indonesia and philippines due diligence report, january 2013

7/29/2019 Indonesia and Philippines Due Diligence Report, January 2013

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Due Diligence Report on Indonesia and Philippines

for the

ADB Inclusive Business Fund Initiative

Key Findings

SUBMITTED BY NOAH BECKWITH

ADB BOP INVESTMENT FUNDS INITIATIVE

DATE: 17 JANUARY, 2013



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Table of Contents

Section Page No.

I. Introductory Remarks 3

II. Indonesia 3

III. Philippines 12

IV. Key Issues and Recommendations 16



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I. Introductory Remarks

This report follows detailed due diligence on Indonesia and the Philippines to assess the viability of

establishing a fund focused on improving people’s lives at the base of the pyramid (BOP) by investing

in inclusive businesses. The challenges of making investments, whether debt or equity, of $500,000

to $10m in private businesses in Indonesia and Philippines are not insignificant. In the case of

Indonesia, political instability and security issues, currency depreciation and structural imbalances

between very large, dominant parastatals and large corporations on the one hand, and small and

medium sized enterprises (SMEs) on the other (among other issues) make for a testing operating

environment. In Philippines, despite significant inroads made by microfinance in recent years, access

to debt and equity for SMEs remains difficult, hampering expansion in the supply chain among

companies that could be drawn more closely into the production activities of larger corporates.

Notwithstanding, the strong conclusion of this report is that there is an opportunity for the Asian

Development Bank (ADB) to sponsor the establishment of a debt facility (the Facility) which both

contributes to poverty alleviation by addressing production, supply, consumption and employment-

related challenges that affect the BOP in Indonesia and the Philippines, and helps to build the base

of well-managed, profitable businesses in both countries.

II. Indonesia

Macroeconomic and Political Landscape and Structural Challenges

Despite intermittent bouts of terrorist activity which continue to concern investors, Indonesia has

made significant inroads in modifying the image of the country as a more stable environment in

which to do business, with relatively sound macro-economic fundamentals. Although currency

depreciation remains a significant concern—important in the context of the ADB initiative because

of the impact on returns, whether debt repayments or realisation of equity stakes—the elevation of

the country’s sovereign credit rating to investment grade by two of the three biggest international

rating agencies in 2012 was a significant cross-roads. To some extent, this reflects the emergence,

within the burgeoning population of over 200 million people, of more and more incumbents of the

middle class, all with aspirational demand tastes that are driving consumption and the development

of deeper domestic production markets.

With specific regard to the ADB’s inclusive business (IB) initiative , one of the biggest challenges

posed by the structure of the Indonesian economy is the vast gap between quasi-oligopolistic large



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corporates and parastatal companies on the one hand—and not simply in the energy sector—and

the vast swath of SMEs on the other, with little in between. The groundwork for these structural

imbalances was laid in the 1960s, when the so-called ‘new order’, or more modern approach to

economic development, was initiated. Decades later, the lasting impact is that it is very difficult and

unusual for SMEs to be drawn into the supply chains of larger corporates in a meaningful way that

enables the former to increase their value added activities.

These structural asymmetries are further exacerbated by the fact that the Indonesian economy is

heavily intermediated by small-scale traders and distributors. In some ways, it could be argued that

this is a proxy for the lack of conducive physical infrastructure (with the exception of the greater

Jakarta and Surabaya areas) and the inherent challenges of moving goods and services around such a

vast archipelago. Be that as it may, however, from the perspective of inclusive business, the salient

point is that it affects the way in which goods are procured from the SME sector by larger

companies, and partially explains why few SMEs are successful at developing export markets for

themselves. There are some exceptions to this, where buyer-driven trade networks have developed

in sectors such as furniture and garments in Jakarta, and garments and carved wooden furniture in

Bali, but given that the SME sector accounts for over 90 per cent of employment in the country and

that its rapid growth will therefore be critical to any lasting poverty alleviation, more concerted

efforts are required to address these structural challenges.

The Financial Landscape and Inclusive Business

In recent years, the central bank of Indonesia has strengthened the regulatory framework and

supervisory arrangements for the banking sector, which has increased confidence significantly since

the Asian financial and economic crisis of 1997-1998. The focus, more recently, has turned to further

development of the financial markets and new investment vectors and disciplines, such as venture

capital, private equity, microfinance and angel investing. Importantly, the ministry of finance is

looking to strengthen entry regulations for non-bank financial institutions (NBFIs), their transition to

regulated entities, licensing arrangements more generally, and capital requirements for all actors in

the financial sector. This is important to the ADB’s IB initiative because SMEs’ pervasive inability to

access finance from formal financial institutions means that they are often left at the mercy of

predatory, unregulated, semi-formal purveyors of finance that charge punitive rates for loans.

Also significant from the inclusive business perspective is the government’s decision to grant venture

capital firms tax exemptions for investing in certain sectors. Although there are concerns that this



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could distort the allocation of capital and promote ‘rent-seeking’ behaviour among some players,

the overarching recognition that alternatives to bank finance from heavily collateral-focussed

institutions for SMEs and the non-corporate sector more generally is critical to more broad-based

growth in the country.

An Inclusive Business Facility in Indonesia: A Natural Focus on the SME Sector

The ADB’s IB initiative in Indonesia will, naturally, have a significant focus on the SME sector. With

the exception of the oil and gas sector, over 90 per cent of all firms in the country are SMEs,

providing livelihoods for more than 90 per cent of the population. Moreover, the SME sector

accounts for nearly all new employment creation in the country, according to the Organisation for

Economic Co-operation and Development (OECD). With regard to the crucial agriculture sector,

according to data published by the Ministry of Co-operatives and SMEs, 87% of output is attributable

to micro-, small and medium-sized enterprises. It is therefore clear that in order for the strategy of

an IB initiative in Indonesia to be meaningful, it must have a significant focus on the agriculture

sector and an emphasis on strengthening the linkages between small producers and larger

aggregators and processors.

The challenges to improving the competitiveness and dynamism of Indonesia’s SME sector arefamiliar in the South-East Asian context. SMEs tend to have relatively high production costs, low

levels of efficiency, and struggle to invest consistently and meaningfully in human resources,

technology, machinery and other vital fixed assets. As a result, their ability to capture greater value

by producing more semi-finished and finished goods is compromised which, in turn, often keeps

incomes relatively low. Part of an IB strategy for Indonesia must therefore concentrate not just on

the more effective incorporation of SMEs into supply chains, but creating opportunities for them to

add and retain value themselves.

The Indonesian government has recognised the importance of incentivising larger companies to

reach into the supply chain and incorporate SMEs, especially in the non-oil and gas sectors. Indeed,

there have been some important policy initiatives around incentivising larger companies to create

clusters of SME producers and suppliers since the late 2000s. By the same token, however, some

small firms are protected under Indonesian law through the reservation of certain industries for

them. This, in turn, requires larger companies, especially foreign ones, to partner with them in order

to gain access to foreign direct investment (FDI) opportunities. The concern, nevertheless, is that this



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could discourage FDI inflows to sectors which are particularly SME-intensive because SMEs are

unfamiliar with and vulnerable to exploitation by larger companies.

Constraints to Growth in and Inclusion of the SME Sector

In addition to access to finance (see below), there are several important constraints to faster growth

in the SME sector which are critical to note in the context of the IB initiative. This is because their

hampered growth is, to a large extent, the result of their lack of inclusion. First, SMEs’ ability to

invest and grow organically is impeded by price fluctuations for raw materials, marketing challenges,

transportation and distribution difficulties, high energy prices and supply interruptions and often

high labour costs. Given that all of these challenges, in the aggregate, signify a relatively high

expense-base in which to operate, ‘savings’ are often made by avoiding formalisation. Whilst on the

one hand this enables them to remain below the radar of tax authorities, on the other hand it

damages them in the long term because it makes them harder for larger companies to identify,

engage with and draw into their supply chains. Second, this naturally limits export development

opportunities and translates into poor export performance. Indeed, the OECD notes that Indonesian

SMEs are among the least likely in South-East Asia to export directly to buyers; i.e., to the extent that

there are linkages forged with SME markets abroad (and even domestically), these tend to be

brokered through intermediaries such as traders or trading companies. Third, productivity levels

remain low because turnover and profit does not increase sufficiently to enable business owners to

afford new machinery, modern tools, information, technology and other inputs. Ironically, some of

these structural and systemic challenges have been obscured by the steady depreciation of the

rupiah, which ‘flatters’ the performance of the SME sector in local currency terms. However, in the

long run, the inflationary impacts of depreciation far outweigh the benefits which SMEs might

perceive in nominal local currency.

Improved Access to Finance: The Key to Inclusive Business in Indonesia

Bearing in mind the contribution of the SME sector to Indonesia’s economic output and the fact that

many of Indonesia’s poor are, by definition, engaged in micro- or small enterprise, then in can be

argued that rapid growth in the SME sector is vital to poverty alleviation. This, in turn, could be

accelerated by greater inclusion of the SME sector in economic activity, but only if SMEs’ ability to

access finance is vastly improved. There is an enormous opportunity, therefore, for ADB’s IB

initiative to work with financial institutions to create, or further develop, products offered by



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financial institutions that help to alleviate bottlenecks in access to finance. Before considering the

nature of such products, it is important to highlight the main factors which, inter alia, impede SMEs’

access to finance in Indonesia:

Insufficient collateral: Like many South-East Asian countries, and particularly since the Asian

Crisis of 1997-98, Indonesian banks are most comfortable with collateral-based lending,

which proves a high hurdle for most SMEs (especially in frequent cases of inability to use

individual or communally-owned land);

Incomplete or sub-standard financial records: Banks generally require at least three years’

historical financial information from prospective borrowers. SMEs often lack the financial

and accountancy training to prepare this information to standard;

Reticence to consider cash flow-based lending: Given the high concentration of SMEs in the

agriculture sector, the combination of exogenous risk factors such as weather fluctuations

and risk of natural disaster with seasonality and volatility of earnings makes banks very

nervous about lending against future cash flows; and

Inflexible repayment terms: Similarly, most banks are unwilling to consider accommodating

the irregular cash flows of prospective SME clients in repayment schedules, again excluding

them from the formal financial system.

The World Bank recently highlighted SMEs’ inability to access finance regularly and in meaningful

amounts as among the top impediments to more rapid, broad-based growth and private-sector

development in Indonesia. The reason for this is that SMEs must rely on either retained earnings,

finance from family and friends, or loans at punitive interest rates from money lenders, loan sharks

or other highly informal sources to fund basic working capital needs. As a result, professionalisation,

up-skilling, human resource-development, improving technology and gaining access to new

technology, product development, more effective marketing strategies and other key business

needs suffer. Additionally, the chances of SMEs being drawn into larger, deeper, more lucrative

supply chains are reduced.

The ‘short-circuiting’ of SMEs’ access to finance also limits their ability to develop export

opportunities. Unlike some other South-East Asian countries, for instance Vietnam and Thailand,

there is a notable lack of direct contact between Indonesia’s SME sector and foreign buyers—with

the exception of some sectors such as wood products, garments and textiles—meaning that the



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export sector as a whole is dominated by larger players. As highlighted above, marketing linkages

tend to be forged between SMEs and trading houses, distributors and other local intermediaries,

with the result that income-growth and employment-generation potential is muted at the SME level.

In addition, SMEs lack the information and expertise to penetrate export markets, are unable to

adapt to rapid changes in foreign market conditions or tastes and, above all, struggle to

accommodate time lags in payments often due to long shipment times. There is some evidence that

rising internet connectivity is helping current and prospective exporters to access information on

sales opportunities, inputs, raw materials, new technologies and machinery, but given Indonesia’s

vast geography and significant disparities in connectivity and literacy across the archipelago,

improvements are patchy.

Another important factor which impedes more consistent export development among SMEs is that,

since the financial crisis of 2008-2011, exporters are no longer able to collect payments by showing a

bill of lading to their bank. Due to tighter regulations, banks are forcing them to await remittance of

payments by the issuing banks into their accounts before releasing funds. Not only does this

represent a significant time lag for cash flow-sensitive SMEs, but also, the slow ‘turnover’ in cash

means that they are unable to plan and initiate other activities—for example, servicing future orders

in adjacent or even independent business lines—until payment has been received.

Opportunities for the ADB IB Facility

Whilst the litany of inefficiencies and structural and systemic imbalances highlighted above may

appear to indicate that Indonesia is not suitable to an IB Facility, in fact, due diligence suggests that

significant opportunities would present themselves for a vehicle, particularly if focused on debt (see

Section IV below). Before briefly presenting them below, it should be mentioned, however, that it

would be advisable for Facility interventions in Indonesia to take the form of debt rather than equity,

although it may be possible to deploy equity in some specific cases. This is for two main reasons:

first, because it is arguably on the SME sector that an IB initiative should focus; and second, because

SMEs, by and large, have little familiarity with equity and are loath to allow external shareholders

into their ownership structures. Furthermore, may are not sufficiently sophisticated to even have

shareholding structures, which significantly augments the risk for external investors.

Due diligence revealed that the following sectors, inter alia, would be particularly well positioned for

debt allocations by an IB Facility:



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Financial Services: Although access to financial services has improved significantly in

Indonesia at the individual credit level in recent years, primarily through the medium of

microfinance provided by institutions such as Bank Rakyat Indonesia (BRI), as discussed

above, all but the largest corporates and parastatals struggle to get access finance from

formal institutions. The IB Facility could, therefore, work with financial institutions to

develop products which are inclusive in the sense of enabling BOP incumbents to participate

more fully in production and supply chains. Such products might include:

Agricultural finance: including contract finance, warehouse finance, factoring,

reverse factoring and products that facilitate access to improved inputs such as

seeds, fertilizers, herbicides, pesticides, insecticides, machinery and so on;

Access to energy and clean energy more generally: including solar lighting, waste to

energy initiatives, small-hydro, bio-gas etc.;

Cash flow-based products: At the more sectorally agnostic level, there is an

opportunity to help financial institutions to create cash flow-based lending windows

which would enable vast numbers of SMEs, currently excluded due to a lack of

collateral, to get access to credit. With strategically-deployed technical assistance

for training and implementation of risk management systems, financial institutions

could begin to provide unsecured lending products—admittedly, probably more to

medium-sized than to small businesses in the first instance—the idea being that,

over time, the institutions gain comfort with cash flow-based lending and credit risk

assessment more generally.

Agri-business and agro-processing: In light of the dominance of the agriculture sector, and

the vast potential for local producers to be drawn into domestic supply chains—let alone to

develop export opportunities—there will be enormous opportunities in agri-business and

agro-processing. As more Indonesians enter the middle class, tastes are changing, meaning

that demand for processed vegetable-based foods and dairy products has increased

significantly. This presents opportunities for the IB Facility from two angles. First, it could

look to lend at the medium-sized, and in some cases small business level. But second, it

could look to lend to larger producers based in or near cities like Jakarta and Surabaya, that



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understand the long-term benefits of engaging with the SME sector in order to strengthen

local supply chains and, in some cases, begin to ‘go organic’;

Value-added niche agriculture and aquaculture: Given the enormity of the Indonesian

archipelago and its varied topography, small-scale producers of niche products such as

spices, balms, essential oils, extracts and the like need to be connected not only with

aggregators in urban centres, but also larger international producers of foods, cosmetics,

medicines and luxury products. In many cases, such companies require urgent investment

and technical assistance in branding, marketing, certification and so on. They also need to be

connected with international purchasers;

Wood products: There is a clear opportunity in Indonesia to contribute to the development

of sustainable use of timber resources by helping craft makers, furniture manufacturers and

providers of flooring, wood panelling and other wood to procure raw materials from

sustainable sources. A more sophisticated IB approach, additionally, would also help such

businesses to work with local communities so that the latter are engaged in a more

consistent way in supply chains, thereby improving the consistency and quality of supply to

IB investees, whilst translating into increased incomes for local households;

Utilities: SMEs in many rural and peri-urban areas desperately lack consistent, quality

utilities such as water, sanitation and energy. This provides an opportunity to lend to

secondary and tertiary irrigation developers, waste water management companies, small-

hydro and bio-gas companies and the like;

Manufacturing: Since the 1990s, Indonesia has successfully and prominently inserted itself

into global supply chains of automotive parts and other components manufactures. This

dynamic has been accelerated by off-shoring and out-sourcing from North Asian companies

located in Japan and Korea, and even China, more recently, which have seen domestic

manufacturing costs rise considerably. The opportunity for the IB Facility is twofold: supply-

chain focused BOP engagement models looking to incorporate smaller producers of specific,

often high-value added components into their supply chains; and employee-based BOP

engagement models where there is an opportunity to influence the lives of significant

numbers of workers; and



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III. Philippines

Macroeconomic and Political Landscape and Structural Challenges

Although the election of Benigno Aquino III has been welcomed by many as a watershed moment inmacroeconomic management and, crucially, the tackling of corruption in the Philippines, the country

remains somewhat of a laggard compared to other members of the Association of South-East Asian

Nations (ASEAN)-6 region. Not unlike Indonesia, this can partly be attributed to geographical

challenges posed by an archipelago comprised of thousands of islands—the cost of transportation

and logistics in Philippines is exorbitant, for example—however, independent economic analysts and

ratings agencies concur that the outlook for the country is increasingly bright. The combination of a

relatively well-educated population, much of which, in the service sector, speaks excellent English,

has helped to make services exports a thriving sector in recent decades. Additionally, the Philippines

has been able to make inroads in the development of a distinctive tourism destination brand, helped

by security concerns in Indonesia and intermittent political instability in Thailand, its two major

competitors. The agri-business sector is also well-placed to capitalise not just on burgeoning

domestic demand and increasingly sophisticated tastes and desire for processed foods, reflecting

growing upward movement into the middle class, but also, greater regional demand (China is a

notable source) for both raw and processed agricultural products.

Importantly, at the structural level, the government has been successful in taming inflation, which is

now well in single digits, and rapid currency depreciation is no longer a problem. On the contrary,

the consistent appreciation of the peso since the late 2000s has eroded some of the artificial

competitiveness which Philippine exports have traditionally relied upon. The longer-term advantage

of this, however, is that it is forcing Philippine exporters to focus on productivity and efficiency gains,

opportunities to move up the value chain and improve quality as a means of safeguarding existing

export markets and creating new ones.

Structural Issues Affecting the SME Sector

Given the preponderance of micro-, small and medium-sized enterprises (MSMEs) in the Philippines,

and a significantly more populated middle ground between MSMEs and large corporates—this is

important with regard to the prospects for drawing the former into supply chains—the prospects for

an IB Facility are broadly favourable. The challenge, however, is that of the 761,000 enterprises

registered in 2008, nearly 92% of them were micro-enterprises. This implies a degree of informality



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and lack of critical mass which makes it very challenging for formal institutions and larger companies

to work with. In recognition of this, from the 1970s the government began to focus on providing

access to finance and technology transfer to SMEs, and on improving information flowing to them.

Few formal institutions would touch the sector, however, because of the perceived risk levels, even

though the government had implemented protectionist measures to stimulate it. By the 1980s and

1990s economic policy focused on trade liberalisation, promoting competition among SMEs and

helping them to gain market access. The focus on creating sub-contracting linkages with larger

companies and the provision of financing and guarantees to exporting SMEs did begin to achieve

more rapid and lasting growth rates in the sector, along with improvements in physical

infrastructure (although patchy, depending on location), which facilitated access to markets.

Despite the foregoing, the Philippine Development Plan (PDP) of 2011-2016 plainly acknowledges

that the country has fallen short of its targets both for the SME sector as a whole, and inclusive

growth more generally. Importantly, it recognises access to finance as one of the key obstacles to

SMEs being able to play a more robust role in the economy and insert themselves into production

chains more consistently. Whilst recognising that programmes such as the SME Unified Lending

Opportunities for Growth, established in the early 2000s, which funds export finance initiatives and

provides short-term working capital loans to SMEs—more than $600m of loans have been approved

since 2003—the PDP also acknowledges that all of the accompanying ‘hand holding’ and value

addition that SMEs desperately require, especially in the area of financial management and strategic

planning, has been absent.

Access to Finance

Unsurprisingly, at the heart of the stunted growth record of SMEs lies the challenge of access to

finance. Disappointingly, despite the many initiatives launched since the 1990s and 2000s, the

volume of financing has proven too small, it has been skewed by the mandatory nature of credit

allocation stipulated by various policy directives, and chiefly, has failed because a large proportion of

government funds goes to ‘livelihood’, small-holder and micro-enterprise projects that often fail to

achieve critical mass. Additionally, the Small Business Corporation (SBC) established by the

government has relatively limited geographical coverage, and applicants complain of lengthy

proposal evaluation times, general bureaucracy and an unwillingness to consider early-stage or

start-up companies.



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At the same time, the banking sector has broadly complied with mandatory lending directives

focused on the SME sector. The problem, however, is that much of the funding gravitates towards

larger small enterprises and medium-sized enterprises, many of which are actually large enterprises

that deliberately under-state their assets in order to qualify for funding. The general structure of the

banking sector also exacerbates access to finance challenges. Banks in the Philippines are divided

into commercial, rural and ‘thrift’ banks, the idea being that this helps to ensure that credit does not

flow only to large borrowers. From their establishment, thrift and rural banks were incentivised to

lend to SMEs through mechanisms like lower capital and reserve requirements and access to re-

discount facilities from the central bank. The problem is that even they are far too exigent vis-à-vis

SMEs: familiar requirements of three years’ historical financials, lengthy business plans,

cumbersome additional documentation requirements and so on. Banks also complain of the very

high transaction costs associated with servicing the SME sector, choosing to focus instead on larger,

‘safer’ clients.

The government’s MSME plan for 2010-2016 has once again highlighted access to finance as a key

obstacle to faster growth in the SME sector and, encouragingly, mentions the importance of

promoting inclusiveness as part of the MSME development and modernisation strategy. It points out

that MSMEs are unable to meet the stringent and ‘voluminous’ requirements of banks, that funds

for start-ups are unavailable, and that interest rates still remain on the high side for many. It also

highlights the fact that, theoretically, there should be sufficient funds in the banking system to meet

the needs of SMEs, given that banks are mandated by law to allocate 8% of their loan books to

SMEs.

Opportunities for an IB Facility in Philippines

As in the case of Indonesia, the inimical operating environment and structural challenges that SMEs

face in the Philippines creates opportunities for an inclusive business Facility. Perhaps even more

than in Indonesia, however, significant technical assistance will be required in the Philippines to

address issues such as sub-standard or non-existent financial record-keeping, poor or absent

business plans, weak financial management, lack of understanding of sound cash flow management,

poor marketing and client-outreach strategies and so on. The opportunities for IB in Philippines are

not, however, limited to the SME sector. The linkages between larger corporates and aggregators

are far more robust that in Indonesia, especially in the greater Manila area and in other major

conurbations. In summary, this would enable to IB Facility to engage with the BOP through almost all



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recognised models. They are presented below, along with the sectors that might be categorised

under them, although naturally, there will be cross-over in many cases:

BOP as employee models: Partly because of the preponderance of good English speakers,

and also because of the service-orientated culture, Philippines has developed a prowess in

call centres and related information services. This has provided the opportunity for many

incumbents of upper echelons of the BOP to gain access to employment opportunities. Not

only could the IB Facility look to invest in new labour-intensive facilities, especially those

beyond metro-Manila, but also, it could explore opportunities in:

transcription services: including the medical sector, legal profession, accounting,

banking and so on. Some medium-sized firms are emerging (in contract to much

larger call-centres) that are servicing regional and international (mostly US)

corporates and financial and medical institutions. Such firms tend to be relatively

labour intensive.

BOP as supplier models: Given the importance of agriculture and aquaculture to the

Philippine economy, the IB Facility should definitely focus on incorporating small and

medium-sized players into the supply chains of aggregators and producers. But the BOP as

supplier model can incorporate other sectors in Philippines, notably the electronics and

similarly ‘semi-sophisticated’ manufacturing sectors (not to overlook more opportunities in

more traditional manufacturing). As the trend of North Asian companies out-sourcing and

off-shoring production of items such as chip boards and semi-conductors has intensified,

Philippines has emerged as a major producer of semi-finished or ‘interim’ goods that lie

below the high-tech prowess of Japan, Singapore and Korea. Such businesses tend to involve

significant up-skilling of labour which, in turn, enables workers to command higher wages

and preserves retention rates.

BOP as consumer models: The delivery of key goods and services for the poor remains a

challenge throughout much of non-urban Philippines. Given the geography of the country,

franchise models are particularly relevant in segments such as primary and secondary

education and healthcare. Similarly, demand for nutritional foods and beverages has sky-

rocketed in the country, and not just among the middle classes, creating opportunities for

more domestic production. Due diligence also revealed opportunities in the provision of



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essential utilities, such as energy (small hydro, waste-to-energy projects, solar), irrigation,

waste-water management and so on.

BOP as distributor models: Again, in light of the geography of the country, franchising and

devolved, localised distribution models are essential in order for companies to achieve scale

domestically. The Facility will be well-placed to explore opportunities in key pro-poor market

segments such as provision of solar lighting, remote medical diagnostics, e-learning and the

like.

Access to finance: A cross-cutting theme opportunity which would provide significant

investment opportunities in the Philippines is providing debt to financial institutions to

develop new, inclusive financial products for BOP incumbents. The characteristics of such

products are no different to those highlighted in Section II above.

IV. Key Issues and Recommendations

Due diligence revealed a compelling case for establishing an ADB inclusive business Facility in

Indonesia and the Philippines. Given that so many SMEs still struggle to access finance from formal

institutions, and that larger, more forward-looking companies are becoming more familiar, even if

gradually, with the concept of inclusive business, there is scope to establish a Facility of up to $100

million with the following key features:

Focus on debt finance: Especially at the SME level, but also in many larger companies, there

is an unfamiliarity with equity and an unwillingness to open shareholding structures to

outsiders. Debt is a much more familiar modality, and from the Facility’s perspective,

especially where smaller borrowers are concerned, it is important to establish the discipline

of regular repayment;

Prudent currency-risk management: Although the Philippine peso has appreciated

significantly for the last four years, this will not necessarily be the case over the life of a

facility, and the Indonesian rupiah certainly tends to depreciate fairly consistently. For this

reason, the advantage of a debt-focused Facility is that cash flows will accrue throughout its

life, meaning that they can be translated back into hard currency at the earliest possible

juncture. This will not eradicate the impact of currency depreciation, but will help to reduce



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the effect on overall returns. This, in turn, is important from the perspective of replicability

and scalability of future facilities;

Loans of $500,000-$10 million: Part of the rationale for incorporating Indonesia and the

Philippines into a wider South-East Asian initiative is that both countries have the critical

mass to provide larger opportunities that counter-balance smaller, and arguably riskier

transactions in the Mekong region. It is even possible to conceive of larger loans beyond $10

million in the case of consumer and employee-orientated BOP plays in both Indonesia and

the Philippines;

Fund management options: Neither country has a particularly well-developed private equity

fund management sector. Many of the large, international houses do undertake transactions

in both countries, but they tend to focus on deals that are far beyond the scope of the

Facility. Due diligence has, however, identified managers based in Singapore and Thailand

with deep relationships in both countries and expertise in completing transactions there. A

prudent strategy for the Facility might therefore be to stipulate that such managers either

establish a small, local presence in Indonesia and the Philippines, or enter into partnership

with investment boutiques in which capacity can be built in inclusive business and

undertaking relevant transactions.

Returns: Given that the Facility would likely have a debt orientation, with equity possibly to

be used in a few, limited cases, it is likely that returns would be in the region of 4-7% per

annum. In the event that quasi-equity instruments are used where some sort of ‘equity

kicker’ is possible, slightly higher returns might be feasible.

Potential Investors: To some extent Indonesia and the Philippines ‘fall between two stools’.

On the one hand, development finance institutions (DFIs) are experiencing unprecedented

pressure on budgets, along with pressure from sovereigns to prove that they are investing in

the poorest countries. On the other, there is certainly increasing interest in both countries

among more traditional investors who are looking beyond the BRICs (Brazil, Russia, India and

China) given the challenges experienced in the latter since the late 2000s. The trick will be to

persuade the DFIs that including both countries into a greater Mekong Facility provides a

welcome counter-balance to the Mekong countries, and that this stability will enable them



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to access investments more effectively via a pooled vehicle focused on broader developing

South-East Asia.

________________________

indonesia and philippines due diligence report, january 2013

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