Before Rescheduling(Rs billions)

Year 1983 1984 1985 1986 1987188 /a

Amount RescheduledDuring the Year 0.09 0.17 0.17 0.19 0.30

Arrears At Year End 0.16 0.20 0.31 0.44 0.63

Loans Outstanding 12.52 15.26 18.65 23.88 30.36

ARREARS RATIO: 2.02 2.42 2.62 2.6Z 3.12

Arrears Of Principal After Rescheduling(Rs billions)

Year 1983 1984 1985 1986 1987

Arrears At Year End 0.16 0.20 0.31 0.44 0.63

Loans Outstanding 12.52 15.26 18.65 23.88 30.36

ARREARS RATIO: 1.3Z 1.32 1.72 1.82 2.12

la Fifteen months.

Source: ICICI.

'able 1.6: The Industrial Credit and Investment Corporation of India Limited (ICICI)Average Spreads

Foreign Currency Loans 1983 1984 1985 1986 1987188

Average yield on foreign 11.96S 12.842 12.242 12.50Z 11.252currency loans

Average cost of funds 8.79Z 9.362 8.45Z 8.48Z 7.20ZGross Spread 3.172 3.482 3.792 4.02Z 4.05ZRisk 0.59Z 0.952 1.412 1.322 1.602Administrative Expenses 0.40Z 0.392 0.362 0.302 0.302

(2 of assets)

Net Spread 2.18Z 2.14Z 2.022 2.402 2.152

Rupee Loans

Average yield on rupee loans 12.702 13.302 13.302 13.53Z 13.212Average cost of funds 7.55Z 7.802 8.192 8.252 9.302Gross Spread 5.15Z 5.502 5.11Z 5.282 3.912Risk 1.87Z 1.782 1.652 1.802 2.01ZAdministrative Expenses 0.402 0.39Z 0.362 0.30Z

(2 of assets)

Net Spread 2.88Z 3.332 3.102 3.182 1.612

Source: ICICI.

Table 1.7: The Industrial Credit and Investment Corporation of India Limited (ICICI)

Resource Position as at December 31, 1988(Rs billions)

Share Capital 801

Reserves 2,408

Loans 3,326

Deposits and Others 112

Total Resources 36,546

Loan Portfolio 29,334

Investments 1,640

Advance Paymentsfor Creditors 670

Other Assets 1.341

Cash Availablefor Disbursement 32,984

Undisbursed Commitments /a 4,837

N.B.

Ja Includes US$116.72 million in foreign currency loans.

Rs 100 = US$6.84

-50- ANNEX IIPage 1 of 3

THE EXPORT-IMPORT BANK OF INDIA (EXIMBANK)

1. The Export-Import Bank of India was established by an act ofParliament on January 1, 1982 to finance exporters and importers andpromote India's international trade. Wholly owned by the Government, ittook over the export loans and guarantees portfolio of IDBI, and became thecentral body for coordinating the activities of financial institutionsengaged in the financing of exports and imports. It has its headquartersin Bombay, three regional offices in New Delhi, Calcutta, and Madras andthree overseas representative offices in Washington, D.C., Abidjan andSingapore. Its primary function is providing medium and long-term financefor exports. Eximbank is a well managed bank which has grown rapidly andmaintained a sound financial coudition. Total assets grew to Rs 12.8billion as at December 31,1987 from Rs 3.6 billion in 1982, representing acompound annual growth rate of 192 p.a. Net income has risen consistentlyover the same period to Rs 199 million from Rs 62 million and equity hastripled to Rs 2.5 oillion. Eximbank is the implementing agency for anIFC-funded US$15 million Agency Credit Line (ACL) for supporting small andmedium size exporters and the Export Marketing Fund component of theongoing IEP. To-date it has committed about US$7.2 million for about 120subprojects under the IEP.

Management and Staff

2. Eximbank's operating policies are decided by a 15-man Board ofDirectors headed by Mr. Kalyan Banerji, an experienced banker, who has beenChairman and Managing Director since 1985. The rest of the Board includesthe Secretaries of Commerce, Finance and Industry, the Deputy Governor ofthe Reserve Bank, the chairmen of the Reserve Bank, IDBI, the Export CreditGuarantee Corporation, Chairman of SBI and Canara Bank and Chief Executivesof selected exporting firms.

3. Eximbank is organized into six major operational groupss (i) theProject Finance Group handles overseas construction and turnkey projectsand technical services exports; (ii) the Trade Finance Group providesexport finance and refinaiice and funding for imports; (iii) the OverseasInvestment Group finances the equity contributions of Indian firms inoverseas joint ventures; and (iv) the Co-ordination Group is responsiblefor liaising with various domestic and foreign institutions and agenciesincluding the multilateral organizations. Two other groups are responsiblefor administration and planning respectively. Eximbank has 200 employees.The Bank continues to attract and retain high calibre staff who get theopportunity to develop specialist knowledge of export products and markets.

Operations

4. Eximbank's main financing role is the provision of medium and longterm credit for export activities. Short term pre-shipment finance islargely the domain of the commercial banks while Eximbank refinances theirlong term exposure on pre-shipment finance. It provides post-shipmentfinance through direct credits and refinancing of commercial banks' loans.Eximbank has continually expanded the range of financing schemes andservices that it offers exporters. It has been able to remain a lean and


highly responsive organization. Eximbank also works with clients'commercial banks, giving expert analysis of export markets and projectproposals and participating in export transactions either directly, or byproviding refinance in the case of smaller projects. Eximbank currentlyoffers 14 export financing programs.

5. Eight of these programs allow Indian exporters of goods andservices to give term credit to their overseas customers, namelyt DirectFinancial AssistLnce to Exporters, Consultancy and Technology Services,Overseas Buyers' Credit, Lines Of Credit(to foreign government agencies),Refinance of Export Credit, Relending Facility, Export Bills Rediscounting,Small Scale Industry Export Bills Rediscounting. The other six programsenable Indian exporters to finance pre-shipment and investment activities:Pre-shipment Credit, Hundred Percent Export Oriented Units, OverseasInvestment Finance, Computer Software Exports, the IFC Agency Credit Lineand the IEP Export Marketing Fund.

6. Eximbank is the chairman of the Working Group on export projectfinance. The Group also comprises representatives of the Ministry OfCommerce, the Departments of Exchange Control and Industrial Export CreditControl of RBI, ECGC and the Commercial Banks. The Group's main functionis to approve and facilitate Indian firms' bids for overseas contracts inexcess of Rs 20 million. Smaller contracts may be cleared by thecommercial banks, while those between Rs 50 million and Rs 200 million maybe cleared by Eximbank.

Developmental Activities

7. Eximbank continues to play an important role in increasing theknowledge and awareness of Indian firms about export opportunities. Itprovides information on bidding opportunities for contracts offered bymultilateral agencies and is currently building up a detailed database ofimporters of products which could be sourced from India. In addition Eximregularly sponsors seminars and workshops on export marketing. Under theIEP, it is working closely with firms to help them develop viable exportplans. However it needs to increase the number and skills of its staffthat have responsibility fcr helping firms identify overseas market nichesand develop appropriate export plans. The technical assistance componentof the proposed EDP will assist in this process by providing training forselected staff as well as continuing access to data bases and internationalexperts.

Funding

8. Eximbank operations are currently funded mainly with Rs 2.5 billionin equity capital and reserves and borrowings of Rs 8.6 billion. About Rs1 billion or 13Z of total borrowing is in the form of foreign currencyloans. Between 1982 and 1988 Eximbank raised about US$130 million and onebillion Japanese yen in the international markets through loan syndicationsand swaps on increasingly favorable terms. A substantial portion ofEximbank's borrowed resources are provided by the Government and theReserve Bank at concessional rates, in order to allow it to finance exportactivities at below-market rates. Out of its total domestic borrowings ofabout Rs 7.6 billion, Rs 4.35 billion or 57Z is in loans from the ReserveBank at 7Z p.a. In addition Eximbank inherited about Rs 1 billion in low-priced debt (6Z) when it took over IDBI's export portfolio in 1983.


Loan Portfolio

9. Given current average borrowing costs of about 8.4Z and the factthat 15Z of total resources are provided by equity the bank is able to earna comfortable net spread of about 3Z; despite the fact that about 952 ofits lending is priced at 7.52-8.5Z p.a. The portfolio is of high quality.Between 85Z and 902 of the non-funded portfolio of guarantees is counter-guaranteed with the Export Credit Guarantee Corporation and of the fundedportfolio about 14Z is short term commercial bank risk; 142 is long termcommercial bank risk which has been refinanced by Eximbank and the other72Z of loans is 851-902 covered by ECGC.

Profitability

10. Eximbank's five-year historical results are provided in Table 2.The bank has maintained a rising trend of growth and profitability sinceits establishment. In 1987 the value of overseas turnkey and constructioncontracts approved by the Working Group rose 4002 to Rs 82 billion,disbursements were up 142 to Rs 6 billion and guarantees issued increasedby 38Z to Rs 548 million. Net income was up 172 to Rs 199 million. Returnon average assets (1.7Z) and return on average equity (7.8Z) and thedebt:equity ratio (2.92) are low, reflecting the promotional nature of theorganization and its conservative liability structure.

Future Prospects

11. In addition to maintaining its current profitability and soundfinancial condition, the bank expects to receive a total of about Rs 1.75billion in Government equity contributions over the next five years.

Table 2.1: Export-Import Bank of India (Eximbank)

Audited Income Statements(Re millions)

Fiscal Year End December 31 1983 1984 1985 1986 1987

--------------- Actual-----------------

Income

Interest and Discount 324.3 497.5 617.2 733.9 908.8

Exchange, Commission, Brokerageand Fees 12.8 14.4 13.3 10.7 11.4

Other Income 0.7 3.1 6.3 2.2 4.5

Total 337.8 515.0 636.8 746.8 924.7

Expenditure

Interest 196.5 323.8 391.6 475.0 594.0

Credit Insurance 3.6 3.8 4.4 3.3 5.5

Administrative Expenses 19.3 24.3 31.7 36.4 44.3

Provisions 24.7 36.5 46.2 54.4 72.3

Depreciation 5.6 6.4 9.2 8.2 9.8

Total Expenses 249.6 394.7 483.1 577.2 725.9

Net Income 88.1 120.3 153.7 169.6 198.8

ROE (2) 8.78 8.76 7.9 7.75

ROA (2) 2.0 2.06 1.81 1.71

Source: Eximbank.

Table 2.2: Export-Import Bank of India (Eximbank)Audited Balance Sheets

(Rs millions)

Fiscal Year End December 31 1983 1984 1985 1986 1987-------------------Actual------__________

Assets

Cash and Bank Balances 257.5 476.7 312.4 827.0 1,398.8

Investments 1,906.1 1,690.2 1,822.9 2,475.2 3,484.2

Bills Discounted 459.0 500.0 927.3 1,000.0 1,000.0

Loans and Advances 2,471.2 3,647.3 4,616.8 5,437.8 6,231.5

Other Assets 257.5 359.8 431.5 682.1 646.0

Net Fixed Assets 17.9 16.8 52.1 52.0 51.7

TOTAL ASSETS 5,369.2 6,690.9 8,163.1 10,474.1 12,812.2

Liabilities and Net Worth

Current Liabilities and Provisions 133.3 167.3 244.6 367.9 521.8

Other Liabilities 34.0 58.4 81.5 294.7 846.1

Dividend Payable 20.0 30.0 40.0 50.0 60.0

Borrowings 3,486.1 4,337.7 5,089.7 6,235.2 6,992.4

Notes, Bonds and Debentures 530.0 530.0 780.0 1,175.0 1,609.5

Total Long Term Debt 4,016.1 4,067.7 5,869.7 7,410.2 8,601.9

Share Capital 1,000.0 1,275.0 1,475.0 1,725.0 1,945.0

Reserves 120.9 211.2 324.9 444.4 583.1

Reserve for loan loss 44.9 81.3 127.5 181.9 254.2

Total Equity 1,165.8 1,567.5 1,927.4 2,351.3 2,782.3

TOTAL LIABILITIESAND NETWORTH 5,369.2 6,690.9 8,163.1 10,474.1 12,812.1

= m= _ __= c= = = _z0

Guarantees Outstanding 4,515.0 5,102.0 4,661.0 5,290.0 4,844.0

Source: Eximbank.

-55- ANNEX IIIPage 1 of 2

BANK OF BARODA

1. Bank of Baroda was set up in 1908 and nationalized in 1969. It iscurrently one of the ten largest commercial banks in India with totalassets of Rs 101 billion. It operates nationwide with a network of over2,000 branches, and internationially, through 52 branch offices in fourteencountries. The bank employs about 42,500. Like the other major national-ized banks, Baroda has grown steadily in recent years and enjoyed risingprofits. Compound asset growth was 11.5 2 p.a between 1983 and 1987 andnet profits rose 1532 to Rs 218 million over the same period. Net worthcurrently stands at Rs 1.6 billion, or 1.6Z of assets. Bank of Baroda isone of the Participating Commercial Benks under the Industrial ExportProject. Its performance under the project has been satisfactory. It hasmade sub-loan commitments of about US$ 4.4 million to 22 firms to-date.Furthermore the Bank's project appraisal skills and procedures have beendeveloped, to include economic analysis, as a result of its participationin the IEP.

Ownership, Management and Staff

2. Baroda has been 1002 Government-owned since 1969. The bank'soperating policy guidelines are laid down by a Board of 4 Directors,including one representative of the Government of India and one fromReserve Bank of India. Day-to-day operations are handled by a seniormanagement team comprising the Chairman and Managing Director Mr. PremitSingh, one Executive Director and five General Managers in India and onebased in London. They are assisted by 13 Deputy General managers withfunctional responsibilities.

Operations

3. The bank's domestic operations are divided into 12 zones, eachheaded by Deputy General Manager, or in the case of smaller zones-anAssistant General Manager. Below this level there are about 52 RegionalManagers, who each control 40-50 branches. Baroda has the largest numberof foreign branches among Indian banks. The European operations arehandled from branches in London and Brussels, while the New York branchcovers the Americas and the Pacific. Baroda provides a full range of com-mercial banking services and also offers various capital market productsincluding management of public issues of equities and debentures, under-writing, funds management and financial advisory services. For its basiclending business the bank has decentralized approval authorities right upto the branch level, with provisions for post-sanction scrutiny of loandecisions. Proposals involving amounts in excess of Rs 30 million aredecided by the Board of Directors.

Funding

4. About 902 of Baroda's total funding is provided by deposits withthe balance coming from long term borrowings (6.3Z), equity (1.72) andother sources (2Z). Deposits rose 172 in 1987 to Rs 86 billion, withcurrent accounts representing about 162 of total. At the internationallevel, the bank maintained its presence in the capital markets with twoFloating Rate Certificate of Deposit issues for a total of USS 60 million.

-56- ANNEX IIIPage 2 of 2

Loan Portfolio

5. In 1987 Baroda's loan portfolio grew 162 to Re 47 billion. Aswith other commercial banks in India only limited information is availableon portfolio status. The bank has referred about 64 medium and large scalecompanies representing loans outstanding of Rs 1.3 billion (2.7? of total)to the Board for Industrial and Financial Reconstruction (BIFR), for finan-cial rehabilitation. Baroda continues to place emphasis on improvingcredit quality. An important part of this process is staff training incredit analysis as well as the ongoing computerization of its operations,which should help provide more timely information and facilitate closermonitoring of accounts. In addition the procedures for economic rate ofreturn analysis of investment projects, introduced as a result of itsparticipation in the Industrial Export Project is helping to upgrade thebank's project analysis capabilities.

Profitability and Future Prospects

6. Baroda's profits doubled between 1985 and 1987 to Rs 218 million,reflecting a rapid increase in business volumes and return on equityincreased 302 to 13.61 over the period. The bank has a strong commitmentto supporting exports, and in particular, manufactured exports. It hasrecently set up five International Business Branches to provide specialistservices to export clients. In addition, the bank has established sixexport advisory cells, to assist smaller firms with the planning and imple-mentation of their export strategies. Baroda intends to build on the gainsachieved uader the IEP during implementation of the Export DevelopmentProject. As part of its preparation for the new project it has carried outa preliminary market survey to highlight the geographical areas and productgroups on which it will concentrate its marketing efforts under the EDP.Like the country's other lending institutions the bank will need to paycloser attention to the quality of loans made,given the more diffictitlending environment that is developing as a result of the ongoing indus-trial deregulation and other policy measures. The management has expressedits commitment in this important area.

Table 3.1: Bank of BarodaAudited Profit and Loss Statements

(Re billion)

December 31 1983 1984 1985 1986 1987

Income

Interest and Discount 4.20 5.10 5.86 6.46 7.61Commission, Exchange & Brokerage 0.33 0.35 0.42 0.57 0.72Other _ 0.01 -- 0.01 0.06

Total Income 4.53 5.46 6.28 7.04 8.39

8xpenditure

Interest 3.22 3.88 4.45 4.94 5.99Salaries and Allowances 0.85 1.10 1.28 1.36 1.51Administration and Taxes 0.13 0.15 0.17 0.21 0.24Depreciation 0.03 0.04 0.04 0.07 0.10Other 0.21 0.22 0.24 0.27 0.33

Total Expenditure 4.44 5.39 6.18 6.85 8.17

Profit After Tax 0.09 0.07 0.10 0.19 0.22

ROE (2) 0.79 1.38 1.81 1.74ROE (Z) 0.11 0.15 0.24 0.24

Source: Bank of Baroda.

Table 8.2: Bank of BrodaAudited Balance Show

(Rs Bi ll on)

Docember 1 1988 1984 1985 1986 1987

Cash ond Short. Term Funds 10.65 11.98 11.11 14.76 16.66Investments 18.68 18.68 10.24 18.68 25.18Advanes 27.84 31.98 85.76 40.18 46.66Bills Receivable 8.86 8.84 4.81 4.78 6.02

Net Fixed Assets 0.26 0.80 0.88 0.88 0.40Other Assets 8.88 8.65 4.48 4.89 4.80

Total Assets 68.47 65.81 72.28 88.8 9 101.2

Liabilities

Deposits and Other Accounts 61.94 68.12 61.87 78.80 86.60Borrowinp 1.86 8.68 8.76 2.95 6.986

ills Payable 0.28 0.31 0.60 0.47 0.41BIlls Roeivablo 8.86 8.84 4.81 4.70 6.02Other Liabilities 0.65 0.92 0.84 0.98 1.42

Total Liabilities 65.04 64.82 71.28 82.48 99.61

Eaulw

Share Capital 0.14 0.14 0.52 0.68 0.66Rmrves 0.29 0.86 0.48 0.78 0.98

TotI Equity -0.48 0.49 0.06 1.41 1.61

Total Liabilitie and Equity 68.47 76.21 7.83 88.89 101.22

Contra Ites 2.64 2.B1 8.26 8.48 4.65

Source: Bank of Baroda.

Table 3.3i Bank of BarodaSpread Analysis

Spreads(2 of deposits) 1984 1985 1986

Average Yield on Loans & Investments /a 8.592 8.972 8.512

Average Cost of Funds 6.542 6.812 6.512

Gross Spread 2.052 2.162 2.002

Fee Income 0.592 0.642 0.752

Establishment Expenses 1.842 1.96Z 1.802

Net Spread 0.792 0.842 0.962

NB.

la Net of provisions.

Source: Indian Banks' Association-Financial Analysis of Banks, va:rous

issues.

-60- ANNEX IVPage 1 of 2

CANARA BANK

1. Founded in 1906 Canara Bank is today the fifth largest commercialbank in India. As ai December 31, 1988 it had total assets of Re 109billion and employs over 48,000 people. The bank has its head office inBangalore and its 1,864 branches are located throughout the country. Italso has a branch in London. In recent years Canara has developed areputation as a highly innovative, aggressive and responsive bank and thisis reflected in the rapid growth of its operations. Over the last fiveyears (1983-87) it has outstripped the other nationalized commercial banksin virtually all the major performance indicators. Total assets have grownat an annual compound rate of 202, deposits and other accounts rose by182 p.a. to Rs 79 billion, or 6? of the total for all Scheduled CommercialBanks. Reflecting the massive profitability of the bank total equity hasgrown at an annual compound rate of 452 since 1983, making Canara one ofthe best capitalized of all the nationalized banks. Net profit rose by148Z to Rs 455 million in FY87. The bank expects to maintain the currentmomentum and grow at a similar rate in the coming years. Such continuedfast growth will pose challenging management issues for the bank'sleadership. Given the more difficult lending environment that has resultedfrom the ongoing industrial liberalization there will be a need for greateremphasis on the quality of additional assets booked. Canara is one of theParticipating Commercial Banks under the Engineering Ancillary component ofthe IEP. This is the first time that Canara has worked with the Bank andthe results have been beneficial. Canara has expanded its appraisalmethods to incorporate economic analysis of projects. The Bank hascommitted US$4.2 million covering 22 sub-projects to-date.

Ownership

2. Canara Bank is 100X Government-owned. It was one of 14 commercialbanks that were nationalized in 1969, as part of the Government's effortsto direct credit and investment patterns in harmony with nationalpriorities and social objectives.

Management and Staff

3. Canara Bank's dynamic growth has been maintained under theleadership of Mr. N.D. Prabhu, who became Chairman and Managing Director in1988, after previously serving as Executive Director. Mr. Prabhu is aseasoned banker, who has spent practically his entire career at Canara andhas risen rapidly through the ranks since joining the bank in 1958. Therest of the 4-man Board is made up of representatives of the CentralGovernment, the Reserve Bank, an Executive Director and an employeesrepresentative. As with other large commercial banks Canara has a highly-decentralized organizational structure, based on branch, region and circle-level management tiers. The management team comprises 6 General Managersand 16 Deputy General Managers.

Operations

4. Canara provides the full range of commercial banking activities.A hall-mark of the bank's rapid growth has been the aggressive pursuit ofmarket-share through the introduction of new products and services. A

-61- ANNEX IVPage 2 of 2

variety of consumer banking services and savings schemes have been broughtto the market in quick succession. Furthermore the bank established amerchant banking division in 1983 to perform a variety of capital marketservices,including, issue management, underwriting, corporate finance andinvestment advisory services. The bank has a dominant role in merchantbanking; it enjoyed a 322 market share of all new issues business in 1987.Merchant banking profits contributed significantly to total profits in1987. A new subsidiary-Canbank Financial Services Limited-is nowresponsible for merchant banking business. The subsidiary entered theleasing business in 1987 and this activity is expected to grow rapidly andmake a strong contribution to profits, given the higher spreads that accrueto this activity. Other highly profitable activities into which the bankhas recently diversified, with considerable success, are mutual funds andsecondary market-making for Government bonds. As a direct result of itsparticipation in the IEP the bank has upgraded its project appraisalmethods to include economic rate of return and domestic resource costcalculations. The technical assistance component of the EDP will enablethe bank to further develop its institutional skills for handling exportprojects.

Funding

5. Canara Bank's deposits have grown rapidly in recent years andprovided the basis for the expansion of its lending activities. The bankhas a 6.22 share of the deposits of all Scheduled Commerical Banks. In1987, Canara had total deposits of about Rs 79 billion which representedrecord growth of 162. However, the share of term deposits rose to nearly60Z from 55? the previous year and the proportion of savings deposits alsorose slightly, with a corresponding reduction in the proportion of currentaccount funds. This led to a rise in overall funding costs and ifcontinued, this trend will adversely affect profitability.

Profitability

6. As mentioned above Canara bank has, like other lendinginstitutions in India, diversified into financial services which are higheryielding by virtue of the fact that their pricing is not administered byti- authorities. One area in which the bank was especially successful wasin the active management of its investment portfolio and the secondarymarket trading of Government securities. Record profits of Rs 450 millionin 1987 point to the success of the bank's overall strategies andinitiatives.

Future Prospects

7. Although Canara has had impressive and sustained growth andprofitability in recent years, it remains to be seen how well it can managethe results of such growth. Aware of the need to consolidate the gainsalready made senior management is already focusing on achieving improvedcollection rates. Nevertheless the bank appears poised to maintain thecurrent pace of expansion.

Table 4.1: Canara BankAudited Profit and Loss Statements

(Rs billions)

December 31 1983 1984 1985 1986 1987

Income

Interest and Discount 3.15 4.18 5.50 6.77 8.48

Commission, Exchange 0.21 0.25 0.34 0.45 0.59

and BrokerageOther Receipts -- -- -- 0.01 0.01

Total Income 3.36 4.43 5.84 7.23 9.08

Expenditure

Interest on Deposits,Borrowings 2.21 2.92 3.91 4.93 6.16

Salaries and Allowances 0.76 1.02 1.25 1.37 1.58

Administrative Expenses 0.16 0.21 0.26 0.32 0.42

Depreciation .03 .04 0.06 0.1 0.11

Other Expenses 0.15 0.18 0.25 0.33 0.36

Total Expenditure 3.31 4.37 5.73 7.05 8.63

Profit After Tax 0.05 0.06 0.11 0.18 0.45

Ratios:

ROE (2) 19.23 13.04 14.19 13.74 22.28

ROA (2) 0.13 0.13 0.18 0.23 0.49

Source: Canara Bank.

Table 4.2: Canara BankAudit;Tga Banee Shoets

(Rs million)

December 31 1988 1904 1986 )988 1987

Assets

Cash and ShoK Term Funds 5.87 8.4 9.60 10.88 16.78Investments 10.60 12.35 14.98 21.53 27.22Advances 21.40 28.14 3F.60 41.68 46.69Bills Receivable 2.08 2.75 a.04 3.42 8.91

Not Fixed Assets 0.25 0.31 0.67 0.70 0.91Other Assets 1.99 1.76 8.04 7.40 6.77

Total Asets 41.54 65.70 89.78 85.19 100.18

Liabilities

Depolits and OtherAccounts 84.60 43.26 65.28 68.19 78.78Borrowing 2.80 8.84 5.31 6.97 10.59Bills Payable 0.62 0.70 0.86 2.94 1.18Bill Receivablo 2.03 2.76 8.04 8.42 8.91Other Ltabilitile 1.22 8.11 8.26 3.08 8.25

Total LiabilIties 41.17 58.16 68.78 88.67 97.71

Equity

Share Capital 0.07 0.07 0.30 0.42 0.42Resorves p.80 0.48 0.70 1.20 2.0

Total Equity 0.87 0.56 1.00 1.62 2.42

TOTAL LIABILITIES AND EqUITY 41.64 63.70 69.78 85.19 100.13

Contingents 2.86 7.18 6.46 8.0 8.85

Source: Canara Bank.

Table 4.3: Canara BankSpread Analysis

Spreads(I of deposits) 1984 1985 1986

Average Yield On Loans and Investments La 8.97Z 8.93Z 9.132

Average Cost Of Funds 6.27Z 6.352 6.65Z

Gross Spread * 2.702 2.582 2.481

Fee Income 0.552 0.541 0.622

Establishment Expenses 2.182 2.022 1.851

Net Spread 1.062 1.101 1.252

NB

la Net of proxvisions.

Source: Indian Banks' Association-Financial Analysis Of Banks,

various issues.

-65- ANNEX VPage 1 of 10

THE EXPORT DEVELOPMENT FUNDS - DRAFT STATEMENT OF POLICIESAND OPERATING PROCEDURES

Obiectives

1. The project objectives is to assist actual and potential exportersto search, enter and maintain export markets. The specific objective ofall four Export Development Funds (EDFs) is to motivate and assist indivi-dual firms with the preparation and implementation of export expansionplans, that will create, cost-effective expansion of export sales.

2. The success of each EDF in achieving this objective will bemeasured very simply. Each fund will be expected to generate incrementalexports, directlv attributable to fund assistance, over the 5 years fromproject start, of 10 times the arant support given by the iunds. So, forinstance, if an EDF client is already generating modest export growth in aparticular market, proposals must demonstrate how grant-supported activ-ities can be expected to lead directly to this 10:01 additionally in exportexpansion.

Resources and Level of Support

3. Resources to be Provided. During the three-year commitment periodof the project, the EDFs in ICICI and Eximbank will be provided with US$7million of IBRD funds each; and the EDFs in Bank of Baroda aned Canara Bankwith US$3 million each.

4. Level of Support. The money will be used to give grant support toeligible expenditures of up to 502. The intention is that, initially, allsupport will be at the standard level of 50X. However, each fund operatorwill have the discretion to reduce this standard rate, either in individualcases, or, during the commitment period, for all further cases.

Eligibility Criteria

5. Eligible Sub-Sectors. The funds are to support any manufacturedexports, plus in addition, computer software services exports. Otherservice exports, such as in tourism or construction, would not be covered.

6. Eligible Firms. To be eligible, firms must be eligible to beclients of the fund operator, for its normal term lending business. It isexpected that EDP clients will come predominantly from the private sector.Operations primarily funded from tha central or state budgets would not beeligible.

7. Grant assistance is intended primarily for manufacturing firms.However, non-manufacturing exporters may be considered in exceptionalcases, subject to the following limitations:

(a) The supported export activity should be on the basis of stablesourcing relationships with manufacturing suppliers, not on thebasis of pure trading.


(b) The exporter should add significant value within the completetransaction chain, either by providing support services tomanufacturers, that they are not in a position to providethemselves, or by providing sourcing services to foreign buyers.

8. Eligible Export Markets. Support will deliberately beconcentrated on those import markets where the effectiveness of exportmarketing and adaptation is most likely to be a signJficant determinant ofexport success. Thus, support will be concentrated on exports directed tothe industrialized market economies, plus the newly industrializingcountries.

9. In exceptional cases, EDF grant assistance may be used forexporting to other markets, all such cases are to be referred to the WorldBank for prior approval.

10. Eligible Activities. In principle, any activity within a properlyformulated eligible export expansion plan, that can be convincinglydemonstrated to be cost-effective in terms of its 10:1 impact on exportexpansion, is eligible for support. For guidance, however, a list oftypical eligible activities are:

(a) Desk Research is an important measure in directing field researchat most promising geographical areas, and product market segments.

(b) Overseas Field Market Research, a main input into the formulationof an export marketing strategy, should aim to answer the fourquestions fundamental to such a strategy: (i) Which products arerequired? (ii) What are the channels of distribution? (iii) Whomakes the purchasing decision? (iv) What factors affect thisdecision?

(c) Minor Product Adaptation. When market research shows productadaptation to be required/justified, support will be given foradvisory and technical services in product redesign, advice onpackaging and product testing.

(d) Overseas Travel by Company Executives. Travel and subsistencecosts would be supported for purposes directly related to thecompany's marketing strategy, e.g., (i) finding and appointingagents and distributors; (ii) direct selling; and (iii) keepingup-to-date with product developments. This activity would besupported only when travel is directly reiated to a strategy basedon adequate market research.

(e) Product Inspection Services. In cases in which overseas buyersare concerned about product quality and consistency, companiesshould be encouraged to use the seal of approval of a recognizedinspection agency. The choice of inspection agency will be opento the company, but it is likely that most buyers will beimpressed by a seal of approval from an internationally recognizedagency.


(f) Training. To encourage a more informed, strategic approach toexport marketing, particularly in industrialized corntries,support will be given to training in export marketing, including:(i) export marketing methods such as pricing, distributionchannels, and promotion methods; (ii) export market research;(iii) organizing an export department; and (iv) export proceduresincluding GOI support schemes, shipping and forwarding.

(g) Establishing Overseas Operations. While the direct operatingexpenses of overseas operation (e.g., warehouses, sales offices)will not be funded by the EDFs. support will be given during theplanning and start-up phases of such operations for travel bycompany executives and the costs of advisory and technicalservices on warehouse siting, recruiting local staff, and salesforce organization.

(h) Travel to India by Potential Buyers. Support will apply onlywhere a buyer is invited by one or more exporters, and will extendonly to the contribution to travel costs made by these buyers.

(i) Productivity Consultants and Technicians assist in analyzing andimplementing: (i) cost reduction and quality improvement moveswhich firms could make with or without additional fixed investmentbut which would increase sales volume with a focus on improvingmaterial handling, processing methods and tooling to increaseproduction efficiency and achieve consistent quality; (ii) choiceof process/product technology which would be compatible with asignificant expansion in exports to more demanding markets; (iii)setting up of Productivity Cells with specific work plans and withmeasurable achievements on projected yields and quality ofproduction; or (iv) shared R&D effort to increase productionefficiency.

(j) Ancillary Development Consultancy. Such assistance would be madeavailable to supplier development departments of individualcompanies, as well as to groups of r- ant firms. It would beused to identify with larger firms p .acts suitable forproduction by ancillaries; to select ancillaries in a position tospecialize, modernize and expand to meet a growing portion of alarger firm's requirzments; and recommend appropriate internalorganizations for more active ancillary development by largerfirms.

(k) Supervisor TraininR. Trainers and materials to develop andimplement supervisor training in formal sessions and on the shopfloor to improve the efficiency and effectiveness of supervisoryfunctions, and enable needed improvements in productivity inrelation to either the market in India or abroad.

(1) Design and Product Adaptation. Consultancy and small materialexpenditures to undertake design and product adaptation inresponse to identified market opportunities at unit level orthrough group cooperation and action.


(m) Exposure to plants in competing countries and to other factoriesoperated with foreign collaborators to tap the strong capabilitiesamong Indian manufacturers to adapt appropriate productionpractices of others.

(n) Workshops, seminars and firm level work by potential collaboratorsor institutions which see potential for expanding under exports,with such exercises directed at productivity and technologyimprovement.

(o) Expenditures incurred ons (i) acquiring design/process know-how;(ii) R&D, especially of developmental nature with a view toadapting product to export demand.

11. Normally, grant support will be restricted to one export expansionplan per firm, or per separate marketing operation within a divisionalizedfirm. The intention is that grant support will encourage the firm ordivision into a planned approach to export expansion. Once thisencouragement has been given once, it should not be necessary to repeat it.However, the benefits of advice on export planning; help with clearances;and the promotion of the benefits of exporting to top management may beextended, at its discretion, by each operator beyond the first grant-assisted expansion plan. To monitor this, firms will be requested, intheir applications, to certify that no EDF grant has been received from anyother operator.

12. Once a firm or separate product division with independent exportmarketing management has obtained EDF grant assistance from one of the fouroperators, it automatically becomes ineligible for assistance from the EDFof any other operator.

13. Eligible Export Expansion Plans. Such a plan should take a firm,or division, from its present exporting situation to a future situationrepresenting a significant expansion in export performance. Normally, sucha plan would take the form of three distinct stagest

Ca) Market Exploration. An export expansion plan should normallystart with exploration of market opportunities. Desk work inIndia should firstly determine the most suitable import markets tovisit. The field marketing research would then use one-to-onepersonal interviews with potential buyers and others, to answerfour fundamental marketing questions: (i) What products are beingbought? (ii) What are the channels of distribution? (iii) Whomakes the buying decision? (iv) What factors affect this decision?This information from the markets is then compared with the firm'spresent supply capability, not just in terms of the productspecification itself, but covering all aspects of the supplypackage, including delivery reliability, maintenance of quality,speed of response to letters, etc. This analysis leads into thenext stage.

(b) Supply Package Adaptation. This stage consists of a series ofspecific measures, which will upgrade those supply package aspectshighlighted in the first stage analysis. The measures might, for


instance, be in product redesign, quality maintenance systems,packaging, export office efficiency, training of export staff,etc.

(c) Sales Promotion. Once adequate progress has been made in adaptingthe supply package, so as to meet market preferences, then, andonly then, will this third stage begin. Activities directedspecifically at achieving sales will take place during this stage.They might include, for instance, direct selling visits byrepresentatives of the firm itself; or visits to appoint agents ordistributors; or participation in specialized trade fairs.

14. The intention is that adaptation expenditures would need to bejustified by specific evidence from market exploration that these measureswould address critical constraints, and would do so in a manner likely tobe effective in achieving additional export sales. Equally, salespromotion expenditures would need to be justified by evidence that progresswith adaptation had created a supply package adequately in line with marketpreferences, as revealed by the initial exploration.

15. Eligible Expenditures. Grant support will be given forexpenditures on services and travel, incurred specifically on eligibleactivities. Support will be restricted to once-off start-up costs only.No ongoing expenditures, such as salaries or rentals, will be supported.Similarly, support will be restricted to incremental costs only. No 'sunkcosts' will be supported.

16. Purchase of jigs, fixtures, tools, equipment, machinery and otherhardware will not be eligible. They may, however, be supported separately,using term loan finance provided under this project. The 50t grant supportis not intended to cover, as of right, every expenditure incurred inrespect of a firm's export activities. The intention is to motivate properplanned expansion. It is also to encourage particularly the use of outsideexpertise, to speed the initial learning curve; and also to encourage theuse of overseas travel, to speed the process of comprehending and meetingthe preferences of distant markets.

GOI Supervision of the Funds

17. The Two Steering Committees. The two existing committeessupervising the funds in ICICI and Eximbank will continue. The EximbankSteering Committee, chaired by the representative of the Ministry ofCommerce, will extend its coverage to the two new fund operators.

18. Each EDF will be managed by its operator. But these operationswill be guided, on behalf of GOI, by the responsible steering committee.The committee wills

(a) approve this SPOP and any updates;

(b) review progress in each fund, on the basis of qvarterly reports;and

(c) delegate to the operators the power to approve grants below theagreed approval limits (see below).


(d) since the present EMF committee will extend its coverage to twofurther funds, a representative of the operator concerned will beseconded to the committee, when discussions concern one of thesetwo additional funds.

19. The actual make-up of the committees is expected to continue muchas in the first project. However, additional representation from theconcerned industry could be included as appropriate.

20. GOI Clearances. Experience in the first project has demonstratedthe importance of this element of the support package, in offering single-point clearances, by the various GOI authorities represented on thecommittees. Such clearances are given on the basis of fund support for afirm's ex?ort expansion plan. This element will be further strengthened inthe new project.

21. The present EMP Blanket Permit Scheme will be extended toincorporate the PCBs. In addition, the steering committees will havedelegated to them the following additional specific clearance powers:

- The committees will have the power to approve specific foreigntechnical or marketing consultants, required within an approvedexport expansion plan.

- On the basis that the EDF's would only support specializedproduct-specific trade-fair participation, the committees willhave the power to approve participation within an approvedexpansion plan.

- In order to achieve the desired motivational effect in a varietyof travel circumstances, invitations to foreign buyers to visitexporters' facilities in India will no longer be restricted to theuse of the national carrier.

22. Approval Limits for individual proposals will be US$100,000 ofgrant support for ICICI and Eximbank; and US$50,000 for Bank of Baroda andCanara Bank. The intention is that each firm would normally go through asequence of three approvals, corresponding to the three stages describedabove. Each steering committee will therefore retain the power to approveany proposal which takes a firm or product division through a totalcumulative level of grant support of US$200,000 in the case of ICICI andEximbank, or $100,000 for Bank of Baroda or Canara.

23. The intention is that the average size of an individual proposalwill be substantially less than in the first project. It is hoped that allbut a few proposals for market exploration will be below US$20,000; foradaptation below US$50,000; and for sales promotion below US$20,000.

24. No firm may receive total EDF grant support in excess ofUS$500,00. In the case of firms with separate product divisions, eachhaving separate export marketing management, this limit will apply to eachdivision.


Implementing Arrangements

25. For convenience, the EDF operated by Eximbank will continue to beknown as the *Export Marketing Fund".

26. Internal Management Arrangements will be different for eachoperator. They are described in more detail in the final section of thisAn.ex, under 'Details for Individual Operators.* However, the commonfeatures is that each operator will have an Export Development Cell,managed within the operator's head office, responsible for administrationof the fund. This cell will be staffed by specialist Export DevelopmentOfficers.

27. The Extension-Service Concept developed during the first projectwill be continued and strengthened in this project. Each EDP officer willbe expected to spend at least 25 man-days each operational quarter awayfrom base, visiting clients and potential clients. He or she will beexpected to visit each active client at least once each quarter. Theindicators will be monitored in quarterly reports. Each officer will goout and 'sell' exporting to potential clients; develop with them a basicstrategy on how the intend exports to contribute to total turnover andprofits; and develop with each firm its initial export expansion plan, tobe assisted by EDF support plus loan finance.

28. During implementation, the officer will monitor compliance withthe approved proposal; give continuing advice and support; and encouragefurther expansion beyond the initial plan, on the basis of its demonstratedcontribution to overall profitability.

29. Processing of Proposals will normally go through the followingstages:

(a) proposal preparation by the client firm and the local EDP officer,normally at the client's premises;

(b) submission of the completed proposal by the officer, operating asadvocate of the firm, to a higher level within the fund operator,or to the steering committee; and

(c) negative decis!.ons conveyed to the client in person, by the localofficer.

30. Monitoring Compliance. Each operator will need to introducesystems for monitoring compliance with the terms of each grant approval.In particular, they will need to view specified outputs, such as marketresearch reports; overseas visit repoitst etc., in order to satisfythemselves that grant expenditures have been for specified purposes. Inaddition, they will need to satisfy themselves that each grant recipienthas made payments of his agreed percentage contribution to the total costinvolved.

31. Confidentiality. Operators will need to gain access toconfidential business information, if they are to be effective inappraising proposals. Officers will have the right to view such outputs of


grant-aided activities as reports; market entry plans; upgraded prototypedesigns; etc. They will not have the right to copy them, or remove themfrom clients' premises.

32. Planning and Reporting Cycles will be common to all four funds.Each operator will prepare detailed Action Plans for each full 12-monthperiod of the project, to be approved first by the steering committee, andthen submitted to IBRD 2 months in advance, for approval. Detailed ActionPlans for launching the new funds have been developed by each operator, andagreed with IBRD.

33. Each operator will also prepare Quarterly Progress Reports eachcalendar quarter. These reports will be submitted to the respectiveSteering Committee, and to the World Bank. The reports will indicate indetail:

- whether or not the specific actions agreed in the Action Plan havebeen achieved;

- totals for the quarter, and cumulative to date, for grantsapproved internally; grants approved by the Steering Committee;grant applications rejected; grant applications prepared, butpending; and grants disbursed (total approvals and disbursementsshould be compared with budgeted figures);

- a report on the status of reimbursements, compared with agreedtimetables;

- a list of grants by firm, with export expansion plan projectionsfor the following five years given for each, plus a computedexpected rate of return" on the grant expenditure for each.

34. In addition, each operator will submit to the Steering Committee,and to the World Bank, fully audited accounts for each operating year ofthe project.

35. Quarterly reports are to be submitted to the World Bank within onecalendar month of period end; annual accounts within two calendar months.

36. Monitoring. Supervision Missions by IBRD will take placeregularly. These missions will have the same rights of access to firm-level outputs as does each operator.

37. In order to monitor progress towards achievement of the target,10:1 impact of the funds, each operator will commit its client firms toprovide export performance figures, right up to 5 years from project start-up. Each operator will also introduce within the first operating quartersystems for capturing and analyzing this information on a regular annualbasis. Each operator will report on this at least once each calendar year,showing expansion plan performance against target, both actual andcumulative, for each supported firm. This reporting routine will continuefor five years from project start-up.


Details for Individual Operators

38. ICICI will continue arrangements developed under the firstproject. The cell which administered the Productivity Fund will become theExport Development Cell, with a strength at Head Office of at least fiveofficers.

39. This cell will rely heavily on the client prospecting activitiesof ICICI's three regional offices. Ahead of effectiveness, formalpresentations will be conducted in each of these centers, so as to informall concerned officers as to the details of the EDP scbeme. Similarpresentations will be carried out in Bombay for other officers concernedwith initial promoting of ICICI services, located for instance within themerchant banking and leasing sections.

40. The concept of joint appraisal of export-oriented term loans willbe extended under the second project, so as to develop further thecapabilities within Operations in appraising projects relying oninternational competitiveness.

41. Eximbank will also continue arrangements developed under the firstproject. The EM? Cell will continue under the direction of one DeputyGeneral Manager, devoting 502 of his time to the EM?. At least twoofficers will operate full-time on EM? duties; and at least three more 502on EMF duties. This team will be spread between at least three Eximbankregional offices.

42. Bank of Baroda will operate its EDP within the existing ExportDevelopment Cell, currently administering term finance only, under thefirst project. This cell will continue to be headed by a Chief Manager(Technical). He will be assisted at head office by at least threeofficers, one of which will be of a level capable of deputizing for thecell head.

43. Bank of Baroda will commence EDP operations with an initialnetwork of ten centers. Each region concerned will nominate a RegionalExport Development Officer, who will spend at least 252 of his time on EDFwork. At least three quarters of this team will be from the Bank's fast-track cadre of "DRO's".

44. Bank of Baroda will initially target the following product groups:castings and forgings; garments, hosiery and silk fabrics; granite, stonesand tiles; leather products; brassware and steelwares; diamonds andjewelry; plus either chemicals or electronic items.

45. Bank of Baroda has identified the following ten regions, where ED?activities in these product groups will initially be targeteds

Madras, Bangalore, Coimbatore, Delhi, IndorelBhopal, Bombay, Pune,Surat, Ahmedabad and Lucknow.

46. Canara Bank has established an Export Development Cell at HeadOffice, which will continue operations into the second project, dealingboth with term finance and EDF grant appraisals. This cell will consist ofa Project Leader plus at least one officer.


47. Canara Bank will commence operation with Export DevelopmentOfficers appointed in at least three "Overseas Branches,' in Bangalore,Bombay and Delhi. Initial concentration will be in the following productgroups:

- garments, jewelry, software, auto components and other lightengineering products.

48. Operations will be ertended in the next phase to Canara Bank'sother Overseas Branches, at Madras and Calcutta.

49. Canara Bank will have an internal Sanctioning Committee forapproving free-limit EDF grants and, authorizing submission of non free-limit grants to the Steering Committee.

-75- ANNiX VIPage 1 of 2

THE TECHNICAL ASSISTANCE FUNDS - DRAFT STATEMENT OF POLICIESAND OPERATING PROCEDURES

Ob3ectives

1. The four Technical Assistance Funds (TAFs) will operate in supportof the main instruments of the project, namely the term finance and grantsupport extended by the participating institutions to exporters. Theobjective of the TAFs is to enhance capabilities of these institutions inimplementing these instruments. In particular, the objective will be toenhance capabilities in term finance and grant support appraisal, appliedto exporting activities; and in the advisory support the institutionsextend to new exporters.

Resources and Level of Support

2. During the three-year commitment period of the project, theinstitutions will be provided with the following funds: US$1,175,000 forICICI; US$675,000 for Eximbank; and US$425,000 each for Bank of Baroda andCanara. For these funds, a Japanese grant will be utilized and passed onto the four institutions as grants, exactly parallel to the arrangementsfor the four EDF's.

3. Support will cover 1002 of the foreign exchange elements ofeligible expenditures. The recipient institution will contribute the localcurrency elements of eligible expenditures.

Eligibility Criteria

4. Eligible Activities. TAF support will be given for the followingactivities:

(a) training of EDF cell staff, but also training extending to stafffrom other departments, particularly those with an involvement inappraisal;

(b) hiring experts with specific technical and marketing skills, on atemporary basis, to assist staff both in advising exporters, andin appraising proposals for grantL and term finance support underthe project;

(c) purchasing information abroad, in support of these advisory andappraisal functions; e.g., simple market pointers, to assist inpromoting the benefit of exporting; and

(d) promotional activities, aimed at motivating more firms to expandexports, and to make use of the services offered by theinstitutions.

5. Eligible Expenditures. TAF grant support will be given forexpenditures on services and on travel only, incurred specifically oneligible activities. No sunk costs," such as salaries or rentals will besupported, nor will hardware purchases.

-76- ANNEX VIPage 2 of 2

Implementing Arrangements

6. Annual Budgets. Each institution will be required to submit toIBRD an annual budget for each 12-month period of the project, to reachIBRD 2 months in advance.

7. Approval of Expenditures. With the exception of small purchasesof information of under US$20,000, all proposals for expenditures to besupported will require prior approval by IBRD. Appointment of allconsultants would be in accordance with IBRD Guidelines.

8. IBRD approvals for proposals will specify the ̂ 1tputs to beavailable for Supervision Mission to view, as evidence of satisfactorycompletion of supported activities. These might take the form ofcertificates of attendance and performance on training courses; reportsfrom technical experts; copies of information purchased; etc.

The Initial Group Training Program

9. The TAF Funds will be used to finance the foreign exchange costsof an Initial Group Training Program. Each institution will be invited tonominate four or five candidates, for which it will bear the local currencycosts of the program. The implementing agency for this group programcontract will be ICICI.

10. The foreign exchange costs will be divided pro-rata per partici-pant, and debited from each institution's TAF account.

11. The training program will consist of two modules. The first willconsist of around 12 days cf residential classroom training in India. Thesecond will consist of four to five weeks of individual fieldwork in Europeand/or the USA. If the program is well-received, it may be repeated lateron for other staff, at the discretion of the participating institutions.

12. The individual fieldwork astignment will represent the core of theprogram. Each participant will operate this assignment on behalf of aparticular Indian firm. Before leaving India, each participant willcollect a firm profile, samples, and prices. The assignment will be tocarry out a market exploration exercise in one or two import markets, andto develop for the firm a full market entry plan.

13. During the program, participants will be given the opportunitiesto establish contact with commercial and other information providerscovering several import markets; and also with organizations operatingregisters of technical experts. These contacts will assist staff in thepurchasing of information during the project, and with the selection oftechnical experts.

Table 0.1 The Technical Assistnce FundsTechn ice l Assistance oMponent

(Rs Million)

1988198 1989490 1es0/9 19s1/92

Locl Foron Total Lel Forlon Total forinT Local foreign Total

Prolect Elmt

Initial Group Training 1.10 8.54 4.71 - - - - - - -- -- -

Consultancy Fen - - - 2.98 5.92 8.69 3.29 6.67 9.68 2.20 4.41 0.01Data and Informalon Purchase - 0.a 8.s 4.23 0.7 . 4 024 2. .4 .18

Subtotal Base Costs 1.16 8.54 4.71 8.29 2.67 13.17 8.86 10.95 14.61 2.46 7.84 0.79

Physical Contingencies 0.12 0.38 0.47 0.s8 0.99 1.82 0.87 1.10 1.40 0.24 0.73 0.98 -a

Price Contingencis 0.10 0.81 0.41 0.68 1.74 2.82 0.88 2.U a.6s 0.81 2.42 s.23

Total 1.40 4.20 5.60 4.20 12.60 16.60 4.90 14.70 19.60 8.50 10.60 14.00

Table A.l: ExPrrt Structure and PrformanceMerchandiso Exports, 1980/92-1987198(St M IIlion at Curront Prices)

1980,01 1981/82 1982/88 083jL4 1984/86 1985/86 1986/87 1987186

Prim ry Exrerta 1 8,845 8,876 8,244 8,894 8,588 8,889 8,a04 8,818

Met 2 69 91 87 7o 79 66 88 70Fish a 266 820 895 887 866 8so a89 480Rice 4 279 420 286 121 162 178 187 26Ollcakes 5 156 185 161 161 131 118 1s6 142Cashws 6 175 207 147 1o6 17i 198 267 261Coffee 7 267 187 208 108 202 240 268 216Tea 6 580 452 401 548 788 551 467 485Spices 9 1U9 118 102 124 198 244 224 258Tobacco 10 176 269 269 190 171 149 145 89Raw Cotton 11 221 50 li1 177 61 61 1SS 78Iron Ore 12 878 402 412 427 441 509 452 444Other Primary 18 669 749 714 827 819 722 586 609

Manufactured Exports 20 4,967 5,821 5,148 5,696 6,281 6,072 7,160 9,675

ChemIcals 21 298 429 878 849 468 847 8ig 640Leather Manufactures 22 470 464 426 498 648 568 775 94aTextiles 28 1,272 1,178 1,031 1,010 1,885 1,108 1,290 1,800arments 26 705 762 ess 789 994 974 1,143 1,490

Goms and Jeowlry 29 m 927 1,100 1,877 1,197 1,821 1,774 2,141Enginerlng Goods 80 994 1,064 900 85S Ol 887 793 1,170Petroleum Products 81 81 28 186 880 246 448 Y47 S46Other Manufactures 82 460 479 4a8 438 498 459 725 844

Total (B.O.P.) /a 40 8,882 8,697 8,888 9,089 9,789 9,481 10,464 12,888

MEMO: Statistical Dlscrepancy 89 185 176 848 807 1,0OS 669 632 760

/a Net of Crude Petrolem Exports. The statical discrepancy betwen customs and rceipt. date has beenproportionally distributed among the various coponents of export.

TWbA A.2: Export Structure and PerformnceMorchandise FExports, 1980 /81-1987/8(US Million at Constant 80/81 Prices)

1990/81 1981/82 1982/83 1988/84 1984/86 1986/86 1988/87 1987/88

Primry Exports 41 3,845 3,346 3,288 3,330 8,518 8,315 3,757 8,476

meat 42 89 91 90 78 90 72 72 72Fish 43 286 293 388 399 401 366 411 404RICe 44 279 348 186 75 110 103 75 102OIc akes 46 1S6 150 209 192 189 155 188 130Cashews 46 175 173 178 224 204 220 274 212Coffee 47 267 284 249 242 289 881 247 298Tea 48 630 S13 478 485 574 520 477 492Spices 49 189 134 140 178 197 160 169 148Tobacco S0 175 286 289 201 209 169 185 158

Raw Cotton 61 221 41 189 216 79 65 819 182Iron Ore 62 878 416 388 416 499 6S8 618 515Other Primary 68 887 824 881 746 696 827 817

Manufactured Exports 60 4,987 5,848 5,268 5,682 8,401 8,286 6,899 8,694

Chmicals 61 293 449 447 850 492 408 S10 S88Leather Manufactures 82 470 728 702 787 1,040 887 999 1,169Toxtiles 63 1,272 1,189 1,089 1,029 1,811 1,072 1,207 1,464

armnts 68 705 870 698 720 937 926 1,118 1,847Gne and Jewlry 69 771 780 916 1,146 1,086 1,084 1,489 1,664Engineering Goods 70 994 1,009 879 811 978 958 769 1,088Petroleum Products 71 S1 86 326 484 806 578 702 983

Other Manufctures 72 449 491 882 388 2568 379 817 341

Total (B.O.P.) /a 80 8,332 8,693 8,S56 8,M 9,918 9,680 10,657 12,070

MEMO ITEMS: UNIT VALUE INDICE

Primry Exports 81 100.0 100.9 98.7 101.9 100.6 102.2 87.9 95.8Manufactured Exports 100 100.0 99.5 97.8 100.8 97.8 96.9 108.8 111.4

Total (B.O.P.) 120 100.0 100.0 98.0 101.1 98.6 98.8 98.2 108.8

/a Net of Crude Petrolem Exports. The statistical discrepancy between customs and receipts data has beenproportionally distributed mong the various components of exports.

Table B.l: The Financial SystemCommercial Bank Spreads

1986 1986 Ja 1985 1985 la 198 4 1984 la

Average Yield On Loans 8.742 8.602 8.802 8.681 8.75 8.64Z

and Investments

Average Cost Of Funds 6.37? 6.35Z 6.322 6.32? 6.312 6.31?

Gross Spread 2.382 2.25Z 2.482 2.36? 2.442 2.33Z

Fee Income 0.86Z 0.81? 0.78? 0.742 0.782 0.752

Establisnment Expenses 2.10Z 2.092 2.212 2.202 2.212 2.192

Provisions 0.002 0.00? 0.00? 0.00? 0.00? 0.00?

Net Sfrpad 1.132 0.972 1.05? 0.90? 1.012 0.892

NB: Based on data for State Bank Group, 20 Nationalized Banks, and 50 Private Sector

Banks (including 20 foreign).

la Excluding Private Sector Banks.

Source: Indian Banks' Association-Financial Analysis Of Banks, various issues.

Table B.2: The Financial SystemStructure of the Industrial Finance For the Private

Corporate Sector in India(Z)

Fiscal Year End March 31 1981 1982 1983 1984 1985 1986 1987

Internal Sources

Retained Profits 20.22 17.72 12.3? 10.9? 11.4Z 12.92 11.52Depreciation 30.32 27.52 28.72 35.3? 33.42 27.5? 26.4?

50.6Z 45.2Z 41.0 46.2? 44.8Z 40.3? 37.82

External Sources

Capital Markets:Equity 1.6t 3.92 3.8? 4.1? 5.7? 9.3Z 10.0?Debentures 1.3? 5.0? 7.12 7.42 10.92 14.02 14.6?

2.9? 9.0? 11.0? 11.5? 16.62 23.3? 24.62

Comercial Bank Credit 20.4? 15.32 23.0? 21.21 19.62 16.62 16.52Development Finance 19.4? 19.22 18.0? 17.5? 16.8? 16.7? 17.72Institutions

39.8? 34.5? 41.0? 38.6? 36.4? 33.4? 34.2?

Public deposits 4.3Z 3.42 3.2? 1.4? 0.5? 1.52 1.92

Booking/dealership deposits 0.4? 1.4? 2.3? 0.62 0.42 0.5? 0.5?

Others (incl. foreign loans) 2.0? 6.6? 1.5? 1.6? 1.3? 1.0? 1.02

Total 100.0 100.0 100.0 100.0 100.0 100.0 100.0

Sourcet CMIE estimates.

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