IDA's Support for Private Sector Development

International Development Association April 1998

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Executive Summary

1. This note discusses the lending instruments and non-lending activities of the Bank Group in supporting private sector development (PSD) in IDA countries--with the ultimate goal of reducing poverty. A common thread across PSD activities is the attempt to capitalize on the potential benefits of policy reforms--in recognition of the fact that sound macroeconomic policies are a necessary but not sufficient condition for growth. Because of this, the mix of interventions in support of PSD varies considerably, depending on the situation in each country.

2. Macroeconomic Reforms and Adjustment Operations. The enabling environment is the critical starting point for successful private sector development. Macroeconomic and financial reforms, trade liberalization and good governance benefit a broad spectrum of business groups and entrepreneurs, allowing them to respond to market incentives without undue government interference or bureaucracy. In countries where policies are weak and incentives distorted, the most effective intervention--and sometimes the only intervention feasible--is support for policy reforms. Hence, adjustment operations, sectoral reforms and related TA will continue to be an important part of the lending program in a number of IDA countries.

3. Support for Microenterprises. The large microenterprise sector is comprised of self-employed individuals, households and small groups engaged in informal, "survivalist" activities in urban and rural areas. Microfinance programs supporting them have the potential to stabilize or supplement the incomes of the poor households. Drawing on the pioneering experience of a number of NGOs and bilateral donors, IDA has increased its support for microenterprises--through social investment funds, stand­alone microfinance projects, and rural finance projects. The challenge is to encourage the growth of microfinance intermediaries capable of running sustainable programs over time, including mobilizing savings as well.

4. Increasing attention is being given to sustainability in designing microfinance operations, in large part due to partnerships like the Consultative Group to Assist the Poorest (CGAP). Experience to date demonstrates that the capacity building needed to improve the financial skills of intermediary NGOs, credit unions and other micro finance agencies is substantial and requires continued attention in project design and implementation. Support is also needed to encourage an appropriate regulatory environment for micro finance and to build links with commercial banks.

5. Small and Medium Enterprise Programs (SMEs). In countries where adequate progress has been made on the policy front, support for SMEs can play an important role­-because of their potential for growth. IDA projects in support of SMEs fall roughly into three categories: (i) urban development or social investment funds that sponsor public works, creating demand for SMEs in the construction industry; (ii) rural finance projects,

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which carry the same challenges as micro finance operations in tenns of financial capacity building; and (iii) components of PSD and Enterprise Development Projects fostering private partnerships to enhance business skills and market knowledge, reducing finn level constraints affecting the SME response to favorable policy changes.

6. SMEs must compete with larger local finns and with imports, hence the importance of competitiveness, market responsiveness, technical capability and quality control. Bank Group activities fostering enterprise learning are growing. Matching grant programs and fonnation of business associations have shown promising results. Though cost shared in part with clients, the bulk of initial funding for such programs comes from IDA, typically with substantial bilateral grant support as well. SMEs also need better access to finance, which will come largely through deeper fmancial sector refonn, but can be supported further by programs to help commercial banks fmd cost effective ways to serve them.

7. IFC Facilities for SMEs. IFC's small business support programs in Africa are also extremely important, offering clients financial and business advisory services at different stages, ranging from preparation of business plans to management, production, marketing and MIS support. These programs include the Africa Project Development Facility (APDF), the African Management Services Company (AMSCO) and Enterprise Support Services for Africa (ESSA). While all involve some cost sharing, they too rely heavily on bilateral grant funding because of their capacity building nature. IFC sees a strong client need to forge these initiatives into an overall program for SMEs, which could garner broader, longer tenn funding.

8. Business capacity building is a natural area for IDA-IFC cooperation. There may be ways to integrate further the efforts of both institutions in this area--cooperating under one umbrella to build a stronger continuing partnership with donors interested in small business development.

9. Opportunities in the Formal Business Sector. In IDA countries with soUnd economic management, the Bank Group can also make effective contributions to growth and poverty reduction by supporting programs designed to encourage private investment (both domestic and foreign) in key sectors: agribusiness, extractive industries, telecommunications and other infrastructure services. Expanding opportunities in these industries also can create opportunities for SMEs.

10. Privatization Programs and Private Participation in Infrastructure. A growing number of IDA countries are starting to privatize large state enterprises, particularly in major infrastructure such as telecommunications, electric power, ports and railways. Building on the lessons learned from early privatization transactions, steps are needed to improve public infonnation about the goals and process of privatization, establish policies for social safety nets, and broaden share ownership.

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11. A major area for private sector investment--and an opportunity for better public services--is infrastructure. The investment needs are enonnous; thus, it is essential to attract private capital, both in the fonn of investment and financing. The Bank Group's hierarchy of guarantee instruments offers varying fonns of risk coverage, helping client countries to attract private funding.

12. Both IFC and MIGA guarantees are being utilized in IDA countries. IBRD guarantees are available in blend countries, and IBRD enclave guarantees are available for IDA-only countries when projects meet the required conditions. In certain situations, none of these may be suitable, and yet other preconditions for a successful guarantee exist. Cases where an IDA guarantee might fit are in large, privately-sponsored projects in the power sector or in building and operating other major infrastructure (eg. natural gas pipelines). They are projects involving pUblic-private partnerships--where project revenues depend heavily on government perfonnance, and there is little or no foreign exchange revenue.

13. IDA Partial Risk Guarantees. IDA's Board approved a pilot program for IDA "partial risk" guarantees in December 1997 to gauge the business need for this instrument through actual cases. The pilot program is currently limited to $300 million.

14. IDA guarantee proposals will be submitted to the Board on a case by case basis. Consistent with their "last resort" nature, the criteria for IDA guarantees are the following: (i) use of the guarantee fits within the framework of the CAS; (ii) the operation has high potential impact on economic growth, helping to generate resources for sustained poverty reduction; (iii) the guarantee complements--does not displace--other Bank Group guarantees; and (iv) the guarantee supports sound government policies--it does not substitute for them.

15. The pilot program will be reviewed by the Board when the value of approved guarantees reaches $300 million or after two years, whichever comes first. If the review of the pilot concludes that the program has been successful and further use of guarantees is endorsed, IDA-12 resources would need to be made available for this instrument.

IDA's SUPPORT FOR PRIVATE SECTOR DEVELOPMENT

L Introduction

1. IDA aims to reduce poverty both directly and through sustainable economic growth. The private sector is the "engine" of economic growth in successful economies, generating employment and additional resources which can be reinvested, thereby fueling further growth. The private sector is still weak in many IDA countries. Its development depends on the following elements, which are interactive and have a cumulative impact:

• sound economic incentives and liberalized markets • adequate institutional underpinnings for markets-fiscal, legal and administrative • functioning physical infrastructure, allowing access to markets • healthy financial systems, offering short and long term finance to the various

segments of the economy • and, very importantly, "business capacity"--entrepreneurs and a labor force with the

education, skills and business knowledge to respond to growing market opportunities.

2. Table 1 below shows the substantial growth over the decade of the 1990s in IDA operations directly supporting or having a major impact on private sector development (PSD) in client countries.

Table I: IDA Lending Supporting Private Sector Development

($ billion) Program for

Region FY91-93 FY94-96 FY97 FY98-99

Africa 1.79 1.92 0.534 1.362 East Asia and Pacific 0.33 0.35 0.080 0.304 South Asia 0.58 0.65 0.080 1.183 Europe & Central Asia 0.06 0.37 0.169 0.228 LACandMNA 0.06 0.38 0.018 0.286 Total 2.82 3.66 0.881 3.364

Number of operations 74 91 36 81

Note: Including blend and supplemental operations. The volume of lending covers a broad spectrum of operations, all with PSD as a major objective.

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3. This note goes beyond the overall lending figures to describe the range of IDA lending instruments and non-lending services supporting PSD. It, first, discusses the importance of the "enabling environment"-macroeconomic, trade and financial sector reforms and good governance-in encouraging opportunities in the private sector.

4. Second, it describes the different groups comprising the private sector in IDA countries and IDA operations supporting them. They are:

• the large, diverse micro enterprise sector---comprised of self-employed individuals, . households or very small groups--engaged in informal, mostly "survivalist" activities in rural and urban areas;

• small to medium enterprises (SMEs), the small but growing "middle class" of business activity, with the potential to create jobs more broadly within the economy and even to take the lead in stimulating local private sector activity over time; and

• the formal private sector, characterized by a small number of large firms--in the past, heavily represented in "enclave" extractive industries; many business opportunities here remain undeveloped because of lack of capital and insufficient investment.

5. This notes focuses especially on microenterprises and SMEs because of their potential for income stabilization, job creation and poverty reduction. Also discussed are the opportunities and entry points to develop further the "formal" private sector and to attract greater private capital and foreign investment, acknowledging that the expansion of business opportunities overall creates further opportunities for SME growth. Finally, the note describes the results and direction of ongoing privatization programs and the opportunities they generate, particularly in private provision of major infrastructure such as telecommunications, electric power, ports and transport.

6. Highlighted throughout is the extent of capacity building needed in PSD and the importance of partnerships with the local private sector, non-governmental organizations (NGOs) and bilateral donors and within the Bank Group itself, especially with IFC because of its experience serving the private sector.

7. Box 1, on page 3, outlines the different areas ofPSD and the associated IDAlBank Group instruments, which can be tailored to specific circumstances and brought together as a program to address the various aspects of PSD in client countries. I Annex 1 shows examples of the mix ofPSD operations in selected IDA countries.

Box 1 also provides a "road map" to the remaining sections of this paper.

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Box 1: PSD Activities and Instruments

AreaofPSD

(Section in Note) Goals IDAlWBG Instruments

Enabling * Macroeconomic stability * Adjustment Operations Environment * Trade policy reform * Financial Sector Development Projects (Section II) * Financial sector dev. * Institutional TA

* Institutional development & good governance

Microenterprises * Access to working capital for * Social investment funds and poverty alleviation (Section III) micro-entrepreneurs projects

* Better access to markets * Stand-alone microfmance projects * Reduction of learning constraints * Rural finance projects

(illiteracy) * Infrastructure projects * Education projects

Small & Medium * Improved competitiveness and * Matching grants, business partnerships or Enterprises business learning matchmaking T A components in PSD Projects (Section IV) * Opportunities for public works * IFC 5MB support facilities

contracts * Public works in municipal or sector investments, or * Access to working capital & in Social Funds

investment fmance * Access to credit under PSDIFSD Projects, or IFC * Better access to markets Funds (AEF, SEF)

* Rural Finance Projects * Rural Infrastructure Projects

Opportunities in * Sound sector investment climate * Mining or Energy TA Projects the Formal * Greater equity investment and * Formation of regional business or economic Business Sector commercial financing networks (Section V) * FlAS, MIGA investment promotion

* IFC investment/financing * MIGA, IFC, IBRD G'tee Programs * IBRD "enclave" loans

Privatization * Sound design of privatization * Privatization or Enterprise Restructuring Projects, Programs programs and public information and associated T A Programs

(Section VI) and social safety net programs * Complete major transactions to

demonstrate benefits

Private Provision * Attraction of private capital, both * Private Sector Infrastructure Development Projects of Infrastructure equity and commercial fmancing * MIGA, IFC, IBRD G'tee Programs (Section VII) for rehabilitation & expansion * IFC B-loan participation

* Improved infrastructure and * IBRD "enclave" loan services * IDA "partial risk" guarantee (pilot)

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IL The Macroeconomic Context and Enabling Environment

8. Getting the macroeconomic signals right is key. Sound macroeconomic policies, liberalized markets, and well-managed public finance are the starting points for economic growth and improved resource allocation, creating an environment which fosters business confidence and a willingness to invest, benefiting most groups in the private sector. IDA operations have supported measures to open economies to private participation and to increase competition, while reducing rent seeking. Fiscal reforms have reduced excessive tax burdens, a factor often inhibiting SME growth. Trade policy reforms have especially benefited agriculture, a vital part of private sector activity in many IDA countries.

9. A sound fmancial system is also vital to private sector growth and one of the most difficult areas of reform. Often government dominance of the banking system prevents efficient financial intermediation; this is a major problem in IDA economies in both South Asia and Africa. IDA supports adjustment and financial sector operations in many client countries to build financial capacity in the form of healthy commercial banking systems, including encouraging private entry into banking to spur competition. Increasing the domestic savings rate-to finance domestic investment-requires a financial infrastructure capable of mobilizing the savings of many segments of the population.

10. IDA support for macroeconomics reforms has increasingly been extended to the underlying institutions and administration of government. PSD is nurtured by good governance: financial accountability, transparent procurement, the rule oflaw and stable "rules of the game", collateral and contract enforcement, and freedom of information. Public institutions influence private performance via their impact on non-commercial risk and the transaction costs of doing business.

11. Adjustment operations and some PSD projects support institutional changes which can lead to better governance, through technical assistance (TA) programs (see Box 2). They encourage civil service reform and improved incentive systems, as well as policies and systems which promote accountability for performance and related reporting and monitoring.

Box 2: Public Sector Capacity Building

Examples of TA linked to high impact adjustment operations in Africa include: Malawi (Second Institutional Development Project), Madagascar (public Sector Capacity Building), Mozambique (Financial Sector Capacity Building), Tanzania (TA for Public Sector Reform), Zambia (Financial and Legal Management Upgrading Project).

12. There is still much to do in following through with structural reforms and related capacity building, all of which take time and steady political will. As a result, adjustment operations remain an essential part of many IDA country lending programs.

13. These reforms, however, are often not enough in themselves to get the rapid "supply response" from potential entrepreneurs. More targeted actions are needed to tackle other institutional, operating and learning constraints, many at· the firm level, as well as practical

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problems related to lack of credit and poor physical infrastructure. A mix of operations is needed to propel private sector activity in order to reach the rapid economic growth needed in IDA countries (see Box 3 concerning Africa).

Box 3: Africa - Economic Growth and Link to Poverty Reduction

In Africa, there are some positive economic signs. Fiscal deficits have contracted sharply in recent years, and trade barriers have come down, although there is still a ways to go. After a long period of stagnation, exports have grown at almost 8% in recent years, and private capital flows and investor interest have grown, although they benefit only a few countries and sectors at the present time.

Economic performance has been strongest in those countries which have achieved social and macroeconomic stability and have implemented structural reforms to improve resource allocation; their economies have typically grown at 6% or more over the period 1994-97. Private savings and investment, though still too low, have begun to respond gradually; in some countries, e.g., Uganda, capital flight has begun to reverse. Overall, however, Africa needs growth rates of 8-10% to make significant gains in poverty reduction. A flourishing, broad-based private sector could help boost economic growth and extend the impact across the economy.

III. Supporting the Microenterprise Sector

14. Microenterprises are businesses ranging from small fanners in rural areas, who trade part of their production, to an urban street vendor or dressmaker, or a family business running a market stall. They start up in markets where barriers to entry are low, and most tend to remain small throughout their lifetimes. The sector is the largest net job creator in most IDA countries due to the continual stream of new entrants, many of whom are women and young people. While they rarely act as incubators for SMEs, microenterprises sometimes grow horizontally; for instance, the profit from one venture may go to start up another microenterprise run by a relative.

15. Studies show that access to working capital can help raise or stabilize incomes of micro­entrepreneurs, for example by enabling part-time, seasonal employment to become full-time, providing greater income security. Studies of Grameen Bank clients (Bangladesh) confirm the program's positive impact in increasing clients' incomes, their household expenditures for basic needs, and their nutritional status; these effects are particularly notable when clients are women.

16. Micro-entrepreneurs also face lack of access to markets; most micro enterprises operate in rural areas, where poor roads bring high transport costs, hindering efforts to reach larger markets and raising the price of any needed inputs. Investments in rural infrastructure therefore can make an important difference to microenterprise opportunities. Finally, illiteracy is also a constraint for micro-entrepreneurs, affecting their ability to upgrade product quality or find broader markets. Providing basic education for low income people, especially women, continues to be a major goal of IDA.

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17. Support [or Microenterprises via Projects Targeting the Poor. Over the period 1993-97, IDA has fmanced 23 projects (representing total IDA credits of $708 million) which provide direct or indirect support to microenterprises, typically as part of a package of measures to reduce poverty; another 5 projects will be approved in FY98. Many of these projects are social investment funds (SIF) or poverty alleviation projects; their size vary from small pilots to quite large programs. They focus on small public works and community development, largely in rural areas. They have been especially effective in improving community infrastructure and local roads, beneficial to microenterprises trying to reach broader markets. These projects also generate some temporary employment opportunities. Table 2 below offers selected examples, which show the diversity in the size of operations.

Table 2: Examples of Poverty-targeted Projects also helping Microenterprises

Country/Project

Albania: Rural Poverty Alleviation, FY93

Benin: Rural Savings & Loan Rehabilitation

China: Qinba Mtn. Poverty Reduction, FY97

Honduras: Social Investment Fund III, FY96

Egypt: Social Fund for Development II, FY96

Kenya: Micro & Small Enterprise Training, FY94

Mongolia: Poverty Alleviation for Vulnerable Groups, FY96

Credit Amount ($million)

3.8

30.0

180.0

30.0

120.0

21.8

10.0

18. Micro./inance Components. SIF and poverty alleviation projects often include micro finance components, which offer working capital finance to the working poor. Of the projects cited above at para. 17, microfinance components represent credits of $242 million. Most of these components are small, averaging US$6-8 million per project. The reason for the small size of these interventions is not lack of demand, which is very large, but the pilot nature of most of these operations and the absorptive capacity of participating intennediaries. Only one of the projects in IDA's microfinance portfolio is a large, stand-alone microcredit project, and that is in Bangladesh which has a long tradition of micro credit delivery (see Box 6).

19. The intennediaries in these projects are typically NGOs which have strong local outreach capabilities and are actively engaged in a variety of activities serving the rural poor. They are usually not focused on provision of financial services, however, with the credit management skills that entails. This issue and related concerns have led some microfinance experts to recommend against combining microcredit operations with poverty alleviation projects; they feel it is very important to consider these operations as financial projects, giving them the attention they deserve in regard to financial policy and regulatory issues and financial capacity building. As a corollary, these experts see a constructive role for social funds in providing subsidized training for micro-entrepreneurs to improve their business skills sufficiently to enable them to qualify for microcredit. The high costs of teaching very poor potential clients how to fonn

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groups, manage their money and operate a business inhibit some microfinance programs from expanding as rapidly as they might. A Social Fund which is farsighted in providing such support to micro-entrepreneurs is described in Box 4 below.

Box 4: The Benin Social Fund (AGepm}-Special Focus on Social Intermediation

The Benin Social Fund is innovative in that it does not provide funds for on lending. Rather, it addresses the problem that many poor people face in getting access to financial services. While there are many a number of microfinance programs in Benin, only a small proportion reach the poor. In response to this problem, the Social Fund supports several NGOs in helping poor villagers to establish a working relationship with existing microfinance agencies. The NGOs organize visits to the microfinance agencies and assist the villagers in opening accounts and processing loan applications. The NGOs are not involved in fmancial intermediation, but they play an active role in social intermediation. A preparatory grant from the Policy and Human Resources Development Fund (pHRD), provided by Japan, facilitated the design of the Social Fund and initial start-up activities.

A separate operation in Benin, the Private Sector Development Project, supports financial intermediation by providing credit lines directly to microfmance agencies or helping them to establish a relationship with a commercial bank. Thus, the two projects are complementary. The Social Fund helps clients access services, and the PSD project supports the fmancial institutions.

Source: CGAP

20. The Bank Group's experience with microfinance is still quite new; most of its lending in this area is less than ten years old. Consequently, there is much to learn from bilateral donors and NGOs which have worked in micro finance for some 20 years. The successes of institutions, such as Grameen Bank in Bangladesh, BRI Unit Desa in Indonesia, and ACCION International in Latin America, have led the way in demonstrating that micro finance can be self-sustaining and is effective in stabilizing the incomes of the poor.

21. Partnerships with External Groups and Internal Capacity Building. Bilateral partners and the Bank Group have launched several important initiatives for exchanging knowledge about microfinance among practitioners and building capacity within client countries. They are described below.

=> The Consultative Group to Assist the Poorest (CGAP), set up in 1995, is a multi­donor effort to expand credit and savings services that reach the poor.2 It provides governments, donors, and practitioners with information on best practices in microfmance and makes grants directly to a small number of sound (or potentially viable) microfinance institutions. It has helped to improve donor coordination in the area of microfinance, especially in the use of an agreed set of standards. CGAP's separate grant facility has committed $16.4 million to some 28 private microfmance institutions and networks for capacity-building initiatives and

2 There are some 25 donors now supporting CGAP. Annex 4 lists them.

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training, as of end-1997. CGAP has also set up a special "pilot microfmance capacity building initiative" in Africa.

The Sustainable Banking with the Poor Program (SBP), created in early 1995, aims to improve the ability of donors, governments, and practitioners to implement programs that effectively reach the poor while building sustainable microfmance institutions. It is funded by the Governments of Switzerland and Norway as well as the Ford Foundation. SBP has published a worldwide inventory of micro finance institutions and is conducting 30 case studies of microfmance programs in Asia, Africa, and Latin America pioneering innovative approaches. It conducts seminars and prepares training materials to disseminate best practice.

Action Research on Sustainable Microfinance Institutions in Africa, initiated in 1994 and supported by the Government of Switzerland, focuses on Ghana, Cameroon, Kenya, Ethiopia, Mozambique and Zambia. Based in the Bank's Africa Region, its goals are to create and strengthen national networks of rural finance and micro finance agencies and to improve the capabilities of institutions to deliver financial services to the poor on a sustainable basis. Achievements to date include the launching of networks in four countries and, with the European Union, enlarging its network in Zambia.

22. The increasing attention to sustainability in design of microcredit operations under IDA is, in large part, due to the efforts of CGAP, SBP and Action Research. They offer training and other opportunities for Bank Group staff to learn the fundamentals of micro finance and what constitutes best practice. Other recent steps to improve staff support are formation of a "Rural and Microfinance Thematic Group" Bankwide and a Microfinance and SME Unit within the Bank's central PSD Department.

23. Future Opportunities in Supporting Micro./inance. Microfinance operations offer a way to support the working poor beyond what can be achieved in a single project. According to a CGAP publication, there are an estimated 500 million economically active poor people in the world running microenterprises and small businesses. Therefore, even with millions of clients currently served by microcredit programs worldwide, the degree of market penetration is low. Only two countries, Bangladesh and Indonesia, are exceptional in their degree of outreach. 3

24. The challenge in micro finance operations is to reconcile poverty alleviation needs with financial good practice, so that micro finance programs can become self-sustaining over time. The vast majority of micro finance programs are not financially viable-because the managerial capacity is not there or the credit/pricing methodologies and follow up systems are not in place to assure high repayment rates. A businesslike approach, structuring programs as business services

3 Grameen Bank alone, in Bangladesh, has 2 million borrowers and savers. The Bank Rakyat IndonesialUnit Desa system has 2 million borrowers and 16 million savers.

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and pricing them based on their costs, is essential to build long term viability. Also key are efforts to include savings mobilization in these programs, rather than remaining credit-only programs. But building the capacity to manage savings also takes time and training.

25. Experience to date suggests that the capacity building activities needed to improve the skills of intermediary NGOs and other nascent microfinance agencies are substantial. The example of the Social Investment Fund III in Honduras illustrates this. The project included a small microcredit component ($3 million), which was managed by a well-established apex institution (FHIS) working through a network of intermediary NGOs, most of which were new to microcredit. A capacity building program for the participating NGOs was funded largely by the Dutch Government at a cost roughly double that of the microfinance program itself. The T A was considered essential by the borrower and is well regarded by micro finance experts for its careful attention to institutional development.

26. T A to strengthen micro finance institutions is difficult for IDA to finance, on a sole basis. The recipients are typically NGOs or small credit unions, and governments are not always willing to borrow for these purposes. Building institutional capacity takes a long, concerted effort and involves outreach activities that are labor intensive and time-consuming. And, very importantly, tangible results usually do not come quickly. As efforts continue to extend microfmance to the poor via NGOs inexperienced in prudent financial practices, there will be a continuing substantial need for education, technical assistance and policy advice related to microfinance. There will also be continuing needs to support capacity building efforts directed at micro-entrepreneurs, the users of microfinance (see Box 5 regarding EDI's innovative program). In this regard, the Bank Group will continue to work closely with special groups that provide grant funding (CGAP), as well as directly with bilateral donors.

Box 5: Economic Development Institute (EDI) - Grass Roots Management Training (GMT)

EDI started GMT with pilot programs in six countries-Tanzania, Malawi, Burkina Faso, Senegal, Nigeria and India--to provide training in basic business skills for women micro-entrepreneurs through local NGOs. In India, for example, the program's goal was to improve the income-earning capacity of illiterate, landless women in rural areas and assetless women in urban areas. A steering group of leading practitioners worked together to design a training strategy, and an NGO was formed to implement the program; it works with local NGOs to extend training and follow-up support services. Overall, the results show that GMT has helped participants to select and plan more viable businesses, to be more aware of markets, and to learn how to apply for credit. GMT now has expanded to reach new groups in Africa, Middle East and Asia.

27. For IDA, the cost effectiveness of launching a number of small microfinance programs is also an issue. The costs of preparing and implementing such projects could be lowered by concentrating on a smaller number of microfinance institutions and helping them to achieve the required fmancial skills and operational scale as quickly as possible. This may be a feasible strategy, as follow up operations are planned which draw on the experience of earlier efforts.

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28. In the case of Honduras, a new microfmance program is planned which will concentrate on those intermediaries that demonstrated the best commitment and track record for sOWld financial management in the pilot component (cited at para. 25). The new program is planned as a separate operation, a proposed "learning and innovation" loan (LIL) of $5 million. Two other examples of stand alone microfinance programs are the Poverty Alleviation Microfinance Project in Bangladesh (see Box 6) and the Moldova Rural Finance Project, just starting implementation.

29. Another approach to supporting microfinance further is to develop linkages between the formal banking sector and non-banking institutions which lend to the self-employed poor. The savings mobilization and high loan repayment rates of some NGOs have helped them to become formal fmancial institutions, such as Banco Sol in Bolivia and K-Rep bank: in Kenya. Credit unions have also modernized and become players in lending operations to microenterprises in both urban and rural areas.

Box 6: Poverty Alleviation Microfmance Project, Bangladesh

The Poverty Alleviation Microfinance Project in Bangladesh ($105 million credit, FY97) is a rare large, stand-alone microfinance project Of the total credit, $99 million goes to microfinance and $6 million to institutional development. The project delivers microfmance at low cost (keeping the costs of transactions low) by using a well-established apex institution (PKSF) to wholesale funding through some 250 small to medium NGOs. The institutional component supports the introduction of MIS and fmandal accountability systems as well as recruitment of staff and training. The project benefits from the long and successful tradition in Bangladesh of NGO delivery of microfinance programs, although many of the participating NGOs in this program are new to microcredit delivery. The established microfinance institutions and NGOs (e.g., Grameen Bank and BRAC) have typically benefited from substantial bilateral aid and/or external NGO support. IDA support is intended to enlarge financial and institutional capacity to extend these efforts.

This credit is to be followed by a separate but complementary project, now under preparation. The proposed Sodal Investment Program (lOA credit of $50 million) would provide support for village infrastructure and community partnerships through NGOs; it may also include additional T A to support local groups managing microcredit programs.

IV. Building Indigenous Entrepreneurship Through the Growth of SMEs

30. SMEs have the potential to play a major role in IDA economies, both as a source of employment and, through creation of a local middle class, as a source of economic democracy and social stability. SMEs have special needs, however. They differ from microenterprises in the amoWlt and nature of finance they require and especially in their need to be competitive with larger, locally-based firms and with imports, which requires greater market knowledge and attention to quality control.

31. The Bank: Group supports SME development in several ways-by opening up opportWlities for them in various sectoral projects, finding ways to reduce firm-level constraints that affect their ability to compete, and continuing to improve their access to financial services.

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Over the period of 1993-1997, IDA has financed 23 projects with specific components targeted at SMEs (totaling $609 million). In addition, there are 12 projects in the FY98 lending program representing credits of $230 million. The projects fall into roughly three categories: (i) components of PSD and Enterprise Development Projects which offer SMEs access to small general lines of credit and T A aimed at improving their business environment or their competitiveness; (ii) urban development projects or social investment funds that sponsor public works, creating demand for SMEs in the construction industry; and (iii) rural finance projects.

32. Encouraging SME Competitiveness. A growing area of support for SMEs is in activities to increase SME competitiveness. In contrast to past delivery of TA through government promotion/extension agencies, the new programs show a much greater reliance on private partnerships and market forces than their predecessors. Increasingly, they are designed in consultation with the potential users-local businessmen!

33. Recent SME projects have emphasized upgrading national capacity in technology-related areas, including standards, technology consulting, and twinning with external companies. Some focus on building capacity within supporting institutions, usually organizations that offer training and consultancy services to SMEs. Other projects encourage collective learning activities through business associations and networks that can improve the flow of information and access to foreign partners, lowering individual firm costs. For example, the Enterprise Development Project in Zimbabwe includes components that support industry business associations and a program for catalyzing exports through matchmaking.

34. The Regional Program on Enterprise Development in Africa (RPED) plays an important role in understanding the factors affecting SME growth in Africa. Operating since 1991, it has undertaken a series of firm level surveys and market studies looking at microeconomic constraints to the growth of manufactured exports, focusing on "early stage" manufacturing sectors­textiles and garments, food processing, woodworking, and metalworking-in nine countries. They are: Cameroon, Cote d'Ivoire, Ghana, Kenya, Rwanda, Burundi, Tanzania, Zambia, and Zimbabwe. Its market studies have looked at demand for African products in US and European markets. RPED is

Box 7: Findings from RPED Surveys and Studies

RPED concludes that constraints at the enterprise level, e.g., production and marketing know-how, access to finance, and institutional structures of production, continue to hamper the supply response to the more favorable policy reforms now underway in parts of Africa. It also finds that the largest gains in firm productivity come with improvements in learning mechanisms, particularly through worker training, informational links related to foreign direct investment, and relationships with foreign buyers and suppliers, as weIl as access to TA contracts and technology licenses.

supported by a group of donors: Belgium, Canada, Denmark, Finland, France, Germany, Italy, the Netherlands, Norway, Sweden, Switzerland and United Kingdom.

35. RPED's findings (see Box 7) are being operationalized in a variety of TA interventions aimed at building up the capabilities of firms to respond to market opportunities. Its impact on operations include the following activities:

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• fonnulation of private sector development strategies • development of export promotion projects • design of cost-sharing assistance schemes to help finns raise technological

capabilities • design of technology promotion centers and programs to facilitate technology training • training of trade negotiators and export trading companies • design of programs to support the institutional foundations of financial markets

As an example, RPED's finn survey approach is currently being employed to design a component supporting SME competitiveness, as part of a larger PSD Project in Mozambique, building on recent economic refonns and an ongoing privatization program. The TA component will help finns take advantage of new market opportunities in the country.

36. RPED is also undertaking studies to monitor and evaluate the results of matching grant programs (see below). With a growing number of initiatives trying to catalyze SME competitiveness and growth, it will be important to monitor what works and what does not as feedback in design of future interventions.

37. Matching grant programs are an increasingly popular mechanism to support private learning opportunities at the enterprise level, with the goal of improving business and market knowledge. Originally designed to provide assistance to exporters (in several IBRD projects in LAC and India), some recently implemented programs have broadened the scope to support general competitiveness efforts. They are designed to be demand driven and flexible in scope, and beneficiaries are asked to pay part of the costs.

Box 8: Matching Grant Program in Uganda

The Private Sector Competitiveness Project in Uganda (credit of 12.9 million), a project designed with major input by Ugandans in the private sector, has a "matching grant" component of $3 million. supplemented by grant funding from the Austrian Government. The Business Uganda Development Scheme (BUDS) is successful in providing "know-how" (training or TA) on grant basis with 50/50 cost sharing. Some 15 months into its 4 year program, BUDS has already serviced some 10,000 people in 22 of Uganda's 55 district (vs. 2000 people originally estimated over the life of the project). The broad outreach results from efforts by local communities or association to organize group activities and training, thereby reducing overall costs. Clients have ranged from a group of women entrepreneurs concerned about disease control in raising rabbits ... to a coffee grower developing a market in the US ... to a group of vanilla farmers seeking planting techniques (vanilla is being revived as an export crop in Uganda). An ancillary impact of BUDS has been to build-up the local consulting industry.

BUDS is located within the Private Sector Foundation (PSF), an "apex" business association at the national level, instituted under the project, representing member business groups throughout the country. PSF is taking a "grass roots" approach to building its client base by first tackling issues important to businesses at the local and regional levels, although it has addressed some national issues (e.g., it helped in resolving a national strike concerning VAT). Feedback from clients of BUDS is also used in PSF's policy advocacy work.

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38. Nine IDA-funded PSD projects in the Africa Region have a matching grant component; together these programs use IDA funding of about $30 million, typically combined with additional bilateral support. They include: a successful grass roots program in Uganda (see Box 8 above); an initiative in Zimbabwe for enterprises seeking to expand their international competitiveness; and a pilot program for cashew processors in Mozambique under its Industrial Enterprise Restructuring Project. Two schemes in IBRD countries (Mauritius and South Africa) target research and development; a recent assessment of the program in Mauritius found it to be very effective. In South Asia, a matching grant program is planned under the Bangladesh Export Diversification Project to help firms improve marketing and product quality.

39. SME Access to Financial Services. SME access to funding-from equity to commercial financing-remains a serious constraint. Because of the "start up" nature of many of these ventures, ideally they would benefit from equity interest, but such funding is virtually unavailable for small companies in IDA countries (other than whatever pooling of limited family resources is feasible), because of the absence or thinness of capital markets. In addition, few commercial banks in IDA countries have developed the skills and technologies required for successful SME lending operations. Most SMEs have little in the way of collateral to secure their loans, and the costs of securing sufficient information to support a loan are very high.

40. In the Bank Groups' lending program, there is also "missing middle" for loan sizes of $20,000-200,000, appropriate to meet the working capital and investment financing of SMEs. This is partly a result of disappointing experience with targeted credit lines in the 1970s and 80s, which were hampered by the lack of macroeconomic and financial sector reforms. The current strategy is to move away from targeted credit lines and to encourage SME lending, as far as possible, in the context of broad financial sector reform and improved banking and financial services within client countries. This still requires substantial "institution building" to promote commercial lending to SMEs in a cost effective way.

41. Countries such as Sri Lanka and Ecuador have successfully encouraged commercial banks to commit to developing SMEs as a profitable client group, through staff training, decentralization of decision-making, strong follow up, and portfolio performance incentives. They offer a model to pursue more broadly in the context of overall commercial banking development. In addition, there appears to be scope for transferring lending methods and practices from micro finance to SME lending, including building the same kind of T A support for SMEs that CGAP and other groups give to development of the microfinance industry.

42. Several recent rural finance operations in Georgia and Zimbabwe (and in an upcoming project in Armenia) specifically support financing for SMEs. They focus on rebuilding rural financial institutions (credit associations) which offer credit lines for farm and non-farm enterprises.

43. There is also much greater scope for leasing instruments (related to equipment purchase), . risk-sharing mechanisms, and portfolio guarantees. The IFC has successfully invested in leasing companies in a number of African countries, for instance, and may be able to work with IDA in deVeloping other products suited to SMEs.

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44. SME Opportunities in Infrastructure. About half the projects supporting SMEs, cited at para. 31, are infrastructure and public works projects. These projects began in West Africa with the objective of building or repairing municipal and rural infrastructure through contracts with the private sector, usually local SME contractors. Bank-financed units, known as "AGETIPs,,4 after their prototypes in Senegal, typically extend matching funding for contracts and some technical assistance to small contractors. The employment generated by contracting SMEs has been an extra benefit. There have been further job opportunities for SMEs under SIFs. A broader effect from these jobs has been the creation of local contractor networks.

45. A further challenge for IDA is to find ways, via public/private partnerships, to extend access to basic services (power, water, telecommunications) more broadly in rural areas, beyond what can be achieved under small SIFs. In Africa, the IDA energy team is trying to develop a model, in cooperation with IFC, that would involve local private investors in providing village­based systems (Public/private partnerships). There may be an opportunity in Ethiopia to try out this model, as there has been a request for help in developing the rural energy supply. Such operations would create the linkage between energy and social/economic development. One option for increasing access to electricity is the development of decentralized power systems with a majority of local private participation. Such systems have been developed in Bolivia and Peru and could serve as models.

46. IFe's Business Support Facilities in Africa. IFC's long-standing business capacity building activities in Africa parallel the growing efforts under IDA operations and non-lending activities to promote business development among SMEs and local entrepreneurs. IFC is executing agency for three complementary programs organized with donor funding over the past 10 years to provide support to small businesses. They are:

The Africa Project Development Facility (APDF) was set up in 1986 to assist local entrepreneurs to ~'package" project concepts into viable business plans and to raise financing. Since then, APDF has assisted in 281 projects in 33 countries in Africa through six field offices. Other programs have followed from that experience, described below. Boxes 9 and 10 describe early interventions by APDF working with entrepreneurs in Cote d'Ivoire and Uganda, who have been extremely successful and become models for other entrepreneurs in their countries.

The African Management Services Company (AMSCO) was launched in 1989 by IFC, UNDP and AIDB to provide management development and training services to the African business community. It is supported by 11 bilateral donors and contributions from some 53 international private. companies. AMSCO sends experienced managers to client companies to work with local managers and staff in improving operational performance and building managerial capabilities to compete effectively in their respective markets. Since its inception, AMSCO has seconded over 200 managers to 102

4 Agence d'Execution des Travaux d'Interet Public Contre Ie Sous-Emploi (Executing Agency for Public Works for Employment).

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companies in 25 sub-Saharan countries and organized over 300 training events. In recent years, its client focus has turned toward SMEs, which today account for two-thirds of its portfolio.

The Enterprise Support Services for Africa (ESSA) was launched in 1995, as a three year pilot program, in response to IFC's experience that many promising projects fail at the implementation stage because of managerial weaknesses in the key areas of marketing, financial management, and MIS. ESSA has been funded initially by CIDA (Canada) and the IFC. The pilot phase has focused on Ghana, providing TA to businesses after they secure financing. ESSA has worked with 23 companies and trained 100 managers. Box 11 highlights an example in telecommunications. Demand for ESSA's services are growing fast in Ghana and, subject to securing additional funding, ESSA is considering expanding to other countries, especially in southern Africa

47. In 1988, as a result of APDF's work and recognition of the fmancing gaps faced by SMEs, IFC set up a special financing window for SMEs-the Africa Enterprise Fund-to demonstrate the viability of SME fmancing. Its staff are almost entirely field-based with offices in 8 countries, and investments are processed and supervised in the field. This approach has been extended through the launch of the Small Enterprise Fund (SEF) in FY97 under the "Extending IFC's Reach Initiative." IFC has now opened 3 additional offices and serves some 15 additional African countries. IFC also finances SMEs indirectly through its interventions in the financial sector (credit lines, leasing companies, etc.).

48. IFC's business support programs complement its SME financing mechanisms by providing advisory services at different stages, from the pre-financing "business planning" stage to post-financing implementation. While these programs have been successful and all involve some form of cost sharing, the managerial and transaction costs of such capacity buildinglbusiness support activities are high, making them difficult to sustain without substantial grant support. Moreover, the programs are fragmented, having started up at different times and established with support from different groups of donors. Individually, they now face downsizing because of funding constraints, at a time when the need for business support for SMEs is now gaining more attention. Annual funding needs for the three programs are expected to grow from $7 million to $16 million per year over the period 1999-2003, based on conservative estimates of demand, as current funding for ongoing programs is completed.

49. IFC sees a strong client need to forge these initiatives into an overall program in support of SMEs with broad funding support. As part of that process, it is exploring opportunities to leverage its programs with the capacity building initiatives in the Bank Group and ED!.

50. The Africa Region (IDNIBRD) and IFC together are preparing a joint private PSD strategy for Sub-Saharan Africa (entitled "Africa Can Compete!"), which describes the range of activities of the Bank Group aimed at addressing the micro constraints on small businesses (from RPED efforts ... to capacity building TA components ... to IFC's business support facilities). Business capacity building is a natural area for IFC cooperation with IDA because of the transactional experience of IFC staff as well as the specific "on the ground" experience under the

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APDF, AMSCO and ESSA programs. There may be ways to integrate the efforts at capacity building under IDA and IFC-perhaps bringing them under one umbrella, building a broader partnership with donors, and making it easier to work in a more comprehensive way and on a continuing basis with those partners.

Box 9: Pechazur, Cote d'Ivoire

Over the years, both the APDF and AEF have given special support to small fish-processing enterprises which, because of their strong backward linkages, have touched the lives of thousands of people in rural and coastal areas throughout Africa An excellent example of the economic contributions made by such projects is Pechazur, a fish and shrimp processing plant which operates in Dabou (Cote d'Ivoire).

In 1987, with the assistance of APDF, Pechazur defined a program to substantially expand and modernize its shrimp processing activities and improve its quality standards to enter the export market. Designed with the assistance of external consultants, the project led to the establishment of a small but modem fish processing plant with a processing capacity of 1,000 tons of shrimp p.a A local bank financed part of this US$1.6 million project, and the Company approached AEF to complete the financing package, as other sources of long-term financing were not available at the time. AEF has since supported Pechazur along its way to a well-integrated company and approved three investments totaling a further US$l.5 million equivalent which have allowed the Company to acquire a small fishing fleet and establish additional shrimp and fish processing facilities in Benin. Pechazur has developed its own export distribution networks in Europe. Although its export sales represent less than 0.5% of EU demand, the Company has been able to consolidate its position in the European market and achieve brand-name recognition among the major European fish importers.

In Cote d'Ivoire, the Company currently employs 540 workers, of whom 500 are women. For 70% of its output, Pechazur relies on shrimps and fish provided by some 3,000 independent artisanal fishermen organized in cooperatives, thereby ensuring daily living for a population estimated at about 13,000 in the fishing villages scattered along the Ivorian coast.

V. Encouraging the Growth of the Private Sector More Generally

51. Expanding opportunities in the formal business sector in turn creates employment and opportunities for SMEs to grow. The Bank Group's PSD strategy in Africa, for example, emphasizes "entry points," particular sectors where there are opportunities for private sector growth and significant foreign investment, and where integrated efforts can be made to address the various constraints, ranging from government policies or regulations to institutional or firm­level problems. The entry points are: agribusiness, urban manufacturing and commercial services, tourism, telecommunications and information technology, other infrastructure (power, transport), mining, and oil and gas. In each of these industries, there are opportunities to attract capital and encourage both public/private partnerships and foreign/local private sector partnerships, offering opportunities for large companies and small entrepreneurs. Some examples follow.

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52. Special Opportunities in Agribusiness. Agribusiness offers large potential for SME growth in many IDA countries. In Africa, there are good export prospects and opportunities to move to higher value products, generating ancillary growth. Already, there are some success stories--in cut flowers (Uganda, Kenya, Zambia) and high quality green beans, for instance. Agribusiness in fact accounts for the largest share ofIFC's SME financing, and IFC has played a role in fostering the growing horticulture industry in Africa (see Box 10).

Box 10: Uganda: Development of the Cut-Flower Industry Supported by APDF

Prior to 1993, the business of exporting cut flowers to Europe and other markets was completely unknown in Uganda The Africa Project Development Facility (ADPF) worked with local entrepreneurs to start the country's first cut-flower projects. APDF prepared feasibility studies for Nile Roses and Ziwa Horticultural Exporters and identified funding from IFC's AEF and local institutions. Since the floriculture industry was new in Uganda, APDF obtained grant funding to hire qualified foreign staff to implement the project and manage commercial operations. Managers were recruited from Kenya and Israel using funds from USAID and FMO (Netherlands). As part of project design, qualified Ugandans were recruited at the same time to understudy with expatriate staff, over time to become managers. Nile Roses and Kiwa Horticultural Exporters have been operating successfully since implementation and serve as models in Uganda

Local entrepreneurs have now developed 14 other cut-flower projects since 1993. Of the 16 projects now operating in Uganda, APDF prepared feasibility studies for 9 projects, and helped the sponsors raise fmancing and hire managers to transfer the technology and managerial skills. Over 4,000 people are now employed in the industry, two-thirds of whom are women. Foreign exchange earningsfrom this industry are expected to reach US$15 million in 1998 and double by the year 2000.

53. The Bank Group's PSD strategy for Africa anticipates targeting the agribusiness industry for further business capacity building activities to encourage the emergence of small to mid-size firms which can then participate in growing opportunities in the sector, as trade policy reforms take hold. Various bilateral donors, such as USAID, have been successful in promoting non­traditional agriculture through intensive T A usually with significant specialized expatriate involvement; the one drawback is that the unit costs of such efforts are high. IDA is seeking ways to incorporate similar programs in its operations in a cost effective way. As a catalytic activity, IDA is also encouraging the fonnation of a network of agriculture businesses in southern Africa.

54. Telecommunications and Information Technology. Some fifteen African IDA countries now have significant private activity in telecommunications, and six are privatizing state-owned national telephone systems (Cameroon, Gabon, Kenya, Tanzania, Togo, and Uganda). Information technology (IT) opportunities are also growing, but from a very low base. Trends in some countries (Ghana, Togo, Uganda, Tanzania) strongly indicate that IT is an industry where the barriers to entry by local private entrepreneurs can be potentially low, if regulatory and associated constraints can be overcome. Box 11 provides an example supported by IFC in Ghana.

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Box 11: Datatel (Data Telecom Limited), Ghana

Datatel is a locally-owned wireless communications company in Ghana Formed in 1994, it operates a nationwide Public Data Transmission Network a wide area network for companies allowing information flows between factories and distribution points. The first in Ghana to provide this type of service, Datatel has attracted an excellent customer base: major banks, oil companies, and other multinationals. Because of its rapid growth, the company needed help i n the following areas:

• customer service--to improve the delivery and quality of service; • employee training-to upgrade skills, mainly on the technical side; • organizational structure--a new structure to accommodate business growth.

The company contracted with ESSA for a technical consultant to address these areas, sharing 45% of the direct costs. As a result, various measures were taken. Changes were made in the internal organization of the fir to accommodate customers better and assign lines of responsibility more clearly. The consultant helped to source equipment which allowed Datatel to analyze its technical difficulties and improve the quality of service. Technical training improved the skills and confidence of staff. Consequently, service delivery improved-from 3 months to 4 weeks. Sales increased dramatically with the firm's ability to hook up and service clients faster and more effectively. Five major clients signed up in January 1998. Internal costs to the company declined by 10% as a result of staff training and added equipment. At the same time, because of company growth, there was an increase in jobs (nine people added recently).

On a macro level, Datatel's success has a positive effect on the business and service environment within Ghana, and the availability of first-rate telecommunication services increases the country's attraction to potential foreign investors.

55. Mining and Petroleum. There still are many opportunities in mining industries in some 30 countries in Africa. Developing these opportunities with private foreign capital could have a significant impact on export earnings in these countries. If the government shows a commitment to sectoral reform, creating the necessary enabling environment, IDA can provide support for business promotion activities through T A credits. It is providing assistance through Mining T A credits and non-lending activities (via development grants) in a number of countries (Ghana, Zambia, Tanzania, Mali, Cote d'lvoire, and Burkina Faso) aimed at promoting opportunities for investment to the private sector and foreign investors.

56. In the oil and gas industry, there remain opportunities even outside the large producing countries-particularly gas development for local market use. IDA's Africa Gas Initiative, launched in 1994 to facilitate the development of indigenous gas resources for local markets, is working to create an enabling environment so that natural gas projects can be developed by the private sector.

57. Need for Private Capital and Investment Promotion. Private capital flows are very small in IDA countries. In Africa, for instance, such flows totaled some $12 billion in 1996, up from previous years but still modest. Foreign direct investment in Africa represented $2.6 billion in 1996, compared to an average of $1. 7 billion in 1990-95. Overwhelmingly, these flows went to South Africa and a few natural resource projects. The low levels of capital flows and foreign

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investment are in part due to perceptions which are anchored in past policies. It takes time and a very consistent policy and regulatory environment to tum around such perceptions.

58. Various efforts are underway to promote infonnation about investment opportunities in IDA countries. The Foreign Investment Advisory Service (FIAS) has been involved in 233 projects related to foreign direct investment and capital market development, since its fonnation in 1985; some 30% of these have been in Africa. MIGA also has been active in foreign investment promotion in Africa through its Investment Marketing Services Department, especially in mining and tourism sectors. It also provides infonnation to businesses in Africa through an internet marketplace, called IP ANET. The Africa Business Network (ABN), launched in 1997 by IFC and the Bank, is another internet-based infonnation service oriented towards the needs of African entrepreneurs and international investors.

59. Building Regional Networks and Markets. IDA sponsored activities are also building regional partnerships and markets. By broadening the "economic space" beyond the very small size of individual country markets, such refonns are highly supportive of private sector entry. Examples in Africa are trade and fiscal refonn in Central Africa (UDEAC), creation of an economic community in West Africa (UEMOA), the South African Development Community (SADC), and a similar initiative in East Africa (COMESA), as well as broader initiatives such as the BanklEU supported Cross Border Initiative to transcend national boundaries. Planned IDA projects--interconnection of power grids, telecommunications and transport networks-will expand markets and business opportunities further.

60. IDA and a group of donors are also supporting the fonnation of business networks, for example the West Africa Enterprise Network (350 businessmen from 13 West African countries), as a way of fostering business knowledge sharing and expansion of markets; this approach is now being extended to East and Southern Africa.

VI. IDA's Support for Privatization Programs

61. Privatization programs can promote private sector development by transferring assets to more efficient management; by eliminating unfair competition or monopolies; and by avoiding the financial crowding out resulting from large parastatal subsidies. Privatization is underway in many IDA countries--in virtually all the high to top performing countries as part of overall refonn, and in a number of countries in the lower to middle range of perfonnance as they take steps towards broader refonn. The last five to seven years have represented a learning phase, with the overriding lesson being the importance of strong government commitment and, relatedly, the need to keep the public infonned about the goals and process of privatization.

62. In Africa, for instance, a growing number of countries have privatization programs underway (see Box 12 highlighting the case of Zambia). Over 2000 transactions were reported in 1995; some 2700 were reported in 1996 (with a sales value of $2.8 billion). Prior to 1996, privatization focused primarily on small enterprises. The larger enterprises in Africa, predominantly utilities, were not included in privatization programs. Hence, the impact-in

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tenns of fiscal deficit reduction, economic efficiency, foreign investment, and employment-has been small.

Box 12: Privatization in Africa-the Zambia Example

The Zambia privatization program, which started in mid-1995, has been successful in many elements, although-as with any new, complicated program-it has had its share of problems too. A study of privatization programs in Afiica rated Zambia's program medium to high in eight performance indicators. They are: extent of divestiture (Le., the government's willingness to exit totally from ownership of enterprises), fiscal impact, the efforts made and achievement in broadening ownership, the level of foreign direct investment attracted, post-privatization performance of enterprises, the depth and quality of program design and management, transparency, and government commitment. Zambia's program also enjoyed very strong donor coordination in providing TA support.

The privatization program is managed by the Zambia Privatization Agency (ZPA), which is private sector led. It has a board of 12 directors, but only 3 are appointed by the government; the other directors are selected by representative private groups. Individual transactions are conducted by small teams, through contracts with professional firms. The number of concluded transactions reached 204 at end-March 1997, with about US$I77 million in divestiture proceeds; the transparency of the process has been highly rated. An integral part of the program is the Privatization Trust Fund, established to warehouse shares which would later be sold through public flotations. ZPA is now responsible for a new generation of transactions, including privatization of the major utilities and the largest public enterprise, the Zambia Consolidated Copper Mines.

Problems have also occurred. A major state holding company created obstacles to the program until its closure. Several major public enterprises went into liquidation. Since ZPA was made responsible for overseeing these liquidations, in the minds of many people "privatization" became synonymous with "liquidation." ZPA has had to work hard to correct that popular misconception. Also, because of the country's fragile economic situation, Zambia was not readily attractive to foreign investors, although this may now be changing.

63. During 1996-97, many more utilities, notably in telecommunications, have entered into privatization. Upcoming privatization activities will include electric power, railways and ports. These transactions are expected to show a much greater impact over time, in improved operational and financial performance. In the medium to long tenn, privatization should bring needed additional private investment in technology, people and marketing; better value products and services; and more sustainable employment.

64. While privatization is moving forward, there are still some problems to work out. First, it is critical to build public consensus for privatization, through public infonnation programs, particularly using infonnal venues. Most privatization programs commenced with the public being generally unaware of the extent of government ownership and how poorly public enterprises were perfonning. As a result, in some cases, privatization has been associated primarily with liquidation.

65. In some countries, there has also been insufficient attention to policies to assure appropriate social safety nets; better separation policies (redundancy and retirement benefits) are

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needed for those who lose their jobs because of downsizing or liquidation. Also important is greater use of mechanisms to broaden share ownership (e.g., through warehousing and investment funds). In the next phase, continued capacity building will be important to improve the design of privatization programs in these areas. In addition, formal efforts are needed to monitor the results of privatization to provide early feedback to policymakers and the public.

VII. Private Provision of Infrastructure (PPI) and Role of WBG Guarantees

66. All groups in IDA countries bear the high cost of inadequate and poorly functioning infrastructure. Private provision of infrastructure, though still at an early stage in most countries, offers promise in terms of improving and expanding services and reducing the public burden; it also would create ancillary business opportunities.

67. The enormous capital needs for infrastructure rehabilitation and expansion reflect the years of underinvestment in many IDA countries. Attracting private sponsors and related commercial financing for infrastructure investments is, in fact, essential, because the capital needs cannot be met by governments alone. The Bank Group has a variety of instruments to help attract private investors, ranging from "private infrastructure development projects" under IDA, helping to finance the government's share in a project, to a variety of products designed to give c-omfort or risk coverage to private investors or financiers-an IFC guarantee or B-Ioan program, MIGA insurance, IBRD enclave loans or guarantees, and, last in the hierarchy, the IDA "partial risk" guarantee (under a pilot program).

68. Box 13 lists IDA countries with upcoming private infrastructure projects for which some form of risk coverage from the Bank Group, possibly an IDA guarantee, may be appropriate.

Box 13: Countries with Upcoming Infrastructure Projects with Private Participation

Power Sector: Bangladesh, Benin, Cote d'Ivoire, Ghana, Kenya, Nicaragua, Senegal, Sri Lanka., Togo, Uganda, Vietnam, Yemen

Water Sector: Ghana, Senegal Railways: Malawi, Senegal, Mali, Zambia, Mongolia

Ports/Airports: Ghana, Sri Lanka, Vietnam

69. The Role of IDA Guarantees. An IDA "partial risk" guarantee covers private lenders in IDA-only countries against country risks beyond the control of investors. Cases where an IDA guarantee might fit are in large, privately-sponsored projects in the power sector and in building and operating other major infrastructure (e.g., natural gas pipelines). They involve public-private partnerships, where project revenues depend heavily on government performance, for example in purchasing the project's production. Such a project may represent the country's first major commercial financing of infrastructure. An IDA guarantee could reinforce the assurances provided by the government and playa transitional role in supporting the country's introduction to international financial markets. It is also important to consider the tangible project benefits­improved services for IDA populations and public savings which can go into social programs.

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70. Two potential projects demonstrate the kind of transaction for which an IDA guarantee is suitable: the Haripur Power Project in Bangladesh and the Vietnam Phu-My 2-2 Power Project (see Box 14). Both are tentative transactions at this stage. If they go ahead, they will represent commitments totaling $125 million, or 40% of the allocation ($300 million) under the pilot program.

Box 14: Two Private Infrastructure Projects-Potential Use of an IDA Guarantee

Bangladesh: Haripur Independent Power Project The Private Sector Infrastructure Development Project (PSIDP) with a credit of US$235 million (approved in early FY98) is expected to facilitate financing for very large, privately sponsored infrastructure projects. It provides: (i) long term loans to meet financing shortfalls and (ii) TA to help the government identity, develop and promote viable transactions. Initial transactions will be in power generation (with independent power producers), gas pipelines and transmission, and telecommunications. Subprojects in ports, water supply and highways are perceived to carry greater risks and will therefore involve longer lead times and more development work. The T A component represents a partnership among CIDA (Canada), DFID (UK) and IDA, with the IDA component being $3 million.

An expected beneficiary of the PSIDP is the Haripur Power Project, an independent power production (lPP) project using domestically-produced natural gas. About US$175 million is needed for this project, including about US$40 million in equity from the private sponsor; it is the first private infrastructure financing of this size in Bangladesh and therefore will test commercial market interest in such a financing.

IDA funding, via the PSIDP, provides the publicly sponsored subordinated debt. It is expected to be complemented by IFC participation (A-loan) and commercial financing, perhaps under a B-Ioan (offering the comfort of joint participation). An IDA partial risk guarantee may be offered to attract additional commercial bank fmancing (as much as $50 million) beyond that which can be organized under an IFC B-Ioan. If an IDA guarantee is employed, this will reduce the funding required of the PSIDP, conserving resources for other needed infrastructure. The approach highlights the complementarity among WBG instruments in an overall financing package.

Vietnam: Phu-My 2-2 Power Project The Phu My 2-2 Power Project is the first major private infrastructure project in Vietnam to be bid competitively and contracted on a BOT basis using limited recourse finance. The project consists of a proposed 700 MW combined cycle power facility, representing the second phase of the Phu My 2 power plant. IDA is financing the flTSt phase of the power station and TA for the second phase under the Power Development Credit ($180 million).

In the second phase project, natural gas for the power station will be supplied by the state-owned gas company, and in turn the power will be sold to the state-owned electric utility; there will also be a land-lease agreement with the provincial government. While the country has started developing the legal and regulatory framework for private investment in the power sector, it is not yet fully established. Nor has the viability of major limited-recourse project finance for Vietnam been tested in the market. Given the non-investment grade credit standing of the country and the lack of a performance record by state-owned agencies, prospective private fmanciers face substantial risks.

A request for proposals for the project was sent out in late 1997. Prospective bidders have sought guarantees for the non-commercial risks of the project, and the Government has recently informed the bidders that an IDA partial risk guarantee is an option. The IDA guarantee could cover the political risk for a minimum amount of commercial financing, taking into account the availability of coverage through export credit agencies and IFC. Approval of the guarantee would be subject to satisfactory appraisal of the project by IDA and provision of a counterguarantee to IDA by the Government. An IDA guarantee in this case would help mitigate the risks of non-performance by the government agencies involved, facilitating mobilization of the financing required. Overall, WBG involvement in the project would help Vietnam establish the credibility ofits independent power development program, encouraging future private investment in the sector.

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71. Developing the IDA Guarantee Pilot Program. During the course of IDA 11 negotiations, the Deputies discussed the potential role of an IDA guarantee instrument. They concluded that more work was needed in exploring the business needs and justification for use of IDA resources, before a decision could be made. In February 1997, the Deputies agreed that IDA guarantees should be explored in the context ofIDA's role in private sector development.

72. An overview of the Bank Group's instruments, distributed to IDA's Board in March 1997, concluded that the Bank Group had appropriate instruments to foster private sector investment in the middle income and blend countries, but it was at a disadvantage in dealing with the poorest countries, specifically the IDA-only countries. In April 1997, the Board considered and approved the use of IBRD guarantees in IDA-only countries on an enclave basis. IBRD enclave guarantees provide credit enhancement for projects in countries that would not generally be creditworthy for IBRD financing. Several criteria must be met. The project must yield substantial economic benefits to the country. It also must generate adequate foreign exchange revenues and provide risk mitigation measures which make the guarantee undertaking an acceptable risk to IBRD on a project baSiS, even though the country itself is not creditworthy.

73. While the enclave guarantee program is considered useful in extending IBRD guarantee coverage to some IDA countries, its scope is limited. Thus, further discussions were held with IDA's Executive Directors during the course of 1997 on the workability of offering IDA guarantees and potential cases where they would be justified. On the basis of these consultations and a subsequent management proposal, the Board adopted a pilot program of IDA guarantees on December 31, 1997. 5

74. IDA guarantees will be considered only when other Bank Group support is either unavailable or insufficient. Thus, IDA guarantees would only be used when IBRD enclave guarantees are not feasible, and neither MIGA nor IFC are in a position to offer sufficient coverage. Annex 3 describes the specific coverage of these various instruments.

75. The pilot will be funded up to a limit of $300 million. Guarantee proposals will be submitted to the Board for approval on a case by case basis. The criteria for approval will be the following: (i) use of the guarantee fits within the framework of the CAS; (ii) the operation strongly supports economic growth which, in turn, generates resources for priorities such as poverty reduction; (iii) the guarantee complements--<ioes not displace-other Bank Group guarantees; and (iv) the guarantee supports sound government policies; it does not substitute for them.

76. Because IDA resolutions do not specifically authorize the use of contributions for guarantees, the guarantees to be provided under the pilot program will be funded by IDA's initial subscriptions. The pilot program will be reviewed by IDA's Executive Directors when the value of approved guarantees reaches $300 million or after two years, whichever comes first.

5 The memorandum to Executive Directors proposing the IDA guarantee program is dated October 31,1998.

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77. If the review of the pilot program concludes that it has been successful and further use of guarantees is envisaged, authorization would be needed to use general IDA resources to fund this instrument. The Deputies are therefore asked to consider making IDA-I2 resources available for the IDA "partial risk" guarantee. Such an authorization would be subject to confirmation of successful performance during the mandated review of the pilot program and would incorporate, at that time, any Board-recommended improvements in design or execution of the program in the future.

VIIL The Way Ahead for IDA and PSD

78. IDA-sponsored PSD activities are broad and varied as demonstrated by the range of approaches used in addressing the needs/constraints of different business groups. The broad approach to PSD and the flexibility provided by different instruments are key to being effective in designing country-specific programs, based on the framework of the CAS.

79. This note highlights efforts targeting microenterprises and SMEs, the former because of the need to stabilize incomes of the poor and the latter because of their broader economic potential. Three interventions are critical: the need to improve access to finance and build links to general improvements in the commercial banking system; to continue to support improvements in infrastructure in poor areas; and to build and strengthen partnerships to be able to deliver intensive, sustained capacity building-aimed at sustainability in microfinance institutions, broader availability of financial services for SMEs, and improved business capabilities and competitiveness of SMEs.",

80. Microenterprise initiatives will continue to be launched in a wide variety of IDA countries, those strongly perfonning as well as those taking early steps towards refonn. IDA operations targeted at SMEs and the fonnal business community, as well as private provision of infrastructure, will occur largely in the better perfonning countries. These countries present opportunities to work closely with IFC and use the strengths of the World Bank Group more effectively in supporting different groups within the private sector, including joint participation in financing packages for large private or public-private infrastructure projects.

81. Capacity building is part of virtually every PSD initiative described in this note. Institutional capacity is one of the key constraints to greater resource transfers in IDA countries. Developing human and institutional capacity takes time; it involves continuing "on-the-ground" coordination and attention to the details of implementation; and the delivery mechanisms need to be largely decentralized using staff having the requisite business skills. Because the organizational and transaction costs are so high, such efforts require grants as well as credits. As a result, capacity building programs are best undertaken in partnership with donors and NGOs.

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82. This note concludes with some questions for the IDA Deputies to consider:

* Do the Deputies see the scope for more focused and organized partnerships to support the range of capacity building activities encouraging microfinance and SME development? Do they agree that, if so required, IDA grants could be selectively used for this purpose in the context ofIDA 12?

* Do the Deputies agree that IDA guarantees should be provided for in the context of the IDA-12 Replenishment Agreement, subject to the Board's review of the pilot program?

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Annex 1: Examples of the Range of PSD Activities in Selected IDA Countries (Top &: upper quintiles ofperjormance)

Bolivia Regulatory Reform & Capacity Building (FY95, $14.7 million) Judicial Reform (FY95, $11 million) Financial Markets & Pension Reform (FY96, $9 million) Capitalization ProgramlReform (FY96, $8 million) Capitalization Program (FY96, $50 million) Hydrocarbon Sector Reform & Capitalization (FY96, $10.6 million) Capitalization IT (FY97, $5.4 million) Micro and Small Enterprise (FY98, $30.7 million)

Cote d'lvoire Privatization Support (FY92, $15 million) Municipal Support (FY94, $48.7 million)-SME public works Rural Savings (FY94, $2.2 million)-S&Ls/microcredit Regulatory Reform (FY94, $50 million, ... ) Private Electricity (FY95, $79.7 million)-Privatization Private Sector Development (FY96, $180 million)­Railways Rehabilitation (FY96, $20 million) Private Sector Development (FY97, $54.6 million)-AdjustmentlPSD support

Mongolia Transport Rehabilitation (FY94, $30 million) Poverty Alleviation for Vulnerable Groups (FY96, $10 million) Coal Project (FY96, $35 million) Ulaanbaatar Services Improvement (FY97, $16.5 million) Banking & Enterprise Sector (FY97, $10 million) Banking, Enterprise & Legal TA (FY97, $2 million)

Ugandll Enterprise Development (FY92, $65.6 million)-Privatization Cotton Sector Development (FY94, $14 million)-Financial Sector Adjustment (FY94, $1.1 million) Institutional Capacity Building (FY95, $36.4 million) Private Sector Competition (FY96, $12.3 million)-SME support/Credit line Finance-Restructuring & Rehab. (FY98, $20 million)-Microcredit

Vietnam Agriculture Rehabilitation (FY94, $96 million) Highway Rehabilitation (FY94, $158.5 million) Power Sector Rehabilitation (FY95, $165 million) Payment Systems & Bank Modernization (FY96, $49 million) Power Development (FY96, $180 million) Rural Finance (FY96, $122 million)

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Annex 2: Characteristics of Microenterprises and SMEs

Microenterprises Small to Medium Enterprises

Who? - self-employed individuals and their families or - up to 50 workers (smaH) business; with 5 workers or less; many entrants are iHiterate - 5()"100 workers (medium)

-large proportion are women

Typical activities - use little or no technology - use labor-intensive traditional technology (smaH)

- market stan or shop; repair services; crafts - trade, construction, light manufacturing (smaH

- markets within a few km of home to medium)

- enter local or regional markets

Economic role - main source of income for majority of non- - overaN growth potential varies; many start up, farm population but most fail; some grow to be large firms or

exporters - rarely grow in size, but may spin off new enterprises for family members; tend not to be -labor intensive relative to large firms and incubators for SMEs therefore create jobs with limited capital

investment; potential source of broad employment as sector grows

- can act as seedbeds that foster and train future entrepreneurs in the modem sector of the economy

Firm level hoblom -low or jlu,ctuating income - poor access to working and investment capital Constraints

- no access to working capital - poor physical access to markets, due to poor infrastructure, e.g., transport & unreliable

- poor roads and other infrastructure.. related power problems inhibit market access

-low national education attainment affecting - illiteracy affects ability to access market and avai/ability of skilled technicians and engineers product information and task-level efficiency ofworkers

- insufficient technology transfer and learning

Goals of WBG Proj - increase and smooth incomes for families, - encourage investment through better access to Directly Targeted at mainly by credit through microfinance finance these BUSiness Gro institutions

- improve both institutional and physical - upgrade roads and other local infrastructure infrastructure to improve market access

- foster the spread of business "know-how" via - Primary education for basic literacy firm or collective learning

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Annex 3: WBG Guarantee Instruments

The IDA "partial risk" guarantee is part of a hierarchy of WBG instruments, each offering specific coverage, as described below:

MIGA offers broad coverage of private investment against the risks of expropriation, war and civil disturbance, breech of contract and currency transfer. Eligible fonns of investment include equity, shareholder loans, loan guaranties issued by equity holders, and loans of unrelated lenders (if a shareholder investment is also insured). Other fonns of investment including technical assistance, management contracts, and licensing agreements can also be covered. To issue coverage, MIGA does not require a counter-guarantee from the host government.

IFC instruments include guarantees or syndicated loan arrangements with private lenders. Its guarantee offers full risk (not partial) coverage, therefore would not cover solely the political risk on government undertakings. Under B-Ioans, IFC is the lender of record for the account of other participating financial institutions, which enter into individual participation agreements with IFC. All project risks, commercial and political, are assumed by the participants, but each participant does share in IFC's privileges and immunities. IFC does not guarantee B-loan lenders nor does it obtain counterguarantees host governments.

IBRD "enclave" guarantees are available for large foreign exchange earning projects, offering substantial benefits to the country, and where risk mitigation measures are in place satisfactory to IBRD, making it possible to extend the guarantee despite the country's lack of creditworthiness. The IBRD guarantee, in this case, provides coverage for non-commercial risk.

The IDA "partial risk" guarantee covers political risk for debt financing, for example due to breach of contract. It is backed by the guarantee of the host government. Breach of contract is a major risk in public-private infrastructure projects, where the role of the government in the fonn of its contractual obligations remain central. IDA has a strong advantage given its long tenn relationship with IDA countries and the possibility of cross-default with the rest of the lending program.

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Bilateral Donors

Australia Belgium Canada Denmark Finland France Gennany Japan Luxembourg Norway The Netherlands Sweden Switzerland United Kingdom United States

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Annex 4: CGAP Member Donors

Multilateral Donors

African Development Bank Asian Development Bank

European Commission Inter-American Development Bank

International Fund for Agricultural Development International Labour Office

United Nations (UN) Capital Development Fund United Nations Development Programme

UN Conference on Trade and Development The World Bank