Document of

The World Bank

FOR OFFICIAL USE ONLY

Report No. 16218

IMPLEMENTATION COMPLETION REPORT

INDIA

SECOND NATIONAL DAIRY PROJECT(CREDIT 1859-IN/LOAN 2893-IN)

JANUARY 14, 1997

Agriculture and Water Operations DivisionCountry Department IISouth Asia Region

This document has a restricted distribution and may be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS

Currency Unit = Indian Rupees (Rs.)Rs. 13.50 = US$1.00 (Appraisal: November 1987)Rs. 22.00 = US$1.00 (Intervening years: 1988-95)Rs. 34.5() = Completion year: 1996

WEIGHTS AND MEASURES

1 hectare (ha) = 2.47 acres (ac)I kilogram (kg) = 2.205 pounds (lb)

I kilometer (km) = 0.6214 miles (mi)1 meter (m) = 3.281 feet (ft)

I square kilometer (kM2) = 0.385 square miles (mi2)I liter = 0.264 gallons

I metric ton (MT) = 2,205 pounds

FISCAL YEAR OF THE BORROWER

Apnrl I to March 31

Vice President D Joseph Wood

Director R. Drysdale

Division Chief/Manager : S. Barghouti

Staff Member Herman van Wersch, Pnnc. Operations Officer

FOR OFFICLAL USE ONLY

ABBREVIATIONS AND ACRONYMS

AHID Animal Husbandry Department (in the states)Al Artificial InseminationAMUL Anand Milk Union LimitedCDP Cooperative Development ProgramCFP Cattle Feed PlantDCS Dairy Cooperative SocietyEEC European Economic CommunityERR Economic Rate of ReturnEU European UnionFAO Food and Agriculture Organisation of the United NationsFMD Foot and Mouth DiseaseFRR Financial Rate of ReturnGOI Government of IndiaHF Holstein FnresianICB Intemational Competitive BiddingIDA Intemational Development Association[DC Indian Dairy CorporationLCB Local Competitive BiddingLPD Liters Per DayMIS Management Information SystemsM&E Monitoring and EvaluationMLPD Million Liters Per DayMPUI Milk Producers UnionNCAER National Council of Applied Economic ResearchNCDFI National Cooperative Dairy Federation of IndiaNDDB National Dairy Development BoardNDP-I First National Dairy ProjectNDP-I1 Second National Dairy ProjectNMG National Milk GridOF Operation FloodROI Retum on investmentSAR Staff Appraisal ReportSF State FederationSMP Skimmed Milk PowderSNF Solids Non FatSOE Statement of ExpenditureTMDD Technology Mission for Dairy DevelopmentUAS Uniform Accounting SystemUHT Ultra High TemperatureUMB Urea Molasses Block

This document has a restricted distribution and may be used by recipients onry in the performance of theirofficial duties. Its contents may not otheruise be disclosed iLhout World Bank authorization.

IMPLEMENTATION COMPLETION REPORT

INDIA

SECOND NATIONAL DAIRY PROJECT(Cr. 1859-IN/Ln. 2893-IN)

Table of Contents

PREFACE .................. .................................................... i

EVALUATION SUMMARY ............................................................. . ...... ii

PART I: PROJECT IMPLEMENTATION ASSESSMENT .......................................................... 1

A. PROJECT OBJECTIVES ...................................................................... 1Statement of Project Objective ...................................................................... 1Evaluation of Project Objectives .................. 2.............................................. 2

B. ACHIEVEMENT OF PROJECT OBJECTIVES ............................. 3.........................3Physical Objectives ..................................................................... 4Financial Situation of Participating Entities ................. ................................. 12NDDB's Role and Performance ..................................................................... 15

C. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THEPROJECT ..................................................................... 17

D. PROJECT SUSTAINABILITY ..................................................................... 18

E. BANK PERFORMANCE ..................................................................... 19Identification and Preparation ..................................................................... 19Appraisal ..................................................................... 19Supervision ...................................................................... 21

F. BORROWER PERFORMANCE ..................................................................... 22Preparation. ..................................................................... 22Implementation ..................................................................... 22

G. ASSESSMENT OF OUTCOME ......................................... ............................ 24

H. FUTURE OPERATION ..................................................................... 24

I. KEY LESSONS LEARNED .24

PART II: STATISTICAL ANNEXES

Table 1 Summary of Assessments .......................................... 27Table 2 Related Bank Loans/Credits .......................................... 29Table 3 Project Timetable .......................................... 30Table 4 Loan/Credit Disbursements: Cumulative Estimated and Actual ............. 31Table 5 Key Indicators for Project Implementation .......................................... 32Table 6 Key Indicators for Project Operation . ......................................... 33Table 7 Studies Included in Project .......................................... 33Table 8A Project Costs .......................................... 34Table 8B Project Financing .......................................... 35Table 9 Economic Costs and Benefits .............. ............................ 35Table 10 Status of Legal Covenants .......................................... 36Table 11 Compliance with Operational Manual Statements .................................. 38Table 12 Bank Resources: Staff Inputs ............... ........................... 39Table 13 Bank Resources: Missions .......................................... 39

APPENDICES

A. Aide-Memoire .......................... 40B. Financial and Economic Re-Evaluation .......................... 55C. NDDB's Role and Performance .......................... 58D. Borrower's Evaluation Report .......................... 66

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IMPLEMENTATION COMPLETION REPORT

INDIA

SECOND NATIONAL DAIRY PROJECT(Cr. 1859-IN/Ln. 2893-IN)

PREFACE

This is the Implementation Completion Report (ICR) for the Second NationalDairy Project in India, for which Credit 1859-IN in the amount of SDR 121.2 million(US$160 million equivalent) and Loan 2893-IN in the amount of US$200 million wereapproved on December 15, 1987 and made effective on April 8, 1988.

The Credit was closed on December 31, 1994 as originally scheduled. Finaldisbursement from the Credit, which was fully disbursed, took place on July 28, 1993. TheLoan was reduced by two cancellations, US$53 million in September 1995 and a furtherUS$29.9 million in June 1996. It was closed on April 30, 1996, compared with the originalclosing date of December 31, 1994. Final disbursement took place on June 24, 1996.

The ICR was prepared by an FAO/CP mission'/ which visited India inMay/June 1996. It was revised by H. van Wersch (Agriculture and Water OperationsDivision II) of the South Asia Region and reviewed by S. Barghouti (Chief, Agriculture andWater Operations Division II) and K. Uchimura (Project Adviser). The Borrowercontributed to the preparation of the ICR through the project evaluation report prepared bythe National Dairy Development Board (NDDB), as well as NDDB's comments on themission's aide-memoire and the draft ICR. The ICR is based on a review of the StaffAppraisal Report and legal documents, supervision reports and project files as well as fieldinvestigations and discussions with Bank staff, officials of NDDB, and the participatingstate dairy federations, milk producers unions and dairy cooperative societies.

" Messrs. K. Selvavinayagam (Financial Analyst, Mission leader), J.A. Phelan (Livestock IndustrySpecialist) and Ms. Frances Sinha (Cooperatives Management Specialist, Consultant).

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IMPLEMENTATION COMPLETION REPORT

INDIA

SECOND NATIONAL DAIRY PROJECT(Cr. 1859-IN/Ln. 2893-IN)

Evaluation Summary

Introduction

1. The Bank has been associated with the Indian dairy sector since 1974 when itapproved three state-level projects (Karnataka Dairy Development Project for US$30.0million, Rajasthan Dairy Development Project for US$27.7 million and Madhya PradeshDairy Development Project for US$16.4 million), and the National Dairy Project forUS$150.0 million in 1978, followed by the Second National Dairy Project for US$360million in 1987.

Project Objectives

2. The Second National Dairy Project (NDP-II) was designed in support of thethird phase of Operation Flood2 (OF III), India's dairy cooperative development program,building on the experience of the three state-level projects and the first national levelproject. The objectives of the Second National Dairy Project were to promote theestablishment of viable cooperative businesses owned and managed by producers, forcollecting, processing and marketing milk products in order to expand rural incomes andimprove milch animal productivity. These were to be achieved by: (a) expanding andconsolidating the integrated cooperative institutional structures; (b) providing the necessaryprerequisites for milk productivity enhancement; (c) establishment and expansion of milkcollection, processing, storage and distribution activities; and (d) strengthening institutionsand training.

3. Loan covenants. Special legal covenants or agreements that were expected topromote the achievement of project objectives were for the Government of India (GOI) tocause participating states to ensure that state federations, unions and societies follow

/ The beginnings of India's dairy cooperative development are in the Kaira district of Gujarat and theestablishment in 1946 of the Anand Milk Union Limited (AMUL) responding to the limitedmarketing opportunities for traditional milk producers in the face of the marketing practices of aprivate dairy monopoly. Operation Flood (OF) built on this experience when cooperative dairydevelopment became an agricultural development priority in the national development plan. The firstphase (OF I) covered milksheds in ten states during the period 1970-77, followed by OF II in 1978-86extending the program to cover virtually the entire country.

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Operation Flood conditionality and for NDDB to ensure that state federations, unions andsocieties function under by-laws and charters consistent with OF principles.

4. Evaluation of project objectives. The project, based on the sound foundationof improving rural incomes and milch animal productivity through the integrated dairycooperative structures for the production, collection, processing and marketing of milk andmilk products, was important for the Indian dairy sector. Although the design was based onthe well-tested, locally developed 'AMUL' model, the appraisal mission was overoptimisticin assessing the rate of change of state governments to the concept of farmer control atvarious levels of the cooperative structure, though the SAR highlighted this as a major risk.The project was also complex as it involved many states which have their own prioritiesand commitments, in addition to the scale and spread of project activities which called for alevel of high-quality management which many federations/unions found difficult tocommand. Significant implementation delays or shortfalls in achievements were foreseenat appraisal. A longer-than-normal implementation period was therefore regarded asacceptable if it helped promote institutional changes to ensure the long-term viability of thedairy cooperative sector.

Implementation Experience and Results

5. Physical implementation of the project was slower than envisaged due to thedelayed start in some of the participating states. Nevertheless, the project, by and large, hasachieved its physical, sectoral policy, financial and institutional development objectives inGujarat, but only partially in other states. Although they were not stated objectives underthe project, gender issues and equity have received substantial support, particularly duringthe later years of project implementation. While the evidence is not systematic and variesconsiderably across areas, mission findings from field visits and from various samplesurveys indicate that dairying has made a significant contribution to the incomes of small,marginal and landless farmers. The dairy societies provide a market outlet which is muchfairer to the milk producers than the private vendor although the societies are not (usually)able to displace fully the pattern of informal credit which binds poorer milk producers toprivate vendors. In addition, women are increasingly enrolled as members (and in somecases in the managing committees as well), in line with state policies and the objectives ofthe Cooperative Development Program of NDDB. The delicensing of the dairy sector in1991 had a negative impact on milk procurement by the cooperative sector. As a result ofthis and other factors, the current estimate of the project's economic rate of return is 21percent, down 6 percent from the appraisal estimate of 27 percent. Both appraisal andcompletion estimates are more speculative than usual, because they incorporate projectedreturns to investments not yet completed.

6. In major states, the dairy cooperative societies (DCS) have been generatingsurpluses while the performance of many district milk producers unions (MPU) and statefederations (SF) is still unsatisfactory, although they have shown improvement in recentyears. At project completion, profit-making units have risen to 63 percent, compared to 50percent at appraisal. As under the predecessor National Dairy Project (NDP- 1), NDDB was

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the primary implementing agency. Over 70 percent of its staff have degree or post-graduatelevel qualifications, leaving no doubt as to the professional competence of NDDB staff.The promotion aspect of NDDB's lending activity acts as an essential catalyst fordevelopment and not merely as a conduit through which lending resources pass. NDDB inthis way has an impact on tangible factors such as proper management practices andappropriate levels of technology. NDDB's continued claim on a significant portion ofGOI's scarce development resources calls for a more critical analysis of its operations andin particular of the allocation of resources placed at its disposal. Its overall financialmanagement has improved and is now generally sound. A principal finding is that NDDBshould be encouraged to find ways to further improve its operations rather than that it bedismantled.

7. Project sustainability. The economic rate of return (ERR) of the project issufficiently robust to suggest sustainable economic performance. The major challenge tothe sustainability of the dairy cooperatives is their rational development with proper staffingand maintenance of a sound financial structure to ensure solvency and liquidity forcommercial survival. This requires that the entities are owned and directed by farmersunder some form of participatory decision-making mechanism assuring autonomy inpricing, investment and marketing decisions, efficiency in production and processing, andguaranteeing better incomes to farmers and the lowest possible price to consumers. Theseconditions exist in Gujarat but only partially in the other states. Consumer prices in metrocities such as Bangalore, Calcutta, Hyderabad, Madras and New Delhi are administered. Asthese prices are not likely to be increased in the immediate future, the options available tothe federations/unions are to introduce cost-saving measures, better management practicesand expansion into high-value product lines. These steps must be complemented bymeasures for enhancing animal productivity, training and technical assistance to cooperativesocieties, improvements in financial management, and better market promotion.

8. Development of fully sustainable operations in a consumer industry requiresthe involvement of a regulatory body to assure product quality. Thus far, NDDB hasperformed this function. However, as the apex institution of the cooperative dairy system,responsibility for quality assurance as well as other industry-related issues constitutes aconflict of interest for NDDB. Government needs to establish an industry body, of whichNDDB would be a member, to look after such matters. Operating costs of such a regulatorybody would need to be shared between the industry and government.

9. Actual cost, financing, and implementation timetable. At appraisal, it wasestimated that the project would be completed by December 31, 1994. Current estimatesindicate that final completion is not likely to be before June 30, 1997, although the Creditwas closed on April 30, 1996. The final cost of the project is now estimated at Rs12,553million (US$503 million) compared to the appraisal estimate of Rs9,150 million (US$678million), representing a 37 percent cost overrun in nominal rupee terms. The Credit wasable to finance about 66 percent of total actual expenditure compared to 53 percent of theproject costs at appraisal, mainly due to an increase in the disbursement percentage.

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10. Key factors relating to achievement of project objectives. The mostimportant shortfalls which hindered project implementation can be classified into:

Factors not generally subject to Government control. Theseincluded employee unrest, though short-lived, in a few unions.

Factors generally subject to Government control. These includeddelays in land acquisition, lack of reliable electricity and water supply,failure or delay in full adoption of OF principles, heavy accumulatedlosses and poor financial position of SFs and MPUs in some states,and lack of freedom in setting prices in many states.

Factors generally subject to implementing agency control. Theseincluded delays in appraisal of sub-projects, delays in theimplementation of institutional strengthening measures such asmonitoring and evaluation (M&E).

11. Performance of the Bank and Borrower. The performance of both the Bankand Borrower has been mixed. Both have satisfactorily carried out project identificationand preparation, and appraisal was also satisfactory, overall. Supervision of the project bythe Bank received inadequate attention while covenant compliance by the Borrower hasonly been partial.

12. Project outcome assessment. The project outcome is rated satisfactory.

Summary of Findings, Future Operations and Key Lessons Learned

13. Findings. The institutional, managerial and technical adjustments promotedunder the project have helped the dairy sector to improve its performance and set the stagefor sustained development of a competitive commercially-oriented domestic dairy industryable to respond to increasing domestic demand for milk and milk products. The project'sre-estimated economic rate of return is robust. A matter of particular concern is the stillpoor, though substantially improved, financial performance of many state federations anddistrict unions. Continuing emphasis is required on the commercial and financial viabilityof cooperatives. Equal emphasis, if not more, is required to sustained measures aimed atenhancing milk yields. NDDB is aware of these shortcomings and has initiated programs toaddress these issues. Given the quality of its senior management and its competent andloyal staff (many counting over 20 years of service), NDDB's continued attention to theseissues is likely to be assured.

14. Plans for completion of OF II objectives and future operations. NDDB hasindicated that it will: (a) help completion of all unfinished sub-projects by June 1997, andmake available adequate funds for this purpose on a full loan basis at an annual interest rateof 14-15 percent; (b) continue the cooperative development program covering selected

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DCSs; (c) intensify its efforts to rehabilitate selected state federations and MPUs on thelines adopted in Mysore union; and (d) encourage cooperatives to upgrade theirproductivity enhancement programs. While the Tamil Nadu federation and unions haveutilized their own funds to carry out sub-projects as a result of the embargo on fund releaseto that state by NDDB, Maharashtra which has sub-projects that are incomplete due to theirlate start-up is reluctant to accept funding on a loan basis at 14-15 percent p.a. The subjectis under discussion between the concerned states and NDDB.

15. Lessons for future projects. The main lessons learnt are:

(a) In any project involving farmer-controlled cooperatives, an understandingof the proper role of government in project implementation is crucial.Project design should explicitly take this role into account. The AMULmodel, a successful experience in milk collection, processing andmarketing, controlled and directed by farmers in Gujarat, was consideredfeasible for replication in other states which had different cooperativetraditions and culture. The model hinges on autonomous farmer control atDCS, union and federation levels. Many other state governments do notfully support the concept of farmer control at the union and federationlevels. The requirement of state guarantee for loans taken by unions orfederations has not helped the development of a "hands-off' policy of stategovernments. It would, therefore, appear that a successful expansion ofAMUL principles throughout the country requires, in the final analysis, asupportive role by governments to the cooperative movement such aspresently enjoyed in Karnataka and Bihar. Accordingly, the bank mighthave taken a tougher line during project supervision in scrutinizing sub-project appraisals rejecting those of states which did not meet anacceptable level of compliance with the institutional requirements of theproject.

(b) In a sheltered industry, promotion of competition is essential to enhanceoperating efficiency. Although private competition has adversely affectedcooperative milk procurement in the early years after delicensing, it hashelped to raise cooperatives out of their complacency and acted as a spurto efficiency in many cases, forcing them to contract out some of theiractivities to the private sector like milk transport, packing andmaintenance of factory gardens.

(c) In project design, especially in the case of complex developmentprograms, particular attention should be paid to assessing the existingsituation and to devising ways to overcome or manage existingimpediments. In NDP-II, the quality of management was perceived as aprincipal risk, thus requiring special attention.

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(d) Development of fully sustainable operations in a consumer industryrequires the involvement of a regulatory body to assure product quality. Atpresent this role is performed by NDDB. However, there is a conflict ofinterest between NDDB's function as the apex body for the dairycooperative system and an industry-wide regulatory function. Most of thedairy plants visited made heavy demands on NDDB for technicalassistance in all aspects of the dairy sector. There was general agreementthat the industry would meet some of the costs of a separate regulatorybody. However, the Government must also make a contribution to theagency which would be responsible for maintaining quality standards fortechnically guiding the industry, and for ensuring that good manufacturingpractices are applied throughout the dairy industry.

(e) Government commitment to resolving sectoral and state-wide issues iscritical to the successful project implementation and operation. In NDP-II,solutions to some problems depended on the willingness of stategovernments to address difficult issues which could not be resolved atproject level, e.g. adoption of OF III principles, pricing decisions,amendment to State Cooperative Acts and reduction in staffing.

(f) State governments must be fully involved in the design of reformssponsored by the central government as a basis for project design. Someof the reforms implicit in OF III principles initiated by NDDB covered thetrue cooperative principles. While it is too early to say whether NDP-IIhas been successful in having a lasting effect on the dairy cooperativestructure, the Bank's positive support to project investment andcompliance with OF principles proved valuable to India's drive to increasemilk output.

(g) For a project of the size and scope of NDP-II, the Bank should haveinsisted on the establishment and monitoring of key performanceindicators aimed at providing intermediate assessments of projectoutcomes and likely impacts.

(h) The Bank should not add new sub-projects toward the end of the projectimplementation period without first examining both the prospects fortimely completion and for achieving satisfactory benefits. The inclusionof additional sub-projects within the last two years before Credit closing(e.g. Maharashtra) has been one of the reasons for the delay in thecompletion of NDP-II. The experience of NDP-I had already taught thislesson which was not applied to the follow-on NDP-II. While utilizationof Credit savings was a major objective of these additions, the prospect ofdelays in completion and accrual of benefits therefrom should havereceived adequate scrutiny before this decision was made.

IMPLEMENTATION COMPLETION REPORT

INDIA

SECOND NATIONAL DAIRY PROJECT

(Cr. 1859-IN/Ln. 2893-IN)

PART I: PROJECT IMPLEMENTATION ASSESSMENT

A. PROJECT OBJECTIVES

A. Statement of Project Objectives

1. The Second National Dairy Project (NDP-II) was designed in support ofOperation Flood III (OF III), building on the implementation experience of three state-level dairyprojects (Karnataka, Madhya Pradesh and Rajasthan, all approved in 1974) and one national-levelproject (National Dairy Project, approved in 1978) through which the Bank assisted in developingIndia's livestock subsector. The objectives of NDP-II were to promote the establishment of viablecooperative businesses owned and managed by producers, for collecting, processing andmarketing of milk products in order to improve milch animal productivity and expand ruralincomes. These were to be achieved by: (a) expanding and consolidating the integratedcooperative institutional structures; (b) providing the necessary prerequisites for productivityenhancement; (c) establishment and expansion of milk collection, processing, storage anddistribution activities; and (d) strengthening of institutions, and training.

2. Project cost. The project was to be implemented over seven years from December1987 to December 1994, and the total project cost including physical and price contingencies wasestimated at US$678 million (Rs9,150 million). The IDA Credit of SDR121.2 million (US$160million equivalent) and Bank Loan of US$200 million, amounting in total to US$360 million(Rs4,860 million) were to finance about 53% of the project costs. The remainder (US$318rmillion or Rs4,290 million) was to be met out of NDDB resources, which were expected to besupplemented by commodity aid from the European Economic Community (EEC), supplied on agrant basis and equivalent to about US$150 million (Rs2,025 million)."

3. Special legal covenants. Special legal covenants or agreements that were expectedto promote the achievement of project objectives were for GOI to cause project states to ensurethat state federations, milk producers' unions and dairy cooperative societies follow OperationFlood conditionality and SFs to submit satisfactory annual development plans. In addition,covenants required NDDB to: (a) ensure that DCSs, MIPUs and SFs function under by-laws and

Subsequently revised to Rs2,227 M. This understates the value of EC contribution of Rupees 2,227 Million asa minimum, but also has maximum food aid quantities (75,000 tonnes of SMP and 25,000 tonnes of BO),provided that these could be justified as a commodity need.

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charters consistent with OF III principles; (b) appraise sub-projects and ensure they meet certaincriteria spelled out in the Project Agreement (including a financial rate of return of at least 12%)and institutions receiving NDDB project sub-loans deduct an amount necessary to maintain equityin real terms before paying dividends and bonuses; and (c) take steps satisfactory to the Bank toprogressively reduce subsidies.

4. Although the participating states have all agreed to adopt OF principles, despiteconsistent prodding by NDDB some states have yet to comply in part due to obstructiveprovisions in the State Cooperative Acts. The enactment of the Andhra Pradesh Mutually-AidedCooperative Societies Act of 1995 represents a positive new development. It has resulted fromthe combined efforts of NDDB, the Cooperative Development Foundation and the CooperativeInitiative Project in a state where government interference in the past has manifestly weakened theabilitv of the dairy cooperatives to compete with the growing private sector. It would be highlydesirable if other laggard states would follow the Andhra Pradesh example and enact legislation toconfer greater functional autonomy on cooperatives, enabling them to frame and amend their ownby-laws, conduct elections, hire chartered accountants of their choice, take investment andmarketing decisions, and allocate funds independently of the government. However, NDDB,finding it unrealistic to expect the State Cooperative Act to be amended has recommended to thecentral Government that dairy cooperatives be incorporated under the Cooperative CompaniesAct. This recommendation is still pending with the Government. Strengthening of sub-projectappraisal techniques and procedures was of critical importance for ensuring technically andinstitutionally sound and financially viable development of the dairy cooperative sector. Afterfollowing the "return on investment" (ROI) methodology in the initial years with the approval ofthe Bank, NDDB has from 1993 introduced, at the request of the Bank, revised procedures takinginto consideration the main criterion of the financial rate of return (FRR) specified in the ProjectAgreement. Although action has been taken to charge for services, an increased level of costrecovery has not been achieved by the closing date of the Credit.

Evaluation of Project Objectives

5. Claritv. The basic concept of the project - improving rural incomes and milchanimal productivity - using the integrated dairy cooperative program for the production,collection, processing and marketing of milk and milk products, was important for development ofthe Indian livestock sector.

6. Realism. The project design was based on the well-tested, locally developedAnand Milk Union Limited (AMUL) dairy cooperative development model on which GOIdecided to build its national dairy development strategy. However, the appraisal mission wasoveroptimistic in its assessment of the rate of change of state governments to adopt the conceptof farmer control at various levels of the cooperative structure, though this was highlighted asmajor risk area in the SAR. Although the model hinges on autonomous farmer control at DCS,MVPU and SF levels, many state governments do not fully support the concept of farmer control atall levels of the cooperative structure. A successful expansion of AMUL principles throughoutthe country requires, in the final analysis, a supportive role (without excessive involvement orinterference) by state governments to the cooperative movement.

7. Complexity. The project was a massive and complex program in states which eachhave their own priorities and commitments. The scale and spread of project activities called for

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high-quality management and skillful planning of implementation, which many SFs and MPUshave found difficult to command. Insofar as the quality of management at federation and unionlevel was perceived to be the principal risk, special attention should have been devoted toexamining the existing constraints and making a detailed investigation about if and how existingimpediments could be overcome. Deficiencies such as the poor financial position of SFs andMPUs had haunted the dairy cooperatives in many states in the past, and the pace of change wasrecognized as a risk. The importance of financial viability of the dairy cooperative structure wasexplicitly emphasized at appraisal and the Bank had specifically provided for a longer-than-usualproject implementation period to help promote institutional adjustments to ensure the long-termsustainability and financial viability of the dairy cooperative sector.

8. Responsiveness to Borrower's circumstances. The project responded well toGOI's strategy to build its national dairy development through the Operation Flood programs.

9. Risks. The willingness of the st.ates to implement OF conditionalities wasrecognized as the project's main risk. Significant implementation delays or shortfalls inachievements were foreseen at appraisal. A longer-than-usual implementation period (more thanseven years) was regarded as acceptable if it helped promote institutional changes to ensurefinancial viability of the OF dairy cooperative sector. The risk of NDDB not completing sub-projects started under OF III was considered to be small.

B. ACHIEVEMENT OF PROJECT OBJECTIVES

10. Overall Achievement. The project, by and large, has achieved its physical, sectorpolicy, financial and institutional development objectives in Gujarat, but only partially in othermajor states.2 Macro-economic policies were not applicable to the project. Although not statedobjectives under the project, gender issues and equity have received much attention under thisproject and poverty alleviation was highlighted as a project benefit. While the evidence is notsystematic and varies considerably across areas, mission findings from field visits and from varioussample surveys3 indicate that dairying has made a particularly significant contribution to theincomes of small, marginal and landless farmers. DCSs provide a market which is much fairer tothe milk producers than the private traders although the society is not usually able to replace orsubstitute for the pattern of informal credit which bind poorer milk producers to private vendors.In addition, women are increasingly enrolled as DCS members (and in some cases, in the

2/ Including together with Gujarat. Andhra Pradesh, Karnataka, Maharashtra, Tamil Nadu and Uttar Pradesh,which together account for over 82% of total milk procurement, 76% of total investment costs and 74% offunds released by NDDB.

3/ "Case studies of Successful and Unsuccessful Primary Cooperative Service Society and Milk ProducersCooperative Society in Punjab." J.S. Sidhu and R. S. Sidhu. Indian Journal of Agricultural Economics, July-September 1990; "Performance of Dairy Cooperatives in Saurashtra, and Econometric Analysis." IndianJournal of Agricultural Economics, April- June 1994; and "Present Status and Promise of Dairying inIndia." R.K. Patel, Indian Journal of Agricultural Economics, January- March 1993.

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management committee as well), in line with State policies and the objectives of the CooperativeDevelopment Program (CDP) of NDDB.

Physical Objectives

11. General. A comparative statement of targets and achievements of the majorproject components as on April 30, 1996, is given in Table 5 of Part II. Appraisal (or revised)targets were attained or surpassed with respect to some elements of the productivity enhancementcomponent (DCSs covered by artificial insemination (Al), AIs performed per year, bulls fornatural service, bull mother farms, silvipasture, urea molasses blocks (UMB) plants anddistribution of mini-kits/varietal demonstrations), the number of milksheds covered, the number ofDCSs organized, liquid milk marketing, milk powder storage, drying and chilling capacity and railmilk tankers. Shortfalls were experienced in other elements of the productivity enhancementcomponent such as cattle feed plants, seed processing units, first aid centers, semen productionstations and sire evaluation centers, and in milk procurement, rural and metro processing andbutter storage. The objectives of the major components and their degree of achievement arediscussed below.

12. Cooperative Institutional Structure. After a rapid growth during OF II (1981-86),the dairy cooperative structure underwent a period of consolidation and strengthening under thefollow-up program - OF III or NDP-11, as indicated by the key indicators of national dairycooperative development.

Dairy Cooperative Development

Indicators Unit Appraisal Actual Percentagtargets achievement e

Average milk procurement per Mlpd 13.7 11.0 80year ____

Farm families million 6.7 9.2 137

DCSs '000 70 71.8 103

MPUs No. 190 170 95

State Federations No. 22 22 100

All development indicators show achievement well above appraisal targets except milkprocurement and number of MPUs. Liberalization has allowed the entry of the private sector tocompete away a share of the milk market particularly through its impact on new plants in certainareas and, as a result, average milk procurement by the DCSs fell short of the targets. Thereduced number of MPUs was part of a deliberate strategy of consolidation and strengtheningrather than geographic expansion of the unions. To continue sustained progress, the cooperatives- SFs and MPUs - will have to further improve their financial profitability and institutional self-sufficiency.

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13. Productivity Enhancement. A major thrust under OF III was to be an increase inanimal productivity supported by measures to promote animal health care, feed and fodder usage,genetic improvement and better animal husbandry. Through the project period, increasingemphasis has been placed on increasing cost recovery for technical input provision. This has beenparticularly by direct payments by farmers for services used and through a charge on the milkprices The charging policy varies between states and unions and is strongly influenced by thecharging policies of the Animal Husbandry Departments (AHD). This is a major issue for theTechnology Mission for Dairy Development (TMDD) and the dovetailing of OF and AHDservices where progress is still very variable. In particular, extension efforts are very limited. Theparticipatory rural management approach being used on a pilot basis has shown promise inidentifying the particular concerns of the farmers but extension should be addressed by TMDD ifthe productivity enhancement objectives of sustainable and economically viable production are tobe achieved in the longer term.

14. The artificial insemination program has been strengthened technically by the policyof developing "cluster" centers serving a number of villages rather than the single centersproposed in the SAR. The Al program is concentrated in a relatively small number of majorstates and involves both the upgrading of buffaloes and breeding of crossbred cattle. For thecattle, crossing with Holstein Friesian (HIF) blood has become increasingly important andcrossbreds with rather high exotic inheritance can be found even in the more resource-poor ruralareas - despite the SAR recommendation that expansion of Al with exotic semen be limited toareas with relatively favorable conditions. In some cases (Bihar), a number of farmers have beenable to cope surprisingly well with newly introduced crossbred cattle whereas in eastern AndhraPradesh the introduction of such cattle was generally unsuccessful. The HF appears to be thebreed of choice of most farmers, but there may well be a case for the small landowner or landlessmembers to concentrate on the use of Jersey semen. HF is chosen on account of the greaterquantity of milk produced, but the Jersey, with its lower fodder requirement and higher butterfatproduction, could be equally profitable where resources are severely limited. The publishedreports of the numbers of calves born under the Al program understate the effectiveness of theoperation. A particular problem is that there is a substantial trade in pregnant animals of highergenetic potential so that the Al program may have only a small impact on milk production withinthe breeding village. Nevertheless, there is fairly wide variation in the success rate of Al. Whererecords are available at DCS level, conceptions to first and second inseminations by Bos cowsvaries from as much as 73% to as little as 30%. There is a system of re-training inseminators. Itis more likely that the effectiveness of the system is variable and depends on the resources whichlocal management are prepared to devote to re-training. Another problem appears to be thatmany farmers seem to miss observing the subsequent oestrus after AI. Several DCS records showthat only 50% of animals show positive when presented for diagnosis three months afterinsemination. Clearlv, this results in a loss of production through extended calving intervals.Buffalo AI is even more variable, and in the Amritsar area of Punjab many farmers are reverting tonatural service. Both these matters merit fiirther attention.

15. In most of the villages visited, the animal health services were given the highestranking by the farmers in terms of the importance of the input services provided by the unions.The change during OF III from regular veterinary routes to the provision of emergency servicesand infertility camps appears to have been accepted by the farmers as part of the rationalization

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and cost reduction program. Village society secretaries have also been given training in basicanimal health care.

16. For livestock feeding, the process of producing urea molasses blocks has beenchanged but the program is still at a pilot stage. Consideration is being given to the inclusion inthe blocks of mineral mixtures and anthelmintic. The greater use of such measures shouldsignificantly improve animal health. In India, silvipasture can only play a minor role in feedingimproved animal breeds. More recently, the provision of fodder seeds has been given greaterpriority in addition to the program of distributing mini-kits and varietal demonstrations, but landavailability restricts the use of these to the larger landholder. However, landless and smallerlandholders can sometimes purchase standing crops from these more affluent farmers.Demonstrations of urea treatment of straw continue to be undertaken but the impact of theprogram appears to be still limited. If the widespread production of UMBs is resumed, the use ofthese may well have a much wider rate of adoption than straw treatment.

17. Processing and Marketing Facilities. This component represents the largest share(54%) of the total project cost. Milk collection, processing, storage and distribution were theactivities covered under this component. Planned milkshed processing capacity was not fullyachieved partly due to incomplete sub-projects in Maharashtra, while drying and chilling capacitywas more or less achieved. Liquid milk marketing capacity has exceeded appraisal targets (112%)due to the creation of additional capacities in big cities - Bangalore, Hyderabad and Ahmedabad -other than the originally planned four metro dairies - one each in Bombay, Calcutta, Delhi andMadras. A total additional storage capacity of 44,900 metric tons (MT) was constructed,representing a modest shortfall compared to the appraisal target. At appraisal, it was envisagedthat an additional 183 rail tankers would be required for long-distance transportation of milk.However, actual procurement was 169 or 92% of appraised target (97% of revised target). Lessstorage capacity was required due to reduced reliance on re-combination for the supply of liquidrmilk to major urban centers in the lean seasons. Greater use was made of road transport ratherthan rail in order to provide a more flexible milk distribution network. Thus, in a sense, failure tomeet those targets is a positive indication of flexible management. The performance of the mainsub-projects is highlighted in the following paras.

18. Cooperatives are obliged to accept all the milk delivered by producers and theinstalled processing capacity must therefore be capable of handling peak daily intake. Since thereare considerable variations (3:2) in milk production, plant utilization will always theoretically beless than 70% installed capacity. In practice, however, many plants are handling considerablymore than rated capacity through operating up to three shifts. The data on rated capacities andactual utilization in the Operation Flood dairies showed considerable inter-and intra-statevariation. Gujarat and Maharashtra do better than most. With few exceptions, the units inMadhya Pradesh and Andhra Pradesh operate at low capacity. Some units, however, operateconsiderably above rated capacity and these are mainly concerned with liquid milk processingwhere the introduction of three shifts and the additional packaging material has allowed them toprocess and package more liquid milk. Milk drying and butter making activities have beendesigned largely to cope with the surplus milk at peak supply, and the capacity utilization istherefore generally much lower and more variable. NDDB has proposed management contractsfor some of these cooperatives to upgrade performance and improve competitiveness with theprivate sector.

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19. The technology and equipment introduced were tried and tested elsewhere andconsequently there were no major problems with installations assisted by the project. The NDDBEngineering Group, with the assistance of experts provided by the project, established drawingsand specifications for the various sub-projects and offered turnkey consultancy service at a fee -5% of sub-project cost.

20. Where possible, NDDB prepared standardized specifications and drawings foritems of equipment which were common to a number of projects, e.g., storage tanks, pasteurizers,cleaning systems, and also for cattle feed plants. High standards were set for locally producedequipment. However, the expected cost savings were not always fully realized. Nevertheless,capital cost per liter of processing capacity was below Rs500 for most installations of expandedcapacity.

21. The financial feasibility calculations were based on high throughput rates for mostof the season (>70% utilization capacity) which may be difficult to achieve due to the high prioritybeing given to supplying the liquid milk market. All five major sub-projects initiated in recentyears at Gandhinagar, Amul, Kheda, Noida and Calcutta metro dairy involved an increase in thelevel of automation which was justified as much on the basis of quality and efficiencyconsiderations as on labor savings. The standards for civil works were for a combination ofreasons set at a very high level. The first three plants involved a high capacity energy-efficientplant for the production of milk powder, butter and cheese products, which met highestinternational standards. Drying and mechanized automated cheese plants are capital-intensive andcapital cost of Rsl,000 per liter of processing capacity are acceptable, though slightly on the highside.

22. NDDB also played an important role in guiding the evolution of the technologyand equipment used within the dairy cooperative sector. There has been a progressive increase inplant capacity and degree of sophistication. It may be argued that some of the most recent plantsare too complex, but the impressive level of indigenization of manufacture of the processingequipment and automation would suggest that they are appropriate (for the progressivefederations/unions) for the rapidly improving conditions in India. An innovative pilot scheme tosubstitute bulk chilling tanks for the traditional can collection at village level was successfullyintroduced in the Kaira district of Gujarat. These centers have potential for better operation ofthe National Milk Grid, but their replication must be preceded by comprehensive feasibility studiesin each location.

23. The Dairy at Noida also has a number of innovative features such as vertical designand an ETP which combines anaerobic and aerobic treatment on a compact site. The total cost ofthe project is estimated at Rs430 million for 400,000 liters per day (LPD) of pasteurized milk insachets. The fifth plant at Metro Dairy, Calcutta is impressive by any standards and in addition to400,000 LPD liquid milk, has facilities for ice cream and UHT milk processing. The total cost isnearly Rs500 million. The cost per liter of processing capacity in both cases is in excess ofRsl,000 and this will constitute an exceptionally high loan servicing cost per liter of milk even at100% capacity utilization. This must be taken in the context of total operating costs for liquidmilk in sachets of approximately Rs1.0 per liter given by both cooperative and private factoriessupplying urban markets.

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24. Realizing the need for competent management of processing facilities, NDDB hasto a large extent, concentrated investment in Gujarat and mother dairies where required expertisewas available or secured without much difficulty and trained.

25. Cattle Feed Plants (CFP). Some 11 cattle feed plants have been financed under theproject, mostly for expansion of existing capacities and, of these, six units were taken up underNDP-I and completed under NDP-I. The available operating results of all plants indicate thatnine completed in 1992/93, eight in 1993/94 and one in 1994/95, have made small net profits.Pricing strategy adopted by the federations/unions for cattle feed involved either making no-profit, no-loss (Gujarat) or selling slightly below cost due to input cost increases ahead of priceincrease (Karnataka), on the grounds that cattle feed is a necessary input for production of milkwithin the system and the total operation of the federation/union (and not simply the CFP) shouldconstitute the criterion for financial viability. There is some merit in this argument provided thatcross-subsidy by MPUs through DCSs does not penalize farmers purchasing cattle feed fromother sources as against those who do buy from DCSs, although it was agreed during negotiationsof the NDP-II that investments in CFP should be viable, regardless of other activities of thefederation/union. Field visits indicate that some CFP units are incurring losses partly due tosubstandard product quality which does not help them to achieve profitable levels (Madurai),while some produce good-quality feed, capturing markets in neighboring states (CFP in Punjaband Karnataka). Another reason for low prices could be the desire to attract farmers to thecooperative fold. Overall, action has been taken by NDDB to overcome these problems in severalways including input cost control, range of feed production and feed grid. However, sellingbelow cost is a bad strategy from the society's point of view because efficiency gains fromcompetition by the private sector are stifled.

26. Objectives of Sector Policies. The cooperative sector policies relevant to theproject included the adoption of Operation Flood principles, milk pricing and subsidies. Theseobjectives were only partially achieved. As of April 30, 1996, Gujarat continued to be the onlystate in the country in which ownership and control of the milk industry was fully in the hands offarrmers at all three levels - DCS, MPU and SF. All other states continue to exercise varyingdegrees of control through appointed administrators at union/federation level, usually the latter.Progress in regularizing the situation is slow, thus delaying the application of the OF principlesnation-wide. The lack of compliance by the states in this respect was considered the most seriousimpediment to OF generally under NDP-I and at appraisal of NDP-II, and persists as the majoroutstanding issue at the completion in NDP-II. The state governments have controlled bothproducers' and consumers' prices of milk in some states, seriously affecting the growth andfinancial viability of the dairy cooperatives. Milksheds where the price is decided by stategovernments/union territory include Bhavnagar, Kutch, Surendranagar and Junagadh in Gujarat,and Sikkim. Milksheds where price is decided by the federation in consultation with the unions,include all the milksheds of Haryana, Karnataka, Kerala, Orissa and Tamil Nadu (where the stategovernment is also consulted). As regards subsidies, specific steps have been initiated to chargefor services provided. However, the level of charges is still too low in many cases to satisfy fullcost recovery.

27. Financial Objectives. The project has fully achieved its financial objectives inDC Ss (except those defunct or dormant which have not yet been liquidated), but only partially inSF/MIPUs. The shortfall is largely due to the lack of adoption of OF III principles fully except in

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Gujarat, excessive staffing levels in SFs and MPUs, and limited freedom in setting realistic prices.This issue is discussed in detail in paras 39-46 as the financial viability of cooperative businesseswas an overarching objective under the project.

28. Institutional Development Objectives. The project impact on institutionaldevelopment was mixed. The main means of achieving the institutional development objectiveswere by the provision of infrastructure and equipment, training of NDDB and union levelpersonnel, studies related to marketing and management, monitoring and evaluation activities.These were all provided to varying degrees of success. Staff training has been provided asplanned. Various studies have been carried out with grant funding from the EU. As a result,NDDB, which acted as project promoters, consultants and financiers, gained a high level ofpromotional ability, technical skills, financial expertise and overall control, without which theconsiderable gains made would not have been possible. Its innovative approach to milkprocurement and marketing, and rural organization, its dynamic management, market andcoordination activities are all highly commendable.

29. On the other hand, the managerial and financial performance of SFs and MPUshave generally suffered due to a number of reasons: the common cadre system in some states(Andhra Pradesh, Karnataka, Tamil Nadu and Uttar Pradesh), with frequent transfers has impededproper management, accountability and stability of operations. The information system is largelydesigned to provide data on milk procurement, marketing: and inputs. In certain respects, theinformation generated does not provide a valid basis for monitoring results or evaluating impact.For example, in two key areas -- socio-economic impact (or income effects on different socio-economic groups), changes in animal productivity and progress of sub-projects -- there is scopefor streamlining and clearly defining the parameters (member-pourers/non-member pourers;number and type of animals as well as members' landholding on a sample basis; and time and costoverruns as well as revised FRR for sub-projects) and relating inputs to outputs (e.g. Al).Greater flexibility is also necessary to reflect changes -- for example, the introduction of by-passcattle feed, and coverage of DCS by government services under the TMDD.

30. Equity and Gender Objectives. Although equity and gender issues were notexplicitly stated objectives of the NDP-II, the project has contributed to poverty alleviation andinvolvement of women in dairy activities. In the absence of clearly defined M&E data onbeneficiary participation, it is not possible to make a precise assessment. The preliminary resultsof a sample survey" indicate that in the OF villages about 78% of total households own milchanimals and nearly 63% are members of DCS. About 87% of member households possessoperational land while, in the case of non-member households, it is 79%, showing that landownership is not a distinguishing criterion among member or non-member households.Distribution of members by different social groups show the mix as: scheduled castes (14%),scheduled tribes (4%) and other backward castes (41%). The project's impact on rural incomesis, thus, considerably more equitable than most crop production programs as a result of the muchmore even distribution of animals between social groups. Female participation is about 20% oftotal membership of DCSs, representing an important change in an overwhelmingly male-dominated society. Given the social constraints, women's membership does not, by itself,

' "Impact Evaluation of Operation Flood Programme on Rural Dairy Sector, preliminary observations",NCAER, May 1996.

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guarantee active participation. Nonetheless, in many areas, and particularly in some women'sDCS, women have gained an increase in mobility, in self assurance and some access to income.

31. Another significant contribution under OF III has been the emerging realizationthat cooperative development is not just about numbers - numbers of DCS or numbers ofregistered members. Members may be registered but that does not mean that they are involved inthe cooperative, or if they are involved, that they understand what is going on and participateactively. This has emerged as a critical area as the rapid expansion of the dairy cooperative sectorthroughout the country has involved a more 'top-down', target-oriented, approach in contrastwith the initial process of growth of dairy cooperatives in Gujarat in response to local needs andleadership initiative. The Cooperative Development Program of the NDDB represents a veryimportant, innovative, committed and generally gender-sensitive effort for membership educationand institution building at both DCS and district union level. The drawbacks lie in the scale of thetask involved and the need to achieve a balance between more intensive follow-up (which limitscoverage but improves effectiveness) and wider coverage (which may reduce effectiveness).Impact studies of the Cooperative Development Program have not contributed as much as theymight have to achieving this balance since they tend to be limited to assessments of short-termeffects.

32. Operation Flood has been criticized as a program which draws on substantialinternational and government funding for a development program which benefits the better-off,larger farmers. These criticisms tend to be vigorously denied. However, the debate tends to bemore emotional than rigorous. A careful assessment of the distribution of benefits needs to bemade. This is apparently being done by the NCAER. There may be scope for supplementing thiswith a careful examination in different regions of existing data at selected DCS combined withcareful cross-checking and interviews with DCS members.

33. At the same time, it is apparent that, whilst poorer members may be benefitingfrom DCS membership: (i) it is larger farmers who have the resources to invest in more andimproved animals and to feed and maintain them very efficiently; and (ii) marginal farmers andlandless families do not have the same level of resources and usually find it more difficult tomaintain improved animals efficiently.

34. Project Impact. The institutional, managerial and technical adjustments promotedunder the project have helped the dairy cooperative sector to improve efficiency and productivity,and set the stage for sustained development of a competitive commercially-oriented domesticdairy industry capable of responding to the expanding domestic demand for milk and milkproducts. An outstanding impact of the project is the continued development of milksheds,making them attractive for the entry of the private sector which itself was facilitated by thedelicensing of the dairy sector in 1991. In addition, the project can claim substantial credit for theimpressive gains made in annual milk procurement and to some extent productivity of milchanimals; increase in per capita milk consumption; expansion in number and capacity of dairyplants; creation/expansion of infrastructure for greater procurement, processing, and marketing ofmilk, produced in rural areas which, in turn, has increased urban milk supplies; increase in thenumber, membership and earnings of DCSs; evening out seasonal and regional imbalances in milksupply; expansion of dairy equipment manufacture to meet country's demand indigenously; andemergence of the country as a potential exporter.

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35. The project had a major impact on rural incomes and employment of a goodproportion of small, marginal and landless farmers. It benefited about 4.1 million additional ruralhouseholds (22.5 million people) and continued support towards improving milk yields and familyincomes of the 9.2 million households (50.6 million people) already enrolled under OF. Costs perbeneficiary household are low, estimated at Rs3,060 (US$90) per incremental household orRs1,365 (US$40) in terms of total households. As on March 31, 1996, an average milkprocurement of 10.7 million liters per day (Mlpd) (or peak procurement of 13.4 Mlpd) has beenachieved, representing Rs33.8 billion (or nearly US$1billion) in cash revenues for rural farmers,and a significant increase in the availability of milk and milk products in urban areas. Thepresence of DCSs in the market has also provided competition, thereby improving retums toproducers in general, regardless of the purchasing agent. It has also generated significant, thoughunquantified, social benefits to the rural community through provision of funds principally forvillage communal facilities, school/college buildings, and recreational facilities.

36. Economic Rate of Return. The current economic rate of return re-estimated atcompletion is 21%. The recalculated ERR is based on actual expenditures incurred up to theclosing date as well as the costs to complete ongoing activities until June 1997, and an actual andupdated projection of benefits. Underlying assumptions about costs and benefits, and otherinformation supporting the analysis, are shown in Table 9 of Part II and Appendix B. The re-estimated ERR differs from the appraisal estimate of 27%, mainly due to the shortfall in milkprocurement.

37. Sensitivity Analysis. The three factors which are expected to influence the ERRare the net value added through rural-urban transfer, the inability of the SFs/MPUs to operate andmanage processing plants as designed and, to a lesser extent, the assumed productivity growth. Ifthe net valued added is reduced by 20%, the ERR falls to 19%. Poor operation and managementwould lower ERR to 5%, assuming that the ineffective operation of SFs/MPUs would depressproject benefits by 20%. The decline in value of incremental production by 20% would lowerERR to 9%. Thus, both management and incremental value of production have a criticalinfluence on the ERR.

38. Financial Re-evaluation. Project investments have ranged over a variety of newand expanding processing capacities and feed mills located throughout the country. Appendix Bshows the FRR on models estimated at appraisal and at completion, which are summarized below.

FRR (%)Appraisal Completion

Average DCS 15% 17%New MPU dairy plant 20% )

30%Existing city dairy plant 28% )Gandhinagar plant 18% 12%Cattle feed plant 16% 9%

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At completion, financial results are more or less similar to those estimated at appraisal except forthe Gandhinagar plant and cattle feed investment. Considering the growing diversification of citydairies, a single analysis has been done for city dairy/MPU dairy plant at project completion. Thelower results of the Gandhinagar plant are attributed to low capacity utilization while the lowerFRR for the cattle feed plant was not unexpected due to the policy of the investing SF/unionoperating these plants on a no-profit no-loss basis.

Financial Situation of Participating Entities

39. Overall Performance. In major states, DCSs have been generating surpluses andbuilding up their liquid balances in the form of deposits with banks or with their unions andinvestments in approved securities. The financial performance of many SFs/MPUs is stillunsatisfactory, although they have shown improvement in recent years. At appraisal, about 50%of participating borrowers (SFs, MPUs and city dairies) were earning annual profits with the other50% either earning a cash profit (i.e. excluding depreciation and interest accrued but not yet due)or varying levels of losses. At project completion, profit-making units have risen to 63% (85 outof 13 6 entities). Moreover, there is a definite trend of improved performance. In addition to thernilk operations, several states have cattle feed operations which are run on a no-profit no-lossbasis (see para 25).

40. Implementation experience indicates that SFs and MIPUs operating substantiallywithin OF principles (substantial farmer control and direction, and independence from stategovernments) have the more profitable operations (e.g. Gujarat, Karnataka and Maharashtra). Onthe other hand, other SFs and MPUs operating with state government intervention (e.g. AndhraPradesh, Haryana, Tamil Nadu and Uttar Pradesh) usually suffer from inadequate selling prices,overstaffing and less motivated management. The overstaffing is an inevitable consequence of thecooperatives taking over facilities and staff from government without the necessary re-structuring.An exception is the Gujarat Federation which was very careful to avoid doing this. Otherimportant causes for losses have been insufficient development of milk procurement andmarketing potential, and limited diversification into high-margin milk products. The SARprovision for equity build-up resulted in increased equity in many unions but not far enough tosustain the high risk of operating losses.

41. Poor management has also affected the financial performance of unions andfederations. To an extent this is because the dairy industry has become more competitive andcontestable. One of the reasons for this is the recent (1991) delicensing of the dairy industry.Thus, the real question facing the dairy cooperative sector is: is an MPU in a position to developand institutionalize capabilities to the point of earning attractive returns? This breaks down intotwo further questions. Can an MPU develop capabilities to increase revenue per unit? Can itdevelop capabilities to decrease cost per unit? Investment in facilities for diversified products hasbeen a major attempt to increase revenues. Operating costs are variable (transport costs, productlosses). The greatest leeway is in capital cost (fixed costs) and selling price, and if MPUs couldreduce this cost and increase the selling price to a tolerable level, then their profitability should bepossible.

42. None of the societies visited by the ICR mission were able to raise share capitalvoluntarily from members beyond the minimum share ofRslO per member. As a result, the build-

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up of equity was slow until later years of the project when unions made deductions from pricedifferences or bonuses paid to members in order to beef up capital (e.g., Gujarat, Karnataka,Maharashtra). In other states like Tamil Nadu, share capital had remained constant until effortswere made to convert some of balances in reserve funds in DCSs into the capital of the union.

43. . Financial Profitability. Financial profitability of the federations/unions has longbeen a matter of serious concern even in the previously completed projects and during supervisionof the NDP-II carried out by the Bank. For the purpose of analysis under NDP-II, six majorstates have been selected, based on a combination of milk procurement levels, investment costsand financing for sub-projects, as indicated below. Because of the interdependence of theindividual units within the three-tier structure, financial analysis, in substance though not in legalform, must treat them as one integrated whole, particularly because of the impact of transferprices between the unions and federations. Viewed collectively in this light, financial position ofthe integrated structure would appear better due to returns made by profitable unions andpractically all DCSs. However, as each unit in,the tier is a profit center, analysis of individualunits makes sense from a performance evaluation angle.

Milk procurement Investment costs Release of funds by NDDB(volume in 'OOOs)

(kg per day) (%) Rs million (%) Rs million

Gujarat 3,313 29 3.898 36 3,843 40

Uttar Pradesh 819 7 1.201 11 806 8

Karnataka 1,098 10 951 9 860 9

Tamil Nadu 1,203 11 735 7 602 6

Maharashtra 1.908 17 728 7 391 4

Andhra Pradesh 848 8 709 6 628 7

Other states 2,091 18 2.689 24 2,472 26

All India 11I280 100 10 911 100 9,6041 _O0

44. As noted above, financial performance is generally improving. NDDB recordsindicate that there had been wide variations among the assisted units within a state and betweenstates, with Gujarat and to some extent Maharashtra ranking well above others. The change in thenumber of profit/loss making unions and federations and their associated value of profit or loss isshown below.

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1992/93 1993/94 1994/95State Unions& Federations l

No. making Profit No. making Profit No. making Profitor or or

(Loss) (Loss) (Loss)(Rs M) (Rs M) (Rs M)

Net Net Net Net Net Netprofit loss profit loss profit loss

Gujarat 15 - 57 13 2 28 12 3 36

Uttar Pradesh 10 13 (33) 11 12 (49) 12 11 (3)

Karnataka 2 11 (131) 3 10 (125) 10 3 115

Tamil Nadu 5 6 (171) 6 5 53 6 5 (3)

Maharashtra 9 2 (7) 10 1 28 10 1 112

Andhra 2 10 (168) 2 10 (121) 6 6 (58)Pradesh

As shown above, Andhra Pradesh and Karnataka show significant changes in numbers, while allhave improved their profits or reduced their losses by 1994/95. This is confirmed by ratio analysisas indicated below.

State Unions Return on Turnover (%) Return on Total Assets (%)& Federations

1992-93 1993-94 1994-95 1992-93 1993-94 1994-95

Gujarat a/ 0.31 0.14 0.16 5.57 1.38 1.18

Uttar Pradesh -1.35 -1.85 -0.10 -12.58 -16.07 -0.80

Karnatakab/ -3.62 -2.79 2.53 -24.81 -20.04 20.29

TamilNaduc/ -3.91 1.01 -0.05 -69.81 20.54 -1.27

Maharashtra d/ -0.12 0.45 1.62 -2.24 7.99 29.12

Andhra Pradesh -4.76 -3.18 -1.50 -37.94 -27.88 -13.57

a/ Taxation on Gujarat federation, Anand (Unit 3) increased substantially from 31% of profits to 80%. Profits after taxtherefore fell fromRs3O.5 toRs. 7.9 million: a74%reduction. As aresult, profits after tax fell by 51%between 1992-93and 1993-94; they recovered somewhat the following year. Tumover has increased in a steady fashion. Total assetsdoubled from 1992-93 to 1993-94 when the assets of the federation are counted. Between 1993-94 and 1994-95, Kaira(Unit 2) increased its own assets by approximately Rs300 million and total assets saw the same absolute increase. Facedwith falling profits after tax and increasing sales and assets, return on sales and assets have fallen.

b/ Kamataka: losses in first two years with remarkable tumarounds in last year. Steady growth in tumover and assets.

c/ Tamil Nadu: shows a fluctuating performance while Uttar Pradesh shows negative but declining rates of retum.

d/ Maharashtra: highly variable profits but steadily increasing tumover and assets. In all cases, tumover has been boostedby the new processing units coming into production combined with increases in selling price of milk.

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45. Efficiency Measures. It is important to get away from the idea that it is possible toencapsulate cooperative performance as a whole in a single figure of profitability. This is becausethe degree of profitability in dairy cooperatives is determined mainly by the level of selling priceswhich, in turn, are strongly influenced by the policies of the state governments. Assessment ofdairy cooperative performance in terms of profitability may thus reveal more about governmentpolicy than about the cooperative's own efficiency. A variety of performance indicators would benecessary to reveal the different aspects of performance. For this purpose, four indicators havebeen prepared and presented below. Extrapolating these results state-wide, a tentative conclusion isthat Gujarat, Karnataka, Maharashtra and Tamil Nadu - show a more efficient performance thanthe others

46. Past Losses. All the major states except Gujarat and Maharashtra have federations andsome unions with negative net worth, as a result of accumulated past losses, with some predatingthe NDP-II. Most of them need to be recapitalized while the rest will have to be liquidated. Themain contributory factors for poor financial performance include administered prices of milk inmetro cities like Bangalore, Calcutta, Madras and New Delhi; poor management as in Jalgaon orDharwar, and low capacity utilization due to competition from the private dairies as in AndhraPradesh, Punjab and Uttar Pradesh, and overstaffing in many units. Audits pending for periodsranging for some entities from one to seven years have affected the initiation of correctivemeasures.

Unions Indicators

Procurement Turnover per Net profit/(loss) Assets perper employee employee per employee employee

(litres) (Rs.'000) (Rs. '000) (Rs. '000)

Sabarkantha (Gujarat) 328 1,532 4 155

Kanpur (Uttar Pradesh) 143 741 32 104

Mvsore (Karnataka) 321 1,227 33 242

Salem (Tamil Nadu) 497 1,293 8 587

Kolhapur (Maharashtra) 802 4.000 149 211

Krishna (Andhra Pradesh) 49 269 2 27

NDDB's Role and Performance

47. Management. As under NDP-I, NDDB was assigned the overall responsibility forimplementing the project. As part of this, the Board has promoted, appraised, financed, andguided federations/unions and their investments. The promotion aspect of NDDB's lendingactivity supported by project funds and involving 'directed credit' to processing plants makes theessential difference as to its functions as a real catalyst of development and not merely a conduitthrough which lending resources pass. The Board in this way has an impact on tangible factorssuch as proper management policies and appropriate levels of technology. Total staff of NDDB

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numbers 1, 1 19, of which over 70% (832) have degree or post-graduate level qualifications.There is no reason to doubt the professional competence of the staff to carry out the tasksassigned to them. NDDB's continued access to a significant share of national developmentresources calls for a more critical analysis of the Board's operations and in particular of theallocation of resources at its disposal.

48. Operating Procedures. India's protected environment, her shortage of capital,abundance of under-employed labor and her need for exports are cause for reviewing the way thatsub-projects are chosen and steered. In evaluating such sub-projects, NDDB has used ROImethodology (changed to FRR method since 1993) which relates profit to capital employed. Theterms 'capital' and 'profit' are capable of many interpretations and can be expressed at variouslevels according to purpose of use. The method also ignores the residual value of assets such asland and buildings. The most important defect is that it fails to recognize the phasing of costs andrevenues (time value of money) and concentrates on financial flows in accounting terms ratherthan cash flows. NDDB has also not introduced ERR calculations, even for large projects, intheir evaluations. In this, NDDB's procedures lag behind those of the Industrial Credit andInvestment Corporation of India. It is not axiomatic that the plans to establish/expand a particularplant are right in terms of national economic advantage. A financial analysis is no substitute forconsistent economic appraisal in selecting sub-projects in terms of national advantage. A reviewof INDDB's operational procedures suggests that the major deficiencies are unwarranted relianceon the state plans and consequently no use of ERR in decision-making process and to someextent, inadequate attention to monitoring and evaluation of investments, which is largely due tolower priority being given to M&E than to lack of systems.

49. Financial Management. Generally, overall financial management seems sound.NDDB's surplus (excess of income over expenses) has risen from Rs150 million to Rs466 millionbetween FY1987 and FY1995 while its total assets have increased over the same period fromRs569 million to Rs27,771 million. Its equity has also increased sharply from Rs150 million toRs 14,116 million over the same period, reflecting its expanded involvement in oilseeds and morerecently salt in addition to its milk portfolio. However, its difficulties are reflected in itsoutstanding loan portfolio which is affected by arrears. Arrears of interest and principal areequivalent to about 185% of NDDB's surplus.

50. Loan Recovery and Portfolio Quality. Loan overdues have mounted steadily fromRs82 million in 1990/91 to Rs863 million in 1994/95, representing an annual growth rate of180%. They are still only about 1% of NDDB's loan portfolio. While the rapid growth indisbursements has helped to diminish overdues as a percentage of NDDB's portfolio, they alsohave masked the true state of portfolio quality. Loan recovery rates have declined steadily from100% (of principal) and 79% (of interest) to 32% and 36%, respectively, between 1990/91 and1995/96. Most overdues (over 40%) are over two years past due. Total recovery, thus, mightnot reflect current performance. Data indicate that NDDB's current recoveries (collections fromloans falling due in the current year), although better, are still 43% for principal and 67% forinterest, indicating poor quality of its loan portfolio. The deteriorating trend is further evidencedby the growth of overdues which has outpaced the growth of loan portfolio (NDDB's loanportfolio has recorded an annual growth rate of 133% compared to 180% for overdues between1990/91 and 1994/95). Federations/unions have huge overdue loan and working capital dues,amounting to Rsl,623 million (Rsl,059 million in loans and Rs564 million in working capital

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facilities), with Rajasthan accounting for 27% followed by Madhya Pradesh (26%), AndhraPradesh (19%), Haryana (7%), Punjab (4%) and others (17%). This clearly underlines thedeterioration in the quality of NDDB's portfolio and the critical importance to NDDB inachieving a marked improvement in loan recovery rates. NDDB has recognized these problemsand undertaken a selective rehabilitation program in Rajasthan, Mysore union, Jalgaon union andcurrently Dharwar union. A huge effort still remains to be made.

51. Industry Regulation. Development of fully sustainable operations in a consumerindustry requires the involvement of a regulatory body to assure product quality. Thus far,NDDB has performed this function. However, as the apex institution of the cooperative dairysystem, responsibility for quality assurance as well as other industry-related issues constitutes aconflict of interest for NDDB. Government needs to establish an industry body, of which NDDBwould be a member, to look after such matters. Operating costs of such a regulatory body wouldneed to be shared between the industry and' government.

52. An Assessment. These findings concerning the effects of NDDB's financialoperations do not appear encouraging for further promotion of the Board's financing activities.However, the main implication of this is to find ways of improving NDDB's operations--not todismantle it.

C. IMPLEMENTATION RECORD AND MAJOR FACTORS

AFFECTING THE PROJECT

53. Implementation Record. As in the case of its predecessor, OF III was successfullyimplemented overall, but it too experienced considerable implementation difficulties. The mostcommon of these was the delay in execution of the agreements between NDDB and the stategovernments, adoption of the OF principles and cooperative bye-laws, and later introduction ofappraisal methodology as specified in the Project Agreement, and delays in allocation of land,adequate water and power by the state governments in some cases. Another factor contributingto implementation delays has been the reorganization and merger of NDDB and IDC which tooklonger than expected. Despite these delays, the project has made significant achievements,although such achievements in some cases fell short of appraisal targets. The project alsodemonstrated that technological inputs alone cannot increase milk production if not supported bya year-round market for milk (as provided by the project) at a remunerative price through the"Anand Pattern" milk producers cooperatives. Appraisal targets were surpassed with respect tothe number of DCS organized, the number of farm families covered, milk chilling capacity, liquidmilk marketing capacity and metro and milkshed dairies. The reasons for the shortfalls in othershave been identified and for the most part are being corrected.

54. The main contributory factors for the implementation delays/shortfalls were:

- Factors not generally subject to Government control. These include employeeunrest, though short-lived, in a few unions.

- Factors generally subject to Government control. These included delays in landacquisition (Balaji dairy, Andhra Pradesh), lack of adequate power supply (Dharwar,

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Raichur, Bijapur dairy in Karnataka and Kamal dairy in Haryana), lack of adequatewater supply (Ongole dairy, Andhra Pradesh, Namakkal, Tamil Nadu) and lack ofboth adequate power and water supply (Kodakkal, Tamil Nadu), delayed or non-adoption of OF principles in (Andhra Pradesh, Haryana, Madhra Pradesh,Maharashtra, Tamil Nadu and Uttar Pradesh), heavy accumulated losses and poorfinancial position of SFs and MPUs (Andhra Pradesh, Haryana, Madhya Pradesh,Punjab, Rajasthan and Tamil Nadu), and lack of freedom in setting prices in manystates.

- Factors generally subject to implementing agency control. These includeddelays in appraisal of sub-projects, and delays in the implementation of institutionalstrengthening measures such as M&E.

55. Actual Project Cost. Table 8A of Part II gives a comparative statement ofappraisal estimates and final costs. The project, as envisaged at appraisal, was completed by theextended Credit closing date except for some ongoing sub-projects in a few states (e.g.Maharashtra). When allowance is made for costs to complete, the total final cost would amount toRsI2,553 million (or US$503 million), representing a 37% cost overrun in nominal rupee terms,which comprise changes in both quantity and price. Expressed in US dollars reflecting thedepreciation of the rupee against the US dollar (and US dollar depreciation against SDR), therewould be a cost underrun of 26%. The cost of processing facilities (which constituted 54% of thetotal cost as against 43% at appraisal) increased in nominal terms by 123%, followed by milkmarketing system (89%), productivity enhancement (85%), marketing, M&E, training and studies(44%), technical inputs (-49%), and animal breeding (-72%). It is worth noting that technicalinputs and animal breeding costs were influenced by the dovetailing with government services,improved efficiency (e.g. Al centers) and the increased emphasis on input cost recovery.

56. Proiect Financing. Both Credit and Loan disbursements have lagged well behindactual expenditures, before gaining momentum since 1994. The project financed about 66% oftotal actual expenditure compared to 53% of the project costs at appraisal, mainly due to anincrease in the disbursement percentage. The EU provided funding for about 19% of the totalactual expenditures and the remaining 15% was met by NDDB.

D. PROJECT SUSTAINABILITY

57. The sustainability of the cooperatives, which is in the interests of all participants,requires that they develop rationally, be staffed properly and maintain a sound financial structureto ensure solvency and liquidity for commercial survival. Rational development generatingadequate farmer incomes and better milch animal productivity is therefore a key requirement.This means that the three-level units, or two-tiers as appropriate, should only be established whereadequate financial strength is present and/or the investment cash flow is supported by the assistedentities and with an adequate return; and where institutional and management aspects are such asto allow a self-reliant (e.g., Gujarat OF cooperatives) or evolution towards a self-reliant entity(e.g., Karnataka), whether it is DCS, MPU or federation. It is also essential that the followingconditions are fulfilled: the entities are owned and directed by farmers under some form ofparticipatory decision-making; autonomy in pricing, investment and marketing decisions;

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efficiency in production and processing, assuring better incomes to farmers and the lowestpossible price to consumers, and generating productivity increase of yield per animal per farm.These conditions, by and large, prevail in Gujarat, but are present in widely varying degrees inother states. Given these circumstances, the major challenge for the sustainability of thecooperative dairy development is to further move the dairy cooperative structure in other statestowards adoption of OF principles as practiced in Gujarat. This will ensure provision of anattractive price to retain and expand pouring members. This in turn depends on the ability of theunions and federations to pass on the increased costs in the form of reasonably higher prices toconsumers. With the exception of Gujarat, all the other states exercise some control on liquidrmilk prices in the metro cities like Bangalore, Calcutta, Hyderabad, Madras and New Delhi. Asthe prices in these cities are not likely to be increased in the immediate future, the optionsavailable to the unions and federations are to introduce cost-reduction measures and expand intohigh-value product markets. These steps must be complemented by measures for enhancinganimal productivity, training and technical assistance for cooperatives, improvements in financialmanagement, auditing and cost accounting, better market promotion and field monitoring andevaluation. Continuing emphasis is also required on commercial and financial viability ofcooperatives. NDDB is aware of these shortcomings and has initiated programs to address theseissues.

E. BANK PERFORMANCE

Identification and Preparation

58. General. The conceptual foundation for the project (increasing milk supply tosatisfy the urban demand and improving yield per animal) was based on previous experience underthe three state-level projects and one national level project, in line with GOI's developmentpriorities for the livestock subsector. Owing to the rapid expansion of infrastructure during NDP-I and the need to improve profitability of the federations and unions, the emphasis on OperationFlood III was, rightly, placed more on consolidation than on expansion. The Bank's performancein project identification and preparation was satisfactory.

Appraisal

59. General. The performance of the Bank during the appraisal process wassatisfactory overall, though several shortcomings are noted below. Overall, the project appraisalidentified project goals and established concise project objectives consistent with sectoralstrategy. Two preappraisal and one appraisal mission with the participation of four, one andseven professional specialists, respectively (including two from the EEC at appraisal), carried outa thorough review of the project concept and components. The missions were fairly wellbalanced and represented in relevant disciplines -- economics, dairy specialization, agro-industriesand marketing, livestock processing and financial analysis.

60. Design. The appraisal mission supported the AMU