Report and Recommendation of the President to the Board … · Report and Recommendation of the President to the Board of ... H. Details of Models for New Ventures in Khadi ... for

Report and Recommendation of the President to the Board of Directors

Sri Lanka Project Number: 42151 September 2008

Proposed Program Loan and Technical Assistance Grant India: Khadi Reform and Development Program

CURRENCY EQUIVALENTS (as of 9 September 2008)

Currency Unit – Indian rupees (Re/Rs)

Re1.00 = $0.022 $1.00 = Rs44.74

ABBREVIATIONS

ADB – Asian Development Bank CSP – central sliver plant FY – fiscal year FYP – five year plan GDP – gross domestic product KVI – khadi and village industries KVIB – khadi and village industries board KVIC – Khadi and Village Industries Commission MIS – management information system MOU – memorandum of understanding MMSME – Ministry of Micro, Small and Medium Enterprises NGO – nongovernment organization PPP – public-private partnership RID – reform implementation division RMU – reform management unit RNFS – rural nonfarm sector TA – technical assistance

NOTES

(i) The fiscal year (FY) of the Government ends on 31 March. FY before a calendar year denotes the year in which the FY begins. e.g., FY2007 ends on 31 March 2008.

(ii) In this report, "$" refers to US dollars. Vice-President B. N. Lohani, Vice-President-in-Charge, Operations 1 Director General K. Senga, South Asia Department (SARD) Director A. Sharma, Governance, Finance and Trade Division, SARD Team leader J. Tsunoda, Senior Finance Specialist, SARD Team members R. Ahmad, Governance Specialist, SARD J. Fernandez, Administrative Assistant, SARD M. Ozaki, Finance Specialist (Rural and Microfinance), SARD S. Shah, Financial Sector Specialist, SARD S. Viswanathan, Senior Social Economics Officer, SARD S. Zaidansyah, Counsel, Office of the General Counsel

CONTENTS

Page LOAN AND PROGRAM SUMMARY i I. THE PROPOSAL 1 II. THE MACROECONOMIC CONTEXT 1 III. THE SECTOR 1

A. Sector Description and Performance 1 B. Issues and Opportunities 7

IV. THE PROPOSED PROGRAM 11 A. Impact and Outcome 11 B. Policy Framework and Actions 12 C. Important Features 16 D. Financing Plan 16 E. Implementation Arrangements 17

V. TECHNICAL ASSISTANCE 20 VI. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS 21

A. Benefits and Impact 21 B. Assumptions and Risks 23

VII. ASSURANCES AND CONDITIONS 24 A. Specific Assurances 24 B. Conditions for Loan Effectiveness 26

VIII. RECOMMENDATION 26 APPENDIXES 1. Design and Monitoring Framework 27 2. Rural Nonfarm Sector and Khadi and Village Industries Analysis 33 3. Problem Tree Analysis 40 4. Development Coordination Matrix 41 5. Development Policy Letter 42 6. Policy Matrix 48 7. Program Management Chart 55 8. Program Implementation Schedule 56 9. List of Ineligible Items 58 10. Governance and Anticorruption Risk Assessment 59 11. Summary Poverty Reduction and Social Strategy 63 12. Gender Action Plan 67

SUPPLEMENTARY APPENDIXES (available on request) A. Criteria for Selecting Khadi Institutions B. List of Khadi Institutions Eligible for Program Support C. Draft Memorandum of Understanding Between Khadi and Village Industries Commission

and Khadi Institutions D. Procedures and Enforceability of Intellectual Property Rights E. Draft Business Plan of the Marketing Organization F. Quality Norms for Raw Material Procurement

G. Guidelines for Utilization of Fund for Public-Private Partnerships H. Details of Models for New Ventures in Khadi I. Restructuring and Devolution Plan – Khadi and Village Industries Commission J. Scope of Comprehensive Reforms at Khadi Institution Level K. Financial Management Assessment L. Capacity Building for Reforming the Khadi and Village Industry Subsector M. Cost Estimates for Counterpart Funds N. Gender Assessment and Gender Action Plan O. Poverty Impact Assessment of the Policy Reform P. Chronology of Program Development and Processing

LOAN AND PROJECT SUMMARY Borrower India Classification Targeting classification: General intervention

Sector: Industry and trade Subsector: Small and medium-scale enterprises Themes: Sustainable economic growth, gender and development, inclusive social development Subthemes: Developing rural area, gender equity in opportunities

Environment Assessment

Category C. An environmental assessment of the policy matrix was undertaken and no potential environmental impacts are expected.

Rationale Rapid economic growth in India has led to a marked decrease in

poverty incidence from 36% in fiscal year (FY) 1994 to 27.5% in FY2005. Nevertheless, in absolute numbers, India still has 302 million poor; 73% or nearly 220 million of the poor live in rural areas. The growing rural–urban divide is reflected in sharp disparity in per capita income. In addition, gender inequalities in terms of nutrition, health, education, work burden, and powerlessness persist. While over 70% of the Indian population resides in rural India and 56% draw their sustenance from agriculture, agricultural productivity has been decelerating. As a result, the agriculture sector is unable to absorb the large rural work force even at subsistence levels. With an overarching focus on inclusive growth, the 11th Five Year Plan (FY2007–FY2011) seeks to increase employment by 58 million, mostly in the rural nonfarm sector (RNFS). Growth of real per capita nonagricultural output through the promotion of the RNFS can have a significant impact on reducing rural poverty. The RNFS has immense potential to generate new jobs with relatively low direct investments, by utilizing local skills and resources or by meeting local demands by adopting simple technology. About 90 million people representing about 18% of the total workforce are estimated to be engaged in the RNFS.

Khadi and village industries (KVI), originally promoted by Mahatma Gandhi in 1920s for rural self employment, are integral to the RNFS and identified by the 11th Five Year Plan as one of the subsectors with significant prospects for employment. Currently, KVI subsector accounts for nearly 9 million of total RNFS employment. Khadi, a handspun and handwoven cloth, is the single largest component of KVI subsector. The production of khadi is organized by nongovernment organizations known as khadi institutions through artisans (spinners and weavers). Khadi is marketed by the outlets of khadi institutions through out the country. At the apex, the Khadi and Village Industries Commission (KVIC) provides policy, technical, and marketing support. The Government extends financial support through subsidies to promote khadi.

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Notwithstanding the recognition of khadi in India and the large and diverse potential market that the country provides, khadi sales has nearly stagnated even when the textile market is making remarkable progress. Production and marketing inefficiencies left unattended for decades have isolated khadi from changing consumer preferences. The constraints include (i) ageing equipment and inconsistent product quality; (ii) khadi institutions are fragmented and dispersed; and lack professional expertise, financial means, and unified vision to adjust to changing market trends; (iii) marketing and sales are primarily through 7,050 undifferentiated and dilapidated outlets of khadi institutions that are isolated from current marketing trends in terms of products design and service quality; and (iv) incentive structures through subsidies for production and marketing have impeded reforms meant to anchor khadi to changing consumer preferences.

Impact and Outcome The impact of the proposed Khadi Reform and Development

Program (the Program) is enhancement of income and employment growth for the RNFS. The Program outcome is revitalization of the KVI subsector with enhanced sustainability of khadi, increased employment generation and incomes, increased artisan welfare, and development of select traditional village industries. The reform of production and marketing of khadi will lead to sustainable employment opportunities at low per capita investment. In addition to reduction in income poverty, the Program will also reduce nonincome poverty. Khadi is a geographically widespread economic activity encompassing all states and regions in the country. Given the high involvement of women, and marginalized groups in the KVI subsector, its development will promote inclusive growth. Reforms of khadi will help facilitate KVI subsector wide reforms.

Policy Framework and Program Components

The Program comprises following measures for ensuring sustainability of khadi (i) establishing a policy reform and implementation framework

including a comprehensive reform package for the development of khadi;

(ii) promoting and marketing khadi by establishing a “khadi mark”, and a marketing organization majority owned by the private sector;

(iii) realizing procurement and production efficiencies by facilitating raw material production and procurement, introducing market-linked pricing, rationalizing financial assistance for khadi, and encouraging khadi entrepreneurs and empowering artisans; and

(iv) implementing institutional reforms, including restructuring KVIC to enhance its development role, revitalizing khadi institutions, building capacity, and developing synergies with village industries.

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The views expressed herein are those of the consultant and do not necessarily represent those of ADB’s members, Board of Directors, Management, or staff, and may be preliminary in nature.

Financing Plan A loan of $150,000,000 from the ordinary capital resources of the Asian Development Bank (ADB) will be provided under ADB’s London interbank offered rate-based lending facility. The loan will have a 15-year term including a grace period of 3 years, and an interest rate to be determined in accordance with ADB’s London interbank offered rate-based lending facility, a commitment charge of 0.15% per annum, and such other terms and conditions set forth in the draft loan agreement.

Program Period and Tranching

The loan will be released in four tranches to be implemented over 3 years. The first tranche of $20 million will be released upon compliance with the first tranche release conditions, expected to occur at loan effectiveness. The second tranche of $40 million is expected to be released within 8 months of the first tranche, the third tranche of $40 million within 13 months of the second tranche, and the fourth tranche of $50 million within 15 months of the third tranche. Each release will be subject to compliance with the respective tranche release conditions.

Implementation Arrangements

The Ministry of Micro, Small and Medium Enterprises will be the Executing Agency, and KVIC the Implementing Agency. A reform implementation division will be set up at KVIC. The state and divisional offices of KVIC will establish reform management units to support institutional reform. The reform implementation division will be responsible for coordinating actions under the Program and monitoring the overall progress. A reform implementation and monitoring committee at the Ministry of Micro, Small and Medium Enterprises will serve as the program steering committee.

Technical Assistance A technical assistance (TA) grant from the Japan Special Fund,

funded by the Government of Japan in the amount of $2,000,000 is attached to the Program. The goal of the TA titled Capacity Building for Reforming Khadi and Village Industry Subsector is to support implementation of the khadi reform package and its objective is to expedite commencement of the reforms. The purpose of the TA is to strengthen implementation and monitoring of the khadi reform package to revitalize khadi as a source of robust nonfarm livelihoods for many rural poor.

Program Benefits and Beneficiaries

The Program addresses politically sensitive and long-standing issues and socially significant measures to enhance employment for the poor and marginalized. Comprehensive reforms seek to increase the involvement of private entrepreneurs by enabling the use of khadi mark, phasing out subsidies, and ensuring professionalism in marketing. Removing restrictions on product pricing will improve links between production and marketing.

The reform of khadi institutions, the primary producers, will enhance quality, design, and artisan income. Nearly half of the program resources are directed to supporting khadi institutions. The institutional reforms at KVIC will strengthen its development role. Minimizing raw material production and marketing activities

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of KVIC will allow greater private sector participation in the production and marketing of khadi.

At the macro level, the Program supports poverty reduction by enhancing employment and incomes, and thus contributing to stability and peace in rural areas. KVI subsector provides employment opportunities to the rural poor including in remote and hilly areas. The poverty impact will be widespread and cover the country’s poorest states, and those with low human development and social indicators, as khadi production and marketing encompass the entire country. The Program will have positive impacts in terms of reducing nonincome poverty. Increases in household incomes will lead to a change in expenditure patterns in favor of nonmaterial consumption, such as education and health. The impact of khadi on rural development, and in reducing rural–urban migration is also significant. Development of khadi will therefore promote inclusive growth, involving women, and socially and geographically marginalized groups. The Program will not have any adverse impact on indigenous peoples. Anchored in an overall strategy of inclusive growth, the Program will enhance artisans’ employment and earnings through production, marketing, and governance reforms for khadi institutions. Governance reforms ensure artisan representation on boards of directors of khadi institutions to empower artisans by involving them in decisions relating to wages and distribution of surplus. The licensing conditions for the use of a khadi mark and the removal of restrictions on pricing of products will help provide higher wages for artisans. Production of khadi by new entrepreneurs encouraged by conducive policies established under the Program will generate further employment.

Risks and Assumptions While overall commitment to the reforms is strong, the extensive

reform hierarchy involving stakeholders all the way down to grassroots level could slow the pace of reform. This risk is dealt with, in part, by front loading the conditions relating to the policy reform and implementation framework, as well as up-front legal assurances. In addition, program support is based on defined criteria. Continuity of support will require achievement of specified key results.

The implementation risk due to inadequate skills is being minimized through adequate technical support for capacity building.

Staff at KVIC and khadi institutions, and artisans could resist institutional and governance reforms, thereby undermining expected performance improvements. Factors that mitigate these risks include (i) up-front commitment to the khadi reform package; (ii) redefinition of role and vision of KVIC and khadi institutions; and (iii) significant investments in human resource development.

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The private sector’s confidence to invest and associate with khadi depends on whether the Government and KVIC can produce successful outcomes as a result of the reforms. Any redirection of the reform policies might cause the private sector to lose confidence. The measures under the Program to improve investor confidence include (i) up-front policy decision to commit to the reform agenda, and (ii) rigorous monitoring of implementation to meet performance benchmarks.

While the Program has benefited from successful practices, the possibility that final products may, at least initially, not find a positive market response cannot be ruled out. In this event, the reasons will have to be analyzed and appropriately addressed. The Government also anticipates that adjusting to new business processes and market expectations could take time. As a result, the Program is designed as a pilot and all actions are phased. In addition, support to each selected khadi institution will be spread over time to enable engagement throughout the adjustment process.

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on (i) a proposed loan to India for the Khadi Reform and Development Program (the Program), and (ii) proposed advisory technical assistance (TA) for Capacity Building for Reforming the Khadi and Village Industry Subsector. The design and monitoring framework is in Appendix 1.

II. THE MACROECONOMIC CONTEXT

2. The Indian economy grew by an annual average of 7.8% during fiscal year (FY) 2002–2007; 9.6% in FY2006 and 9% in FY2007. Accompanying the high growth rates, poverty incidence decreased markedly from 36% in FY1994 to 27.5% in FY2005.1 Nevertheless, in absolute numbers, India still has nearly 302 million poor people. Regional disparities in poverty and social indicators persist. The rural–urban divide is reflected in several development indicators including per capita income; and access to education, health care, drinking water, and sanitation. Nearly 73% or 220 million of India’s poor live in rural areas. 3. Growth has not necessarily led to positive gender outcomes. Maternal deaths accounted for 15% of deaths of women of reproductive age, and literacy among women was 54.2% versus 75.9% for males.2 Labor force participation rates for women were 22.7%, compared with 51.6% for men. Gender inequalities in terms of nutrition, health, education, and work burden persist. India’s performance on the Millennium Development Goals3 indicates that the country is lagging in gender parity in education, infant mortality, and maternal mortality rates. 4. The Government therefore has made inclusive growth a policy priority. The 11th Five Year Plan 4 for FY2007–FY2011 (11th FYP) aims to bridge the various divides—including economic, social, geographic, and human resources—by providing opportunities for increasing incomes and employment, and including specific programs to cover the marginalized and vulnerable to ensure that growth is more broad based and inclusive. With its overarching focus on inclusive growth, the 11th FYP seeks to increase employment by 58 million.

III. THE SECTOR

A. Sector Description and Performance

1. The Rural Nonfarm Sector

5. Agriculture and allied activities contributed only 18% to the overall gross domestic product of India in FY2007, even though more than 70% of the Indian population resides in rural areas and 56% draw their sustenance from agriculture. During FY1977–FY1999, growth in agriculture employment averaged just 1%. 5 The low productivity of agriculture stems from several factors, including (i) slow progress with land reform, (ii) inadequate rural finance and marketing services for farm produce, (iii) small landholdings that are subject to fragmentation,6 1 Press Information Bureau. Planning Commission. Government of India. 2007. 2 Government of India. 2001. Census of India. New Delhi. 3 Central Statistical Organization, Government of India. New Delhi. 2005. Millennium Development Goals: India

Country Report. 4 Planning Commission. Government of India. 2007. 11th Five Year Plan (2007–2012). New Delhi. 5 World Bank and Government of the United Kingdom’s Department for International Development. 2003. The Rural

Non Farm Economy in India: Some Policy Issues. United Kingdom. 6 Of the nearly 120 million farm holdings, roughly 60% are less than 1 hectare; another 20% are only 1–2 hectares.

About one-third of operating farms constitute tenant farmers, most of whom are poor.

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(iv) slow adoption of modern agricultural practices and technologies, and (v) inadequate irrigation infrastructure resulting in high dependence on rain-fed agriculture. 6. The rural nonfarm sector (RNFS) 7 is critical for providing alternative livelihoods by diversifying income sources of the rural population when the agriculture sector cannot absorb the rural work force in any significant number. Growth of real per capita nonagricultural output through promotion of the RNFS can have a significant impact on reducing rural poverty. The RNFS has immense potential to generate new jobs with relatively low direct investments by utilizing local skills and resources or by meeting local demands by adopting simple technology. 7. The RNFS engages an estimated 90 million people, 18% of the total workforce and 20%–25% of the rural workforce. Employment generation in the RNFS during FY2000–FY2005 was nearly double the overall employment growth. The sector contributes from 25% to 35% of the total income of rural households. Within the RNFS, traditional subsectors8 account for nearly 80% of employment. Nevertheless, the traditional subsectors are in relative decline especially in terms of value of outputs. Nontraditional subsectors that are capital intensive and utilize advanced technologies are growing and contributing significantly to the export market. This broadly reflects a structural change away from agriculture toward the RNFS. 8. RNFS growth is, in large part, a result of private enterprise to ensure livelihood security. The key agencies engaged in implementing RNFS programs are described in Appendix 2, Figure A2. While central and state governments have extensively promoted the sector, the potential of the RNFS continues to be affected by (i) inadequate coordination and follow-up mechanisms over the multiplicity of schemes and agencies; (ii) lack of appropriate policies for developing RNFS capacity to adjust and modernize in response to conditions brought about by globalization, increasing competition, and changing consumer preferences; and (iii) inadequate social and physical infrastructure to ensure conditions for broad-based growth and good investment opportunities. In addition, growth and surpluses in the agriculture sector have not been sufficient to stimulate RNFS production and consumption linkages.

2. Khadi and Village Industries Subsector

9. Khadi and village industries (KVI), originally promoted by Mahatma Gandhi in 1920s for rural self employment, form a significant subsector of the RNFS (Appendix 2). The 11th FYP identifies the KVI subsector as having significant prospects for employment, primarily because it provides employment to women, minorities, and the socioeconomically marginalized.

(i) Khadi is handspun and handwoven cloth. The raw materials (cotton, silk, or wool) are spun and woven on hand-spinning wheels called charkha and woven on handlooms.

(ii) A village industry is based on know-how and skills of artisans and rural raw

materials and/or markets—pottery, black smithing, handmade leather goods, carpentry, various processed foods and condiments, cane and bamboo craft, goods made from various plant fibers, among others.

7 The RNFS encompasses all nonagricultural activities: mining and quarrying, household and nonhousehold

manufacturing, processing, repair, construction, trade and commerce, transport, and other services in villages and rural towns undertaken by enterprises varying in size from household enterprises to factories.

8 The traditional sectors are essentially labor intensive; employ the poor and marginalized, especially women; and employ handcraft skills with simple technology.

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10. An extensive institutional network promotes the KVI subsector (Table 1). The Khadi and Village Industries Commission (KVIC), under administrative control of the Ministry of Micro, Small and Medium Enterprises (MMSME), is the national governing body. The state khadi and village industries boards (KVIB) also support the KVI subsector. Financial institutions provide credit for the subsector. In addition, multiple government and quasi government agencies also implement projects that support the KVI subsector. 9 11. As the apex agency, KVIC’s initiatives for the KVI subsector10 can broadly be classified as:

(i) khadi programs, including raw material procurement, marketing, cost chart,

financial assistance in the form of rebates, and interest rate subsidies; (ii) village industries programs, including the Rural Industry Service Center, which

supports upgrading of production capacity, market promotion, and skills development; and the Rural Employment Generation Programme, 11 which provides margin money subsidy for setting up an enterprise in rural areas with a population less than 20,000; and

(iii) programs for both khadi and village industries, including the Scheme of Funding for Regeneration of Traditional Industries, which supports integrated development of traditional khadi, coir, and village industries, including leather and pottery; research and development; training; and the Product Development Design Intervention and Packaging Scheme, which is to improve quality and develop new product lines.

12. KVIC and the KVIBs implement these programs through the khadi institutions, registered with KVIC or the KVIBs as well as through independent entrepreneurs. Khadi institutions are mostly nongovernment organizations (NGO) formed either under the Societies Registration Act (1860), Charitable Trusts registered under Indian Trust Act, 1882, Section 25 of the Companies Act, 1956 or State Cooperative Societies Acts. The Government provided Rs6.61 billion to KVIC for administrative expenses and promotion of the KVI subsector in FY2006. KVIC provides funds for the KVIBs to implement various KVIC programs (para. 11). The KVIBs’ administrative expenses are met by the state governments. 13. The KVI production and sales grew by 13.3% and 15.0%, respectively during FY2006. Overall sales of KVI goods stood at Rs176 billion and production at Rs140 billion in FY2006. Village industries are responsible for nearly 90% of the sales and production. Currently, the KVI subsector accounts for nearly 9 million of total RNFS employment.

9 These include district rural development agencies, district industries centers, Council for Advancement of People’s

Action and Rural Technology, Handicraft Development Corporation, Minor Forest Products Corporation, Women’s Development Corporation, National Bank for Agriculture and Rural Development, and Small Industries Development Bank of India.

10 This document only refers to the programs of the KVIC implemented by KVIC and the KVIBs for which Government support is available. Programs of other government agencies (footnote 9) are discussed only in relation to the support that they extend to the overall development of the KVI subsector. The term “KVI” has been used interchangeably with KVI subsector to indicate khadi and village industries as a group.

11 Margin money subsidy from the Government is 25% up to Rs1 million for the project cost and an additional 10% for the balance of the cost up to Rs2.5 million. The balance of the project cost is financed by bank loans.

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Table 1: Organization of KVIC Program for KVI Subsector Stakehoders Location/numbers Key Roles and Responsibilities 1. MMSME • Central • Provide policy direction and resources to promote the KVI

subsector 2. KVIC (KVIC Act of 1956)

• Head office, and six zonal and 36 state/divisional offices

• Develop polices and programs • Develop and implement KVI subsector schemes • Facilitate financial support for KVI • Marketing support for KVI (11 direct sales outlets) products • Produce raw materials for khadi (six production plants) • Affiliate with and support khadi institutions

3. KVIBs (KVIB state acts)

• State (33)

• Implement KVIC-sponsored programs • Develop and implement state schemes for KVI subsector • Affiliate and support khadi institutions

4. Khadi institutions

Affiliated to KVIC or KVIBs • 5,549 of which

1,952 for khadi • khadi institutions

operate 7,050 retail sales outlets

• Produce KVI products by subcontracting to artisans, spinners, and weavers

• Market KVI products • Some khadi institutions are exclusively engaged in the

production and marketing of khadi while others are broad- based KVI producers and marketers

5. Village enterprises

• 262,000

• Promoted by KVIC under the Rural Employment Generation Programme; do not include khadi

6. Village enterprise workers

• 9 million

• Mostly poor who produce for khadi institutions or village enterprises either as wage earners or subcontractors and/or suppliers

7. Khadi artisans and khadi institution workers

• 1 million approximately

• Contracted by khadi institutions for various stages of khadi production process (Table 2). Among artisans, spinners are primarily poor rural women; weavers mostly men

8. Financial institutions

• Banks, MFIs, cooperatives

• Credit to enterprises and artisans

KVI = khadi and village industries; KVIB = khadi and village industries board; KVIC = Khadi and Village Industries Commission; MFI = microfinance institution; MMSME = Ministry of Micro, Small and Medium Enterprises. Note: Data refer to KVIC-implemented or sponsored schemes only. Source: Asian Development Bank.

3. Khadi

14. Khadi is the single largest product of the KVI subsector. Within the KVI subsector, khadi is considered to have the most potential for inclusive development due to its marked emphasis on gender, minorities, and other socioeconomically marginalized people, as well as community-based processes. At the bottom of the pyramid of the khadi process are the spinners, weavers, and other artisans, such as skilled embroiders, (collectively referred to as artisans) employed or engaged by khadi institutions. KVIC has 1,252 affiliated khadi institutions and KVIB 700. Khadi institutions are engaged in production—hand spinning of cotton sliver, silk, and/of wool; hand reeling silk into yarn; handloom weaving yarn into fabric; processing for finishing; and garment making—and retailing of khadi products. A few khadi institutions are integrated into the production of raw materials (sliver or threads) from cotton. Of the 1,952 khadi institutions, only 64 are exclusively trading institutions; all others are engaged in producing and retailing khadi. The khadi production process for cotton is described in Table 2. The processes for wool and silk are similar. Khadi is also woven with polyester and marketed as polyvastra.

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Table 2: Khadi Production Process Production Producers Process Market / Marketing Cotton bales

Farm households

Farm produce Sliver (or cotton threads on spindles) plants

Sliver Sliver plants: KVIC (6), sliver plants of khadi institutions and other enterprises

Cotton bale is used to produce cotton tapes, which is then used to produce sliver, a loose soft untwisted strand of textile fiber produced by a carding or combing machine

Khadi institutions

Yarn Spinners, mostly poor women

The sliver is traded by khadi institutions to spinners who convert the sliver into yarn on hand-powered spinning equipment (charkas).

Khadi institutions buy back the yarn from the spinners on payment of conversion charges

Fabric Weavers, mostly poor men

The yarn is traded by khadi institutions to weavers who weave the fabric on handlooms and sell it back to the khadi institutions in return for conversion charges

Fabrics are sold as processed cloth, a more refined product than yarn, either directly to the end consumer through khadi institutions own retail outlets, traded with other khadi institutions, or through direct sales outlets of KVIC

Garments Khadi institutions

The fabrics are processed (e.g., dyed) and converted into garments using mechanized means for preset designs, developed as customized garments, or embellished with value additions, e.g., embroidered by skilled artisans

The garment is sold by the khadi institutions either directly to the end consumers through khadi institutions own retail outlets, traded with other khadi institutions, or sold directly through KVIC outlets

KVIC = Khadi and Village Industries Commission. Source: Asian Development Bank. 15. Khadi production and marketing is supported by KVIC through sales rebate and interest rate subsidy. Khadi institutions undertake annual production planning based on KVIC specified cost chart that includes cost elements and sales price for each khadi product.12 Thereafter, KVIC certifies the khadi institution as eligible for the following.

(i) A sales rebate of about 20% of the sale value of khadi (and polyvastra) products is provided for making khadi price competitive. The sales rebate goes to consumers and is claimed by khadi institutions from KVIC. The sales rebate is proposed to be replaced in 2009 by market development assistance.13

12 Cost chart spells out the costs and conversion ratios at each stage of processing of khadi and includes (i) cost of

raw materials and conversion charges (cotton to sliver); (ii) payments to spinners and weavers by khadi institutions i.e., conversion charges from sliver to yarn and yarn to fabric; (iii) payment to be made to finishers for processing charges; (iv) amount to be apportioned towards establishment cost of khadi institutions (including gross margins); (v) amount to be set aside for maintenance, depreciation, and cost of insurance, and (vi) amount earmarked for artisans’ welfare fund.

13 Khadi institutions would receive market development assistance of about 20% of cost of production, to be utilized for promoting sales, developing new designs, market promotion, renting, buying or modernizing sales outlets, training, and research and development.

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(ii) Interest Rate Subsidy. The requirement of working capital by a khadi institution is calculated on the basis of production cost. KVIC issues an interest subsidy eligibility certificate to khadi institutions to enable them to access bank financing at subsidized interest rates. KVIC pays the difference between the market-based interest rates charged by banks and the interest rate paid by the khadi institution.

16. KVI subsector data and especially for khadi are difficult to obtain because of the largely informal organization of production. Information available for KVIC khadi program suggests that khadi provides rural employment in hand spinning (cotton, wool, and silk), hand reeling of silk, handloom weaving, processing of fabric, and garment making. Semiskilled (principally spinners) and skilled (principally weavers) artisans constitute majority of the khadi production workforce under KVIC khadi program of nearly 1 million dispersed across the country.14 Of these, spinning provides employment to 79%, followed by weaving and fabric processing 12%, and others 9%. Almost 80% of spinners are women. Others or nonartisans, include employees of khadi institutions such as secretaries, sales and administrative personnel, and staff. The high participation of women is an affirmation that spinning is a subsidiary activity and sought by people less able to migrate in search of work or less able to work outdoors due to social customs. 17. Artisan earnings from conversion charges are less than satisfactory. The average annual income in FY2006 was Rs2,555 for cotton, Rs3,143 for wool, and Rs8,141 for silk. The income from cotton and wool are less than the official poverty line of Rs4,275 for rural areas. The income earned by each category of work is (i) spinners: Rs822 for cotton, Rs1,070 for wool, and Rs3,035 for silk; (ii) weavers: Rs7,380 for cotton, Rs7,665 for wool, Rs12,141 for silk; and (iii) others: Rs13,932 for cotton, Rs15,091 for wool, and Rs23,380 for silk. The earnings of spinners across the product categories are much lower than the earnings of weavers and others. Cotton spinners, in particular, earn only Rs822 a year on average, or less than Rs69 a month for khadi spinning. Interactions with spinners indicate that the daily incomes for cotton khadi hover around Rs30 to Rs40.15 Assuming a wage rate of Rs30/day, the full-time employment days of cotton spinners work out to 27.4 days, which is less than 1 month a year. 18. Precisely assessing the current market for khadi is difficult since machine-made textiles are also being sold as khadi. The widely dispersed informal production even for KVIC khadi program makes data collation difficult. Available data indicate that production of khadi under the KVIC khadi program, sold through 7,050 khadi institution outlets and 11 KVIC direct sales outlets, grew on an average by 2% in volume and 3% in value annually during FY2002–FY2006. In FY2006, khadi production grew by 4.9% and sales by 5.5% compared to the previous year. These figures do not include handspun and woven khadi sold by private enterprises for which data is not available. Nearly two thirds of the market is for cotton khadi.

14 The states with a significant number of khadi artisans are Andhra Pradesh, Gujarat, Haryana, Karnataka, Kerala,

Punjab, Rajasthan, Tamil Nadu, Uttar Pradesh, and West Bengal. 15 While local wages in rural areas vary widely across regions and during the year, the peak rate during the farming

season is around Rs30 even in the poorest regions. Although the minimum wage varies across states, the average minimum daily wage is around Rs70.

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B. Issues and Opportunities

1. Issues

19. Khadi is estimated to constitute less than 1% of India’s textile market. The growth in production and sales of khadi (para.18) is marginal compared to the increase in the production of textiles at a compound growth rate of 7% in volume and 15% in value during FY2002–FY2006. The textile industry has made tremendous strides with the adoption of modern technology, branding, and savvy marketing. In contrast, khadi has been unable to adapt to economic and technological advancements. As a result, the community-based production and marketing model of a product that is still revered, is neither able to gain market share nor substantially contribute to rural employment. A problem tree analysis is in Appendix 3. 20. Weak Links in the Value Chain. Khadi production and marketing under the KVIC khadi program are constrained by the following:

(i) Raw Materials. The absence of proper quality control protocol and equipment

leads to variable raw material quality that affects the quality of the final product. (ii) Equipment. With aging equipment and raw material quality constraints, khadi

production cannot be expanded even if demand grows rapidly. (iii) Marketing. Khadi is primarily sold through 7,050 dilapidated retail outlets of

khadi institutions that are isolated from current marketing trends. (iv) Institutions. Khadi institutions are fragmented and dispersed, lack the expertise,

financial means, and unified vision to adjust to changing market trends.

21. Distorted Protective Financial Support. Sustaining khadi though sales rebates and interest rate subsidy has had little, if any, positive impact on the production and marketing of khadi and the employment generation through khadi. Subsidies intended as incentives for promoting khadi have had the unintended negative effect of impeding innovations and sustaining dependencies that are resistant to change.

(i) Sales rebate. The sales rebate applied uniformly on khadi products impede market segmentation. Rebate continues on product categories (silks, merino woolens, muslin) that hardly need support. The sales rebate leads to lumping of sales during the rebate period, which makes it difficult to assess the true market potential of khadi products. The proposed market development assistance (para.15 (i)) also does not facilitate market segmentation.

(ii) Interest rate subsidy. Banks typically fund only 40%–50% of working capital requirement of khadi institutions as per the interest rate eligibility certificate (para. 15(ii)). While marketing and production related reforms could shorten the working capital cycle, working capital requirements of khadi institutions will remain significant. Interest rate eligibility certificate established in mid-1980s needs updation for ensuring timely and adequate access to working capital. Without these, khadi will remain dependent on rebates and subsidies, which in turn will result in a continued relative decline in market share.

22. Ineffective Marketing. Mapping out the production process and product cost through the cost chart breaks the link between production, market, and price points. Inflexible pricing based on the cost chart provides no incentives for new designs and effective marketing. Further, the existing marketing setup of khadi with limited marketing and product development know-how

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cannot target khadi firmly at market segments that are willing to pay for quality products. As a result, khadi has yet to be systematically promoted as a brand that connotes social, cultural, and environmental values. Without an effective marketing and product strategy anchored to market and improved khadi sales outlets, khadi is unlikely to compete in the textile market. The paradigm shift from supply-side focus based on cost chart to demand-side focus needs to be managed by experienced marketing professionals. 23. Inconsistent Raw Material Quality. Raw material procurement is critical from the perspective of working capital requirements and quality of final product. Most khadi institutions procure cotton primarily for direct consumption at sliver plants operated by khadi institutions. These sliver plants use age-old and depreciated machineries and also lack required quality testing capabilities. On the other hand, the sliver produced by central sliver plants of KVIC account for only 30%16 of the total sliver production and cost nearly 10% more compared to the sliver produced by the sliver plants of khadi institutions. Addressing the inadequacies in the quality and price of raw materials is critical for enhancing the value of khadi products. 24. Limited Artisan Earnings and Empowerment. Inefficiencies in the value chain affect the potential for supplementary income for the rural population. The majority of khadi workers are employed by khadi institutions on a part-time basis and engaged in production only several days a year. KVIC determines the income of artisans through conversion charges for different stages of the production process (Tables 1 and 2). While the conversion charges are product and skill specific, increasing creativity and enterprise by spinners, weavers, and artisans cannot lead to higher income in view of the final price of the products and the applicable rebates being prefixed by the cost chart. At the same time, inadequate access to working capital and variable quality of raw materials limit production outputs, which constrain incomes that could have been possible through higher production. As a result, the earning of spinners is especially low; the average spinner earned Rs822 per annum in FY2006. Spinners, 80% of whom are women, are among the poorest paid and most have not been able to cross the poverty threshold.17 In addition, artisan representation in the governing board of khadi institutions is largely nominal. As a result, improving the status of artisans is not necessarily a priority for khadi institutions. 25. Inadequate Incentives for Entrepreneurs. Entrepreneurial participation under the KVIC khadi program is restrained by the impositions on legal structure, commercial flexibility, and decision-making freedom. Other than the production and marketing of khadi through khadi institutions, entrepreneurs willing to produce and market khadi are not supported under the KVIC khadi program or the village industries program, in particular under the Rural Employment Generation Programme. This limits the potential growth of the production base, and impedes the flow of technology and entrepreneurship. 26. Insufficient Synergy with Traditional Village Industries. A multiplicity of government agencies, besides KVIC implement programs for the KVI subsector. The administrative effort in coordinating these interventions often overlook the synergy between village industries and khadi. Among all government agencies, KVIC is in a unique position to provide leadership in pooling of skills and resources for production and marketing of khadi as well as village industries starting from the household level, to khadi institutions, and up to the point of sale. Such synergy could be explored through identification of traditional village industries that are in line with the

16 The balance is being produced by sliver plants of khadi institutions or procured from mills in the private sector. 17 More than two-thirds of workers are from families below the poverty line. Nearly 60% of workers are either illiterate

or have only primary education; 34% are illiterate.

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handmade characteristic of khadi, and developed through a cluster approach especially in areas where both khadi and traditional village industries are not widespread. 27. Weak Khadi Institutions. Barring exceptions, the capabilities of khadi institutions across the entire production and marketing chain need substantial improvements. Most khadi institutions have inadequate and old infrastructure (charkhas, looms, processing unit, garmenting unit, and accounting systems) and dilapidated retail outlets that will impede any reform measure from being effective. This is true even for khadi institutions categorized as A+, A, or B by KVIC. Currently, KVIC has no specific policy for C and D category khadi institutions. Nearly 270 khadi institutions categorized as D continue to receive financial support from KVIC without any effective measures initiated to resolve their difficulties or facilitate their attrition. 28. Organizational Weaknesses of KVIC. In its initial years, KVIC pursued a developmental agenda with emphasis on training and research. Over the years, KVIC undertook or was assigned responsibilities that called for its direct participation in production, marketing, and financing. Eventually, KVIC has gradually acquired the character and image of an entity for dispensing government funds as grants and loans. The norms and values developed over decades of implementing government programs have led to skills sets that are insufficient for positioning khadi as a commercially viable product in the highly competitive textile market. The production of raw materials for khadi and direct sales of khadi are not among the core competencies of KVIC. In addition, the roles and responsibilities of available human resources are insufficiently detailed leading to overlaps and uncoordinated measures. While KVI production is decentralized, the roles of KVIC zonal and state offices remain limited. The current management information system is unable to comprehend and link information on products and institutions that produce these products. Similarly, the database system remains inadequate for both management and business development purposes.

2. Opportunities 29. Given its size and diversity, India has significant opportunities for khadi if it is efficiently produced and marketed. Simultaneously, repositioning of khadi is needed to link the consumer perception of khadi with its environment friendly, socially conscious, and fair wage characteristics. These could help realize the following opportunities.

(i) Economic. Khadi’s employment intensive production process has implications for the livelihoods of millions of workers in rural India. Against this background, a new niche needs to be found for khadi in context of ever-expanding choices for consumers in the rapidly expanding and competitive textile market.

(ii) Development. KVIC and some enterprising khadi institutions have taken, albeit sporadic, measures to improve marketing and production of khadi in Gujarat and Rajasthan, resulting in increasing year-round sales and exports. Similarly, outside the KVIC khadi program, the boutique chain Fabindia has grown to 90 outlets. These indicate the potential for khadi in the middle and upper-income consumer segments.

(iii) Environment. The values underpinning khadi have gained impetus in the context of the global environmental movement and the emphasis on green and sustainable livelihoods. Khadi uses organic dyes and has environment friendly production methods. Buyers are willing to pay a premium for authentic handspun, and handwoven fabric as a fashion product, out of allegiance to the green movement (eco-friendly) and fair wages.

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(iv) Social. Khadi as an economic activity is geographically widespread, and encompasses all states and regions in the country. It offers an opportunity to contribute to inclusive growth as it covers some of the country’s poorest states, and those with low human development. Khadi provides employment to the socially marginalized, women, and the older population.

(v) Gender. Since a large part of the khadi workforce, especially spinners, are low-paid women, reforming the production and marketing of khadi can help enhance their incomes, reduce wage disparities, and enhance empowerment. This is in addition to providing opportunities for skills development, and giving them a voice in decisions relating to the production and distribution of khadi.

30. Government Strategy. Rapid growth that reduces poverty and creates productive employment opportunities is a major component of the Government’s policy for inclusive growth during the 11th FYP. The RNFS is recognized as a major inclusive employment-generating sector. As a result, the Government has initiated public policy measures to ensure that the rural poor are able to participate in the country’s economic growth. 18 Reform of the RNFS, in particular the KVI subsector, has thus emerged as a strategic government priority. Accordingly, the Government, after intensive deliberations and stakeholder consultations, adopted the khadi reform package. The underlying reform principles are as follows.

(i) Establish a distinct and recognizable image of khadi. (ii) Increase private sector participation in khadi production and marketing. (iii) Create conducive conditions to encourage entrepreneurs to khadi production. (iv) Introduce incentives that facilitate market linkages. (v) Enhance artisan earnings and empowerment. (vi) Enable institutional reforms and capacity building.

31. The Government expects these reforms to enhance employment and increase incomes, especially for women; and empower the rural population with opportunities to meaningfully participate in and benefit from economic growth. Increases in productivity and incomes will help draw the rural work force to KVI and reduce dependence on agriculture as the sole source of income. Realizing the importance of the informal sector in economic growth, the Government expects to replicate the key features of the khadi reform package for the KVI subsector. 32. External Assistance to the Sector. Development partners have ongoing interventions in livelihood development, small and medium enterprises, and financial sector with rural development emphasis. The Department for International Development of the United Kingdom funded Rural Livelihood Program aims to enhance livelihood, tackle hunger, and provide access to basic services in socially backward areas. The Small and Medium Enterprise Financing and Development Project of the World Bank is enhancing small and medium enterprises access to finance and business development services for employment creation. The World Bank, German Bank for Reconstruction and Development, the Gesellschaft fur Technische Zusammenarbeit and ADB19 are supporting the reform of the cooperative credit system in India. The development coordination matrix is in Appendix 4. 18 Bharat Nirman enhances rural infrastructure in roads, power, irrigation, telecommunications, among others.

Upgrading of the rural road network has been taken up under the Prime Minister’s rural roads scheme. The National Rural Employment Program being implemented since 2005 seeks to provide 100 days employment to able bodied rural residents. These are just some of the major policy measures and programs for the rural poor.

19 ADB. 2006. Report and Recommendation of the President to the Board of Directors on Proposed Program Loan and Technical Assistance Grant to India for the Rural Cooperative Credit Restructuring and Development Program. Manila.

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33. Lessons. The reform impetus for khadi is driven by the need to make khadi sustainable by anchoring KVI to market prices and phasing out subsidies. In the past, other traditional products have also been rejuvenated successfully, through appropriate measures. For instance, until the late 1980s, poor farmers considered jute to be an ideal crop for rotation with rice. However, synthetic packaging then threatened jute as the traditional material. Prices dropped dramatically and jute farmers plunged into poverty. A national jute development program was launched in 1992 with assistance from the United Nations Development Programme to evolve new technologies and applications for jute, develop new machinery, improve quality, develop markets, promote small and medium-sized enterprises, and create a national institution for jute diversification. Today, jute offers fashionable and eco-friendly products that are attracting new consumers. 34. Similarly, a national leather development program, initiated in 1992 with United Nations Development Programme assistance, upgraded training systems for design and manufacture of footwear, garments, and other leather products. The Leather Technology Mission, launched in 1995, focused on fostering traditional and new skills of workers and artisans engaged in leather industries, especially small and unorganized units, and promoting their links with the organized sector. These resulted in increased earnings and employment for artisans. 35. ADB Strategy. Inclusive social development is a key strategic priority of ADB and one of the three pillars of ADB operations in India, along with sustainable economic growth and good governance. ADB’s proposed country partnership strategy and the earlier country strategy and program update20 highlight the need for strengthening the rural sector to promote inclusive development and stability of rural incomes and employment. In an assessment of this aspect of the strategy, the country assistance program evaluation21 noted that ADB’s focus on rural development activities, among others, was likely to have a positive impact on the reduction of income and nonincome poverty. ADB’s long-term strategic framework 2008–2020 (Strategy 2020)22 acknowledges that support for rural areas is an underlying component of the inclusive growth strategy. To promote inclusive growth, it seeks to create an enabling environment for microfinance, rural finance institutions, and small and medium-sized enterprises, among others. Creating a conducive environment for khadi institutions and enabling them to emerge as viable entities is consistent with the ADB’s overall strategic focus.

IV. THE PROPOSED PROGRAM

A. Impact and Outcome

36. The impact of the proposed Khadi Reform and Development Program (the Program) is enhancement of income and employment growth for the RNFS. The Program outcome is revitalization of the KVI subsector with enhanced sustainability of khadi, increased employment generation and incomes, increased artisan welfare, and development of select traditional village industries. The reform of production and marketing of khadi will lead to sustainable employment opportunities at low per capita investment. In addition to reduction in income poverty, the Program will also reduce nonincome poverty. Khadi is a geographically widespread economic activity encompassing all states and regions in the country. Given the high involvement of

20 ADB. 2006. Country Strategy and Program Update (2006–2008): India. Manila. 21 ADB. 2007. Country Assistance Program Evaluation for India. Manila. 22 ADB. 2008. Strategy 2020. The Long-Term Strategic Framework of the Asian Development Bank 2008–2020.

Manila.

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women, and marginalized groups in the KVI subsector, its development will promote inclusive growth. Reforms of khadi will help facilitate KVI subsector wide reforms. B. Policy Framework and Actions

37. The Program comprises (i) establishing a policy reform and implementation framework, (ii) promoting and marketing khadi, (iii) realizing procurement and production efficiencies, and (iv) implementing institutional reforms. The Program’s main features are described in the development policy letter (Appendix 5) and policy matrix (Appendix 6). The Program draws on the recommendations of high level working group of the Government, ADB assessment of policy and institutional aspects of khadi,23 and intensive consultation with stakeholders over the last two years.

1. Establishing a Policy Reform and Implementation Framework

38. A Comprehensive Reform Package for the Development of Khadi. The policy and institutional framework for khadi needs be anchored to the core principle of sustainability. Khadi has to move away from a welfarist approach to a market-based approach. Accordingly, as part of the Program, the Government has formulated a comprehensive reform package for khadi and established an implementation framework for KVIC to carry out the proposed reforms. Specifically, under the Program

(i) The Government conducts review of the performance of KVIC and other subsidiary institutions and develops a khadi reform package (Appendix 5) for strengthening production and marketing of khadi.

(ii) Khadi reform package comprising policy, legal, marketing, and institutional reforms for achieving sustainability of khadi and enhancing artisan income and empowerment is agreed between the Government and KVIC.

(iii) KVIC develops (a) criteria for selecting khadi institutions eligible for assistance under the khadi reform package, and (b) memorandum of understanding (MOU) on comprehensive reforms of khadi institutions with performance benchmarks and sanctions for khadi institutions that fail to meet the performance benchmarks.

(iv) KVIC selects 300 khadi institutions eligible for support under the Program.

39. These activities have been completed and set a strong foundation for implementation.24 During implementation, KVIC will disseminate the khadi reform package nationwide through workshops and will sign MOUs with approximately 300 eligible khadi institutions to implement the khadi reform package. Prior to assistance under the Program, independent auditors will audit the khadi institutions. Based on audit findings, a minimum threshold for acceptance of

23 The prominent reports are (i) the Khadi and Village Industries Review Committee (M. Ramakrishnayya), 1987; the

basis for changing the definition of village industries; (ii) the High Power Committee constituted under the chairmanship of then Prime Minister P. V. Narasimha Rao (1994) based on which the Rural Employment Generation Programme was introduced; (iii) the Arthur Andersen Report (2000) addressing the organizational structure of KVIC; (iv) the KC Pant Report (2001) based on which the marketing body, Confederation for Promotions of Khadi and Village Industries, was formed; and (v) the Expert Committee Report (D. M. Sukthankar), 2005, which identified the need for change in KVIC’s structure and functioning. ADB assessment in 2008 emphasized fundamental production and marketing reforms for enhanced sustainability of khadi.

24Criteria for selection of khadi institutions is in Supplementary Appendix A, list of khadi institutions eligible for Program support is in Supplementary Appendix B, and draft memorandum of understanding between KVIC and khadi institutions is in Supplementary Appendix C.

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khadi institutions will be developed. During implementation, assessment of the reforms will be conducted and appropriate measures undertaken to address the feedback.

2. Promoting and Marketing Khadi

40. Establish Identity of Khadi through a Khadi Mark. Creating a niche as a handspun and handwoven fabric produced through fair trade practices is the most likely way for khadi to become commercially viable in a highly competitive textiles market. The Program requires KVIC to develop a khadi mark including the design of a logo (i) as an indicator of genuine khadi and to build awareness and popularity of khadi, and (ii) to guarantee the “Earth Friendly” (handspun/woven nature) and “People Centric”/“Ethical” (employment, primarily to women on specified base wages) attributes of khadi. The khadi mark will be linked to specified base earnings for artisans. The khadi mark will be registered under the Trade Mark Act in order to ensure legal protection25 and regulations for granting the use of khadi mark will be developed. All khadi institutions affiliated to KVIC and KVIB will adopt the khadi mark. In addition to khadi institutions, institutions external to the KVIC khadi program will also be allowed to use the khadi mark. Further, basic testing infrastructure for khadi mark will be created and KVIC will conduct random spot audits on the adherence to licensing requirements for khadi mark. The procedures and the enforceability of intellectual property rights are in Supplementary Appendix D.

41. Effective Marketing through Private Sector Participation. Professional capability and orientation to assess evolving market dynamics and the flexibility to respond swiftly is critical for the effective marketing of khadi. Under the Program, KVIC will identify private partner to set up a majority private-owned marketing organization outside of KVIC. The responsibilities of the marketing organization include (i) developing marketing strategies, (ii) identifying products to be marketed in domestic and international markets, (iii) introducing public-private partnership (PPP) in the department sales outlets of KVIC, and (iv) rejuvenating the sales outlets of khadi institutions (or Institutional Sales Outlets). KVIC will transfer the right of promoting and using khadi mark to the marketing organization under a licensing agreement. Draft business plan of the marketing organization is in Supplementary Appendix E.

3. Realizing Procurement and Production Efficiencies

42. Facilitate Procurement and Processing of Raw Materials. High cost of raw material, processing inefficiencies, and inadequate testing capabilities are major constraints in the khadi value chain. Accordingly, the Program requires actions for improving procurement, processing, and quality control of raw material i.e., sliver. KVIC will establish quality norms for raw material procurement (Supplementary Appendix F) by khadi institutions and also train them on quality testing of raw materials. KVIC will also develop a sliver capacity augmentation plan for khadi institutions after a detailed assessment of the current production capacity and constraints.26 To disengage KVIC from sliver production, a fund has been created under the Program (Supplementary Appendix G) to kick start private sector participation in central sliver plants of KVIC through PPPs. Two central sliver plants of KVIC are targeted to be converted into PPPs in the first year of the Program and the remaining central sliver plants by the end of the Program. 25 Such protection includes the right for the holder of a registered intellectual property right, i.e., trademark or a trade

description to file a suit in the court seeking permanent injunction against the person infringing the trademark; claim damages; and restraining the other party from disposing assets in a manner which adversely affects the ability of the holder of the registered intellectual property rights to recover the damages, costs, or other remedies.

26 Based on detailed assessment of the status of plant equipment, geographical dispersion, capacity and current utilization levels, product mix, and quality of current production center.

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43. Market-Linked Pricing to Replace Cost-Based Pricing. Inflexible product pricing due to the cost chart and its linkage with the rebate limits the scope for enhancing artisan earnings. The cost chart also inhibits creativity, enterprise, and the potential for artisans to enhance earnings. A benefit chart, as a replacement, would ensure better linkage of production, marketing, and pricing by enabling the khadi institutions to set khadi prices as determined by the market. While the proposed khadi mark is intended to ensure payment of base wages27 by all producers of khadi, the benefit chart is intended to ensure that surpluses are used for the benefits of the khadi artisans and workers. 28 Accordingly, the Program requires KVIC to formulate and implement a benefit chart in respect of khadi institutions. KVIC will organize training in coordination with the marketing organization for product pricing and familiarization with the benefit chart. The impact of benefit chart on artisans earnings will be assessed. 44. Rationalize Financial Assistance for Khadi. Anchoring the production of khadi to markets requires that financial support that impede innovations and enterprise be discontinued. However, this will need to be done gradually in a manner that does not cause disruption in the artisan income and employment status. Under the Program, KVIC will formulate a production incentive plan for all khadi products and shift to production incentives in lieu of the sales rebate and market development assistance. Further, during the Program period, in consultation with the marketing organization, KVIC will also determine the product categories on which the production incentives could be phased out. Interest subsidy eligibility certificate will also be phased out along with phasing out of production incentives on specific product categories. In addition, working capital requirements for khadi institutions will be assessed and access to working capital will be facilitated. 45. Create New Khadi Ventures with Greater Entrepreneurial Activity and Enhanced Artisan Empowerment. In order to spur growth in khadi and empower artisans, under the Program, KVIC will develop and implement a producer company29 model and an entrepreneur model, for new khadi ventures under the KVIC khadi program. These will complement the khadi institutions by enhancing the production and marketing base of khadi. The producer company, as a means of artisan empowerment, only comprises primary producers (artisans, spinners, and weavers) which collectively appoint a governing board responsible for all decisions to be made for the producer company. The enterprise model enables enterprises without sacrificing artisan income and empowerment and authenticity of khadi that could avail assistance from KVIC in the form of Rural Employment Generation Programme assistance (para. 11 (ii)).

4. Implementing Institutional Reforms

46. Organizational Restructuring of KVIC for Better Focus on Facilitative and Development Role. Given the enormous inclusive development, employment, and income generating scope of khadi, KVIC has significant responsibilities to discharge and a pivotal role to play as the nodal institution for the development of khadi. Efforts to reform KVIC have so far been fragmented and, as a result, it currently is neither appropriately organized nor skilled to bring about an intended transformation in khadi. KVIC needs to focus on promotional and

27 Khadi institutions will have the flexibility to pay over and above the base wages. 28 Options for artisan’s benefits suggested are (i) at least 50% of the surplus to be distributed as bonus on fiscal year

end to artisans based on production record, and (ii) the balance earnings to be utilized for creating provisions for future capital requirements including improved equipment and benefits for artisans.

29 Set up as per provisions of Companies (Amendment) Act 2002, the producer company can form alliance or partnership with any entrepreneur or entity for marketing its products. Details of models for new khadi ventures are in Supplementary Appendix H.

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development role and gradually disengage from direct commercial activities, such as production and marketing, which are not specifically based on its core competencies. Simultaneously, KVIC needs to play a facilitative role to strengthen khadi institutions, enhance the stake and role of artisans, facilitate the flow of raw materials and finances, and to create a niche for khadi through khadi mark. Under the Program, KVIC will adopt and implement a restructuring and devolution plan (Supplementary Appendix I) including (i) restructuring khadi, village industries, science and technology, and economic research directorates; (ii) strengthening of human resource and administration directorate; (iii) realignment of reporting relationships; and (iv) devolution of powers and responsibilities to zonal offices. In addition, KIVC will also develop an integrated management information and e-governance system.

47. Revitalize Khadi Institutions. Being fragmented and dispersed, the khadi institutions lack the professional expertise, financial capacity, and a unified vision to adapt to evolving market trends. As primary level producer and marketers of khadi, the reform of khadi institutions constitute the base for the transformation of khadi envisaged by the Government. Under the Program, KVIC will implement the comprehensive reform plan for 300 khadi institutions, selected primarily on the basis of performance, to ensure enhanced artisan earnings and empowerment and improved viability of khadi institutions, through (i) production, (ii) marketing, (iii) governance, and (iv) information technology and e-governance. The model comprehensive reform plan has been developed with due recognition of the need for adaptation to requirements of specific khadi institutions. Reforms are phased to enable evaluation and incorporation of lessons learned. The scope of comprehensive reforms at khadi institution level is in Supplementary Appendix J. 48. In addition, all khadi institutions 30 will be recategorized based on new norms that emphasize (i) role for artisans, (ii) governance structure, (iii) human resources, (iv) financial health, and (v) diversified networks and market linkages. 49. Strengthen the Capability of All Institutions. Systemic and pervasive skills deficit persists at all levels in the set up for khadi. These deficits will have to be addressed at the level of the institutions (KVIC, khadi institutions) as well as at the artisan level. The Program requires the development of a comprehensive capacity building plan, including physical infrastructure and training of trainers, to strengthen capabilities at all levels. The comprehensive capacity building plan, based on assessment of existing training arrangements (infrastructure, capacity of trainers, and curriculum), will adopt a two-pronged focus (i) demand: a team within KVIC’s human resources development directorate to focus on regular interaction with all other directorates and the marketing organization, to continuously assess the demand (nature/sector/skill level) for training; and (ii) supply: developing linkages with external training programs, enhancing the training institutes under the KVIC, and detailing and implementing capacity building.

50. Develop Synergies with Traditional Village Industries. There are inherent synergies between khadi and traditional village industries, which are in line with the overall ethos of khadi – “handmade,” “use of organic inputs/processes” and/or “socially aware.” The Program requires KVIC to identify around five “traditional village industries” such as herbal products, honey, handmade paper, cane, and pottery based on a market survey by the marketing organization. A cluster approach to pool efforts for developing the identified traditional village industries will be adopted in consultation with the marketing organization. The capacity building needs for the 30 The Program covers 300 eligible khadi institutions whereas the reform of all khadi institutions is part of the khadi

reform package. The Government will develop customized restructuring plan for weak khadi institutions.

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cluster will be integrated with the comprehensive capacity building plan and implemented simultaneously. C. Important Features

51. The Government’s desire to pursue fundamental khadi reforms allows ADB to participate in a high-priority inclusive development intervention. The Program will serve to initiate reforms of khadi institutions as well as future initiatives in village industries, and in the entire informal sector. This could enable continued ADB participation in interventions that conform to the Strategy 2020 agenda of inclusive and environmentally sustainable growth. Creating conducive enabling environment for khadi entrepreneurs will promote inclusive growth. The Government’s request for ADB support is in recognition of its involvement in developing the khadi reform package and the intensive effort for building a consensus on the khadi reform package. 52. Inclusive Growth. Development experience indicates that rapid, broad-based, and labor-intensive economic growth is the most effective means to reduce poverty, and contribute to inclusive growth. The Program provides a framework for (i) drawing seasonally affected agrarian poor into RNFS opportunities for income enhancement, (ii) directly increasing employment and incomes of rural artisans through the reforms, and (iii) reducing distress migration from rural areas through the step up in RNFS work opportunities. Broader sharing of the benefits of growth facilitated by a shift to RNFS will enhance social stability and hence, reinforce the sustainability of the development process. 53. Participatory Process. The Program was formulated in a participatory manner. Extensive consultations with producer groups and beneficiaries from all geographic regions and social groups in the country, were undertaken during program preparation. Consultations with civil society provided useful insights on wages, technology and women’s role, and overall social and institutional issues. These are in addition to extensive consultations with various segments in the Government and development community. During program implementation, gender and NGO institutions development experts will ensure a participatory approach by carrying out information dissemination, need assessments, and capacity development planning especially for women and disadvantaged beneficiaries. 54. Private Sector Development. The Program seeks to enable greater participation of private entrepreneurs by enabling the use of the khadi mark and production and marketing khadi through new ventures. In addition, phasing out of raw material production from KVIC through PPPs and establishing a majority private-owned marketing organization will facilitate greater private sector participation in khadi production. 55. Empowering Artisans. The Program introduces direct measures for enhancing income and empowering artisans, majority of whom are rural poor women. By altering the norms of governance and operations at the khadi institutions, enabling new khadi ventures, and ensuring fair wages through the khadi mark, the Program facilitates a level playing field in rural economic relations. Nearly half of the program resources are directed to support khadi institutions that serve as primary khadi producers and marketers. D. Financing Plan

56. The Government has requested a loan of $150,000,000 equivalent from ADB’s ordinary capital resources to help finance the Program. The loan will have a 15-year term, including a grace period of 3 years, an interest rate to be determined in accordance with ADB’s London

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Interbank Offered Rate (LIBOR)-based lending facility, a commitment charge of 0.15% per annum, and other terms and conditions as set forth in the draft loan agreement. The Government has provided ADB with (i) the reasons for its decision to borrow under ADB’s LIBOR-based lending facility on the basis of these terms and conditions, and (ii) an undertaking that these choices were its own independent decision and not made in reliance on any communication or advice from ADB. 57. The ADB funds will support reforms that address complex and fundamental issues as described in the development policy letter (Appendix 5) and policy matrix (Appendix 6). Costs are triggered by policy and institutional reforms, especially for revitalizing khadi institutions; and constitute the bulk of the cost. KVIC estimates the cost of strengthening all 1,952 khadi institutions at nearly $800 million over 4 years. The cost of reforms is expected to exceed these estimates, if delays are encountered. The impact of proposed reforms on phasing out subsidies will only be felt in the medium term, i.e., when the khadi institutions selected for program support make a turnaround and become sustainable, and other khadi institutions are reformed along similar lines through Government support. The Government will ensure that the counterpart funds are used for costs associated with reforms introduced under the Program (para. 94).31 E. Implementation Arrangements

1. Program Management

58. MMSME, the Executing Agency, will be responsible for overall Program implementation. KVIC, the Implementing Agency, will be responsible for implementation of reforms. MMSME and KVIC will ensure a conducive environment, provide adequate powers and resources to KVIC’s reform implementation division (RID) and the reform management units (RMU), and be responsible for issuing necessary notifications and directives to facilitate implementation and establishment of the khadi mark and the marketing organization. The program management chart is in Appendix 7. 59. Prior to loan effectiveness, KVIC will establish the RID, which will be responsible for (i) coordinating actions under the Program in accordance with the implementation schedule, and (ii) monitoring overall program progress. The RID will be headed by a KVIC director with sufficient knowledge and experience in KVI related programs, who will report to KVIC’s chief executive officer. The RID will comprise four subdivisions: (i) promotion and marketing, (ii) raw material procurement and production, (iii) institutional reform, and (iv) program coordination and administration. KVIC will assign about 13 of its officers to the RID and about 7 administrative staff. Consultants (para. 72) will be hired to provide specialist support. Within one month of loan effectiveness, KVIC will establish an RMU at each of its state and divisional offices to manage and monitor program implementation at khadi institutions. Each RMU will be headed by a KVIC assistant director or an official of similar rank, and at least one officer will be assigned to support the head. The RMUs will coordinate with khadi institutions and facilitate monitoring and implementation of the reforms under the Program. 60. Prior to loan effectiveness, MMSME will set up a reform implementation and monitoring committee to be chaired by the MMSME secretary. The committee will serve as the program steering committee, and (i) provide policy and technical guidance to KVIC and the RID, (ii) review the progress of program implementation, (iii) monitor the performance of the RID and 31 The breakdown of the costs is in Supplementary Appendix M.

18

RMUs, and (iv) ensure program coordination. It will meet at least quarterly and include representatives from the Department of Economic Affairs of Ministry of Finance, Ministry of Textiles, KVIC, a marketing expert from the Confederation of Indian Industry, and a financial expert from the banking sector.

2. Period of Implementation

61. The policy conditions, spread over four tranches, will be implemented over 3 years, from October 2008 to September 2011 (Appendix 8).

3. Procurement and Disbursement

62. In accordance with provisions of ADB’s Simplification of Disbursement Procedures and Related Requirements for Program Loans (1998), the proceeds of the program loan will be disbursed to the Government as the Borrower. The loan proceeds will be utilized to finance the full foreign exchange costs (excluding local duties and taxes) of imports produced in, and procured from, ADB member countries, other than those specified in the list of ineligible items (Appendix 9) and imports financed by other bilateral and multilateral sources. The Government will certify that (i) the value of the country’s eligible imports is equal to, or exceeds, the amount of ADB’s projected disbursements under the loan in a given period; and (ii) the loan proceeds will be utilized in a manner satisfactory to ADB. The loan proceeds will be disbursed based on certification provided by the Government confirming that the requirements for the loan have been met. ADB will have the right to audit the use of the loan proceeds, and to verify the accuracy of the Government’s certification.

4. Monitoring and Tranching

63. The loan will be released in four tranches over 3 years. The first tranche of $20 million will be released upon loan effectiveness. The second tranche of $40 million is expected to be released within 8 months of the first tranche, the third tranche of $40 million within 13 months of the second tranche, and the fourth tranche of $50 million within 15 months of the third tranche; each will be subject to compliance with their respective tranche release conditions. The phasing of tranche release actions is in policy matrix (Appendix 6).

5. Accounting, Auditing, and Reporting

64. An audit of the use of the loan proceeds will be undertaken if requested by ADB and ADB retains the right to (i) audit any account and (ii) verify the validity of the certification issued by the Government for each withdrawal application. Immediately after the loan effective date, the Government shall establish a special account at a commercial bank acceptable for ADB for the special purpose of depositing and utilizing the counterpart funds. Prior to withdrawal, the Government will open a deposit account at the Reserve Bank of India to receive all loan proceeds. The accounts will be established, managed, operated, and liquidated in accordance with terms satisfactory to ADB. MMSME, through KVIC, will maintain separate records and accounts on the use of the counterpart funds following sound accounting principles, and will have such accounts and records audited annually by auditors acceptable to ADB, and will furnish, within 6 months of the close of the financial year, certified copies of the audit report with auditors’ opinion to the Government and ADB. 65. KVIC through RID will prepare quarterly progress reports and submit them to ADB within 20 days of the end of the applicable period. The reports will be prepared in a format acceptable to ADB and include (i) project progress in each state and component, (ii) the status of

19


institutional development activities, (iii) delays and problems encountered and actions taken to resolve them, (iv) compliance with loan covenants, and (v) expected progress during the next 3 months. Within 3 months of program completion, KVIC will prepare and submit to ADB, through MMSME, a project completion report including costs and compliance with loan covenants.

6. Governance and Anticorruption

66. The Program directly addresses governance issues related to KVIC and khadi institutions by (i) conducting independent audits of khadi institutions eligible for the comprehensive reform plan, (ii) reforming the governance structure of khadi institutions for artisans’ autonomy and empowerment by modifying the categorization norms and introducing a new khadi venture model, (iii) establishing new rules for usage and authority of the khadi mark and conducting random spot audits for khadi institutions on the licensing requirement for the khadi mark, and (iv) implementing institutional reforms for KVIC. Independent audit of khadi institutions will reduce the vulnerability to corruption. Modifying the categorization norm of khadi institutions and institutional reform of KVIC will ensure (i) enhanced corporate governance, (ii) compliance with transparency and disclosure requirements, and (iii) adequate monitoring mechanisms. A governance and anticorruption risk assessment is in Appendix 10. 67. In addition, ADB's Anticorruption Policy (1998, as amended to date) and the Second Governance and Anticorruption Action Plan 32 was explained to and discussed with the Executing Agency and Implementing Agency. Consistent with its commitment to good governance, accountability, and transparency, implementation of the Program shall adhere to ADB's Anticorruption Policy (1998, as amended to date). ADB reserves the right to review and examine, directly or through its agents, any alleged corrupt, fraudulent, collusive, or coercive practices relating the Program. In this regard, investigation of government officials, if any, would be requested by ADB to be undertaken by the Government. In this context, a financial management assessment was also undertaken by the Executing Agency (Supplementary Appendix K) to provide assurance that ADB loan funds will be used for their intended purpose. ADB will regularly review the financial reports of the audit authorities to assess any potential financial and administrative irregularities. During regular review missions, the financial management, and governance and anticorruption risk assessments will be updated to ensure that their provisions remain valid and are helping the reforms to succeed.

7. Fiduciary Management

68. The KVIC Act, 1956 stipulates the fund flow control from the Ministry of Finance through MMSME requiring funds to be segregated into three funds: the khadi fund, the village industry fund, and the general and miscellaneous fund. Transfers of financing between the three funds or the use of funds for other purposes are subject to MMSME approval. The KVIC accounts are subject to auditing by the comptroller and auditor general of India. Audit of khadi institutions is regularly conducted and the standing order No. 1616 of KVIC stipulates (i) a pro forma of the audit and/or inspection report on the affairs of khadi institutions, (ii) code of operation on the findings of the audit report, and (iii) code of administrative action on findings of audit reports for the fund flow from KVIC to khadi institutions. The transfer of loan proceeds from KVIC to khadi institutions based on MOUs between KVIC and khadi institutions will bind the usage, release, and monitoring of the fund flows with the terms and corresponding conditions to implement the policy actions. The independent audit of eligible khadi institutions is also part of policy conditions. These together will help ensure the use of loan proceeds for program objectives. 32 ADB. 2006. Second Governance and Anticorruption Action Plan (GACAP II). Manila.

20

8. Program Performance Monitoring and Evaluation

69. KVIC through RID will establish and maintain a program performance management system including a database on the status of policy actions and program indicators based on the policy matrix.

9. Program Review

70. The Government and ADB will conduct semiannual reviews throughout program implementation to identify actions required for the continued development of the khadi sector. The midterm review will be undertaken within 18 months from loan effectiveness and will review (i) compliance status of the third tranche conditions, (ii) status and implementation of policies, (iii) status and implementation of reforms, (iv) initial lessons, and (v) progress in achieving the indicators in the design and monitoring framework.

V. TECHNICAL ASSISTANCE

71. A TA grant from the Japan Special Fund, funded by the Government of Japan in the amount of $2 million is attached to the Program. The goal of the TA titled Capacity Building for Reforming the Khadi and Village Industry Subsector is to support implementation of the khadi reform package and its objective is to expedite commencement of the reforms. The purpose of the TA is to strengthen implementation and monitoring of the khadi reform package to revitalize khadi as a source of robust nonfarm livelihoods for many rural poor. The TA will consist of the following components:

(i) Strengthen program management. The TA will support MMSME and KVIC in the overall management, implementation, and monitoring of the Program.

(ii) Promote and market khadi. The TA will facilitate the design and adoption of the

khadi mark, and the establishment and operation of the marketing organization.

(iii) Facilitate procurement and production. The TA will facilitate raw material procurement and sliver production, introduce market-linked pricing, rationalize financial assistance, and develop the framework for new khadi ventures.

(iv) Support institutional reforms. The TA will support capacity building of KVIC to

enable greater focus on developmental role. It will also assist the transformation of the khadi institutions into viable entities; and provide capacity development support to artisans, especially to women, including information dissemination on reforms, constraint mitigation, skills development, and awareness creation for empowerment.

72. Aligned with the Program, MMSME will be the TA Executing Agency and KVIC the Implementing Agency. The total cost of the TA is estimated at $2.50 million comprising $2 million funded by ADB (the Japan Special Fund) to be used for hiring approximately 210 person-months of national consultants, and $0.50 million funded by the Government to be used for counterpart support, office accommodation and related services, communications, reports, and workshops. The consultant inputs, terms of reference, cost estimates, and implementation arrangements are in Supplementary Appendix L. The TA will commence in October 2008 and be completed in September 2011. The consultants will be recruited through a firm using the quality- and cost-based selection method with full technical proposal. Two consultants will be

21


hired as individual consultants. Consulting services will be procured in accordance with ADB’s Guidelines on the Use of Consultants (2007, as amended from time to time).

VI. PROGRAM BENEFITS, IMPACTS, ASSUMPTIONS, AND RISKS

A. Benefits and Impact

1. Policy

73. The Program’s comprehensive reform agenda will enhance the policy environment for efficient and effective production and marketing of khadi with multiple benefits. The Program supports the Government’s 11th FYP commitments of reforming KVIC, shifting khadi from a welfare approach to a unique selling proposition approach, and promoting the intrinsic qualities of khadi, i.e., handcrafted, handspun, and energy saving. The Program facilitates enlisting new khadi institutions and entrepreneurs, strengthening khadi institutions, strengthening raw material supply, addressing input and working capital shortages, registering khadi as a brand name and domain name, and strengthening the marketing network. The khadi mark; abolition of the cost chart; entry of new entrepreneurs, the marketing organization, and PPPs will end the controlled production and marketing of khadi under the KVIC khadi program. Khadi production, marketing, and pricing will be better aligned with the market as a result of discontinuing the archaic cost chart system. Infusing professionalism in marketing and encouraging PPPs will ensure a consumer-linked marketing strategy. In addition, rationalizing raw material procurement and production, and streamlining financial assistance will decrease the working capital requirements for khadi institutions.

2. Institutional

74. The institutional reform of KVIC strengthens its development role by enhancing capacity for strategic planning. Disengaging KVIC from raw material production and direct marketing will enable it to focus on revitalizing khadi institutions. The Program recategorizes and reforms weak khadi institutions. Enhanced governance, production, and marketing of khadi institutions will serve to increase artisan income. Together, these provide the basis for replicating reforms to the broader KVI subsector.

3. Economic and Financial

75. The Program will generate much-needed employment opportunities in khadi and enhance incomes (rates of remuneration) of artisans. The employment intensity of the registered units in the micro, small and medium enterprise sector including khadi indicates that an investment of Rs72,000 creates employment for one person compared with Rs556,000 in the large organized sector. Employment in khadi institutions will increase because of expanded production supported by improved raw material procurement and enhanced working capital. New marketing and product strategies will increase the sales of khadi products. Employment will be generated by introducing new khadi ventures using the producer company model and entrepreneur model. Replacement of the cost chart with market-linked pricing will let khadi institutions determine pricing based on the product value rather than cost, to respond to market dynamics and incorporate commercial sensitivities. Artisan’s base wages are to be ensured by the proposed khadi mark, while the introduction of the benefit chart will ensure that any surplus is used for the benefits of artisans. Enhanced institutional sustainability of KVIC will enable it to mobilize funds and human resources more efficiently in supporting the KVI subsector. Improved viability of khadi products and enhanced sustainability of khadi institutions will gradually reduce the need for budgetary support to khadi.

22

4. Environment

76. The khadi production and marketing reforms supported by the Program emphasize governance, marketing, and institutional restructuring. No physical construction activities are expected. The fundamental nature of KVI activities, including khadi, is based on agriculture and rural technology. Generating additional employment of this nature will be environmentally sustainable and eco-friendly. It will have indirect beneficial effects on health both in terms of production processes and the organic nature of products generated. Khadi production is also amenable to the use of clean (solar) energy powered improved production techniques that are environment friendly and eliminate drudgery in spinning, especially for women. The Program’s comprehensive capacity building plan will incorporate (i) training and/or environmental awareness raising for artisans, and (ii) transfer and uptake of pollution prevention technologies and techniques to concerned khadi institutions. An environmental assessment of the policy matrix has no potential adverse environmental impact. The environment category is C.

5. Social and Poverty

77. At the macro level, the Program will promote inclusive growth and have significant poverty reduction and social impacts. 33 It will help increase employment opportunities and incomes in the labor intensive KVI subsector, thereby enhancing social stability in rural areas. Increased value addition will be accompanied by measures to increase distribution of enhanced revenues to artisans. A significant benefit is the participation of artisans in the governance at khadi institutions through representation at the governing board, involvement in decision making, and participation in distribution of the surplus. These together will constitute participating in, and benefiting from the development of khadi. The reforms will benefit the artisans and workers in the sector, and increase the competitiveness of the rural labor market, thus improving agriculture labor wages. Such increases in income would clearly bring about a reduction in nonincome poverty, with enhanced education and health spending, given the nature of expenditure elasticity for higher incomes in this sector. 78. The impact of KVI on rural development and rural–urban migration is significant. The expected sector growth as the result of the reforms will create substantial employment and income generating opportunities in the rural sector especially for women and those in remote and hilly areas. KVI covers 261,000 of India’s 639,000 villages, more than 40%. Spinning is largely carried out by women belonging to disadvantaged sections of society, who receive only several days to a few months of part-time employment. However, the reforms will result in engaging them for longer periods and providing them with a substantial and diversified source of income in addition to their subsistence farming. The Program’s assistance to empower producer groups and artisan societies will ensure the poor and marginalized realize equitable wages and increased benefits. The Program will not have any adverse impact on indigenous peoples. The summary poverty reduction and social strategy is in Appendix 11. A gender action plan to enhance and monitor impacts on women is attached as Appendix 12. 79. Labor Standards. The Program seeks to enhance employment and income of artisans. In doing so, it would promote greater adherence to core labor standards for khadi. The reforms will promote widespread production under the quality control of a khadi mark. The khadi mark, a legally registered trade mark for certification of khadi, would also cover guaranteed minimum

33 Gender assessment and action plan is in Supplementary Appendix N and poverty impact assessment of policy

reforms is in Supplementary Appendix O.

23


wages for artisans. This will ensure that artisans are not deprived or discriminated against on remuneration. The reform will not include labor retrenchment, but rather address the issue of underemployment of the rural sector by expanding the khadi production base. B. Assumptions and Risks

80. The Program addresses politically sensitive and long-standing issues and socially significant measures to enhance employment and empowerment for the poor and marginalized. Such reforms entail correcting entrenched policy, regulatory, governance, and institutional issues. At the macro level, the reform agenda is driven by the growing recognition of stakeholders of the significance of improving the living conditions of the rural population. While this is the most effective measure to ensure sustained reform commitment at all levels, achieving expected impacts will depend on several assumptions that are subject to varying degrees of risk. Mitigation measures are being put in place wherever feasible and appropriate. 81. Reform Commitment. Despite the Government’s successful track record in generating employment in the RNFS, there is a significant risk in dealing with khadi institutions particularly the likelihood that khadi institutions may prefer to remain in the current protective low-risk and low-return arrangement where government support is assured. In addition, the extensive reform hierarchy extending all the way down to the grassroots could slow the momentum of reforms. These risks are dealt with in part by front loading the conditions relating to the policy reform and implementation framework, up-front legal assurances, and phased financial assistance. Program support is based on defined criteria and continuity of support will require achievement of specified key results. 82. Implementation. The risk of implementation delay due to inadequate capacity is being minimized by (i) extensive consensus building leading34 to a detailed implementation framework, and (ii) adequate technical support for capacity building. The design of the implementation arrangements reflects the necessity of pooling the limited in-house resources in KVIC and supplementing this with the TA specialists. The attached TA is designed to ensure that actions are timebound and well coordinated. In addition, ADB financial assistance will be released in four tranches, which provides considerable scope for dialogue with the Government, allows more time for the Government to address any implementation issues, and helps increase stakeholder ownership. An intensive orientation program on implementation aspects will be conducted at program start-up. 83. Institutional Reforms. KVIC, the KVIBs, and khadi institutions may have difficulty adapting to reforms. Staff behavior could prove resistant to institutional and governance reforms, thereby undermining the expected improvements in performance. Factors that mitigate these risks include (i) up-front commitment to the new framework, governance, business procedures, and autonomy; (ii) redefinition of the institutional role and vision; and (iii) significant investments in information technology, and management information systems and procedures, and human resource development. 84. Private Sector Perception. The private sector’s confidence to invest and associate in the KVIC khadi program depends on whether the Government and KVIC can produce successful outcomes as a result of the reform. Any redirection of the reform policies might cause the private sector to lose confidence. The program measures to improve investor 34 Chronology of program development and processing is in Supplementary Appendix P.

24

confidence include (i) up-front policy decision to commit to the reform agenda, (ii) rigorous monitoring of implementation of the restructuring process to meet performance benchmarks, and (iii) support to KVIC for supervision of good governance and program implementation. 85. Market Response. The program impact will depend on successful implementation and market response to products of supported khadi institutions. While the Program has benefited from successful practices, the possibility that final products, at least initially, may not find a positive market response cannot be ruled out. In this event, the reasons will have to be analyzed and appropriately addressed. The Government also anticipates that adjusting to new business processes and market expectations could take time. As a result, the Program is designed as a pilot and all actions are phased. In addition, support to khadi institutions will be spread over a period of time to enable support throughout the adjustment process.

VII. ASSURANCES AND CONDITIONS

A. Specific Assurances

86. The Government has given the following assurances, in addition to the standard assurances, which are incorporated in the legal documents: 87. Program Implementation. The Government will, and will cause KVIC to

(i) promptly adopt and implement the policies and actions included in the Program as specified in the development policy letter and policy matrix; and ensure that such policies and actions continue in effect during and subsequent to the program period;

(ii) fulfill the agreed policies and actions under the Program in accordance with the agreed implementation schedule, to ensure that the loan tranches are released in a timely manner; and

(iii) ensure that all activities, documents, and enactments required under the Program will be prepared in consultation with the relevant stakeholders and their feedback will be incorporated, as appropriate.

88. In case of natural calamities and unforeseen circumstances that affect the equity and liquidity of KVIC, the Government will immediately consult ADB and prepare a remedial action plan for the Program, acceptable to ADB. 89. Khadi Policy Reforms. The Government will ensure that

(i) the reforms under the Program, including institutional, legal, and financial reforms under the khadi reform package are formulated, finalized, and implemented to the satisfaction of ADB; and

(ii) (a) the marketing organization to be established for the purpose of facilitating product development and marketing of khadi products will be incorporated through a joint venture between KVIC and a private entity with KVIC having no more 49% of the shares, and (b) at least 50% of the board members of the marketing organization should be independent directors who are renowned specialists in their respective field.

90. Prior to the completion of the Program, the Government will cause KVIC to

25


(i) reorganize all artisans into self-help groups and proactively provide required training support to the group to enable them to constructively serve the purpose of the artisans; and

(ii) ensure that (a) at least 50% of the governing board of a khadi institution will have representation from the artisans, and (b) the criteria for the selection of the other members of the governing board will be based on good governance practices.

91. Marketing Organization. KVIC will agree not to

(i) issue any discriminatory instructions or guidelines that may affect the access of the marketing organization to (a) any khadi institutions and their sales outlets, and (b) the department sales outlets, for the purpose of their promotional or marketing ties, procurement arrangements, wholesale, and export activities; and

(ii) influence, directly or indirectly, the business decisions of the khadi institutions, department sales outlets or other agencies with regards to their business activities with the marketing organization.

92. KVIC will

(i) provide the marketing organization with access to the promotion of the khadi mark and other trade marks registered under its name;

(ii) provide support and facilitation as required and requested by the marketing organization during the program implementation period;

(iii) agree for the marketing organization to implement the marketing related reforms under the program for the khadi institutions; and

(iv) ensure that all new department sales outlets will be established by the marketing organization.

93. Upon the operationalization of the marketing organization, KVIC will utilize the bulk of its marketing budget for promotional and developmental activities in a phased manner during the implementation period of the program. 94. Counterpart Funds. The Government will ensure that the counterpart funds will be used for the adjustment costs associated with the reforms introduced under the Program for KVIC and khadi institutions and will be allocated for the purpose of the adjustment costs related to policy and institutional reforms, including khadi mark and synergy with village industries in the amount of $48,000,000 (forty eight million Dollars); adjustment costs related to marketing reforms in the amount of $27,000,000 (twenty seven million Dollars); and adjustment costs related to the strengthening of khadi institutions in the amount of $75,000,000 (seventy five million Dollars), and as further set out in the table in Supplementary Appendix M. 95. Information Sharing. The Government will, and cause KVIC to regularly exchange views and information with ADB on any problems and constraints encountered during program implementation and seek proper resolution to address these problems and constraints. 96. Technical Assistance. The Government will, and cause KVIC to ensure that in carrying out the policy measures and activities included under the Program, the recommendations made under the TA provided by ADB are duly considered for appropriate adoption in a timely manner and in consultation with ADB.

97. Environment and Social Safeguards. The Government will, and will cause KVIC to ensure that

26

(i) all activities under the Program are carried out in accordance with all applicable environmental laws and regulations of the Government and ADB’s Environment Policy (2002); and

(ii) under the Program no people will be (a) adversely affected in terms of ADB’s Involuntary Resettlement Policy (1995), and (b) affected in terms of ADB’s Policy on Indigenous Peoples (1998).

B. Conditions for Loan Effectiveness

98. Prior to the effectiveness of the loan, the Government will

(i) have complied with all actions relating to the first tranche conditions, to the satisfaction of ADB;

(ii) have constituted a reform implementation and monitoring committee to oversee implementation of the khadi reform package, to the satisfaction of ADB;

(iii) have established the RID, to the satisfaction of ADB; and (iv) have appointed a director with qualifications and experience, acceptable to ADB,

to head the RID.

VIII. RECOMMENDATION

99. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Asian Development Bank (ADB) and, acting in the absence of the President, under the provisions of Article 35.1 of the Articles of Agreement of ADB, I recommend that the Board approve

(i) the loan of $150,000,000 to India for the Khadi Reform and Development Program from ADB’s ordinary capital resources, with interest to be determined in accordance with ADB’s London interbank offered rate-based lending facility; a term of 15 years, including a grace period of 3 years, and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Program Agreements presented to the Board; and

(ii) the provision of technical assistance not exceeding the equivalent of $2,000,000

to the Government of India for Capacity Building for Reforming the Khadi and Village Industry Subsector.

C. Lawrence Greenwood Jr. Vice President

11 September 2008

Appendix 1 27

DESIGN AND MONITORING FRAMEWORK

Design Summary

Performance Targets and/or Indicators Data Sources and/or Reporting Mechanisms

Assumptions and Risks

Impact Enhancement of income and employment growth for the RNFS

• Increased rural nonfarm per capita

income (by at least 5% within 7 years) • 1% increase in employment growth rates

in the RNFS over 3 years

• Government appraisal

of the 11th Five Year Plan

• Government evaluation and impact assessment reports

Assumptions • Government and

states’ sustained political commitment to reforms

• Effective implementation of complementary reforms

• No adverse change in commercial and market environment

Risks • Weak reform

implementation • Extraneous conditions

(such as climate) negatively impact rural economic growth

Outcome Revitalized KVI subsector provides sustainable employment to artisans with higher earnings

• At least 15% increase in number of

artisan employed by khadi institutions over the next 3 years

• At least 20% increase in the 2008 prevailing earnings of khadi artisans over the next 3 years

• Implementation

reports by EA • Government statistics

(India’s Ministry of Statistics and Program Implementation)


states’ sustained commitment to reforms


• No adverse change in commercial and market environment

Risks • Weak reform

implementation • Extraneous conditions

(such as climate) negatively impact rural economic growth

Outputs 1. Policy reform and implementation framework is established to carry out the proposed reforms

• Khadi reform package implemented (by Sep 2011)

• Independent assessments of program implementation and impact

• KVIC annual report


states’ sustained political and financial commitment


• No adverse change for commercial and market environment

Risk • Weak implementation

of reform agenda

28 Appendix 1

Design Summary

Performance Targets and/or Indicators Data Sources and/or Reporting Mechanisms

Assumptions and Risks

2. Khadi is effectively promoted and marketed to ensure commercial viability as well as generate market demand for khadi

• Increase in sales by 10% on annual compounded basis over the next 3 years

• KVIC annual report • Official gazette/

Relevant government notifications






of reform agenda

3. Procurement and production efficiencies are realized to remove major constraints in the khadi production value chain

• A reduction of 15% in raw material (sliver) production cost over the next 3 years (by Sep 2011)

• At least 10 new ventures should be initiated in the khadi sector, preferably under producer company/entrepreneurial mode (by Sep 2011)







of reform agenda

4. Institutional reforms are implemented to restructure KVIC, revitalize khadi institutions and develop synergies between khadi and traditional village industries

• KVIC disengages from direct commercial activities (by Sep 2011)

• The comprehensive reform plan is implemented for 300 eligible khadi institutions (by Sep 2011)

• IT and e-governance systems and practices of KVIC are strengthened (by Sep 2011)

• Five traditional village industries implement the cluster development strategy (by Jul 2010)







of reform agenda

Activities with Milestones Inputs ADB Program Loan

$150 million (OCR) ADTA Grant (JSF) $2,000,000 Government of India counterpart funding $500,000 equivalent

Appendix 1 29

Activities with Milestones Inputs 1.1 A comprehensive reform package for the development of khadi • Khadi reform package formulated and approved by the Government and KVIC (by Oct 2008) • Selection criteria and the list of 300 selected khadi institutions for implementation of khadi

reform package (by Oct 2008) • Draft MOU between KVIC and selected 300 khadi institutions (by Oct 2008) • Audit findings for the selected 300 khadi institutions by independent auditor (by Jul 2010) • KVIC conducts first independent assessment of the khadi reform package (by Jul 2010) • KVIC conducts second independent assessment of the khadi reform package (by Sep 2011) • Reform implementation and monitoring committee constituted (by Oct 2008) • Reform implementation division established (by Oct 2008) 2.1 Establish identity of khadi through khadi mark • KVIC agrees to undertake steps to develop khadi mark and link the artisan’s base earnings to

the use of khadi mark through approval of khadi reform package (by Oct 2008) • KVIC undertakes (i) the formulation and execution of the MOU with the Ministry of Textiles for

testing infrastructure, (ii) the formulation and execution of the model agreement for licensing the use of khadi mark; (iii) the development of the detailed plan for the creation of basic testing infrastructure for khadi mark at KVIC; and (iv) the arrangement for managing khadi mark by KVIC State/Divisional offices supported by ADB ADTA (by Jun 2009)

• KVIC adopts procedures and assigns the khadi coordination directorate to grant usage of khadi mark to khadi institutions and others supported by ADB ADTA (by Jun 2009)

• KVIC through its khadi directorate ensures that the khadi institutions registered at either KVIC or KVIB adopt the khadi mark (by Jun 2009)

• Khadi mark developed and registered by KVIC (by Jun 2009) • KVIC through the khadi directorate prepares and maintains a list of khadi institutions and others

authorized to use khadi mark and publish this in its website supported by ADB ADTA (by Jul 2010)

• KVIC creates the basic testing infrastructure for the khadi mark (by Jul 2010) • The khadi mark is used by at least all KVIC/KVIB registered khadi institutions and other third

party authorized institutions supported by ADB ADTA (by Sep 2011) • First spot audit report by KVIC of khadi institutions and others regarding adherence to licensing

requirements for the use of khadi mark (by Jul 2010) • Second spot audit report by KVIC on khadi institutions and others regarding adherence to

licensing requirements for the use of khadi mark (by Sep 2011) 2.2 Market khadi through private sector participation • KVIC identifies potential private partners for the new marketing organization and incorporates

marketing organization through an MOU and incorporation certificate supported by ADB ADTA (by Jun 2009)

• MMSME issues a directive to allow KVIC to provide capital contribution for the establishment of the joint-venture marketing organization (by Jun 2009)

• The Khadi Marketing Extension Program is developed for incentivizing the establishment of new DSOs by the marketing organization (by Jun 2009)

• Licensing agreement established under which KVIC transfers the rights of promotion and usage of khadi mark to marketing organization under a licensing agreement supported by ADB ADTA (by Jun 2009)

• Survey report of KVI products and a marketing strategy for all khadi related institutions and on identifying products for both domestic and international markets supported by ADB ADTA (by Jun 2009)

• Marketing organization develops framework for introducing PPP in the DSOs and introduces

ADB Review Missions MMSME and KVIC • Counterpart Staff • Office Accommodation • Obtaining required

information • Participation in

meetings

$1 million

$2 million

$27 million

30 Appendix 1

Activities with Milestones Inputs PPP in 2 DSOs supported by ADB ADTA (by Jul 2010)

• Marketing organization develops the Institutional Sales Outlets Rejuvenation Plan (by Jul 2010) • Marketing organization prepares a product catalogue and sets up the market information

system (by Jul 2010) • Marketing organization introduces PPPs in at least two other KVIC DSOs (by Jul 2010) • First progress report on marketing organization’s implementation of the Institutional Sales Outlets Rejuvenation Plan (by Jul 2010) • Marketing organization implements the Institutional Sales Outlets Rejuvenation Plan (by Sep

2011) • Marketing organization formulates guidelines for the setting up of new sales outlets by khadi

institutions (by Sep 2011) • Marketing organization introduces PPP in at least 4 DSOs supported by ADB ADTA (by Sep 2011) • Marketing organization establishes at least 13 DSOs (by Sep 2011) • Sales outlets owned and operated by 300 khadi institutions are renovated (by Sep 2011) • Second progress report on marketing organization’s implementation of the Institutional Sales Outlets Rejuvenation Plan (by Sep 2011) 3.1 Facilitate raw material procurement and cotton sliver production • KVIC develops quality norms for raw material procurement by khadi institutions (by Oct 2008) • KVIC initiates creation of a fund to kick-start private sector participation in sliver/roving

production (by Oct 2008) • KVIC conducts training for the 300 eligible khadi institutions on quality testing of raw materials

supported by ADB ADTA (by Jun 2009) • KVIC executes PPP agreements, on pilot basis, in two CSPs supported by ADB ADTA (by Jun

2009) • Progress report on KVIC assessment of PPP in CSPs supported by ADB ADTA (by Jul 2010) • KVIC develops the sliver capacity augmentation plan for khadi institutions (by Jul 2010) • KVIC executes PPP in the remaining CSPs supported by ADB ADTA (by Sep 2011) 3.2 Replace cost based pricing with market-linked pricing • KVIC agrees to undertake steps to allow khadi institutions to set their khadi prices through

approval of khadi reform package (by Oct 2008) • KVIC formulates benefit chart supported by ADB ADTA (by Jun 2009) • KVIC notifies the benefit chart and the requirement for the benefit chart to be implemented by

khadi institutions (by Jul 2010) • Progress report on the effectiveness of the implementation of the benefit chart supported by

ADB ADTA (by Sep 2011) 3.3 Rationalize financial assistance to khadi • KVIC agrees to undertake steps for the khadi institutions to shift to the production incentive plan

through approval of khadi reform package (by Oct 2008) • KVIC formulates and starts implementation of the production incentive plan to all khadi products

supported by ADB ADTA (by Jun 2009) • KVIC reassesses working capital requirement for khadi production (by Jun 2009) • KVIC appoints a focal person to engage with the bankers to enhance access of working capital

to khadi institutions (by Jun 2009) • In consultation with marketing organization, KVIC determines the product categories to phase

out of production incentives, and commence phasing out supported by ADB ADTA (by Jul 2010) • First progress report on KVIC assessment of the impact on sales as a result of production

incentives phasing out on certain product categories supported by ADB ADTA (by Jul 2010) • First progress report on the phasing out by KVIC of the ISEC, in line with the production

incentives phase out supported by ADB ADTA (by Jul 2010) • Second progress report on the phasing out of production incentives by KVIC on other

categories of products (by Sep 2011) • Second progress report on KVIC assessment of the impact on sales as a result of phasing out

of production incentives on other product categories through a progress report (by Sep 2011) • Second progress report on the phasing out of ISEC by KVIC on other categories of products in

line with phasing out of production incentives (by Sep 2011)

$12 million $2 million $2 million

Appendix 1 31

Activities with Milestones Inputs 3.4 Create new khadi ventures with greater entrepreneurial activity and enhance artisan empowerment • KVIC agrees to pursue the producer company model and enterprise model for new ventures in

khadi through approval of khadi reform package (by Oct 2008) • KVIC develops the framework for producer company model and enterprise model for new

ventures in khadi supported by ADB ADTA (by Jun 2009) • KVIC implements the framework for producer company model and enterprise model for new

ventures in khadi supported by ADB ADTA (by Jul 2010) • First progress report on KVIC implementation of the producer company model and enterprise

model for new ventures in khadi supported by ADB ADTA (by Jul 2010) • Second progress report on KVIC implementation of the producer company model and

enterprise model for new ventures in khadi (by Sep 2011) 4.1 Restructure KVIC organizationally for better focus on facilitative and developmental role • KVIC creates the steering committee and users committee for the IT/IS planning and

implementation (by Oct 2008) • KVIC adopts restructuring devolution plan (by Oct 2008) • KVIC implements restructuring devolution plan supported by ADB ADTA (by Jun 2009) • KVIC develops staffing norms consonant with the khadi reform package supported by ADB

ADTA (by Jun 2009) • KVIC develops integrated MIS supported by ADB ADTA (by Jun 2009) • KVIC develops IT/e-governance roadmap, infrastructure requirements, and linkage of IT/IS

strategy to the khadi reform package supported by ADB ADTA (by Jun 2009) • MMSME reviews the functions of the marketing directorate of KVIC (by Jun 2009) • KVIC reviews the existing structures and process for certification of khadi institutions and to

streamline the certification process including the directorates within KVIC the authority to make such certification (by Jun 2009)

• KVIC implements the MIS supported by ADB ADTA (by Jul 2010) • KVIC implements the integrated application system supported by ADB ADTA (by Jul 2010) • KVIC incorporates the marketing directorate as one of the divisions within the strategic planning

cell (by Jul 2010) • KVIC reallocates resources based on the staffing norms and manpower planning (by Jul 2010) • Review report by KVIC on the role and relevance of the central certification committee in the

certification process of khadi institutions (by Sep 2011) 4.2 Revitalize khadi institutions • KVIC formulates the comprehensive reforms plan for 300 eligible khadi institutions through

approval of khadi reform package (by Oct 2008) • KVIC modifies categorization norms for khadi institutions and recategorizes khadi institutions

using the modified norms supported by ADB ADTA (by Jun 2009) • KVIC adopts the comprehensive reforms plan to empower and revitalize the 300 eligible khadi

institutions supported by ADB ADTA (by Jun 2009) • KVIC signs MOUs with 50 eligible khadi institutions for comprehensive khadi institution reforms

(by Jun 2009) • KVIC ensures that the 50 eligible khadi institutions implement the comprehensive reforms plan

supported by ADB ADTA (by Jul 2010) • KVIC signs MOUs with 250 eligible khadi institutions for comprehensive khadi institution reforms

(by Jul 2010) • KVIC ensures that the additional 250 eligible khadi institutions implement the comprehensive

reforms plan supported by ADB ADTA (by Sep 2011) • Evaluation report by KVIC on performance of the 300 eligible khadi institutions (by Sep 2011) 4.3 Strengthen the capability of all institutions • KVIC agrees to develop a comprehensive capacity building plan (by Oct 2008) • KVIC formulates the comprehensive capacity building plan supported by ADB ADTA (by Jun

2009) • KVIC implements the comprehensive capacity building plan supported by ADB ADTA (by Jul

2010) • KVIC periodically publishes in its website the training calendar with inputs from marketing

organization supported by ADB ADTA (by Jul 2010)

$7 million $6 million

$75 million $9 million

32 Appendix 1

Activities with Milestones Inputs • Progress report by KVIC on the implementation of the comprehensive capacity building plan (by

Sep 2011) 4.4 Develop synergies through traditional village industries • KVIC agrees to identify around 5 village industries that are in line with the ethos of khadi

through approval of khadi reform package (by Oct 2008) • KVIC identifies around five traditional village industries based on the market survey by

marketing organization supported by ADB ADTA (by Jun 2009) • In coordination with the marketing organization, KVIC formulates cluster development strategy

for the identified village industries supported by ADB ADTA (by Jun 2009) • KVIC ensures establishment of one cluster for each of the identified village industry (by Jul

2010) • KVIC implements the comprehensive capacity building plan in the identified clusters (by Jul

2010) • Progress report by KVIC on the performance of the clusters (by Sep 2011)

$7 million

ADB = Asian Development Bank, ADTA = advisory technical assistance, CSP = central sliver plant, DSO = department sales outlets, EA = executing agency, ISEC = interest subsidy eligibility criteria, IT = information technology, IS = information system, JSF = Japan Special Fund, KVI = Khadi and Village Industries, KVIB = Khadi and Village Industries Board, KVIC = Khadi and Village Industry Commission, MIS = management information system, MMSME = Ministry of Micro, Small and Medium Enterprises, MOU = memorandum of understanding, OCR = ordinary capital resource, PPP = public–private partnership, RNFS = rural nonfarm sector.

Appendix 2 33

RURAL NONFARM SECTOR AND KHADI AND VILLAGE INDUSTRIES ANALYSIS A. The Rural Nonfarm Sector 1. Scope. The rural nonfarm sector (RNFS) encompasses all nonagricultural activities: mining and quarrying, household and nonhousehold manufacturing, processing, repair, construction, trade and commerce, transport, and other services in villages and rural towns undertaken by enterprises varying in size from household enterprises to factories.1 2. Significance. Literature assessing the national significance of the RNFS is largely based on employment rather than contribution to gross domestic product.2 Of an estimated labor force of 507 million in 2007, 380 million (76.4 %) are estimated to work in rural areas, with the majority (about 290 million) being engaged in agriculture and allied activities. The RNFS engages about 90 million, representing about 18% of the total workforce (Table A2.1).

Table A2.1: Estimates of Population and Employment 2000 2000 2007 2007 Year (million) Ratios (million) Ratios Total Population (TP) 1,004 1,113 Total Labor Force (LF) 406 0.40 (LF/TP) 507 0.46 (LF/TP) Total Employment (TE) 397 0.98 (TE/LF) 496 0.98 (TE/LF) Rural Employment (RE) 304 0.77 (RE/TE) 380 0.77 (RE/TE) Urban Employment (UE) 93 0.23 (UE/TE) 116 0.23 (UE/TE) Rural Nonfarm (RNF) 72 0.24 (RNF/TRE) 90 0.24 (RNF/TRE) Rural Agriculture/Allied (RAA) 232 0.76 (RAA/TRE) 290 0.76 (RAA/TRE) Total Rural Employment (TRE) 304 1.00 380 1.00

Sources: Estimates based on Government of India, Ministry of Statistics and Program Implementation. Various years, National Sample Survey 55th Round, Kundu A, et al. 2003. Rural Non-farm Employment: An Analysis of Rural Urban Interdependencies. Overseas Development Institute Working Paper 196, London. 3. Studies indicate that the RNFS engages from 20% to 25% of the rural workforce and income from the RNFS contributes approximately 25%–35% of the total income of rural households.3 Such studies suggest that the growth of real per capita nonagricultural output can have a significant impact in reducing rural poverty.4 4. Policy Interventions. The significance of policy interventions in the RNFS arises from the asymmetry in the population residing in rural areas (72%) and the decreasing contribution of agriculture and allied activities to gross domestic product (currently 18%). The declining employment elasticity of agriculture suggests that policy interventions need to focus on creating opportunities in the nonfarm sector where the secondary and tertiary sectors can absorb the

1 Jha, Brajesh. 2006. Rural Non-Farm Employment in India: Macro-trends, Micro-evidences and Policy Options.

Institute of Economic Growth Working Paper 272. New Delhi: Institute of Economic Growth. 2 The literature is based on two main sources of employment data in India, namely, the decennial census (latest

being in 2000), and the quinquennial rounds on employment and unemployment of the national sample survey. 3 Hazell, P.B.R. and S. Haggblade. 1991. Rural Growth Linkages in India. Indian Journal of Agricultural Economics

46(4): 515–529. Also, Walker, T.S. and J.G. Ryan. 1990. Village and Household Economies in India’s Semi-Arid Tropics. Baltimore and London: John Hopkins University Press.

4 Ravallion, Martin. 2000. What is Needed for a More Pro-Poor Growth Process in India? Economic and Political Weekly 35(13): 1,089–1,093 quoted in Daniel Coppard, 2001.

34 Appendix 2

labor displaced by agriculture. The focus of most policy interventions in the RNFS has been on generating employment, enhancing productivity, and catalyzing the flow of credit to the sector. 5. RNFS employment is particularly relevant to landless laborers, farmers with small landholdings, and the socioeconomically marginalized. Recently, the Government has also emphasized the potential of the informal sector to spur growth. In this context, the significance of the RNFS, thus, arises from (i) employment, (ii) growth, (iii) urban migration, and (iv) distributional and social justice perspectives. The RNFS holds potential to generate rural employment, enhance rural incomes, address rural poverty, and tackle issues of unequal income distribution through inclusive growth. 6. Institutional Landscape. The institutional landscape that characterizes the RNFS is provided in Figure A2. Over the years, especially after the 1970s, numerous institutions have been established under different ministries with the mandate to bring about development, create facilitating conditions to develop village industries, enhance productivity, and generate employment in the RNFS. Lack of coordination among these institutions has resulted in overlapping mandates. 7. Agencies such as the district rural development agencies5 and district industries centers6 were created in every district and have considerable infrastructure. After nationalization, banks have been actively involved in the RNFS and associated with government schemes. Financing and policy-making organizations such as the National Bank for Agriculture and Rural Development7 and the Small Industries Development Bank of India have a major nonfarm sector focus across India. The Small Industries Development Bank was established in 1990 to promote, finance, and develop small-scale industries and coordinate the functions of other institutions engaged in similar activities. Its current mission is to empower micro, small, and medium-sized enterprises with a view to contributing to economic growth, employment generation, and balanced regional development. 8. The Council for Advancement of People's Action and Rural Technology, established in 1986, works as a nodal agency for catalyzing and coordinating partnerships between voluntary organizations and the Government for sustainable development of rural areas. Examples of other corporations established in the RNFS include the Handicraft Development Corporation, Leather Development Corporation, and Minor Forest Products Corporation.

5 The district rural development agencies were put in place in the 1970s as specialized professional agencies

capable of managing the antipoverty programs of the Ministry of Rural Development and effectively relating the schemes to the overall effort of poverty reduction in the districts.

6 The district industries centers were set up after 1977 to promote district and grassroots small-scale, village, and cottage industries. These were headed by general managers. The Khadi and Village Industries Commission is represented in their committees.

7 The National Bank for Agriculture and Rural Development (NABARD) was established in 1981 as an apex development bank with a mandate for facilitating credit flow for promotion and development of agriculture, small-scale industries, cottage and village industries, handicrafts, and other rural crafts. It also has the mandate to support all other allied economic activities in rural areas, promote integrated and sustainable rural development, and secure prosperity of rural areas. NABARD also provides refinancing to lending institutions in rural areas, promotes institutional development, and acts as a coordinator in the operations of rural credit institutions. In addition, NABARD provides advice to government and other organizations in matters related to rural development; and offers training and research facilities to banks, cooperatives, and organizations working in the field of rural development. NABARD is the implementing agency for the ongoing ADB-funded Rural Cooperative Credit Restructuring and Development Program.

Appendix 2 35

9. Characteristics of the RNFS. The Fifth Economic Census, conducted during 2005 identifies about 44.1 million nonfarm enterprises in the country (Table A2.2). Of these, the overwhelming proportion has less than 10 workers.

Figure A2: Institutional Landscape of the Rural Nonfarm Sector

CAPART = Council for Advancement of People’s Action and Rural Technology; DIC = district industries center; DRDA = district rural development agency; KVIB = Khadi and Village Industries Board; KVIC = Khadi and Village Industries Commission; MMSME = Ministry of Micro, Small and Medium Enterprises; MOFPI = Ministry of Food Processing Industries; MOT = Ministry of Textiles; MOTA = Ministry of Tribal Affairs; MRD = Ministry of Rural Development; MUE & PA = Ministry of Urban Employment & Poverty Alleviation; NABARD = National Bank for Agriculture and Rural Development; NGO = nongovernment organization; SIDBI = Small Industries Development Bank of India. Source: Asian Development Bank.

Table A2.2: Characteristics of Nonfarm Sector Enterprises 1999–2000 Broad Industry

Number of Enterprises

Employ -ment GVA

Plant and Machinery

GVA Per Enterprise

GVA Per Worker

Plant and Machinery

per Enterprise

Group (million) (%) (%) (%) (Rs) (Rs) (Rs) Manufacturing 14.00 36.16 25.13 57.99 30,921 15,995 17,759 Construction 1.80 3.19 3.67 1.49 34,513 26,515 34,301 Trade and Repair Services

17.40 37.12 46.79 8.79 46,525 29,013 10,364

Hotels and Restaurants

1.80 5.18 5.03 0.95 49,521 22,384 4,994

Transport, Storage, Communication

3.90 6.72 8.08 6.22 35,813 27,687 36,314

Other Services 5.20 11.63 11.30 24.56 37,429 22,356 58,359 Total 44.10 100.00 100.00 100.00 39,157 23,019 20,245

GVA = gross value added. Source: National Sample Survey 55th Round 1999-00, Informal Non-agricultural Enterprises. Computed from National Commission for Enterprises in the Unorganized Sector. 2007. Report on Financing of Enterprises in the Unorganized Sector and Creation of a National Fund for the Unorganized Sector: 7.

Policy and Financing Agencies

NABARD, SIDBI, KVIC, CAPART

Ministries Policies and Schemes

MMSME, MRD, MOT, MUE & PA, MOTA, MOFPI

Government/Quasi Government Implementing

Agencies KVIC/KVIB, DIC, DRDA, Banks

Microfinance Institutions

Policy/Financing Participants

Capacity Building and Training Institutions

For implementing agencies

For rural entrepreneurs

Potential Rural Entrepreneurs

NGOs, Cooperatives, Trusts

Research and Extension Government Departments

Research Institutions Technical & Design

Institutions

Support Institutions

Implementing Agencies

36 Appendix 2

B. The Khadi and Village Industries Subsector 10. Khadi and village industries (KVI) are a subsector of the RNFS. Broadly, khadi refers to a hand-spun, handwoven cloth whereas village industries such as pottery, handicrafts, leather, black smithy, carpentry, various processed foods and condiments, cane and bamboo craft, goods made from various plant fibers refer to small and microenterprises in any industry located in rural areas that produce any goods or renders any service with or without use of power, in which fixed capital investment (in plant, machinery, land, and building) per artisan or worker does not exceed a specific amount. 11. Consistent statistics related to KVI are not available. What is available is information related to the programs of the Khadi and Village Industries Commission (KVIC), which is the apex body to catalyze KVI growth. The KVIC-aided subsector is unique in the sense that it carries an emotive content as it was linked to India’s freedom and is based on Gandhian thought. Today, the values underpinning the khadi concept has gained impetus in the context of (i) the recent global environment movement and the emphasis on green, sustainable, and ethical livelihoods; and (ii) the realization of the importance of the informal sector in spurring economic growth. 12. Most KVI have limited access to institutional credit; the outstanding credit to village artisans is estimated to represent less than 1% of bank credit. Their share between 1990 and 2005 declined from 0.9% to 0.6%.8 Even more apparent is the decline in the number of bank accounts of village artisans from 2.2 million accounts in 1990 to 1.3 million in 2005. 13. The village industries program, currently a focus of the Government’s Rural Employment Generation Programme (REGP), has emerged as its flagship program. REGP targets have been consistently exceeded in the past few years and it is perceived as one of the few fairly successful employment generation schemes on the basis of targets achieved, sustainable employment generated, and bank loan recoveries from beneficiaries. In the process, however, its focus on traditional village industries and rural artisans has gradually been diluted. 14. KVIC was set up in April 1957 as a statutory body.9 It traces its origins to the khadi institutions, the primary producers and marketers of khadi that were largely constituted as nongovernment organizations in the 1920s.10 KVIC is among the earliest agencies set up with the mandate to catalyze the nonfarm sector, generate employment, and create sustainable livelihoods. The purpose of promoting the KVI subsector was to promote local resource-based products and traditional crafts in rural areas.11 The objectives of KVIC include (i) the social objective of providing employment, (ii) the economic objective of producing saleable articles, and (iii) the wider objective of creating self-reliance among the poor and building up a strong rural community spirit.

8 National Commission for Enterprises in the Unorganized Sector. 2007. Report on Financing of Enterprises in the

Unorganized Sector and Creation of a National Fund for the Unorganized Sector. New Delhi. 9 KVIC was established by an Act of Parliament (1956). It commenced operations in April 1957 when it took over the

work of the former All India Khadi and Village Industries Board. The KVIC Act was amended in 1987, 1989, 1994, and 2006.

10 The All India Khadi Samiti was set up by Mahatma Gandhi in December 1923, The All India Spinners’ Association or the Akhil Bharatiya Charkha Sangh was set up in 1925 followed by the All India Village Industries Association.

11 Rural area in this context is any area classified as village as per the revenue records of the state, irrespective of population. This includes areas classified as town but with a population of 20,000 or less.

Appendix 2 37

15. The Ministry of Micro, Small and Medium Enterprises currently administers KVIC.12 KVIC manages its programs through a central office in Mumbai and regional offices in 36 states. The state offices are responsible for implementing the KVIC program and monitoring the program through interaction with state KVI boards (KVIB). The day-to-day operations are handled by the chief executive officer and six zonal deputy chief executive officers. KVIC has separate directorate positions for khadi, village industries, and REGP to maintain focus on activities. 16. KVIC’s interventions are essentially geared to removing barriers to rural livelihoods, i.e., issues of human capital (capacity building), access to appropriate technology, financial (access to credit), location barriers (infrastructure and connectivity), market access, and institutional barriers of policy and practice. Overall, the focus of KVIC is to create facilitating conditions to generate rural employment, make rural entrepreneurs competitive, create self-reliance, build a strong community spirit, promote local resource-based products and traditional crafts, and administer government programs. KVIC’s current role comprises (i) development and implementation of schemes targeted at institutions registered with KVIC and state KVIBs, (ii) policy formulation, (iii) registration and monitoring of khadi institutions, (iv) production and procurement of raw materials and distribution to producers, (v) promotion and marketing of KVI products, (vi) human resource development through training, (vii) research and development, and (viii) financing of eligible KVI institutions (presently only to village industries through the REGP). 17. KVIC interventions are now being refocused to a cluster-based approach to better leverage the efficacy of the interventions. The KVIC program for implementing its objectives comprises KVIC’s policy schemes: (i) khadi program, including raw material procurement, marketing, cost chart, financial assistance in the form of rebates, and interest rate subsidies; (ii) village industries programs, including the Rural Industry Service Center, which supports upgrading of production capacity, market promotion, and skills development; and the Rural Employment Generation Programme,13 which provides margin money subsidy for setting up an enterprise in rural areas with a population less than 20,000; (iii) programs for both khadi and village industries, including the Scheme of Funding for Regeneration of Traditional Industries, which supports integrated development of traditional khadi, coir, and village industries, including leather and pottery, based on a cluster approach; and the Product Development Design Intervention and Packaging Scheme, which is to improve quality and develop new product lines; (iv) training; and (v) research and development. The KVI program is implemented through 5,549 registered institutions, 33 state KVIBs, about 30,000 cooperative societies, 27 public sector banks, regional rural banks, a few selected cooperative banks, and nearly 262,000 REGP entrepreneurs. 18. KVIC is the national government body for khadi and is involved in producing khadi inputs and marketing khadi products (through its own outlets). KVIC provides training, research, and development support to khadi institutions. For village industries, KVIC implements village industry programs along with other agencies under the Ministry of Rural Development and Ministry of Forest Development. Of the total KVI products sold under the KVIC program, 0.26% are sold through marketing outlets and the balance through outlets owned and managed by khadi and village institutions and entrepreneurs (under the KVIC program). The KVIC state offices and KVIBs facilitate implementation in the states. KVIBs are state government bodies;

12 The Micro, Small and Medium Enterprises Development Act, 2006 became effective on 2 October 2006. It governs

the promotion and development of micro, small, and medium-sized enterprises. 13 Margin money subsidy from the Government is 25% up to Rs1 million for the project cost and an additional 10% for

the balance of the cost up to Rs2.5 million. The balance of the project cost is financed by bank loans.

38 Appendix 2

because of their grassroots reach, they are important agencies for implementing the KVIC program. In addition, some of the proactive state governments launch promotional schemes within their states, which are implemented by KVIBs. The state governments fund administrative expenses of KVIBs and KVIC funds the implementation of KVI programs by KVIBs. 19. KVIC has catalyzed capital formation exceeding Rs78 billion in the RNFS, and its aided enterprises have generated livelihoods for more than 9 million people. In FY2006, KVIC-aided enterprises had sales exceeding Rs175 billion. The compound annual growth rate from FY1994–FY2006 for production was 13.1% and for sales 15.1%. The overall production of KVI goods and services increased to Rs140.2 billion (13.28%) and sales to Rs175.6 billion (14.97%) in FY2006 from the previous year. The growth was largely on account of the village industries. Total employment registered with KVIC and the KVIBs also increased from 5.2 million in FY1994 to 9 million in FY2006, of which about 90% are employed in village industries. 20. Strengthening KVI Subsector. The performance of KVI subsector and KVIC is reviewed from time to time. The prominent reviews include The KVI Review Committee (M. Ramakrishnayya) 1987 resulting in the definition of village industries being changed; the High Power Committee constituted under the chairmanship of then Prime Minister Mr. P. V. Narasimha Rao (1994) resulting in the introduction of the REGP program; the Arthur Andersen Report (2000) addressing the organization structure of KVIC; the KC Pant Report (2001) resulting in the development of a marketing body; and the Confederation for Promotions of KVI; and the Expert Committee Report (D.M. Sukthankar) 2005, which identified the need for changes in KVIC’s structure and functioning and recommended measures to revamp the KVIC. C. Khadi 21. Khadi institutions, or the primary producers and marketers of khadi, are registered as charitable societies14 or public charitable trusts, and are affiliated15 with either KVIC or KVIBs. Khadi institutions are rural based and engaged in production (hand spinning of cotton sliver, silk, or wool; hand reeling of silk into yarn; handloom weaving of yarn into fabric; processing for finishing; garment making) 16 and retailing and marketing of khadi products. Some khadi institutions are integrated into the production of raw material from cotton. Of the 1,952 khadi institutions, only 64 are exclusively trading institutions; all the others are engaged in production as well as retailing/marketing of khadi. 22. The size of the current market for khadi is difficult to precisely assess since machine-made textiles are also spuriously sold as khadi. Khadi produced under the KVIC khadi program, sold through 7,050 khadi institution sales outlets and 11 direct sales outlets of KVIC, grew 2% in volume and 3% in value during FY2002–FY2006. In FY2006, production increased by 4.9% and sales by 5.5%. These figures do not include hand-spun and woven khadi sold by around 90 outlets of Fabindia, and other private enterprises for which data is not available. Nearly two thirds of the market is for cotton khadi. Overall, khadi is estimated to constitute less than 1% of the textile market in India. In contrast, the overall textile market has expanded rapidly and changed in composition as the economy has grown. Total textile production increased at a

14 The societies are based on respective state societies registration acts (1860). 15 1,252 are affiliated with KVIC, and 700 with the KVIBs. Delhi, Himachai Pradesh, Punjub, Jharkhand, the

northeastern states, Tamil Nadu, Maharashtra, Chhattisgarh, and Madhya Pradesh have no institutions affiliated to KVIB. Goa, Tripura, and Mizoram have no khadi institutions.

16 In addition to cotton, silk, and wool, polyvastra (polyester–cotton khadi mix) is also produced under the KVIC program.

Appendix 2 39

compound growth rate of 7% (in volume) and 15% (in value) during FY2002–FY2006. Increasingly urban and higher and middle income class consumers are becoming aware of quality and fashion trends. In the more price sensitive lower income segments, synthetics are replacing cotton textiles. 23. Cotton khadi production is preeminent in Uttar Pradesh; West Bengal and Tamil Nadu are the principal silk khadi producers; and Haryana, Uttar Pradesh, and Rajasthan the main producers of woolen khadi (Table A2.3). 24. It is estimated that khadi accounts for 10%–12% of KVI employment, or nearly 1 million. Khadi provides rural employment in hand spinning (cotton, wool, and silk), hand reeling of silk, handloom weaving, processing of fabric, and garment making. Semi-skilled (principally spinners) and skilled (principally weavers) artisans employed by khadi Institutions are the backbone of the khadi production workforce. Nonartisans are categorized as “other,” which includes secretary, sales, and administrative personnel. Spinning provides employment to the largest number 79%, followed by weaving and fabric processing 12%, and others 9%. Almost 80% of spinners are women. The high participation of women is considered an affirmation that spinning is a subsidiary activity and that it is sought by people less able to migrate in search of work or less able to work outdoors due to social customs.

Table A2.3: Top Four Khadi-Producing States

Cotton Khadi Wool Khadi Silk Khadi Rank State (Share %) State (Share %) State (Share %) 1 Uttar Pradesh (45.36) Haryana (23.48) West Bengal (31.48) 2 Tamil Nadu (8.59) Uttar Pradesh (19.12) Tamil Nadu (31.02) 3 Gujarat (6.74) Rajasthan (18.46) Karnataka (7.69) 4 Haryana (6.41) Karnataka (10.20) Gujarat (6.13)

Source: Khadi and Village Industries Commission Annual Report 2006–2007. 25. Artisan earnings from conversion are less than satisfactory. The average annual wages in FY2006 were Rs2,555 for cotton, Rs3,143 for wool, and Rs8,141 for silk. Wages for cotton and wool workers are less than the official poverty line of Rs4,275 for rural areas.17 The wage breakdown by each category of work is (i) spinners: Rs822 for cotton, Rs1,070 for wool, and Rs3.035 for silk, (ii) weavers: Rs7,380 for cotton, Rs7,665 for wool and Rs12,141 for silk, and (iii) others: Rs13,932 for cotton, Rs15,091 for wool, and Rs23,380 for silk. The earnings of spinners across product categories are much lower than the earnings of weavers and others. Cotton spinners, in particular, earn only Rs822 a year on average or less than Rs69 a month from khadi spinning. Findings from interactions with spinners (Rajasthan and Tamil Nadu) indicate that daily wages for cotton khadi hover around Rs30–Rs40.18 Assuming a wage rate of Rs30 a day, the full-time employment days of cotton spinners works out to 27.4 days, less than 1 month a year.

17 Official poverty line for the urban area is Rs6,463. 18 While local wages in rural areas vary widely across regions and during the year, the peak rate during the farming

season is around Rs30 even in the poorest regions. Although the minimum wages vary across states, the average minimum daily wage is around Rs70.

40 Appendix 3

PROBLEM TREE ANALYSIS

w Effects

Key Problem

Causes

Employment potential not

realized

Stagnant production and sales of khadi

Inadequate Capacity of Khadi and Village

Industries Commission

Weak khadi institutions

Ineffective khadi policy and strategy

• Overlaps in the organization of functions

• Inadequate delegation and devolution

• Ineffective strategic planning

• Insufficient skills for managing commercial operations

• Obsolete information technology and management information system

• Governance structure excludes artisan participation

• Obsolete production technology

• Working capital constraints

• Limited marketing and product development capability

• Lack of coherent marketing strategy

• Product strategy not based on consumer preference

• No strategy for promoting khadi as a brand

• Dismal performance of sales outlets

Weak marketing policy

Poor quality and cost of raw materials

t t

Repressive controls and

support schemes

• Inefficient production of raw material

• Inadequate testing capability for quality of raw material and yarn

• Pricing of products does not ensure fair earning for artisans

• Distorted financial assistance plan that subsidizes consumers

Low artisan earning

Source: Asian Development Bank.

41Appendix 4

DEVELOPMENT COORDINATION MATRIX

CCS = credit cooperative system, DFID = Department for International Development, GTZ = Gesellschaft for Technische Zusammenarbeit (German Technical Cooperation Agency), IDA = International Development Association, SME = small and medium-sized enterprise. a Equivalent to approximately $269 million. b Equivalent to approximately $38 million. Source: Asian Development Bank.

Rural Development Small and Medium-Sized Enterprise Finance Sector World Bank: Andhra Pradesh Rural Poverty Reduction Project (additional financing) ($65 million from IDA, approved on 10 July 2007). The project is to facilitate critical investments in institution and capacity building of the community institutions of poor women for them to become sustainable and self-reliant; investments in livelihood-based institutions like business franchises and producer companies; and additional investment including technical support and mainstreaming of various successful pilot approaches. DFID: Rural Livelihood Programs (£143 million,a approved in 2004). The programs are to develop improved approaches to enhance livelihoods, tackling hunger and providing access to basic services in socially backward areas in West Bengal, Madhya Pradesh, and in Western Orissa.

World Bank: SME Financing and Development Project ($120 million from IDA, approved on 30 November 2004). The objective of the project is to improve SME access to finance including term finance, and business development services, thereby fostering SME growth, competitiveness, and employment creation. The Project has three main components: credit facility, risk-sharing facility, and policy and institutional development technical assistance program. DFID: SME Support Project (£20 million,b approved in 2005). The project aims to facilitate increased flow of financial and nonfinancial services to SMEs. The development of SMEs is crucial for the creation of jobs and income needed to reduce India’s poverty. GTZ: Promotion of Industrial Services and Employment (from January 2005 to December 2008). The objective of the project is to adjust the training and advisory services offered by technology centers and the testing and quality certification to conform to the long-term needs of technology-intensive SMEs, at the same time helping meet the goals of the Indian Government’s program for disadvantaged groups.

Asian Development Bank: Rural Cooperative Credit Restructuring and Development Program ($1 billion, approved on 8 December 2006). The goal of the program is to develop a sustainable CCS; the objective is to help the Government carry out its CCS reform agenda. Its impact is enhanced income and employment growth for the rural poor, while its purpose is to improve rural households’ access to affordable financial services through an efficient CCS. World Bank: Strengthening India’s Rural Credit Cooperatives ($600 million from IDA, approved on 26 June 2007). The project will assist in providing members of the Credit Cooperative Bank, including small and marginal farmers, with significantly enhanced access to formal finance by ensuring that the potentially viable credit cooperative banks in the participating states are transformed into efficient and commercially sustainable institutions. GTZ: Rural Financial System Development Program (from January 2005 to December 2012). The program sustainably increases the quality and economic viability of financial services for reforming and revitalizing the Indian cooperative system.

International Monetary Fund: Emphasizes greater progress in structural reforms to ease real sector rigidity, boost productivity and competitiveness, and ensure that the benefits of growth are widely shared. Priorities identified are bridging infrastructure gaps with private sector participation, ensuring access to social services, and promoting a competitive environment that supports private sector investment and job creation. More flexible labor regulations can facilitate the reallocation of labor to stronger sectors, while higher and more effective public spending on education is needed to address the skills gap.

42 Appendix 5

DEVELOPMENT POLICY LETTER

Appendix 5 43

44 Appendix 5

Appendix 5 45

46 Appendix 5

Appendix 5 47

48 Appendix 6

POLICY MATRIX

Policy Actions First Tranche $20 million

Second Tranche $40 million

(Within 8 months from First Tranche)

Third Tranche $40 million

(Within 13 months from Second Tranche)

Fourth Tranche $50 million

(Within 15 months from Third Tranche)

I. Establishing a Policy Reform and Implementation Framework

A comprehensive reform package for the development of khadi

Government of India (the Government) conducts a review of the performance of khadi sub-sector comprising KVIC and other subsidiary institutions and develops a khadi reform package to strengthen the khadi sub-sector. (khadi reform package) KVIC agrees on the khadi reform package comprising – policy, legal, marketing, and institutional reforms for achieving sustainability of khadi and enhancing artisan welfare. (KVIC letter indicating concurrence) KVIC, in consultation with MMSME, develops (i) criteria for selecting khadi institutions eligible for assistance under the khadi reform package, which will primarily be performance-based with due regard to regional balance and the inclusion of backward areas, and (ii) draft MOU between KVIC and khadi institutions on comprehensive reforms for khadi institutions, which

KVIC ensures the completion of the audit for 50 eligible khadi institutions by independent auditors. (summary of audit findings) KVIC disseminates the khadi reform package nationwide through workshops. (list of state-wide workshops)

KVIC (i) undertakes the first independent assessment of the khadi reform package, (ii) holds a stakeholder consultation on the outcome of the assessment, and (iii) prepares appropriate measures to address the feedback. (assessment report ) KVIC ensures the completion of the audit of remaining 250 eligible khadi institutions by independent auditors. (summary of audit findings)

KVIC (i) undertakes the second independent assessment of the khadi reform package, (ii) holds a stakeholder consultation on the outcome of the assessment, and (iii) prepares appropriate measures to address the feedback. (assessment report )

49Appendix 6








will include performance benchmarks and sanctions for khadi institutions that fail to meet the performance benchmarks. (eligibility criteria and MOU) KVIC selects 300 khadi institutions eligible for support under the khadi reform package. (list of eligible khadi institutions)

II. Promoting and Marketing Khadi

Establishing identity of khadi through khadi mark

KVIC agrees to undertake steps to develop khadi mark and link the artisan’s base earnings to the use of khadi mark. (khadi reform package)

KVIC develops the khadi mark, including designing its logo, and registers the khadi mark under the Trade Marks Act. (registration certificate) KVIC undertakes (i) the formulation and execution of the MOU with the Ministry of Textiles for testing infrastructure, (ii) the formulation and execution of the model agreement for licensing the use of khadi mark; (iii) the development of the detailed plan for the creation of basic testing infrastructure for khadi mark at KVIC; and (iv) the arrangement for managing khadi mark by KVIC State/Divisional offices. (khadi mark procedural protocols) KVIC adopts procedures and assigns the Khadi Directorate to grant usage of khadi mark to khadi Institutions and other entities. (notification)

KVIC through its Khadi Directorate prepares and maintains a list of the khadi institutions and other entities authorized to use khadi mark and publish this in its website. (list on KVIC website) KVIC creates the basic testing infrastructure for the khadi mark. (testing infrastructure) KVIC conducts random spot audits of khadi institutions and other entities authorized to use khadi mark regarding their adherence to the licensing requirements for the use of khadi mark. (spot audit report)

KVIC through its Khadi Directorate updates the list of the khadi institutions and other entities authorized to use the khadi mark. (list on KVIC website) KVIC continues to conduct random spot audits of khadi institutions and other entities authorized to use khadi mark regarding their adherence to the licensing requirements for the use of khadi mark. (spot audit report)

50 Appendix 6








KVIC through its Khadi Directorate ensures that the khadi institutions registered at either KVIC or KVIB adopt the khadi mark. (registration records)

Effective marketing through private sector participation

KVIC agrees to establish a new marketing organization with majority private sector ownership (khadi reform package)

KVIC identifies potential private partners for the new marketing organization and ensures the incorporation of marketing organization. (MOU and incorporation certificate) KVIC transfers the rights of promotion and usage of khadi mark to marketing organization under a licensing agreement. (licensing agreement) MMSME issues a directive to allow KVIC to provide capital contribution for the establishment of the joint-venture marketing organization. (directive) Marketing organization commissions a product specific market survey of khadi and village industries products through a specialist firm. (appointment letter) MMSME develops the Khadi Marketing Extension Program for incentivizing the establishment of new DSOs by the marketing organization. (khadi marketing extension programme)

Marketing organization develops the framework for introducing PPP in the KVIC DSOs and introduces PPPs in 2 KVIC DSOs. (PPP framework and PPP agreements) Based on the outcome of the survey, the marketing organization identifies products for both domestic and international markets and develop marketing strategies for all khadi related institutions and products. (marketing strategy) Marketing organization prepares a product catalogue and sets up the market information system. (product catalogue and marketing organization certification) Marketing organization develops and implements the Institutional Sales Outlets Rejuvenation Plan. (institutional sales outlets rejuvenation plan and progress report)

The Marketing organization introduces PPPs in at least 2 other willing KVIC DSOs, in consultation with KVIC. (PPP agreements) Marketing organization continues the implementation of the Institutional Sales Outlets Rejuvenation Plan. (progress report) Marketing organization formulates guidelines for the setting up of new sales outlets by khadi institutions. (guidelines) Marketing organization establishes a minimum of 10 DSOs under the Khadi Marketing Extension Program. (establishment report)

51Appendix 6








Marketing organization establishes three DSOs under the Khadi Marketing Extension Program. (establishment report)

III. Realizing Procurement and Production Efficiencies

Facilitating raw material procurement and cotton sliver production

KVIC develops quality norms for raw material procurement by khadi institutions. (quality norms issued by KVIC) KVIC initiates the creation of a fund to kick-start private sector participation in sliver/roving production. (KVIC letter, which will incorporate the guidelines for utilization of the fund)

KVIC conducts training for the 300 eligible khadi institutions on quality testing of raw materials. (trainings) KVIC executes PPP agreements, on pilot basis, in two CSPs. (executed agreements)

KVIC (i) assesses PPP in CSPs and (ii) identifies the success factors, and the issues to be resolved in the next phase of PPP. (progress report) KVIC develops the sliver capacity augmentation plan for the khadi institutions. (framework)

KVIC executes PPP agreements in the remaining CSPs. (progress report)

Market-linked pricing to replace cost-based pricing

KVIC agrees to undertake steps to allow khadi institutions to set their khadi prices. (khadi reform package)

KVIC issues a notification to allow khadi institutions to set market-linked prices. (notification) KVIC formulates benefit chart. (benefit chart)

KVIC notifies the benefit chart and the requirement for the benefit chart to be implemented by the 300 eligible khadi institutions. (notification)

KVIC monitors and assesses the effectiveness of the implementation of the benefit chart. (assessment report)

Rationalization of financial assistance for khadi

KVIC agrees to undertake steps for the khadi institutions to shift to the production incentive plan. (khadi reform package)

KVIC formulates the production incentive plan and provides production incentive to all khadi products. (production incentive plan) KVIC reassesses working capital requirement for khadi production. (assessment of working capital

In consultation with marketing organization, KVIC (i) determines the product categories that can phase out of production incentives and (ii) commences its phasing out and assesses the impact on sales as a result of this. (assessment report)

In consultation with marketing organization, KVIC continues the phasing out of production incentives on other categories of products, and assesses the impact on sales as a result of this. (progress report)

52 Appendix 6








requirement) KVIC appoints a focal person to engage with the bankers to enhance access of the khadi institutions to working capital. (appointment letter)

KVIC commences phasing out of the ISEC, in line with the production incentives phase out. (progress report)

KVIC continues phasing out of ISEC on other categories of products in line with production incentives phase out. (progress report)

Creation of new khadi ventures with greater entrepreneurial activity and enhanced artisan empowerment

KVIC agrees to pursue the producer company model and enterprise model for new ventures in khadi. (khadi reform package)

KVIC develops the framework for producer company model and enterprise model for new ventures in khadi. (framework for producer company model and entrepreneurial model)

KVIC implements the producer company model and enterprise model for new ventures in khadi. (progress report)

KVIC continues the implementation of the producer company model and the enterprise model for new ventures in khadi. (progress report)

IV. Implementing Institutional Reforms

Organizational restructuring of KVIC for better focus on facilitative and developmental role

KVIC adopts the restructuring devolution plan for (i) restructuring khadi, village industries, science and technology, and economic research directorates; (ii) strengthening of human resource and administration directorate; (iii) realignment of reporting relationships; and (iv) devolution of powers and responsibilities to zonal offices. (restructuring devolution plan) KVIC creates the steering committee and users committee for the IT/IS planning and implementation. (KVIC notification)

KVIC (i) restructures khadi directorates, village industry directorates, science and technology directorates, and economic research directorates, (ii) strengthens human resource and administration directorates, (iii) realigns reporting relationships for efficiency, and (iv) devolves power to zonal offices. (KVIC notification) KVIC (a) reviews the existing structures and processes for the certification of the khadi institutions, and (b) issues appropriate guidelines to empower a committee within the directorates of KVIC with the authority for the certification of khadi institutions, under the guidance and advice of the central certification committee. (guidelines) KVIC develops staffing norms

KVIC reallocates resources based on the staffing norms and manpower planning. (administrative order) KVIC implements the MIS. (progress report) KVIC implements the integrated application system. (progress report) KVIC incorporates the Marketing Directorate as one of the divisions within the Strategic Planning Cell. (revised KVIC organization chart)

KVIC reviews the role and relevance of the central certification committee in the certification process of the khadi institutions.

53Appendix 6








consonant with the khadi reform package. (staffing norms) KVIC develops integrated MIS. (MIS) KVIC develops IT/e-governance roadmap, infrastructure requirements, and linkage of IT/IS strategy to the khadi reform package. (integrated application system) MMSME reviews the functions of the Marketing Directorate of KVIC. (MMSME review report)

Revitalize khadi Institutions

KVIC agrees to formulate the comprehensive reforms plan for the 300 eligible khadi institutions. (khadi reform package)

KVIC modifies categorization norms for khadi institutions and re-categorize khadi institutions using the modified norms. (list of re-categorized khadi institutions) KVIC adopts the comprehensive reforms plan to empower and revitalize the 300 eligible khadi institutions. (comprehensive reforms plan) KVIC signs with 50 eligible khadi institutions the MOUs for comprehensive khadi institution reforms. (MOUs)

KVIC ensures that the 50 eligible khadi institutions implement the comprehensive reforms plan. (progress report) KVIC signs with 250 eligible khadi institutions the MOUs for comprehensive khadi institution reforms. (MOUs)

KVIC ensures that the additional 250 eligible khadi institutions implement the comprehensive reforms plan. (progress report) KVIC evaluates the performance of the 300 eligible khadi Institutions. (evaluation report)

Strengthen the capability of all institutions

KVIC agrees to develop a comprehensive capacity building plan covering KVIC, KVIBs, khadi institutions, and artisans. (khadi reform package)

KVIC completes (i) the assessment of existing training arrangements (infrastructure, capacity of trainers, curriculum, and demand for training), and (ii) based on the assessment, a comprehensive plan for (a) demand driven training delivery; (b) the creation of linkages with external

KVIC implements the comprehensive capacity building plan. (progress report) KVIC periodically publishes in its website the training calendar with inputs from

KVIC continues the implementation of the comprehensive capacity building plan. (progress report)

54 Appendix 6








training program; (c) the upgrade physical infrastructure; and (d) the enhancement of skills of training staff. (comprehensive capacity building plan)

marketing organization. (training calendar in the KVIC website)

Develop synergies through traditional village industries

KVIC agrees to identify around 5 village industries that are in line with the ethos of khadi – handmade, use of organic inputs processes, and socially aware. (khadi reform package)

KVIC identifies around five thrust traditional village industries based on the market survey by marketing organization. (identified village industries) In coordination with the marketing organization, KVIC formulates cluster development strategy for the identified village industries. (cluster development strategy)

KVIC ensures the establishment of one cluster for each of the identified village industry. (progress report) KVIC ensures the implementation of the comprehensive capacity building plan in the identified clusters. (progress report)

KVIC monitors the performance of the clusters. (progress report)

CSP = central sliver plant; DSO = department sales outlets; ISEC = interest subsidy eligibility criteria; IT = information technology; IS = information system; KVIB = Khadi Village Industries Board; KVIC = Khadi and Village Industries Commission; MIS = management information system; MMSME = Ministry of Micro, Small and Medium Enterprises; MOU = memorandum of understanding; PPP = private–public partnership.

Appendix 755

PROGRAM MANAGEMENT CHART

= line of authority, = information flow, = adjustment cost fund flow, = agreement / MOU ADB = Asian Development Bank; DEA = Department of External Affairs; KVIB = Khadi and Village Industries Board; KVIC = Khadi and Village Industries Commission; MMSME = Ministry of Micro, Small and Medium Enterprises; MOF = Ministry of Finance; MOU = memorandum of understanding; RID = reform implementation division; RMU = reform management unit. Source: Asian Development Bank.

MOF DEA

MMSME

(Executing Agency)

KVIC (Implementing Agency)

RID

$150 million

Policy and institutional reforms: $48 million

Marketing reforms: $27 million

Strengthening of khadi institutions: $75 million

KVIC State/ Divisional Office

36 states RMU

Reform Implementation and Monitoring Committee

State KVIBs

Khadi institutions (300)

Zonal Office

ADB

Private Sector Partner

Marketing Organization Joint Venture Company

Program Loan $150 million

$150 million

$150 million

MOU

Joint Venture Equity

56Appendix 8

PROGRAM IMPLEMENTATION SCHEDULE

Planned Activity Precedent to Tranches 2008 2009 2010 2011 Activity

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 A. Establishing a Policy Reform and Implementation Framework

A Comprehensive Reform Package for Development of Khadi

Khadi reform package formulated and disseminated Reform implementation and monitoring committee constituted Reform implementation division constituted Khadi institutions selected and MOU signed Khadi institutions audited Stakeholder consultations B. Promoting and Marketing of Khadi Establishing Identity of Khadi through Khadi Mark Adoption of khadi mark Registration of khadi mark Procedural protocols for khadi mark Adoption of khadi mark by khadi institutions Creation of basic testing infrastructure for khadi mark Random spot audit on adherence to licensing requirements Effective Marketing through Private Sector Participation Capital contribution to the new marketing organization Incorporation of the new marketing organization Formulation of khadi marketing extension program Establishment of at least 13 new direct sales outlets Introduction of PPPs in direct sales outlets of KVIC Product catalogue and market information system developed Institutional sales outlets rejuvenated C. Realizing Procurement and Production Efficiencies Facilitating Raw Material Procurement and Cotton Sliver Production

Quality norms for raw material procurement developed Training on quality testing of raw materials conducted Fund for private participation in sliver/roving production created Sliver capacity augmentation plan for khadi institution

57Appendix 8

Planned Activity Precedent to Tranches

2008 2009 2010 2011 Activity Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3

Market-Linked Pricing to Replace Cost-Based Pricing Khadi institutions allowed to set prices for khadi products Benefit chart formulated and implemented Rationalization of Financial Assistance in Khadi Production incentive plan formulated and implemented ISEC phased out Working capital requirement and enhancement assessed Impact of phasing out financial assistance on sales monitored Creation of New Khadi Ventures with Greater Entrepreneurial Activity and Enhanced Artisan Empowerment

Models for new khadi ventures formulated and implemented D. Institutional Reforms Organizational Restructuring of KVIC for Better Focus on Facilitative and Developmental Role

Restructuring devolution plan formulated and implemented Staffing norms formulated and implemented Integrated application system formulated and implemented Revitalize Khadi Institutions Comprehensive reforms plan formulated and implemented Categorization norms for khadi institutions modified Strengthening the Capability of All Institutions Comprehensive capacity building plan formulated and implemented

Training calendar published Develop Synergies through Traditional Village Industries Five thrust traditional village industries identified Cluster development strategy formulated and implemented Capacity building for identified clusters implemented

ISEC = interest subsidy eligibility certificate; KVIC = Khadi and Village Industries Commission; MOU = memorandum of understanding; MMSME = Ministry of Micro, Small and Medium Enterprise; PPP = public–private partnership.


58 Appendix 9

LIST OF INELIGIBLE ITEMS

1. Loan proceeds will finance the foreign currency expenditures for the reasonable cost of imported goods required during the Khadi Reform and Development Program. 2. No withdrawals shall be made in respect of

(i) expenditures for goods included in the following groups or subgroups of the United Nations Standard International Trade Classification, Revision 3 (SITC, Rev. 3), or any successor groups or subgroups under future revisions to the SITC, as designated by ADB by notice to the Borrower;

Table A9: Ineligible Items

Chapter Heading Description of Items 112 Alcoholic beverages 121 Tobacco, unmanufactured; tobacco refuse 122 Tobacco, manufactured (whether or not containing tobacco

substitute) 525 Radioactive and associated materials 667 Pearls, precious and semiprecious stones, unworked or worked 718 718.7 Nuclear reactors, and parts thereof, fuel elements (cartridges),

nonirradiated for nuclear reactors 728 728.43 Tobacco processing machinery 897 897.3 Jewelry of gold, silver, or platinum-group metals (except

watches and watch cases) and goldsmiths’ or silversmiths’ wares (including set gems)

971 Gold, nonmonetary (excluding gold ore and concentrates) Source: United Nations Development Programme.

(ii) expenditures in the currency of the Borrower or of goods supplied from the territory of the Borrower;

(iii) expenditures for goods supplied under a contract that any national or

international financing institution or agency will have financed or has agreed to finance, including any contract financed under any loan or grant from ,ADB;

(iv) expenditures for goods intended for a military or paramilitary purpose or for

luxury consumption;

(v) expenditures for narcotics; (vi) expenditures for environmentally hazardous goods, the manufacture, use or

import of which is prohibited under the laws of the Borrower or international agreements to which the Borrower is a party; and

(vii) expenditures on account of any payment prohibited by the Borrower in

compliance with a decision of the United Nations Security Council taken under Chapter VII of the Charter of the United Nations.

Appendix 10

59

GOVERNANCE AND ANTICORRUPTION RISK ASSESSMENT 1. The Second Governance and Anticorruption Action Plan of the Asian Development Bank (ADB) specifies that program design should incorporate findings of governance, institutional, and corruption risk assessments; and that program documentation should clearly identify risk, risk management, and mitigation measures. Accordingly, this assessment takes a risk-based approach to, and an institutional focus on, implementation of the Khadi Reform and Development Program (the Program). A. Relevant Governance Issues for Khadi and Village Industries 2. To support, strengthen, and expand initiatives to create mass rural employment, the All India Khadi and Village Industries Board was set up in 1953 and subsequently, the Khadi and Village Industries Commission (KVIC) was created by an act of Parliament in 1956. KVIC functions are under the administrative control of the Ministry of Micro, Small and Medium Enterprises (MMSME). Following the setting up of KVIC, the state governments established state khadi and village industries boards (KVIB) under acts passed by the state legislatures to implement the KVIC program as well as other khadi and village industries programs in their respective territories. KVIC and the KVIBs implement the KVIC program through affiliated khadi institutions. Khadi institutions are constituted as charitable societies or public charitable trusts under state laws. They are rural based and engaged in production and retailing and/or marketing of khadi and village industries products. Of the 5,549 registered under KVIC or KVIB, 1,952 are exclusively engaged in production as well as retailing of khadi. 3. Governance and risk issues with respect to reform of production and marketing of khadi can be categorized under policy framework, institutional dimensions, and accountability and transparency. 4. Policy Framework. KVIC is the nodal institution for reform of production and marketing of khadi. Given the enormous inclusive development, employment, and income-generating scope of khadi, KVIC has significant responsibilities to discharge. Since 1987, review of the working of KVIC has been undertaken from time to time. However, efforts to operationalize these were fragmented. KVIC needs to recapture its original role as a promotional and development agency and facilitator for production of quality consumer products. 5. Institutional Dimensions. The establishment of khadi institutions is in accordance with either the Society Registration Act 1860, Indian Trust Act 1882, or the cooperative society act of each state. The governing board of a typical khadi institution could comprise a chief executive officer, secretary, representative of owners, and artisans. However, in many khadi institutions, artisan representation is nominal and minor, and the overall governance is weak. Management of these institutions has paid scarce attention to improving working conditions of artisans. 6. Accountability and Transparency. KVIC classifies khadi institutions on the basis of their operating status, excluding governance-related parameters. Further, KVIC does not have a specific policy for restructuring nonperforming khadi institutions. Currently, about 270 institutions are underperforming, and KVIC is continuing to provide financial support to them. No effective measures have been introduced to resolve the difficulties of the nonperforming khadi institutions. Dilution in representation of artisans has weakened the governance, accountability, and transparency of these institutions.

Appendix 10

60

B. Risks and Risk Mitigation Measures 7. Underlying Assumptions. The main assumptions in the risk analysis are that (i) the Government will stay the course in its objective of reforming the KVI subsector, particularly khadi, and the political commitment to attain it; (ii) the reforms sought will materialize and be sustained in the immediate future; (iii) effective institution building in key agencies will continue; and (iv) the KVIBs will support the proposed reforms of khadi institutions.

1. Risk Specification

8. Policy and Implementation Risks. Despite the Government’s successful track record of reforms in small and medium-sized enterprises and village industries, the longer time for building consensus to reform the production and marketing of khadi reflects the likely difficulties in pursing the reform agenda. In addition, the reform hierarchy involving participants all the way down to the grassroots could slow the momentum of reforms. KVIC’s commitment as the Program implementing agency and KVIB’s support are essential. These risks are dealt with in part by front loading the conditions relating to policy reform and implementation framework. 9. Accountability and Transparency Risks. Currently, KVIC and its zonal and state offices have no staffing norms, resulting in significant variations in deployment of staff. At the same time, current roles of KVIC directorates or divisions in the existing KVIC organization structure are not adequately identified and need to be reviewed. Moreover, the existing role of zonal offices is limited to monitoring information flow from the KVIC state offices to KVIC head office. No information system roadmap has been developed and KVIC’s information and database system management is inadequate. The present management information system at KVIC does not entirely comprehend and link product information and the institutions that produce products. Thus, internal accountability remains weak. 10. Institutional Risks. The reforms supported by the Program, including the restructuring of khadi institutions and KVIC itself, require understanding of the new policy measures to support khadi, the expected changes in business processes, and the required skill sets to implement these. Central and local government officials, KVIC staff, and khadi institutions might have difficulty orienting to market-linked strategies, declining financial assistance, and private sector professionalism in marketing. The new business processes supported by the Program require different skill sets that long-serving KVIC staff might not have. 11. Program Management. In implementing programs, delays are caused predominantly by lack of technical expertise and of the consensus-building approach needed to enact laws and regulations. Further, staff behavior could prove resistant to institutional and governance reforms, thereby undermining expected performance improvements.

2. Risk Severity 12. Table A10.1 on the next page shows the degree of severity of these and other risks.1 Note that type 1 risks are the most severe, followed by types II and III.

1 The degree of severity is calculated by the product of the range of likelihood of the risk occurring and the potential

impact of such a risk.

Appendix 10

61

Table A10.1. Risk Severity Matrix

Impact (I)

5 4 3 2 1

Very High High Moderate Low Very Low

5 Very likely Type I

• Capacity constraints in all khadi institutions

Type II

Type III

4 Likely • Politicization • Risk of fraud and

mismanagement • Political backlash

from reform of khadi institutions

• Legal and regulatory infrastructure weak

• Delays in strengthening governance norms

• Training targets only senior staff of institutions

3 Moderately likely

• Special audits delayed

• Weak guidelines on internal audit procedures

• Government commitment to reforms derails

• KVIC fails to reform khadi institutions affiliated to khadi and villages industries boards

• State governments unwilling to reform khadi institutions affiliated to khadi and village industries board

• Weak business and financial plans at khadi institutions

• Weak implementation monitoring framework

• High transaction and compliance costs of sustaining reforms

Type IV

2 Unlikely

• Inadequate financing for the khadi institutions selected for reforms

• Inadequacy of new guidelines • Program not easily replicable

Like

lihoo

d of

eve

nt o

ccur

ring

(L)

1 Rare


3. Ongoing and Proposed Mitigation Measures 13. The Government has initiated numerous public policy measures to ensure that the rural poor are able to participate in the economic growth of the country. Reform of the RNFS, in particular khadi and village industries, has thus emerged as a strategic priority of the Government. The Program provides significant opportunities for enhancing RNFS employment and increasing incomes, especially for women, empowering the rural population in communities with opportunities to meaningfully participate in, and benefit from, economic growth. The Program attempts to manage sector-specific and program-related risks in a systematic manner. Some of the mitigating measures for the primary risks can be seen in Table A10.2. C. Controls for Corruption at the Sector and Program Level 14. The Government’s Prevention of Corruption Act, 1988 tries to address the issue of corruption in general; and the Government has recently initiated a review of existing conduct rules specified for members of central and all India services, and training of officials performing the vigilance function in ministries, departments, and public sector enterprises. Efforts to make this review more relevant and in line with best international practices is ongoing.

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15. Other steps under the Program to mitigate corruption include (i) conducting independent audits of khadi institutions eligible for support under the Program, (ii) reforming the governance structure of khadi institutions for artisan empowerment by modifying the categorization norms as well as through new khadi ventures, (iii) conducting random spot audits for khadi institutions on licensing requirements for the khadi mark, and (iv) implementing institutional reforms of KVIC. Independent audit of khadi institutions will reduce vulnerability to corruption. Modifying the categorization norm of khadi institutions and institutional reform of KVIC will ensure (i) enhanced corporate governance, (ii) compliance with transparency and disclosure requirements, and (iii) adequate monitoring mechanisms. 16. In line with ADB’s Anticorruption Policy (1998), MMSME undertook a financial management assessment (Supplementary Appendix K) to ensure that ADB loan funds will be used for their intended purpose. ADB will regularly review the financial reports of the audit authorities to assess any potential irregularities. ADB review missions will update the financial management risk assessments to ensure fiduciary risks are continuously addressed. 17. Implementation risk will be minimized through technical assistance support from ADB for implementation and monitoring. KVIC’s Reform Implementation Division will coordinate implementation, monitor the reforms, and maintain extensive data on program performance. Reform management units will be required to participate in the assessment of implementation.

Table A10.2. Risk Mitigating Measures

Risk Proposed Mitigating Measures Capacity constraints Recruit new skilled staff, realign staff incentives, training Institutional risks Policy dialogue and comprehensive reform package to deepen ownership Fraud and mismanagement risk

Greater publicity of cases and/or incidences of fraud and mismanagement, and more Government willingness/ability to prosecute

Weak legal and regulatory infrastructure

Improve and amend relevant acts, and harmonize policy standards across states

Accountability and transparency

Special audits, improved corporate governance and accounting standards

Program management Local and zonal engagement in the Program, a management design where the reforms are implemented at all levels

Source: Asian Development Bank. D. Recommendations 18. The governance and corruption risk assessment points to several recommendations on ways to enhance the program design and implementation. These recommendations include

(i) incorporate several provisions on good governance and anticorruption as loan conditions, assurances, and tranche release conditions;

(ii) review the risk analysis with Government and other partners, as necessary; (iii) achieve consensus on the khadi reform package comprising policy, production,

marketing, and institutional reforms; (iv) achieve commitments on the new governance framework, business procedures,

and autonomy of khadi institutions; (v) invest significantly in information technology and management information

systems and human resource development; and (vi) collate information during monitoring review missions on incidences of

inefficiencies in all khadi institutions in the selected states.

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SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

Country/Project Title: Khadi Reform and Development Program

Lending/Financing Modality: Policy-Based Program Department/

Division:

South Asia Department/Governance, Finance and Trade Division

I. POVERTY ANALYSIS AND STRATEGY

A. Linkages to the National Poverty Reduction Strategy and Country Partnership Strategy Despite recent rapid economic growth, poverty in India is still substantial. According to the National Sample Survey, 27.5% of the population, or nearly 302 million people, were living below the poverty line. About 72% of the poor live in rural areas and most depend on subsistence farming for their livelihood. Among them, 59% are small landholders, marginal farmers, and landless labors; and two thirds of agricultural laborers are women. Poverty in India is partly attributed to the overconcentration of the work force in the agriculture sector, with corresponding low productivity. In 2007, about 56% of the total population depended on agriculture, while agriculture contributed 18% to the gross national product. To increase opportunities in rural areas, and enhance agricultural productivity concomitantly, the rural nonfarm sector (RNFS) must provide economic opportunities for poor men and women. Poor households value nonagricultural incomes because they increase incomes at the margin as well as minimize risk through diversification. Moreover, an expanding nonfarm sector can help to reduce poverty even for those poor not directly employed off-farm by tightening village labor markets and raising wage rates for agriculture laborers. The Khadi Reform and Development Program (the Program) aims to improve social and economic welfare of low-skilled artisans and workers who are employed in khadi and village industries to enhance returns and earnings potential through comprehensive sector restructuring efforts including governance, marketing, and institutional reforms. The Program also expects to increase employment opportunities for poor rural households as a result of extensive capacity development and empowerment support. The Program is in line with the Government’s 11th Five Year Plan, which advocates inclusive growth by creating productive employment opportunities and reducing poverty in rural areas. The Government recognizes that the RNFS is a major inclusive employment generation sector. Reform of the RNFS, in particular khadi and village industries (KVI), has thus emerged as a strategic government priority. Along with sustainable economic growth and good governance, the Asian Development Bank (ADB) prioritizes inclusive social development as a key priority of ADB operations. The Program is in line with recommendations of ADB’s country assistance program evaluation for India, which advocates that ADB focus on rural development for poverty reduction. B. Poverty Analysis Targeting Classification: General intervention 1. Key Issues The primary beneficiaries of the Program are an estimated 1 million households engaged in khadi and 8 million households drawing their sustenance from village industries. Most khadi artisans (spinners) are women. An initial assessment identified that most of them are poor, disadvantaged, and local residents. About one third of KVI workers belong to low and scheduled castes. More than 60% are either illiterate or have up to primary education. Workers’ earnings based on conversion charges are not sufficient for them to cross the poverty line. This is mainly due to current low productivity and low return in khadi. The Program will address the low income and underemployment issues by revitalizing khadi. Khadi production, as an economic activity, is geographically widespread, and encompasses all states and regions. Hence, its poverty impact will be widespread and will cover the country’s poorest states, and those with low human development and social indicators. The direct benefit of the Program will be extended to those engaged in KVI, including low-skilled artisans, spinners, and laborers, who will receive increased incomes and employment opportunities as a result of improved productivity of KVI and economic return as the result of the reform. As KVI subsector holds greater employment potential for women, the Program will benefit mostly poor rural women. Khadi is produced by institutions generally run by nongovernment organizations (NGO). The NGOs will also benefit as their institutions will emerge more productive and sustainable as a result of the reforms. The Program will yield social and economic benefits to the broader rural poor population in India. The revitalization of KVI subsector will result in better wages for the agriculture and nonagriculture sectors. The reforms will also have positive spin offs in terms of helping reduce nonincome poverty. A study of KVIa clearly noted that increases in incomes of KVI households led to a change in the expenditure pattern of the households in favor of nonmaterial consumption, such as education and health.

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2. Design Features The Program will expand the rural employment base by providing comprehensive reform support including policy reform, promotion and marketing, creation of an enabling business environment, procurement and production reform, financial reform, and capacity development. Each reform activity will have a strong pro-poor gender-sensitive focus. For example, for policy reform, participatory consultations were conducted with civil society, NGOs, and community organizations to inform all concerned about the process and potential implications of the reform and during the implementation, further participatory consultations will be carried out to have an inter-active program monitoring and assessment (Section II.B). The Program includes technical assistance (TA) to provide extensive capacity development support for skills enhancement and empowerment, and participation in governance by beneficiaries, especially female artisans.

C. Poverty Impact Analysis for Policy-Based Lending 1. Discuss the impact channels of the policy reform(s) (direct and indirect, short and medium term) to the country and major

groups affected. The KVI subsector has great potential for generating gainful employment opportunities for the rural poor, decreasing migration of rural unskilled workers to urban areas, and promoting sustainable development. The Program will generate direct poverty reduction impacts for the rural poor, especially low-skilled khadi workers, by enhancing returns from khadi activities and providing more substantial and sustainable employment opportunities. The home-based nature of khadi activities is especially suited for women and the income and employment impact of the Program will be most accrued by poor rural women. The Program is also expected to have an indirect poverty impact including empowerment of the rural poor by developing their bargaining power, creating self-reliance among rural communities, and revitalizing the rural labor market for more competitive wages in agriculture and nonagriculture sectors. Higher wages and higher input costs will be viable due to marketing reforms and overall higher revenues expected from increased sales due to greater market penetration. Specifically, by program completion, the Program envisages that (i) the earnings of the existing khadi artisans will increase because of increased production, minimum wage standards, and reduced underemployment; and (ii) additional employment opportunities will be created, largely for women. 2. Discuss the impact of the policy reform(s) on vulnerable groups and ways to address it/them (refer to social analysis). The main target beneficiaries of the Program are khadi artisans and workers, including women, socially disadvantaged, and those residing in ecologically fragile terrain (Section I.B). The Program will support inclusive growth as it is spread across the country, encompassing poorer states, and remote and dispersed areas. As the reform does not envisage any labor retrenchment, it will not have any adverse labor impact. In addition, the TA’s gender development specialist will identify gender-related issues and develop measures to enhance positive impacts and mitigate negative impacts on gender-specific matters. 3. Discuss how the policy reform(s) contribute(s) to poverty reduction, pro-poor growth, and the Millennium Development

Goals. The Program’s reform package is based on the primary concept of providing sustainable off-farm employment opportunities for the rural poor. The Program includes a pro-poor focus for all reform activities. The policy reform will develop an enabling policy framework to improve the incomes and empowerment of artisans. The marketing and production efficiency improvement will result in better returns and benefits for low-skilled workers, and institutional reform activities will include substantial capacity development support for the poor to diversify their sources of incomes and improve employment opportunities in the RNFS. Given the high income elasticity of demand, the textile market has expanded rapidly as the economy has grown and has changed in composition. Khadi production under the Khadi and Village Industries Commission (KVIC) program has slowed (but not declined), 2% in volume and 3% in value. Hence, the reform package proposes enhance the positive growth by making marketing more professionally managed and in the process enhancing incomes and employment. The Program will have contributions to the Millennium Development Goals to eradicate extreme poverty and hunger, and promote gender equality and empowerment of women.

II. SOCIAL ANALYSIS AND STRATEGY

A. Findings of Social Analysis In general, poverty is the result of low assets, combined with low and uncertain returns. The poor are concentrated in low-paid casual daily wage work; most own little or no land or productive assets. Poor people lack marketable skills and, in most cases, literacy. They are ill-equipped to take advantage of opportunities provided by economic growth. The rural poor in India survive from the marginal returns of farming, but have limited opportunities to diversify their income sources. The Program will enhance rural nonfarm economic activities through the proposed reforms.

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Low skills and limited access to productive social and physical infrastructure are the primary constraints for the rural poor including those employed in khadi, especially women. The Program will provide capacity development support to upgrade their skills to adopt improved technologies. In addition, the Program will carry out participatory poverty analysis at the onset of the Program to identify constraints and needs of the poor, and develop strategies to address their issues in a gender-focused manner. The poverty analysis will be reviewed and reflected in the program design throughout program implementation. B. Consultation and Participation 1. Provide a summary of the consultation and participation process during project preparation. Several stakeholders are involved in the Program. Key stakeholders were consulted during program preparation, including artisans, producer groups, Government, NGOs, and private sector. Interactions with the various stakeholders include

(i) assessment and participatory appraisal of the beneficiaries (artisans and workers) of their livelihood especially income from KVI activities, constraints for employment and income-generating opportunities, and capacity and skill development needs;

(ii) consultation and participatory discussion with NGOs and community-based organizations (producers groups) on measures to develop and extend nonfarm employment opportunities, establish a framework for capacity development and skills training, and extend KVI employment opportunities to women and the disadvantaged;

(iii) dissemination and discussion with Government agencies, KVI institutions, producer groups, and private sector to develop specific reform action plan with pro-poor gender focus; and

(iv) consultation discussion with development partners to receive feedback on relevancy of pro-poor focus of the Program.

2. What level of consultation and participation (C&P) is envisaged during the project implementation and monitoring?

Information sharing Consultation Collaborative decision making Empowerment 3. Was a C&P plan prepared? Yes No If a C&P plan was prepared, describe key features and resources provided to implement the plan (including budget, consultant input, etc.). If no, explain why. The C&P plan will be prepared by the attached TA during program implementation. C. Gender and Development Key Issues. Women play a significant role in khadi production and consumption. Since women comprise a large part of the workforce, the reforms will enhance their employment, upgrade skills, and improve income prospects. With increasing work opportunities in khadi and increased investment by the private sector, more women may be able to participate in the program outputs. The khadi mark and wage stipulations will help reduce wage discrimination of women and promote equality. It will help realize core labor standards in an industry where a large part of the production is in the informal sector. The empowerment of artisans through participation in producer societies will give women a voice in decisions relating to khadi production and distribution. Key Actions. Measures included in the design to promote gender equality and women’s empowerment—access to and use of relevant services, resources, assets, or opportunities and participation in decision-making process:

Gender plan Other actions/measures No action/measure Summarize key design features of the gender plan or other gender-related actions/measures, including performance targets, monitorable indicators, resource allocation, and implementation arrangements. To ensure that the potential positive gender impacts of the Program are realized, close monitoring will be undertaken as per the defined procedures. A gender development specialist will be engaged under the TA to support effective realization of the Program’s overall goals. The consultant will ensure capacity development of institutions engaged in the reform process. The consultant, together with an NGO and institutions development specialist, will help KVIC to implement comprehensive reform of eligible khadi institutions. Such revitalization would ensure gender supportive processes and technologies (solar-powered spindles for instance have greatly benefited women spinners and reduced drudgery). The gender specialist will also assist KVIC in enhancing governance and empowering artisans. The gender development specialist will work closely with other consultants under the technical assistance, i.e., (i) organization and human resource development specialist, (ii) training and capacity building specialist, and (iii) NGO and institutions development specialist, to support gender sensitivity and gender development in a holistic manner.

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III. SOCIAL SAFEGUARD ISSUES AND OTHER SOCIAL RISKS

Issue Significant/Limited/ No Impact

Strategy to Address Issue

Plan or Other Measures Included in Design

Involuntary Resettlement

No impact. The Program will address mainly institutional, managerial, and business process restructuring; no resettlement issues are expected.

Full Plan Short Plan Resettlement Framework No Action

Indigenous Peoples

No impact. No adverse issues related

to indigenous people are anticipated. Rather, indigenous people will benefit from expanded outreach of employment opportunities.

Plan Other Action Indigenous Peoples

Framework No Action

Labor Employment opportunities Labor retrenchment Core labor standards

No impact. No labor issues are expected. Rather, the Program addresses the issue of low labor absorption capacity of khadi through institution, marketing, and technology enhancement, which will result in expanded rural employment opportunities.

Plan Other Action No Action

Affordability No impact. The Program will not create any affordability-related issues. In contrast, improved efficiency in marketing, financial and resource management, and technology enhancement in production of khadi will result in reduced costs and prices.

Action No Action

Other Risks and/or Vulnerabilities

HIV/AIDS Human trafficking Others(conflict, political

instability, etc), please specify

No impact. Plan Other Action No Action

IV. MONITORING AND EVALUATION

Are social indicators included in the design and monitoring framework to facilitate monitoring of social development activities and/or social impacts during project implementation? Yes □ No

a Government of India. 2001. Evaluation Study on the Khadi and Village Industries Program. Program Evaluation Organization. Delhi.

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GENDER ACTION PLAN

Program Component

Proposed Actions

Target Group Indicator Verification Action by

Establishing a policy reform and implementation framework

Include gender-specific strategies in the design of the policy framework by organizing gender specific participatory consultations with khadi institutions (i.e., producer NGOs)

Artisans and producers

Employment generated in terms of person-days by gender, by category, and by location (target benchmarks to be determined by a gender development specialist) A gender development specialist is involved Views of target groups influence implementation framework

Baseline social and employment data and impact assessment MMSME progress reports ADB review missions Feedback from women beneficiaries

MMSME, KVIC, RID, NGOs, gender development specialist

Promoting and marketing of khadi Establish a khadi identity through a khadi mark Effective marketing through private sector participation

Awareness campaigns for women employees of khadi institutions on the rights under the khadi mark (i.e., minimum wages) Marketing training for women’s groups Gender sensitization workshops at all levels of khadi institutions

Female artisans and producers

Number of women’s groups registered Number of women beneficiaries Number of gender sensitization and awareness consultations Number of marketing trainings

MMSME progress reports ADB review missions Feedback from women beneficiaries


Realizing procurement and production efficiencies Facilitate raw material procurement and cotton sliver production Replace cost-based pricing with market-linked pricing

Awareness campaigns for women employees of khadi institutions on new material procurement policies and implications for production activities Awareness campaigns for female


Number of women’s groups registered Number of women’s groups benefited Number of women beneficiaries Number of gender sensitization and awareness consultations

MMSME progress reports ADB review missions Feedback from women beneficiaries

MMSME, KVIC, RID, NGOs, gender development specialist Facilitators of training and awareness workshops

Appendix 12

68

Program Component

Proposed Actions

Target Group Indicator Verification Action by

Rationalize financial assistance in khadi Create new khadi ventures with greater entrepreneurial activity and enhanced artisan empowerment

employees of khadi institutions on new financial and pricing policies and implications for production activities Capacity development training for female employees of khadi institutions on empowerment, negotiation, and entrepreneurship

Number of capacity development training sessions

Implementing institutional reforms Organizational restructuring of KVIC for better focus on facilitative and development role Revitalize khadi institutions Strengthen the capacity of all institutions Develop synergies through traditional village industries

Awareness campaigns on KVIC organizational restructuring and khadi institution reform polices and implications on production activities Capacity development training for women on production management and skills enhancement in traditional village industries


Number of women’s groups benefited Number of women beneficiaries Number of gender sensitization and awareness consultations Number of capacity development training sessions

MMSME progress reports ADB review missions Feedback from women beneficiaries NGO progress reports


ADB = Asian Development Bank; KVIC = Khadi and Village Industries Commission; MMSME = Ministry of Micro, Small and Medium Enterprise; NGO = nongovernment organization; RID = Reform Implementation Division. Source: Asian Development Bank.

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