R E S T R I C T E D Report No. P 113 '& tod'I"RLZv CPY This document was prepared for internal use in the Bank. In making it available to others, the Bank assumes no responsibility to them for. the accuracy or completeness of the information contained herein. INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT REPORT AND RECOMMENDATIONS OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS CONCERNING A PROPOSED LOAN TO THE TATA IRON AND STEEL COMPANY, LTD. IN INDIA June 19, 1956 INMIRNATIONhL BkNK FOR RECONSTR.TCTION Ai) DEWELOP?ENT REPURT A, RECOIaJjEND`TI`Q\S OF TH-E P.R:SDLNT TO TIE EZCr1IVE DIPJGCTOPS COI\TCERIUING A PROP1C6ED LOAFN TO THEE _TATA IRC1,T,M) STEEL C'`;:PAI-Y LTL. 1. I submit herewitlh the follocving report and recommer.dations on a propose6 loan in an amount in various currencies ecuivalant to 7t75 million to the Tata Iron and Steel Company, Ltd. to help finance a project for the expansion of steel works. PART I - HISTORICAL 2. The Tata iron and Steel Company, Ltd. (TISCO), located at Jamshed- pur, is the largest integrated steel plant in Asia. It produces about 70% of India's output of ingot steel. It is the most important of the many enterprises in th.e Tata grou. which includes the manufacture of chemicals, soap, textiles, locomowives and diesel trucks, and power. After th.e viar, shortage of capital -prevented large-scale modernization snd exp7ansion of the steel works. In 1951, the Comcany started a substantial 'tlloderniza- tion and Expansion Prf;ram" (L2?) to inerease outout of finished steel from 780,000 long tons to 930,000 tons. This program is due for comple- tion in March 1958, and is being financed largely from retained earnings and from an advance of Rs. 100 millicn from the Government of India. Be- cause of the increasing demand for steel, the Company, in 1955, with the approval of the Government, undertook further expansion to increase steel ingot capacity to 2.0 million long tons and saleable steel capacity to 1.5 million tons. This orogram is known as the "Two iidllion Ton Program" (TMTP). Engineering and other services for the most important works of TlWiTP are being furnished by the Kaiser Engineering Division of Henry J. Kaiser Co., and Kaiser Overseas Corporation. W;,ork on TiiTP started in January 1956 and orders for equipDment are being placea. It is scneduled for completion in ilay 1945. In order to finance its expansion, the Com- pany has. floated neti common shares, has obtained from the Government an increase irn price for its products during the constr-action period and has obtained credits from banks in India. In Februar- 1956, the Chairman of the Com-pany, '.i!r. J.R.D. Tata, asked the Bank for a loan in foreign ex- change to finance equipment and services under the Kaiser contracts. In April, the Company subtritted technical and financial data on the program and its operations. In MAay, two Bank engineers visited the Company's works at Jamshedpur to investigate the merits of the proposed loan pro- ject. They were satisfied with its technical aspects, with the arrange- ;,ents made ulder the Kaiser contracts and with the ability of the Company to carry out certain required works with its owin forces. They were also satisfied that there will be a sufficient market for the Company's pro- posed increased steel production. 3. Since the end of April, discussions were held in the Bank ;ith i,ir. J.D. Choksi, the Vice Chairman of TISCO, .ir. E.T. hiarren, President of - 2 - Tate Inc. (New York), and MIr. J. Eallett, Vice President of Kaiser Engi- neers, to sup,lement the written information on the prcject. Formal loan negotiations started on iviay 25. Mvr. C.V. FNarasiL:ihan, Joint Secretary to the Government of India, ifinistr-y of Finance, joined the discussions on June 7, 1956, as the Government's representative. 4. If the proposed loan vere made, it wo,uld increase the total amount of Bank loans made to India to 1199,924,313, net of cancellations. T-he loans already made are as follows: Year Serial 1Tov Amount4/ 1949 17 IN Railway rehabilitation $ 32,800,000 1949 19 INi kgricultural machinery 7,203,813 1950 23 IN Electric power development 16,720,500 1952 71 IJ Iron and steel project 31,500,000 1953 72 I H Electric power development 10,500,000 1954 106 IN Electric poa.er develo?rent 16,200,000 1955 109 IN Industrial credit and investment O,O0000 $124,924,313 1/ E-xcludirng cancellations of :;1'4,775,687. As of Ap,ril 30, 1956, $18,636,118 had been re-paid and 850,912,671 remained undisbul-sed. PioRT II - DFSC.ITIPT0I0 OF ?'.PZ.:`cED LOAN Borrowver 5. The Borrower would oe the Tata Iron and Steel Company, Ltd. Guarantor 6. The Guarantor would be India, a member of the Bank. Amount 7. The proposed loan would be in an amount in various currencies equivalent to 475 million. It is likely that about half of the loan vill be used for expeinditures in U.S.A., one third in 1,4. Germany and the bal- ance in the U.K. End Japan. Pur-pose 8. The proceeds of the proposed loan .-.ould be usec to meet a part of the foreign exchange cost of goods and equipmr^nt (includdng spmre parts), sup-lies and services needed for that part of TMTP being engineered and consta7ucted under the Kaiser contracts. (The main elements of this part of Project are described in Part II of Schedule 2 to the draft Loan Agreement). - 3 - The proceeds would also be used for interest and other charges on the loan. Reimbursement w-ould be made for ex;en6itures beginning january 1, 1956, which are estimated to amount to $6 million as of June 1056. Amortization 9. The proposed loan -would be for 15 years, amortized by semi-annual payments beginning December 1, 1959, calculated to retire the loan by June 1, 1971, as set out in "Jchedule 1 to the draft Loan Agreement. Premiums on pre- payment and redemption corres?ond with the revised rates in the Kariba loan. Interest. Commissior and Commitrent CharFes 10. The loan *:ould bear interest, at the rate of 4-3/4% per annum in- cluding the statutory commission of 1%/. The commitment charge would be 3/4 of 1% per annum and would accrue from a date 60 days after the date of the Loan Agreement, or from the iffective Date, whichever is the earlier. LeFal Instruments and Securitv 11. A draft Loan Agreement between TISCO and the B3nk (No. 1), and a draft Guarantee Agreement between India and the Bank (Nlo. 2) are attached. 12. There would be a Trust Deed, with Baring Brotl-hers & Company, Ltd., as Trustees, constituting (except as permitted bv Section 5.05(a) of the Loan Agreement) a first mortgage u;)on all the immovable properties, land, mines, machinery, plant and equipment now owned or hereafter acquired, and a first floating charge upon the Company's undert.akings and assets. There is a prior mortgage securing Rs. 20 million (4 million equivalent) of outstanding debenture stock pledged to the State Bank of India as collateral security for advances aggregating Rs. 20 million. The State Bank has stated that it vwould consent to subordinatlon of its security. 13. It is proposed that the execution of the Trust Deed should not be made a condition of effectiveness as has been done in other loans of this type. Instead, the Borrower would covenant to execute the Trust Deed by January 31, 1957, and would be permitted to draw on the loan only to the extent of $25 million before the Trust Deed is executed. The purpose of this change is to enable the Company to use part of the loan promptly to ease a stringent liquid position in 1956/57. The Trust Deed will follow substantially the form of the Trust Deed for the Trombay Project and there is no reason to exoect any unusual delay in its execution. Nevertheless, the mechanics of its execution will take 6-8 months. 14. The draft Loan Agreement differs from the Bank's normal form main- ly because of provisions relating to the Trust Deed. It differs from the customary form of Bank Loan Agreement providing for a Trust Deed because of the fact mentioned above that the execution of the Trust Deed would not be a conaition of effectiveness. Attention is directed to the recitals and to the following Sections of the Loan Agreement: - 4 - (a) Section 2.02 provi1des that until the Trust Deed has been executed, not more than 425 million equivalent can be .riithdrawn. (b) Section 5,04 provides for thie securitr to be received by the Bank. It also gives the date of January 31, 1957 by which the Trust Deer must be executed. (c) Section 5.05 Provides that the Co:nmanv would not create mortgages or charges on any of its assets without the Bankts consent, except (i) to secure borrojings from bankers on terms: not exceeding one year, end incurred in the ordinary course of busi- ness, to the extent of Rs. 100 million at any time; (ii) on housing pro,perty, to secure loans froim Gov- ernment to build em-)loyee hous-Ing; (iii) to issue, on such terms and con6itions as snall be aFgreeO with the Bank, debentures or otler obligations rbnking spri passi with the bonds in the sec-urity constitu- ted by the Trust Deed, not to exceed, without the consent of the Bank, thle e>-ivalent of j.l3.5 mil- lion. The puroose of the ;revision urder (iii) is to make it easier fo- the C'on.any to finance its long term reQuirezents. This Section also provides that the Co.,janyr shall srecifically assign to the Trustees under the Trwist ADeedl all t.e interest of the Company in such contracts for poi.er, coal or minerals, as the Bank shall rera>uest. (d) Section 5.06 provides for the maintenaance by the Companyr of an e.uity:debt ratic of 1:1. (e) Section 5.08 orovides that, except as the Bank shall other.ise agree, the Company shall oay divi- dends only from current earnings. (f) Section 5.11 provides that the Company shall inL- sulre against such risks and in such amounts as shall be consistent w;ith sound industrial and busi- ness practice. The reason for this is that the loan is expected to becomre effective before the Trust Deed is executed. (g) Section 5.14 prov-ides that none of the three gov- ernment agreements referred to in the recitals shall be amended without Bank approval. (h) Section 7.01 specifies additional conditions of the Agreement's effectiveness. The Cor.pany ex- pects that action on all cwf these can be completed wilthin three months. -5- (i) Schedule 3 section (K) modifyine; Section 6.07 of the Loan Regulations. It *)rovides for the issu- ance of tem,orary bonds before the Trust Deed is executed. 15. Since the Borrower is a privately-owned corporation, the gunran- tee of the Government under the (uarantee Agreement would extend only to the payment of principal, interest and other charges. 16. The rejort of the Committee :rcvtided for in Article III, Section 4(iiit of the Articles of Agreement of the Bank is attached (No. 3). PiRhT III -- AP?1RAISAL OF TH PRO?CCED LOUT 17. A report, "A:praisal of Tata Iron rnd Steel Co., Ltd. Expansion and lviodernization Project", >o. T.0. 117, dated June 14, 1956, is attached (No. 4). Justification of the Project 18. The expansion of iron and steel production is fundamental to the economic development of India and it has been given hign priority in the Second Five Year Plan. India is rich In the raw materials needed for steel making and labor is plentiful and comparatively cheap, and therefore an ex- pansion of iron and steel Droc-uction is justified. Present production is about 1.25 million tons of st-eel, which should increase to about 4.5 mil- lion tons rhen the three new governrment plents and the proposed expansion schemes of the Indian Iron and Steel Company, Ltd. and TISCO are completed. 19. During and since the war steel nas been in chronically short sup- ply in India, and prodlction and imports have been controllerf both as to quantities and ty,es and as to prices. Consumption in 1955 was abo-t 1.8 million tons, of which about 0.55 million tons were im.)ortec. With the abolition of import duties in 1955, imports of steel have been unrestricted and are exoected to r-uL at about 1.9 million tons in 1956. Present Landed costs of imported steel are substantially above the Price of dom.estic steel retained by the producers. 20. The Government estimates that the demand in 1956/57 will be about 3.2 million tons (roughly corresponding to domestic production Alus the current rate of imports) and that it will increase steadily to 4.4 million tons in 1959/60 and 5 million tons in 1960/61. Because the Second Plan may take six years or more, it seems unlikely that the demand will rise as quickly as this; on the other hand domestic Droduction is also unlike- ly to reach 4.5 million tons oefore about 1963/64. The market should ab- sorb TISCO's production,and any surplus which might arise in a particular line could be disoosed of abroad. 21. The TISCO plant is well situated in the center of large metallur- gical coal fields and is no great distance from supplies of iron ore and limestone. Relatively cheap power can be supplied by the Damodar Valley Corporation (DVC). Present costs of production of about $50 per ton of finished steel make the Company one of the lowest cost producers in the world. The program of the Company to increase its production is sound, well conceived and the cost estimates are reasonable. The arrangements for designing the Project, for its construction and for procuring the nec- essary goods and services are satisfactory. Economic and Financial Situation 22. The Bank economic mission is now in India examining the Second Five Year Plan and re-assessing Indiafs creditworthiness. Its report will be circulated to the Executive Directors in due course. The last economic report on India circulated to the Executive Directors was dated November 12, 1954, "Current Economic Position and Prospects of India"', hS 26(a). The report concluded that in view of the progress made in the Five Year Plan 1951/52-1955/56, India could service substantial additional loans. Favor- able developments in the last tvo years of the Plan would indicate that there is no reason to alter this conclusion. 23. Although total development exoenditures during the Plan period were only about 85% of the planned expenditure of $4,850 million equivalent in the public sector, most of the targets of the Plan were achieved and some substantially exceeded. The rate of investment has been increaseing from year to year; the national income has increased in real terms by about 18fh as compared with the 10% increase estimated in the Plan period. Food grain production in the last three years exceeded the Plan target, partly because of favorable weather conditions; the index of industrial production has in- creased by nearly 25$. Although money volume increased by 10% in 1955, the price movement was downward until the winter of 1955/56. 24. The 1955/56 budget provided for an overall deficit of Rs. 3,270 million ($685 million) to be met by the issue of Treasury bills. The re- vised estimates indicate an overall deficit of Rs. 2,220 million ($466 mil- lion), as compared with a total expenditure of Rs. 9,860 million ($2,070 million). The overall deficit for the present year to be financed by the issue of Treasury bills is estimated at Rs. 3,900 million ($819 million). It is likely that the actual deficit will again be smaller. 25. The balance of payments for 1955/56 showed a surplus of about Rs. 350 million (f73.5 million). As a result of the improvement in the dollar balance of payments in the sterling area, India made a net contri- bution of PP53 million to the Central Reserve in' 1955, as compoared with a net withdravjal of Q15 million in 1954. Official foreign exchange assets remained practically unchanged at about $1,500 million equivalent during the last three years. - 7 - 26. By and large, therefore, the economic and 2inancial situiation dur- ing the First Five Year Plan can oe characterized as development with sta- bility. 27. India has now started a Second Five Year Plan which provides for a total outlay in the public sector of Rs. 48,000 million ($10,800 million). Great emDhasis is being placed on development of heavy industries. The ob- ject-Lve of the Second Plan is to raise India's national income by about 251% in real terms and to provide enough new opportunities for employment for 8 to 10 million persons. Whether these ambitious objectives can be achieved in five years will depend on many factors. But as the report of the Plan- ning Commission points out, the Plan ought to be considered as a framework within wvhich more concrete and detailed plans for each year will have to be worked out. Adjustments will have to be made from year to year to make ex- penditures fit resources. 28, As of June 1956, Trdia's external debt amounted to the ecluivalent of $473 million, of which 8235 million consisted of U.S. Government loans, 115 million of a U.S.S.R. credit (incurred for a government steel mill), $112 million of IBSD loans and $11 million of sterling bonds. Arrangements are being made for a sterling credit of L26.5 niill!on (4064.2 million) for another governmient steel mill. The service of this debt viill reach a peak during the years 1960-1964, with service payments running at over `33 mil- lion equivalent per annum, or about 330 of average exports over the past five years. The service of the proposed loan, which will require $4.1 mil- lion equivalent annually, together with the service of the existing debt, is well within India's capacity. Pros-pects of Falfillment of Obligations 29. Tihe Com-pny has been in business since 1907 and has a long tradi- tion of good management and profitable operations, The assets of the Com- pany are very conservatively valued and the depreciation policy is sound. 30. Taking into account the funds expected to be available to the Com- pany to carry out the five year Project from retained earrings, the balance of the government advance, the proceeds of the new share issue, ard the pro- posed Bank loan, there would remain a gap of about Rs. 260 million (':55 mil- lion equivalent). The Company considers that the amount will be less because it expects to have available considerably more by way of retained earnings. For the current year 1956/57, the Company has arrenged to draw on cash credits and on cash balances to meet 'investment requirements. During the rest of the con- struction period, it will arrange for short term loans. The Company will consoli- date such of these short term borrowings as correspond to long term financial requirements into long term loans to be sec-ured by debentures (including de- bentures comnertible into ehares), or will repay them out of the proceeds of future share issues, or will obtain the funds by a combination of both meth- ods. The Company will consult with the Bank at periodical intervals, as long as any part of the loan is outstarnding, concerning its plans for short term or long term financing. In view of the Company's good credit standing in -8- India, the prospects of raising the requisite funds are reasonable. In the o?inion of the Bank, the absence of firm arrangements for financing the gap later in the construction period is an acceptable risk. 31. As far as debt service cover is concerned, net earnings before depre- ciation and interest, less taxes, calculated on a conservative basis, should cover fixed financial charges during the operating period about 2.5 times. By the end of the construction period in 1960, thle Company's equity:debt ratio would be about 54:46, rising to 68:32 after five years of operation. 32. There are two other matters on which the success of the Project lar- gely depends: one is the provision of additional power as needed; the other is the availability of additional railway facilities. For power, a condition of the loan's effectiveness requires that binding arrange.ments, satisfactory to the Bank, shall have been made for the additional povwer needed for the Project (Section 7.01(e)). In this connection the LVC has confirmed to the Company that the additional power reauired -ill be made availahle in time and on the terms of an existing contract. However, the rates under the present contract will only hold good up to June 30, 1951. For railways, the Government has given an aseurance that it will give sufficient priority to meet the trans- port requirements of the steel industry. Method of Procurement 33. All procu-rement has been, and will be based, to the extent -;ractic- able, on international competition. PART IV - COMPLIANq'CE WOITH ARTTCLES OF AG.REFIENT 34. I am satisfied that the proposed loan complies with the reouirements of the Articles of Agreement of the Bank. PART V - RECO3l;ENDMAT-T0N 35. I recommend that the Bank grant a loan to TISCO in various curren- cies equivalent to -i75 million for a term of 15 years at an interest rate of 4-3/4% with the guarantee of India, and on such other terms and conditions as are specified in the draft Loan and Guarantee Agreements attached, and that the Executive Directors adopt a Resolution to that effect in the form attached (No. 5). Eugene R. Black Attachments VWashington, D.C. June 19, 1956