small and medium-sized enterprise (sme) development project · inception mission 11–20 feb 2002 2...

Completion Report

Project Number: 31575 Loan Number: 1799-UZB September 2007

Uzbekistan: Small and Medium Enterprise Development Project

CURRENCY EQUIVALENTS

Currency Unit – Uzbek Sums (SUM)

At Appraisal At Project Completion (20 July 2000) (27 April 2007)

SUM1.00 = $0.003762 $0.000797 $1.00 = SUM265.82 SUM1,254.69

ABBREVIATIONS

AB – Asaka Bank ADB – Asian Development Bank BCC – Business Communication Center CAR – capital adequacy ratio CBU – Central Bank of Uzbekistan CCPE – Chamber of Commodity Producers and Entrepreneurs COS – country operational strategy CRMP – credit and risk management policies DSCR – debt service coverage ratio EA – executing agency EBRD – European Bank for Reconstruction and Development FDI – foreign direct investment FIRR – financial internal rate of return GAAP – generally accepted accounting principles GDP – gross domestic product IAD – Internal Audit Department ICR – intermediation cost ratio IFC – International Finance Corporation IFRS – International Financial Reporting Standards KfW – Kreditanstalt für Wiederaufbau LDR – loan to deposit ratio NBU – National Bank for Foreign Economic Activity of the Republic of

Uzbekistan NPL – nonperforming loan OPEC – Organization of Petroleum Exporting Countries PB – Pakhta Bank PCB – participating commercial bank PCR – project completion report REDP – Rural Enterprise Development Project ROA – return on assets SC – supervision council SMDP – Small and Microfinance Development Project SME – small and medium enterprise SMEDP – Small and Medium Enterprise Development Project SWIFT – Society for Worldwide Interbank Financial Telecommunication TA – technical assistance WACC – weighted average cost of capital

NOTE

(i) In this report, "$" refers to US dollars.

Vice President L. Jin, Operations Group 1 Director General J. Miranda, Central and West Asia Department (CWRD) Director R. Subramaniam, Governance, Finance, and Trade Division, CWRD Team leader R. Narasimham, Sr. Project Management Specialist, CWRD

CONTENTS

Page BASIC DATA i I. BACKGROUND 1

A. History 1 B. Scope of Operations 1 C. Relationship with ADB and Other Lenders 2 D. Relevance of Design and Formulation 4

II. IMPLEMENTATION 5 A. Lending Policies of the Three Participating Commercial Banks 5 B. Characteristics of Subloans 5 C. Implementation and Internal Operation of Subprojects 6 D. Operational Performance of PCBs 9 E. Financial Statements and Ratios 12 F. Covenants 13 G. Performance of ADB 14

III. EVALUATION 14 A. Loan Appraisal 14 B. Implementation 16

IV. ASSESSMENT AND RECOMMENDATIONS 17 A. Relevance 17 B. Effectiveness in Achieving Outcome 17 C. Efficiency in Achieving Outcome and Outputs 18 D. Preliminary Assessment of Sustainability 18 E. Overall Assessment 18 F. Lessons 19 G. Recommendations 20

APPENDIXES 1. National Bank for Foreign Economic Activity of the Republic of Uzbekistan 21 2. Asaka Bank 37 3. Pakhta Bank 48 4. Relevance of Design and Formulation 62 5. Subloan Characteristics 68 6. Implementation and Internal Operational and Financial Performance of Subprojects 74 7. Compliance with Covenants 82 8. Overall Assessment of the Project 91

BASIC DATA

A. Loan Identification 1. Country

2. Loan Number 3. Project Title 4. Borrower 5. Names of Executing Agencies

6. Amount of Loan 7. Project Completion Report

Number

Uzbekistan 1799-UZB, PROJ: UZB 31575 Small and Medium Enterprise Development Project Republic of Uzbekistan National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU), Asaka Bank (AB), and Pakhta Bank (PB) $50,000,000 PCR:UZB 990

B. Loan Data 1. Appraisal – Date Started – Date Completed 2. Loan Negotiations – Date Started – Date Completed 3. Date of Board Approval 4. Date of Loan Agreement 5. Date of Loan Effectiveness – In Loan Agreement – Revised – Number of Extensions 6. Terminal Date for Commitments

– In Loan Agreement – Actual – Number of Extensions

7. Closing Date

– In Loan Agreement – Revised – Number of Extensions 8. Terms to the Borrower – Interest Rate – Maturity (number of years) – Grace Period (number of years)

– Free Limit – Repayment Terms

9. Terms of Relending (if any)

10. Interest Rate for Subloans – Original – Revised

5 July 2000 20 July 2000 18 October 2000 20 October 2000 11 December 2000 09 March 2001 18 October 2001 none none 18 October 2004 18 October 2004 none 18 October 2006 14 December 2006 none Variable interest rate for lending in USD from ordinary capital resourcesa 15 years 3 none 24 half yearly payments Same as loan ADB interest rate + margin none

a Pool-based single currency loan portion: 5.97%; LIBOR-based portion: 5.77%. (Both net of 20% waiver on lending spread.)

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11. Disbursements

a. Dates Initial Disbursement

18 October 2001

Final Disbursement

14 December 2006

Time Interval

62 months

Effective Date

18 October 2001

Original Closing Date

18 October 2006

Time Interval

60 months

b. Amounts ($) Category or Subloan

Original

Allocation

Last Revised

Allocation

Amount

Canceled

Net Amount

Available

Amount

Disbursed

Undisbursed

Balance Asaka Bank

Front-end Fee 150,000 150,000 Delta 2,976,094 2,976,094 Building Industrial Group

1,500,000 1,500,000

Djizak-Mramor 1,836,304 1,836,304 Kuva Konserva 2,169,000 2,169,000 Elkol 2,952,000 212,821 2,739,179 Aral Invest 337,500 337,500 Lola Model 1,300,000 1,300,000 Shark Model 1,779,102 1,779,102 Pakhta Bank

Front-end Fee 150,000 150,000 Quqon Non 361,998 361,998 Osiyo Express 1,755,000 1,755,000 Khonka Qop 495,000 495,000 Lllonsay Parranda 864,818 864,818 Yorqishloq 611,000 30,550 580,450 Aseptic 285,000 285,000 Dudilnozmir 1,144,699 1,144,699 Osiyo Tijorat Savdo 503,580 503,580 Surkhan Export 610,000 52,920 557,080 Margilantekstil 2,500,000 2,500,000 Fruit World Ltd. 1,714,800 85,740 1,629,060 Laser Oqoltin 843,430 843,430 Mega Dry 550,000 550,000 Zuloiha-J.A. 406,350 406,350 Agrar Tehnologiyalari

749,920 749,920

NBU

Front-end Fee 200,000 200,000 Oltin Meva 1,100,000 1,100,000 Ishonch 3,000,000 3,000,000 Rokhat-Kibray 2,955,762 2,955,762 Balikchi 3,000,000 3,000,000 Peshkuteks 2,998,700 2,998,700 Kattakurgan-Meva 1,759,000 1,759,000 Oqtosh Meva 1,759,000 1,759,000 Zumrut 2,968,078 2,968,078 Total 48,286,137 47,904,104

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C. Implementation Data 1. Number of Subloans = 31

2. Sectoral Distribution of Subloans Sector/Subsector Number of Subloans Amount ($) Ladies’ Footwear 1 2,976,094 T-shirt Production 2 3,079,102 Yarn Production 5 14,466,778 Metal and Polyvinyl Chloride Panel Windows 2 2,644,699 Marble Tiles 1 1,836,304 Fruit Juices and Puree Paste 8 13,195,239 Cookies Production 1 843,430 Edible Sunflower Seed Oil 3 1,543,880 Dried Fruits, Vegetables, and Flowers 2 1,299,920 Pasta Production 1 361,998 Feeds 2 1,202,318 Polypropylene Containers 2 998,580 Beer 1 2,955,762

Total 31 47,404,104 Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, and Pakhta Bank.

3. Size of Subloans (actual) Range Number of Subloans Aggregate Amount ($) Up to $1,000,000 12 6,535,126 From $1,000,000 to $2,000,000 10 15,562,165 From $2,000,000 to $3,000,000 9 25,306,813

Total 31 47,404,104

4. Regional Distribution of Subloans

Region Number of Subloans Amount ($) Tashkent 11 17,134,536 Ferghana 6 9,084,578 Khorezm 1 495,000 Karakalpakstan 1 337,500 Samarkand 3 4,382,818 Andijan 2 3,580,450 Bukhara 4 7,595,838 Surkhandarya 1 557,080 Syrdariya 1 1,300,000 Kashkadarya 1 1,100,000 Djizak 1 1,836,304

Total 31 47,404,104 Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan,, Asaka Bank, and Pakhta Bank.

5. Project Performance Report Ratings

Ratings Implementation Period Development Objectives Implementation Progress From 1 Jan 2001 to 31 Dec 2001 Satisfactory Satisfactory From 1 Jan 2002 to 31 Dec 2002 Satisfactory Satisfactory From 1 Jan 2003 to 31 Dec 2003 Satisfactory Satisfactory From 1 Jan 2004 to 31 Dec 2004 Satisfactory Satisfactory From 1 Jan 2005 to 14 Dec 2006 Satisfactory Satisfactory

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D. Data on Asian Development Bank Missions

Name of Mission

Date

No. of Persons

No. of Person-Days

Specialization of Members

Reconnaissance Mission 8–17 Feb 2000

2 18 financial analyst, investment officer

Fact-Finding Mission 1–12 Apr 2000

4 52 financial analyst, investment officer, banking specialist

consultant, poverty alleviation

consultant Appraisal Mission 5–20 Jul

2000 8 61 financial analyst,

investment officer, counsel, poverty

reduction strategy coordinator, financial economist, manager,

resident representative Inception Mission 11–20 Feb

2002 2 18 senior portfolio

management specialist, financial economist

Review Mission 1 23–30 May 2002

1 7 senior portfolio management specialist

Review Mission 2 26 July–2 Aug 2002


Review Mission 3 20–21 Nov 2003


Review Mission 4 21–24 Sep 2004

2 8 senior portfolio management specialist, associate project analyst

Review Mission 5 14–17 May 2005

2 6 senior portfolio management specialist, associate project analyst

Project Completion Reviewa

Mission 14–27 Apr

2007 2 28 senior project

management specialist, associate operations

analyst a This project completion report is prepared by the Project Completion Review Mission, which comprised

R. Narasimham, Senior Project Management Specialist and Mission Leader; and L. Lerum, Associate Operations Analyst and Mission Member.

E. Related Loans

Project Title Loan No. Date of Agreement Amount Rural Enterprise Development Projecta Small and Microfinance Development Project b

1504-UZB 1963-UZB

7 May 1997 25 Sep 2003

$50,000,000 $20,000,000

a National Bank for Foreign Economic Activity of the Republic of Uzbekistan was the executing agency for this loan, approved on 17 December 1996.

b Asaka Bank and Pakhta Bank were the executing agencies for this loan, approved on 9 December 2002.

I. BACKGROUND

A. History

1. In December 2000, the Asian Development Bank (ADB) approved from its ordinary capital resources, a $50 million loan to Uzbekistan for the Small and Medium Enterprise Development Project (SMEDP) to be relent to the National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU), Asaka Bank (AB), and Pakhta Bank (PB), collectively referred to as participating commercial banks (PCBs) for on-lending to viable private sector small and medium enterprises (SMEs). 2. NBU was established in September 1991 as a wholly state-owned universal commercial bank. It is also the Government’s financial agent on domestic and international markets.1 AB was incorporated in November 1995 and obtained its banking license in February 1996. It is also wholly state owned. Originally conceived as a specialized bank to provide financing to the automotive industry, AB had by 2001 evolved into a universal commercial bank. PB was established in July 1995 as a joint-stock commercial bank by a decree of the Cabinet of Ministers, having been spun off from Uzagroprombank, the state bank for agricultural development. Originally established as sector specific and narrowly focused to assist the country’s cotton sector, PB had been a universal commercial bank since 1996.2 B. Scope of Operations

1. NBU

3. NBU’s principal operations include (i) retail banking;3 (ii) trade financing;4 (iii) corporate banking; (iv) loan syndication; (v) foreign exchange trading; 5 (vi) payments, clearing, and settlements in local and foreign currencies; (vii) guarantees; (viii) correspondent banking;6 and (ix) financial intermediation for multilateral and bilateral donor credit lines for SME finance. In the past, NBU managed the country’s foreign reserves, a function now handled by the Central Bank of Uzbekistan (CBU). NBU continues to collect taxes on behalf of the Government, albeit not as a principal operation. NBU has over 22,000 corporate clients in the SME, energy, metallurgy, agriculture, petrochemicals, tourism, aviation, and surface transport sectors (Appendix 1).

1 NBU was the Executing Agency for Loan 1504-UZB: Rural Enterprise Development Project (REDP), approved on

17 December 1996 for $50 million. This project’s project completion report (PCR) was circulated in October 2003 and its project performance evaluation report on 19 February 2007. NBU was the beneficiary of TA 2714-UZB: Institutional Strengthening of the National Bank of Uzbekistan, which was approved simultaneously with that loan.

2 PB obtained from the Central Bank of Uzbekistan (CBU) its banking license on 7 September 1995 and its foreign exchange license on 10 October 1995.

3 On 31 March 2007, it had 16 branches, 76 subbranches, 58 mini-banks and 174 cash point offices. The mini-bank offices offer cash, transfer, and deposit services but no loans and are staffed by 2–6 employees. The cash point offices are housed inside other institutions and serve cash, deposit, and transfer facilities for individuals within that institution and are staffed by 1–2 employees. Cash point offices offer collection and disbursement services only.

4 Including import financing through the opening of letters of credit and trust receipt loans, export financing through purchase of bills and discounting and packing credits, as well as purchase and sale of foreign exchange to cover commercial transactions.

5 To facilitate its foreign exchange trading, NBU has access to Reuters and Telerate dealing systems and is a member of the Society for Worldwide Interbank Financial Telecommunication (SWIFT).

6 As of 31 March 2007, NBU had correspondent banking relationships with 600 banks in 75 countries. This helped NBU in its foreign exchange trading and foreign trade financing.

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2. Asaka Bank

4. Since its evolution to a universal commercial bank, AB (Appendix 2) obtained a foreign exchange license. It has established the infrastructure necessary to operate in this area.7 This also necessitated reducing AB’s skewness in its credit exposure to the automobile industry, to which its lending declined from 50% of its total portfolio in 2000 to 30% on 31 March 2007. To deliver to its retail and corporate customers the benefits of its correspondent banking activities, AB embarked on a domestic branch expansion program.8 This step was particularly relevant to AB’s outreach for its SME finance and microfinancing activities.

3. Pakhta Bank

5. Since PB’s evolution to a universal bank in 1996 (Appendix 3), it ventured into foreign exchange operations and established the necessary infrastructure for these. As an agent of the Government, PB intermediates for the Government’s budget and off-budget funds dedicated to the Government’s priority sectors. Since 1998, PB has diversified into corporate and retail banking while concentrating on SME finance. Since 2000, PB has also entered microfinance. Its total exposure to the cotton sector decreased from 50% of its portfolio in 2000 to 42.5% in March 2007. To deliver the benefits of its universal commercial banking activity to its customers, it has improved its outreach by means of its domestic branch expansion program.9 C. Relationship with ADB and Other Lenders

1. NBU

6. This loan was the second credit line to Uzbekistan using NBU as the Executing Agency (EA).10 NBU was also an EA for a component of an ADB loan to Uzbekistan for basic education and textbook development.11 NBU’s allocation under SMEDP was $20 million. This loan was made from ADB’s ordinary capital resources for a 15-year maturity, including a grace period of 3 years. It has an interest rate determined in accordance with ADB’s pool-based variable lending rate in US dollars and a commitment charge of 0.75% per annum. The Borrower relent the loan funds to NBU on identical terms. The Borrower was also charged a front-end fee equivalent to 1% of the loan amount, which was capitalized into the loan. NBU’s share of the front-end fee of this loan was $200,000 (in proportion to its share of the loan). 7. As Uzbekistan’s lead commercial bank, NBU has participated in the intermediation of other multilateral lenders’ credit lines. It has also lead managed syndicated loans to Uzbekistan (Appendix 1). 8. NBU’s long-term domestic currency lending has been funded through borrowings from the Government’s business fund 12 and other non-budget funds. Pursuant to government regulations, NBU transfers 25% of its gross profits on a tax-deductible basis to a special fund for 7 To facilitate such role, AB has established corresponding banking relationships with 230 banks in 38 countries,

obtained access to Reuters and Telerate dealing services. and become a member of SWIFT. 8 On 31 March 2007, AB had 27 branches and 76 mini-banks. 9 On 31 March 2007, PB had 186 branches and 665 mini-banks. 10 The first credit line to Uzbekistan using NBU as EA was Loan 1504-UZB: Rural Enterprise Development Project. 11 ADB. 1997. Report and Recommendation of the President on a Proposed Loan to Uzbekistan for Basic Education

and Textbook Development. Manila. 12 The business fund is a non-budget fund under Presidential Decree No. 25/64 dated 21 March 2000 and Resolution

No. 195 of the Cabinet of Ministers dated 19 May 2000.

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financing medium-term investment and working capital loans to SMEs at an interest rate not exceeding 50% of the CBU’s refinancing rate. 13 This lending is mandatory and follows Uzbekistan’s development priorities. NBU bears the credit risk for such directed lending at negative real interest rates. NBU’s customers’ deposits have been inadequate to fund its entire lending, which is why its loan to deposit ratio (LDR) has since 2001 exceeded 100% (para. 40). The low banking penetration in Uzbekistan is manifested by a low ratio of broad money to gross domestic product (GDP) of 15% in 2000 (12% in 2006)14 and accounts for the fact that bank deposits are inadequate to fund entirely the loan portfolio.

2. Asaka Bank

9. AB was a beneficiary of ADB’s technical assistance (TA) for strengthening the banking system.15 This loan was ADB’s first using AB as an EA. AB’s allocation under this loan was $15 million and its terms and conditions were identical to those for NBU (para. 6). AB’s share of the front-end fee was $150,000 (at 1% of its loan allocation). AB was also an EA in ADB’s Small and Microfinance Development Project (SMDP).16 AB was an intermediary in commercial banks, export credit agencies, European Bank for Reconstruction and Development (EBRD) and International Finance Corporation (IFC) credit lines (Appendix 2). It has not lead managed any syndicate for commercial financing of projects or entities in Uzbekistan. 10. Similarly to NBU, AB’s domestic lending is funded through borrowings from government non-budget funds. Pursuant to the Government’s policy, AB also undertakes subsidized directed lending to sectors prioritized by the Government. As an EA for the SMDP, AB relent ADB loan funds in local currency without subsidies. AB’s deposit base was inadequate to fund its loan portfolio, which is why its LDR during 2001–2005 was higher than 100% (para. 40).

3. Pakhta Bank

11. PB was a beneficiary of ADB’s TA for strengthening the banking system (footnote 15). This was ADB’s first loan using PB as an EA. PB’s allocation under this loan was $15 million and its terms and conditions for participation were identical to those of NBU and AB. Its front-end fee was $150,000. PB was also an EA for the SMDP (footnote 16). PB has participated in EBRD, US Export-Import Bank, and Kreditanstalt für Wiederaufbau (KfW) credit lines (Appendix 3). 12. PB’s domestic lending is funded both by its domestic deposits and recourse to borrowing from government non-budget funds. It uses the latter to fund its directed lending on a subsidized basis. As an EA in ADB’s SMDP, PB has lent on ADB’s loan funds on a nonsubsidized basis. PB’s deposit base has since 2001 been adequate to fund its lending comfortably. Unlike NBU or AB, PB’s LDR has since 2001 been under 100% (para. 40).

13 CBU’s refinancing rate from 13 December 2006 was 14%. (Source: IMF: 2006 Article IV Consultation Staff Report–

12 February 2007.) 14 Sources: Consultants Draft Final Report, 16 April 2007, TA 4565-UZB: Financial Sector Infrastructure

Development; and IMF: 2006 Article IV Consultation Staff Report–12 February 2007. 15 ADB. 1999. Technical Assistance to Uzbekistan for Strengthening the Banking System. Manila, approved on 20

December 1999 for $1 million (TA 3352-UZB). 16 ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to

Uzbekistan for Small and Microfinance Development Project. Manila, approved on 9 December 2002 for $20 million (Loan 1963-UZB).

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D. Relevance of Design and Formulation

13. The Project’s goal was to promote balanced and sustainable economic growth and thereby reduce poverty. In pursuit of this goal, the Project sought to (i) revitalize, diversify, and enhance the competitiveness of Uzbekistan’s private sector SMEs; (ii) generate and sustain additional employment and exports by value addition through forward and backward linkages; and (iii) help improve the legal, regulatory, and policy environment for SMEs. The Project’s rationale, design, and formulation were relevant to and consistent with ADB’s country operational strategy (COS) for Uzbekistan,17 as well as with the Government’s development objectives (Appendix 4). The main goal of the COS was to assist Uzbekistan’s orderly and sustainable transition to a market economy, with emphasis on supporting the emerging private sector. The COS gave high priority to SME development as a means to this end. The Government specifically requested ADB’s assistance for developing SMEs.18 14. Incorporating the lessons learned from the Rural Enterprise Development Project (REDP) (footnote 1), ADB’s design of this loan (Appendix 4) sought to (i) create an enabling environment for SME development by addressing the regulatory and policy impediments; (ii) enhance institutional support for nascent SMEs’ access to technology, management, and business plans preparation; (iii) identify viable criteria for suitable subproject selection; and (iv) introduce viable, solvent, liquid, and profitable PCBs (para. 39 and appendixes 1, 2, and 3) to efficiently intermediate credit delivery from ADB’s loan to those viable subprojects identified. Importantly, the Project prioritized the financing of subprojects with better export potential to help them to hedge their foreign exchange risks.

15. Policy dialogue during loan processing convinced the Government to introduce legislation to address distortions in fiscal, exchange control, and industrial policies (Appendix 4). New fiscal legislation adopted as part of the SMEDP policy dialogue has helped streamline SMEs’ taxation, registration, licensing, and inspection regimes and thereby reduced arbitrary bureaucratic delays and corruption. Modest banking sector reforms facilitated SMEs’ easier access to cash withdrawals from their bank accounts. Most importantly, ADB sought the Government’s approval under this loan for abolishing the mandatory 50% surrender of SMEs’ export earnings at the overvalued official exchange rate (thereby ending a de-facto tax on exports). This was the first step towards Uzbekistan’s eventual exchange rate unification in 2003, which has since stabilized the sum’s exchange rate. 19 While the SME sector’s contribution to GDP declined from 12% in 1996 to 8% in 1998, it increased to 42.1% in 2006. Also in 2006, the SME sector employed 7.25 million persons and generated exports worth $683 million.20 This reflects the relevance of ADB’s recommended policy interventions in its design and formulation of the Project. The design, formulation, and timing were satisfactory, but arguably these could have benefited from better focus in financial intermediation (para. 44).

17 ADB. 2000. Country Operational Strategy Study (2000-2005): Republic of Uzbekistan. Manila. 18 In resolution No. 296 dated 10 June 1999 of the Cabinet of Ministers. 19 The sum exchange rate has been relatively stable since 2004. This factor coupled with the Project’s prioritization

towards export-oriented subprojects helped to mitigate the exchange risks for subprojects under the REDP. 20 Source: Republic of Uzbekistan: State Committee on Statistics.

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II. IMPLEMENTATION

A. Lending Policies of the Three Participating Commercial Banks

16. NBU’s credit and risk management policies (CRMP) were adequate at the time of appraisal 21 and were further strengthened in 2002. 22 NBU’s credit policy implementation is moderately decentralized. Nevertheless, it has remained subservient to the national policy of rapid economic growth, particularly in the SME sector and even at the expense of banking inefficiency.23 That is why NBU has been increasingly willing to expand lending even though its LDR exceeds 100%. Pursuant to state policy, its lending to the industrial sector was 42% of its portfolio in 2006 (Appendix 1), exceeding a benchmark covenant for loan concentration (paras. 35 and 40). 17. AB’s CRMP at appraisal was rudimentary. It was envisaged that AB’s participation in ADB’s TA (footnote 15) and the World Bank’s Financial Institution Building Loan (approved in 1999) would strengthen its project finance appraisal capacity. AB reported that its credit policy was in accordance with CBU’s circulars. AB’s new CRMP of 2003 emerged as an outcome of the bank’s participation in the aforementioned donor assistance (Appendix 2). Its features were (i) a ceiling on lending to a single borrower (or group of affiliated borrowers) at 15% of equity, (ii) maximum maturity of term loans (effective 2004) of 7 years, and (iii) limiting its exposure to the automotive sector to 50% of its portfolio. Although these steps were in the right direction, they have not been of sufficient magnitude. Ideally, AB’s sectoral loan concentration ceiling should have been 20%. Moreover, the aforementioned limits did not apply to its loans refinanced from the state’s off-budget funds. This dichotomy in its CRMP created a dysfunctional portfolio manifested by LDRs exceeding 100% between 2001 and 2005. This is because, as in the case of most banks in Uzbekistan, AB’s CRMP is subservient to the country’s growth policy. AB’s CRMP implementation faced challenges in the 2004 reorganization of its credit department, whereby its credit approval and recovery functions were separated (para. 31). 18. PB’s CRMP was adequate at appraisal. It was further enhanced in 2006 with the creation of a new risk management department that consolidated its lending, supervision, and recovery functions (Appendix 3). PB, with World Bank assistance, is creating a real-time automated CRMP system accessible also on a real-time basis by its Internal Audit Department (IAD). Since 2006, PB’s IAD has been simultaneously reporting to its supervision council (SC) (para. 29), reflecting the importance of transparency in its CRMP. Despite having to subordinate its credit policy to the country’s overall growth policy, PB has, since 2002, maintained its LDR under 100% (para. 40) and has maintained loan loss provisions fully complying with internationally accepted principles (para. 37). This reflects PB’s prudence in liquidity management and augurs well for the institution’s future. B. Characteristics of Subloans

19. The three PCBs’ lending patterns revealed interesting trends (Appendix 5). Twenty-four subloans, (accounting for 79.7% of the loan amount) were approved for maturities of 4–7 years. This is understandable, given that the loans financed only the foreign exchange components 21 Paras. 4 and 5 of Supplementary Appendix A of the Report and Recommendation of the President. 22 Paras. 10 and 11 and Appendix 2 of the PCR for Loan 1504-UZB: Rural Enterprise Development Project circulated

in October 2003. 23 The creation of a fund to finance SMEs at below market interest rates (para. 8) shows the subservience of the

banks’ credit policies to state direction.

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and were mainly for capital equipment having long gestation periods. Another 24 subloans (and not necessarily the same 24), financing more than 68.4% of the loan amount, financed new subprojects. Given the nascent state of SME development, more new projects needed institutional finance, as opposed to existing SMEs seeking funding for modernization and expansion. The loan was concentrated in the country’s more fertile and affluent regions. The Bukhara, Ferghana, and Tashkent regions accounted for 20 subloans (71.4% of the loan amount). Sixteen subloans (42.6% of the loan amount) went to agro-processing industries located in these three regions. By contrast, only two subloans (1.7% of the loan amount) were made in the arid and poorer regions of Karakalpakstan and Khorezm . The sectoral and regional distribution of subloans and their eligibility criteria corresponded to the projections made at project processing. C. Implementation and Internal Operation of Subprojects

20. Thirteen of the 31 subprojects faced time overruns. 24 These were attributable to (i) delays in the installation of imported machinery; (ii) lack of available raw materials when machinery was installed late (particularly in seasonal agro-processing industries); and (iii) disputes between local and foreign counterparties in joint ventures, which delayed the availability of raw material and working capital (otherwise to have been financed out of equity in accordance with the business plans). Delays in installing imported machinery arose from delays in confirming the three PCBs’ letters of credit by their correspondent banks in Europe or the US without counter-assurances from the CBU on the timely release of foreign exchange.25 CBU’s delay in doing so appeared to be in line with the Government’s policy at that time of import compression. Inevitably, drawdown delays resulted. Delays in installing machinery sourced from the euro area resulted in cost overruns arising from the euro’s appreciation against the dollar. Five subprojects (one financed by NBU and four financed by Pakhta Bank) faced cost overruns. Of the $47.9 million in total loan funds disbursed, $0.5 million (the front-end fee) was the only drawdown in 2001. Subsequently drawn were $9.1 million in 2002, $19.5 million in 2003, $12.1 million in 2004, $6.2 million in 2005, and $0.5 million in 2006 (Appendix 6). All 31 subprojects met ADB’s procurement guidelines and its environmental26 and social27 criteria. 21. The Project created a total of 8,144 jobs (Appendix 6), comprising 1,670 direct jobs and another 6,474 indirect jobs. While the direct jobs fell short of appraisal estimates, indirect jobs created exceeded appraisal estimates,28 a result of backward linkages in cotton yarn and fruit preserves manufacture. Eleven subprojects generated exports worth $21.98 million in 2006.29 Exports were mainly to neighboring Commonwealth of Independent States countries and Russia, whose economies benefited directly or indirectly from rising oil prices, which probably explains why export revenues began climbing in 2005. This was particularly true for agro-processing exports. The cotton yarn producing subprojects (the main exporters) did not diversify into higher

24 These were (i) Rokhat-Kibray, (ii) Ishonch, (iii) Balikchi, (iv) Zumrut, and (v) Oltin Meva financed by NBU; (vi)

Quqon Non, (vii) Margilantekstil, (viii) Osiyo Express, (ix) Laser Oqoltin, (x) Yorqishloq, and (xi) Mega Dry financed by PB; and (xii) Aral and (x) Elkol financed by AB.

25 The loan provided that only actual payments against documents for letters of credit opened by them would be eligible for reimbursement.

26 This required that all subprojects be environmentally friendly with adequate facilities for waste treatment. 27 This required that (i) working hours in factories be limited to 12 hours a day, (ii) adequate safety and health

protection measures be provided to workers against occupational hazards, and (iii) no minors (under 16 years of age) be employed in any subproject financed by the loan.

28 At processing, the Project envisaged the creation of 3,000 direct jobs and another 3,000–5,000 indirect ones. 29 At processing it was envisaged that annual incremental exports under this project would be $90.9 million.

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value-added production of textiles and garments due to limited foreign direct investment. This could probably explain why exports did not reach the levels envisaged at appraisal. 22. Eight of 31 subprojects (with subloans totaling $11.4 million, or 24.0% of the loan) were successful commercially and financially and were prompt in servicing their debts on schedule (Appendix 6).30 They met fully their financial eligibility criteria.31 They had financial internal rates of return (FIRR) equal to or higher than their weighted average costs of capital (WACC), as well as satisfactory debt service coverage ratios (DSCR) and return on assets (ROA). Most importantly, they did not require rescheduling of either their principal or interest payments. Exports of five of these eight subprojects totaled $13.6 million in 2006 (61.9% of total exports related to this Project), which is attributable to their successful management coupled with sectoral competitiveness and their geographical location in the country’s more affluent regions.32 This is evidenced by the fact that none of these eight projects suffered either time or cost overruns. All of them had adequate working capital, which in six of the eight cases was financed out of equity. Their subloans varied from under $500,000 to almost $3 million. This indicates that (in contrast to the REDP) there was no inverse correlation between subloan size and subproject performance and repayment track record. Cumulatively, these eight subprojects generated 471 direct and 3,950 indirect jobs, or 54.3% of the total jobs created. Larger subprojects (i.e., with larger subloans) generated more indirect jobs through backward linkages. These eight subprojects are commercially and financially sustainable. 23. Another seven subprojects (with subloans totaling $10.7 million, or 22.6% of the loan amount) were partially successful. Three of the seven were financed by NBU (appendixes 1 and 6). They were (i) Rokhat-Kibray, (ii) Ishonch, and (iii) Balikchi. Review of their past and projected financial statements showed them having satisfactory FIRRs, DSCRs, and ROAs. In the Project Completion Review Mission’s assessment, the three subborrowers could have repaid their subloans on schedule, yet NBU chose to reschedule them and did so without charging penalty interest. This is tantamount to subsidizing default and in effect breaching Section 2.04(a) of the Project Agreement. These three subprojects were engaged in manufacturing beer and cotton yarn. NBU defended its credit decision (Appendix 1) in the case of Rokhat-Kibray (a beer producer), whose cash flows were seasonal. 33 For Balikchi and Ishonch, two cotton yarn producers, NBU claimed that they faced increased raw cotton procurement costs (due to the partial decontrol of cotton procurement prices under conditions of a World Bank loan) coupled with reduced export prices for yarn. If this argument was valid, then NBU’s credit decision is tantamount to an indirect subsidy to the cotton production industry 30 These were: (i) Kattakurgan-Meva, (ii) Oqtosh Meva, and (iii) Peshkuteks financed by NBU; (iv) Llonsay Parranda,

(v) Khonka Qop, (vi) Dodilnozmir, (vii) Bukhoro Golden Fruit, and (viii) Agrar Tehnologiyalari financed by PB. 31 This required: (i) debt-equity ratio not higher than 75:25; (ii) financial internal rate of return (FIRR) not less than the

weighted average cost of capital (WACC); (iii) debt service coverage ratio (DSCR) not less than 1.5 times after 3 years from subloan disbursement or when subproject reached full capacity, whichever is earlier; (iv) return on assets (ROA) not less than 12% by the time the subprojects reached full capacity; (v) collateral of 120% of subloan; (vi) adequacy of working capital; and (vii) not greater than 25% state ownership in any subborrower.

32 Six of these eight subprojects were involved in agro-processing, cotton yarn manufacture, and, in one case, floriculture. Uzbekistan has competitive advantages in these sectors. These subprojects were located in the Tashkent, Samarkhand, Bukhara, and Ferghana regions, which are more conducive to the agriculture and horticulture that provided these subprojects their raw materials. The remaining two, manufacturing aluminum panels and polypropylene sacks, had dedicated sources of continuous raw material supply.

33 NBU claimed that Rohat-Kibray otherwise had a good track record of interest payments and its rescheduling decision was in accordance with its policy. The Project Completion Review Mission noted that this subborrower’s annual cash flow was nonetheless satisfactory. It therefore appears that the subborrower was using its surplus cash flow in the summer months to finance its working capital cheaply rather than to use it to repay its winter installments of the subloan on schedule.

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through the banking system and thereby vitiates the objective of efficient financial intermediation. However, the validity of such an argument is questionable. Peshkuteks, another cotton yarn producer to whom a subloan of approximately the same size was made, did not face any substantial increase in its raw cotton procurement prices and was a successful subproject in the Project Completion Review Mission’s assessment. Ishonch’s and Balikchi’s exports in 2006 amounted to $6.6 million, which clearly indicates these subprojects’ viability and sustainability. NBU’s credit decision in rescheduling these three subloans was imprudent and breaches Section 2.06 of the Project Agreement. This is particularly the case for Balikchi and Ishonch, where NBU extended their (rescheduled) subloans’ maturities from 7 to 9 years, thereby breaching Section 2.06(b) of the Loan Agreement and Section 2.04(b) of the Project Agreement. 24. The remaining four partially successful subprojects (Aseptic, Osiyo Tijorat Savdo, Mega Dry, and Zuloiha) were financed by PB (Appendix 6). Osiyo Tijorat Savdo was engaged in the production of polypropylene sacks and the others were agro-processing projects. Based on the information furnished by PB (Appendixes 3 and 6), these four subprojects also had satisfactory FIRRs, DSCRs, and ROAs that would have enabled them to service their debts on schedule.34 In the case of Aseptic, PB reassigned the original subloan (after rescheduling) to a new subborrower without consulting ADB. In doing so, PB breached Section 2.01(b) of the Project Agreement and Section 3.03(b) of the Loan Agreement. No penalty interest was charged on any of these rescheduled subloans. PB further reduced its interest rate (on its rescheduled loan) to Mega Dry to 4% per annum, which was lower than its funding cost. This constitutes a violation of Section 2.04(a) of the Project Agreement, which stated that every subloan shall carry a rate of interest at a commercial rate which will take into account the cost of funds, administration costs, credit risks, and profit margin. In practice, this would have required a margin of 4–5% over ADB’s lending rate. This in effect is subsidizing default. PB defended its credit decisions on rescheduling (Appendix 3), claiming that the subprojects were viable but faced temporary setbacks such as raw material scarcity or delay in equipment installation. The four subborrrowers’ financial statements did not corroborate the reasons PB stated for its rescheduling decisions. The Mission therefore reckoned that their subloans were rescheduled for nonbanking reasons. 25. The remaining 16 subprojects (with subloans totaling $25.3 million, or 53.4% of the loan) were unsuccessful (Appendix 6). Two (Oltin Meva and Zumrut) were financed by NBU, six (Food Industry [Quqon Non], Osiyo Express, Surkhan Export, Margilantekstil, Laser Oqoltin, and Yorqishloq) by PB, and eight (Delta, Building Industrial Group, Djizak-Mramor, Kuva Konserva, Elkol, Aral Invest, Lola Model and Shark Model) by AB. Four of these subprojects manufactured fruit juices or purees; two each were engaged in T-shirt manufacture, yarn production, and feeds; and 1 each in manufacturing footwear, PVC window panels, marble tiles, and cookies. Their FIRRs were lower than their WACCs, their DSCRs lower than 1, and their ROAs low or negative. The reasons for these subprojects’ poor performances were (i) delayed assembly of imported equipment for the production facility, 35 (ii) shortage of raw materials, (iii) dispute between local and foreign joint venture counterparties,36 (iv) poor product design and inability to

34 PB stated (in its comments on the draft PCR) that these four subprojects’ financial ratios furnished to ADB were

after rescheduling of their subloans. The Project Completion Review Mission believes that mere rescheduling of subloans cannot improve these subborrowers’ DSCRs and ROAs by the magnitudes reported and that these subprojects were able but unwilling to service their debts on schedule.

35 This was due to discrepancies in the banks’ letters of credit or delays in the release of foreign exchange by CBU to facilitate their negotiation or accommodation.

36 Items (i), (ii), and (iii) resulted in delayed production and shortage of working capital.

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compete with imports from the People’s Republic of China,37 and (v) willful default.38 These factors were unforeseen by ADB at project processing. Many of these subprojects were located in the country’s poorer regions (including Djizak, Karakalpakstan, and Khorezm) and used nonagricultural raw materials. Regrettably, the PCBs failed by not foreseeing, isolating, or ameliorating these problems in the nascent stages. Interestingly, exchange rate movements did not adversely affect the subprojects’ cash flows (unlike in the case of Loan 1504-UZB). Five of NBU’s subprojects and six of PB’s subprojects were export-oriented. 39 For export-oriented subprojects, their export earnings constituted a natural hedge. Even those subprojects that were selling to the domestic market did not falter on account of exchange risk because (i) at the times of their appraisals, the sensitivities of their earnings to adverse exchange rate movements were tested and only those subprojects which passed that test were approved; and (ii) at the macro level the exchange rate for the Uzbek sum remained reasonably stable after November 2003, when Uzbekistan acceded to the International Monetary Fund’s Article VIII.

26. After rescheduling, NBU’s arrears rate for its eight subloans under the loan was 27.5%. If the installments of the rescheduled subloans payable from date of first default up to 1 April 2007 were added back (Appendix 6), NBU’s adjusted arrears rate would be 43.5%. Likewise, PB’s arrears rate on its 15 subloans would be 33.2%. AB’s arrears rate as of 15 April 2007 (as there was no rescheduling) is 81.2%. Overall, the three banks’ arrears rate under the loan is 53.9% which is more than double the arrears rate under REDP.40 None of the three PCBs, however, defaulted in their repayments to ADB through the Borrower. With hindsight, during processing, ADB should have had a covenant in the project agreements stipulating (i) ADB’s approval for any rescheduling of any subloan, (ii) a basis for charging penalty interest on rescheduled loans, and (iii) that PCBs monitor their subborrowers’ financial performance on a quarterly basis and report to ADB on any defaults so as to enable early ameliorative action. Such stipulations in the loan documentation could have reduced, if not prevented, the defaults and/or rescheduling of subloans for nonbanking considerations. D. Operational Performance of PCBs

1. Organization, Management and Staffing

27. NBU’s apex management follows a bimodal collegiate system (Appendix 1) comprising a five-member supervision council (SC) and a 14-member board comprising its chairperson, four deputy chairpersons, and nine executive directors. NBU’s internal management structure underwent a change in 2003. The four deputy chairpersons are functionally responsible (and answerable to its chairperson) for NBU’s four core banking activities: corporate banking, retail banking, investment banking, and business development. The board, which meets twice a month, has four executive committees: (i) asset-liability management, (ii) credit policy, (iii) compliance, and (iv) operational and financial management. Each is headed by an executive director. All its SC and board members are qualified professionals. NBU’s organization and management structure are adequate for an institution of its size in Uzbekistan, and its 2003 management reorganization helped to strengthen that structure.

37 This affected particularly AB’s subborrowers. 38 This affected one of NBU’s (Oltin Meva), two of PB’s (Quqon Non and Yorqishloq), and three of AB’s (Delta Invest,

Djizak-Mramor and Aral Invest) subborrowers. 39 Over 50% of their production was for exports. Two other PB subprojects exported 20% and 30% of their

production, respectively, in 2006. 40 The arrears rate under REDP in February 2003 was 21.8% (para. 19 of the PCR for Loan 1504-UZB).

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28. Asaka Bank’s apex management also follows a bimodal system, with a five-member SC41 and a seven-member board (Appendix 2). The board has executive committees on asset-liability management and credit. Its chairperson is assisted by three deputy chairpersons who are also board members. Its other members are its chief accountant, treasurer, head of project finance, and head of legal department. AB’s entire board comprises the banks’ officers. It has no outside directors. This could inhibit fresh talent and new ideas for the bank’s policies and could limit improvements in its corporate governance. 29. Pakhta Bank’s apex management also follows a bimodal collegiate system similar to those of NBU and AB, comprising a seven-member SC and a seven-member board (Appendix 3). The latter includes its chairperson, three deputy chairpersons, its head of treasury, chief accountant, and head of legal department. The board has two committees, a liquidity committee and a credit committee. The three deputy chairpersons’ responsibilities are divided functionally. Pakhta Bank’s organization and management structure along with its CRMP were enhanced in 2006, which provided adequate institutional checks and balances for PB’s future.

2. Personnel Administration

30. On 31 March 2007, NBU had 6,270 employees, 5,282 of whom were in its field offices and 988 at its head office. Of the total, 740 were professional and 5,530 support staff. Both NBU’s internal hierarchical division (having seven levels) and its personnel distribution between head and field offices appear appropriate to its needs. NBU’s staff remuneration package is competitive in Uzbekistan’s context, judging from its ability to attract well educated individuals to its ranks. Its staff evaluation system and opportunities for staff career development are progressive. Its staff training programs are well focused towards its operational managerial and financial goals. 31. On 31 March 2007, Asaka Bank had 2,508 staff, 2,024 of whom were in its field offices and 484 in its head office. Some 50% of its staff is younger than 30 years of age. AB’s management structure appears top heavy, as its human resources, legal, internal audit, and secretariat departments all report directly to the chairperson. AB’s 2004 internal reorganization separated its project financing and credit approval functions from its post-approval credit monitoring and recovery functions. This segregation proved detrimental, as the former functions were generally staffed by younger and better qualified individuals who benefited from training under ADB’s TA 3352 (footnote 15), many of whom subsequently resigned from AB. By contrast, its officers in the credit monitoring and recovery division were generally older, drawn from the bank’s administrative departments, and had little market knowledge or credit analysis experience. This explains their inability to deal with defaulting clients, which is a reason why AB’s loan default was highest among the three banks.42 AB’s internal and external staff training programs, which covered 1,129 staff in 2006, appear satisfactory to its commercial banking needs. AB’s reported high staff turnover, and particularly during 2004–2007 in its project finance and credit departments suggests either a lack of job satisfaction or inadequate remuneration. 32. On 31 March 2007, Pakhta Bank had 8,323 employees, of which 1,013 are professional staff and 7,310 support staff. Some 75% of PB’s employees are deployed at its field offices. PB’s minimum entry level qualification for professional staff is a university degree. PB’s

41 The composition of AB’s SC is given in Appendix 2. 42 ADB advised AB of the pitfalls of such reorganization in 2005 and requested AB to rectify it, but ADB’s suggestion

was not heeded. AB clarified to ADB on its review of the draft PCR that these management changes were made necessary by the situation then prevailing.

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remuneration package, staff motivation and training systems are relevant and adequate to its operational and management needs, as is reflected in its financial performance (para. 40).

3. Lending Operations

33. The cumulative average processing time per subloan under this Project was 43 days (Appendix 6). NBU’s average subloan processing time was 33 days, AB’s 66 days, and PB’s 37 days. NBU’s processing time was slower than its average of 21 days under REDP. This is because subproject eligibility criteria under this loan were more focused. All three PCBs submitted to ADB detailed information about subprojects’ technical, managerial, commercial, and financial viability prior to each subloan’s approval. The average maturity of approved subloans (before rescheduling) under the Project was 5.9 years, which was shorter than the loan’s maturity. 43 The three PCBs’ combined arrears rate (after adding back rescheduled portions) was 53.9%. NBU’s and PB’s subproject monitoring activities were perfunctory and could have been more rigorous (paras. 44 and 47). By contrast, AB’s subproject monitoring and loan recovery activities were inadequate, which was manifested by defaults on all of its eight subloans. AB’s retrograde management changes exacerbated that bank’s poor subproject monitoring and subloan recovery.

4. Other Operations

34. Taking advantage of their market niches, the three PCBs have embarked on consciously increasing their fee-based incomes from the likes of (i) foreign exchange trading and settlements; (ii) security transfers and custodial services; (iii) clients’ payroll disbursement functions; (iv) electronic funds transfer (through negotiable instruments) for their clients and their clients’ clients; (v) issuing letters of credit and guarantees; and (vi) collection, purchase, negotiation, and discount of foreign documentary and accommodation bills on behalf of their customers. Additionally, NBU undertakes the issue, clearing, and settlement of credit card transactions, which are presently limited to transactions within Uzbekistan. NBU and PB also undertook encashment of foreign exchange denominated traveler’s checks.

5. PCBs’ Financial Performance

35. The three PCBs’ portfolios are still characterized by sectoral loan concentrations. As of 31 December 2006, 42% of NBU’s lending was concentrated in the industrial sector, 30% of AB’s lending was to the automotive sector, and 42.5% of PB’s was to the cotton sector. This phenomenon can be attributed to the three PCBs’ original sector specificities. NBU’s and AB’s single-borrower (or affiliated group of borrowers) exposures remained under 15% of their equity, complying with ADB’s covenant. PB’s single-borrower exposure exceeded 15% of its equity in 2005 and 2006. 36. NBU’s nonperforming loans (NPLs)—comprising substandard, doubtful, and bad debts—increased from 5.2% of its portfolio in 2001 to peak at 59.2% in 2004 and then declined to 31.4% in 2006. This is attributable to NBU’s dollar and euro loans made to state-owned enterprises during 1999–2004 and the sum’s concurrent depreciation during that period. As many of its borrowers did not have foreign exchange earnings (in the absence of hedging mechanisms in Uzbekistan), their exchange risks became NBU’s credit risks. In the Project Completion Review Mission’s assessment, NBU’s percentage of nonperforming assets might 43 NBU’s rescheduling of two subloans for maturities beyond 8 years constitutes a violation of Section 2.06(b) of the

Loan Agreement.

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have been higher if NBU’s portfolio had been classified according to internationally accepted practice. NBU’s loan loss provisions between 2001 and 2004 were lower than would have been warranted by international norms 44 and CBU’s requirements. NBU did not make loan loss provisions on loans (even if warranted by their collectibility) covered by Uzbek sovereign guarantee. 37. AB’s NPLs grew from 10% in 2001 to 16.8% in 2006. Its loan loss provisions were lower than would have been warranted by internationally accepted norms. AB did not make provisions on sovereign guaranteed debt. PB’s NPLs increased from 0.24% in 2001 to 0.35% in 2006. The bank’s loan loss provisioning met internationally accepted norms. PB’s sectorally expansive credit policy, manifested by its highest loan concentration ratio among the three PCBs (relative both to sectors and borrowers) is matched by conservative financial management that is seen in a low NPL ratio and provisioning that is fully satisfactory for its portfolio. E. Financial Statements and Ratios

38. NBU’s financial statements during 2001–2003 were prepared according to US generally accepted accounting principles (GAAP), but since 2004 followed International Financial Reporting Standards (IFRS).45 AB and PB followed IFRS during 2001–2006. NBU denominated its 2001–2006 financial statements in US dollars. AB denominated its 2001–2005 statements in US dollars and its 2006 statements in Uzbek sums. AB justified the change in the currency of reporting because it did not consider Uzbekistan to be a hyperinflationary economy as defined by IAS-29 from 1 January 2006 onwards. AB’s 2006 audited financial statements are therefore not comparable with those from 2001–2005. PB denominated its 2001–2006 financial statements in sums, as it did not consider Uzbekistan to be a hyperinflationary economy for the period 2001–2006 (footnote 45). 39. The Project’s design (paras. 14 and 15) recognized the necessity of financially sound PCBs to efficiently intermediate ADB’s funds for delivering credit to SMEs. The Project therefore established covenants for the financial soundness of the PCBs based on their solvency (judged by their capital adequacy ratios [CARs]), liquidity (judged by their LDRs), and profitability (judged by their ROAs), as well as limiting loan concentrations to individual borrowers and sectors. 40. Analysis of the three PCBs’ 2001–2006 financial statements (appendixes 1, 2, and 3) revealed that all three PCBs are satisfactorily solvent, as judged by their comfortable CARs.46 The three PCBs’ high CARs47 are attributable to their treatment of sovereign guaranteed lending as a risk-free asset. If such loans were to treated as risky assets, their CARs would be lower. The Government has since 2005 curtailed the issue of sovereign guarantees. As a consequence, the banks’ CARs can be expected to decline more sharply in future. NBU’s liquidity was tight, as judged by its LDRs,48 which exceeded 100% during 2001–2006. AB’s LDR exceeded 100% during 2001–2005. It was 93.07% in 2006, meeting ADB’s covenant for the first 44 International norms require loan loss provisions at 25% for substandard, 50% for doubtful, and 100% for bad loans. 45 In 2004, NBU followed IAS-29: Accounting in Hyperinflationary Economies (which is why its financial statements

were denominated in dollars) and IAS-30: Financial Statements for Banks and Financial Institutions. 46 The CAR is the ratio of equity capital and free reserves to risk-bearing assets as defined by the Basel Committee

for Banking Supervision. This loan required PCBs to maintain CARs at not less than 12%. 47 NBU’s CARs ranged between 20% in 2001 and 18.7% in 2006, AB’s between 30% in 2001 and 21.5% in 2006,

and PB’s between 38% in 2001 and 16% in 2006. 48 Loan to deposit ratio measures the net loans (as reduced by those refinanced from specific nondeposit sources) to

customers’ deposits. This loan’s conditions required the PCBs to maintain LDRs at not higher than 100%.

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time. NBU’s and (except for 2003) AB’s profitability judged by their ROAs49 was poor. The principal causes of their poor ROAs were (i) increased loan and extraordinary losses; (ii) increased intermediation cost ratios;50 and (iii) in the case of NBU, declining interest spreads. PB, by contrast, was both safely liquid and satisfactorily profitable. Its LDR (except in 2001) has been under 100% and its ROAs (except in 2002) consistently higher than 1%. PB’s safe LDR is attributable to the bank’s impressive and innovative deposit mobilization measures, and particularly for low-cost deposits. PB’s satisfactory profitability is attributable to (i) increasing interest spreads (due to the optimal funding with low-cost deposits), and (ii) increased gains on fees and commissions plus securities and foreign exchange trading. The loan concentration ratios of the three PCBs’ sectoral exposure exceeded the covenanted 20% of their total portfolios (para. 35). While NBU’s and AB’s single (or group) borrower exposures remained under 15% of equity as covenanted, PB’s exceeded 15% in 2005 and 2006. F. Covenants

41. The three PCB’s compliance with the project covenants was partial (Appendix 7). All of them complied with covenants relating to maintaining their CARs at or above 12%. They complied with the requirements of sections 8, 12, and 13 of the Schedules to the Project Agreements relating to subproject selection criteria. They maintained their financial statements in accordance with IFRS or US GAAP. They complied partially with Section 3.03 of the Project Agreements requiring every subproject to have adequate working capital. They also complied with the reporting requirements set out in Sections 3.06(b) and (c) of the Project Agreements. The PCB’s compliance with the covenants relating to their profitability and liquidity stipulated in the Schedule to the Project Agreement was mixed. NBU was unable to maintain its LDR below 100% during 2001–2006 and AB during 2001–2005. The three PCBs were also unable to maintain their ROAs consistently above 1%. NBU and AB limited their single borrowers’ (or affected group of borrowers’) exposure to under 15% of their paid up share capital. PB was unable to do so. The three PCBs were also unable to limit their sectoral lending exposure to under 20% of their total lending. Of the three PCBs, only PB’s loan loss provisioning fully met internationally acceptable norms. In rescheduling two subloans for maturities beyond 8 years, NBU breached Section 2.06(b) of the Loan Agreement and Section 2.04(b) of the Project Agreement. In rescheduling subloans at lower interest rates than would have been otherwise warranted, the PCBs also breached Section 2.04(a) of the Project Agreement, which stated that every subloan shall carry interest at a commercial rate that takes into account the cost of funds, administration cost, credit risk, and a reasonable margin of profit. Further, the PCBs also violated Section 2.06 of the Project Agreement, which stipulated that PCBs shall exercise their rights in relation to subprojects prudently. PB also breached Section 2.01(b) of the Project Agreement and Section 3.03 of the Loan Agreement, which stipulated that subloans could be made only to qualified subprojects in respect of which the loan funds were withdrawn.

49 Return on assets measures the ratio of net profit after taxes to average total assets. This loan’s conditions required

the PCBs to maintain ROAs of not less than 1%. 50 Intermediation cost ratio (ICR) measures the ratio of noninterest expenses to average total assets (reduced by

those refinanced from specific nondeposit sources) to customers’ deposits. The Project’s covenant required PCBs to maintain LDRs at not higher than 100%.

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G. Performance of ADB

42. ADB’s loan supervision and administration were satisfactory. ADB fielded an inception mission in February 200251 and five review missions during 2002–2005. ADB’s review missions analyzed the PCBs’ financial performance as well as the track records of the subprojects financed and notified the PCBs immediately of any shortcomings observed. Such reviews helped the PCBs to familiarize themselves with and better understand ADB’s subproject selection and institutional assessment criteria. 52 ADB analyzed all subprojects according to technical, environmental, social, managerial, commercial, and financial criteria before approving any subloan on the basis of information furnished by the three PCBs. Based on its experience in REDP, ADB analyzed the sensitivity of each subproject’s revenues to the sum’s depreciation and the effect this could have on its repayment capacity. There were no disagreements between ADB and the PCBs on any subproject’s selection or subloan’s acceptance criteria. The Project Completion Review Mission was fielded in April 2007 within 4 months of the loan’s closing. Although the loan’s effectiveness had been delayed until October 2001, pending the Government’s enacting legislation related to exchange convertibility (paras. 14 and 15) as a condition for effectiveness, the Project maintained satisfactory ratings both for development objectives and implementation progress from 1 January 2001 to 14 December 2006. No amendments to the Loan Agreement or project agreements were necessary during its implementation. The loan was fully committed within its original commitment date of 18 October 2004 and no extensions were necessary. The loan’s closing date for disbursements had to be extended from 18 October 2006 to 14 December 2006 at AB’s and PB’s requests to allow them to draw down their committed funds.

III. EVALUATION

A. Loan Appraisal

1. Quality of Appraisal

43. The Project’s design was satisfactory from the perspectives of facilitating a more enabling environment for SMEs (Appendix 4) and enhancing SMEs’ access to institutional finance. Its design incorporated the lessons learned in REDP. Importantly, the Project facilitated the ending of distortions in the country’s exchange rate policies. Together, these measures reversed the decline of the SME sector to GDP as had been witnessed during 1996–1998. The Project generated 8,144 jobs and exports worth $21.98 million in 2006. The jobs exceeded appraisal estimates but exports were lower than envisaged. This reflects the soundness of the basic direction of the Project’s design. 44. From the perspective of efficient financial intermediation, however, the Project’s design should have incorporated more stringent safeguards for (i) maintaining the financial soundness of PCBs (para. 48); and (ii) imposing tighter discipline on PCBs’ credit decisions, and particularly relating to their post-disbursement recoveries (para. 47). The former could have made PCBs more conscious of their need for overall financial soundness in order to continue as PCBs under the loan. The latter could have acted to check their willingness to reschedule

51 The loan became effective on 18 October 2001. Due to the war in Afghanistan, ADB’s mission could not be fielded

earlier. 52 This was particularly important as most of the PCB staff working on the loan were new to their jobs. The majority of

PCB staff working with the ADB processing missions between February and July 2002 had resigned from the PCBs by 2002 or had been reassigned to other functions.

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subloans for nonbanking considerations, a tendency which interestingly had not been noticeable in the REDP. Indeed, such discipline could have helped to improve PCBs’ overall financial performance. In designing the Project (using REDP as its comparator), ADB had assumed that (i) PCBs, as the primary lenders and bearers of credit risk, would conduct rigorous due diligence of subprojects’ technical and management aspects53 (in addition to their financial and social viability) before referring them to ADB for approval or confirmation; and (ii) PCBs, as commercial banks (responsible creditors), would rigorously follow up recovery of arrears and reschedule subloans only in exceptional cases. ADB’s two assumptions were proven false. The Project Completion Review Mission infers (with hindsight) that (i) requiring PCBs to monitor subprojects’ financial track records on a quarterly basis, and (ii) requiring ADB’s prior approval before rescheduling any subloan could have improved subprojects’ quality and would have prevented an overall arrears rate of 53.9%.

2. Distribution of Subloans

45. There were no specific covenants in the loan or project agreements related to the distribution of subloans by sector or region. Nonetheless, their sectoral and geographical dispersion was adequate and consistent with the projections made at project processing. The subloans’ eligibility and approval criteria covenanted in the Project Agreement were adhered to before any subloan was approved. Fifteen of the subprojects financed—and particularly the eight successful ones—were an important link in the value added chain in generating employment and exports. The Project was fully consistent with Uzbekistan’s development goals.

3. Covenants

46. ADB’s environmental (footnote 26), social (footnote 27), and financial (footnote 31) covenants for determining subproject eligibility and subloan approval criteria were valid in 2000 and remain so in 2007. The social covenants ensured adequate protection to workers against working more than 12 hours a day and provided protection against the employment of minors. 47. The subproject financial covenants sought to ensure subprojects’ solvency, liquidity, and profitability to ensure their sustainability and repayment of subloans on schedule, while also ensuring their private sector status. These covenants’ efficacy is established by the fact that those subprojects which met them fully are successful and sustainable, not only financially but also in their accomplishing the Project’s development objectives. As a further step towards more efficient monitoring of subprojects, ADB should have established covenants requiring that (i) subborrowers prepare quarterly financial statements; and (ii) PCBs monitor subprojects’ solvency, liquidity, and profitability on a quarterly basis. Such covenants would have required the PCBs to monitor subprojects’ quarterly DSCRs and ROAs, which would have alerted the PCBs early to any signs of default by subborrowers. Such early warnings could have enabled PCBs to take early ameliorative actions to address these problems faced by subprojects. Such stipulations could have considerably reduced defaults in subloan repayments. 48. ADB’s financial covenants for the three PCBs were valid benchmarks for measuring their solvency, liquidity, and profitability for efficiently intermediating to deliver ADB’s loan funds to SMEs. They remain valid in 2007. While the three PCBs’ financial track records between 1996

53 Such due diligence could have anticipated and mitigated such problems as raw material shortages or disputes

between the local and foreign counterparts in joint ventures. (The latter problem did not arise in REDP because the majority of subprojects under that loan were wholly Uzbek-owned companies.)

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and 2000 met ADB’s covenanted financial benchmarks, the financial performance of NBU and AB deteriorated between 2000 and 2006. There was no clause in the Project Agreement which would have allowed ADB to suspend loan disbursements to any PCBs whose financial parameters breached covenanted levels. Having such a clause may have alerted NBU and AB to at least try and maintain their past financial performance levels. Further, the Project Agreements should have contained a clause requiring ADB’s prior approval for rescheduling subloans and for charging penalty interest on subloans. Such a clause could have deterred PCBs from rescheduling subloans for nonbanking considerations. B. Implementation

49. Despite a 7-month hiatus between the loan’s signing and its effectiveness, it was implemented on a timely basis without warranting extensions for commitments. All procurements conformed to ADB’s guidelines and to the covenanted social clauses. NBU and PB had, in theory, CRMPs reasonably adequate to support their financial intermediation under the loan. Their adherence to their credit policies was mixed, which accounted for their high arrears under the loan. It was assumed that AB’s CRMP, which was perfunctory at appraisal, would be enhanced by AB’s participation in ADB’s TA. This assumption was proven false. NBU’s and PB’s organization, management, and staffing policies were satisfactory while AB’s deteriorated. While all three PCBs were solvent, only PB was both liquid and profitable in addition to being solvent. All three PCBs had varying degrees of loan concentration. Eight of the 31 subprojects were successful, seven partially successful, and the remaining 16 unsuccessful. There were implicit subsidies in rescheduling subloans without penalties. The overall arrears rate was 53.9%, with AB having the highest arrears rate of 81.2%. For future credit lines, it would be necessary to have stringent safeguards to protect banks’ financial soundness as well as the quality of their subloans. The achievement of the loan’s thematic and sectoral outcomes is summarized in the following table.

Achievement of the Loan’s Thematic and Sectoral Outcomes

Theme Outcome 1. Creation of a more enabling

environment for the SME sector. Policy dialogue with Government helped to bring about reformed fiscal, registration, and licensing legislation to ease SMEs’ burdens. Simultaneously, a liberalized exchange control regime for SMEs was introduced, which was the first step toward Uzbekistan’s accession to the International Monetary Fund’s Article VIII.

2. Increase in the sector’s contribution to GDP, employment, and exports.

Uzbekistan’s SME sector’s decline in GDP contribution was halted and reversed. Whereas the sector’s contribution to GDP had declined from 12% in 1996 to 8% in 1998, it rose to 42% in 2006, when it employed 7.25 million persons and generated $683 million in exports. The 31 subprojects financed under the loan generated incremental employment for 8,144 persons and generated exports totaling $21.98 million in 2006.

3. Access of potentially successful SMEs to institutional finance under ADB’s loan.

Eight of the 31 subprojects were successful, seven partially successful, and the remaining 16 unsuccessful. The eight successful subprojects were (i) located in the country’s more affluent regions (Tashkent, Samarkhand, Bukhara); (ii) mostly engaged in agro-processing, floriculture, or yarn manufacture (sectors in which Uzbekistan has a competitive advantage); and (iii) where the subprojects had an assured supply of raw materials (if not agriculture- or horticulture-based). The seven partially successful subprojects were located in the same affluent regions plus Andijan and Ferghana, which are known for cotton cultivation. The 16 unsuccessful subprojects were distributed all over the country, including in its less developed Karakalpakstan, Khorezm, and Djizak regions, where transport and other infrastructure was weak. Some manufactured products could not compete

17

Theme Outcome with cheap imports from the People’s Republic of China. Many were engaged in sectors such as marble tiles, construction material, and polypropylene products, in which Uzbekistan has no competitive advantage.

4. Efficient financial intermediation by solvent, liquid, and profitable PCBs.

NBU’s and AB’s overall financial performance and intermediation were better during 1996–2000 than 2001–2006 as measured by solvency, liquidity, and profitability. They did not meet ADB’s covenants most of the time. Their deterioration in profitability is due to their loan losses on foreign currency loans made to state-owned enterprises that had no hedging mechanisms when the sum was depreciating against the dollar and euro. Their tight liquidity is attributable to the general low level of deposits relative to GDP in Uzbekistan. The general worsening of their financial performance is for reasons other than the SMEDP. By contrast, PB’s overall financial condition and its intermediation remained solvent, liquid, and profitable—again for reasons other than the SMEDP. PB (despite its attempts to diversify its portfolio) remains a bank specific to the cotton sector. Decontrol of domestic cotton prices (under policy dialogue through a World Bank loan), coupled with increase in cotton prices during 2002–2005 and depreciation of the sum, saw the export revenues of PB’s customers soar. Unlike NBU, PB’s customers did not suffer from an exchange risk and PB did not suffer from a credit risk from the sum’s depreciation. PB was also highly innovative in increasing its customer deposits mobilization despite Uzbekistan’s low deposit/GDP ratio, which is highly impressive and explains why its LDR remained under 100%. High liquidity through customers’ deposits reduced PB’s cost of funds, and that helped to improve its overall profitability.

AB=Asaka Bank, ADB=Asian Development Bank, GDP=gross domestic product, LDR=loan to deposit ratio, NBU=National Bank for Foreign Economic Activity of the Republic of Uzbekistan, PB=Pakhta Bank, PCB=participating commercial banks, SME=small and medium enterprise, SMEDP=Small and Medium Enterprise Development Project. Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, Pakhta Bank, Republic of Uzbekistan, State Committee on Statistics.

IV. ASSESSMENT AND RECOMMENDATIONS

A. Relevance

50. The Project’s design was relevant at its appraisal and throughout its implementation (Appendix 8). It was consistent with ADB’s COS for Uzbekistan. It gave high priority to SME development to support the emerging private sector and facilitate Uzbekistan’s orderly transition to a market economy. This was a common goal of ADB’s COS and the Government’s development policy. Incorporating the lessons learned from Loan 1504-UZB, the Project’s design created through policy dialogue a more enabling legal and regulatory environment for SME development. This included Uzbekistan’s movement toward accession to the International Monetary Fund’s Article VIII, thereby unifying its exchange rate and ending exchange rate distortions. Also, in 2006, restrictions on cash withdrawals from banks were lifted. No change in project design or implementation arrangements was necessary during implementation. B. Effectiveness in Achieving Outcome

51. The Project was overall effective in achieving its outcome (Appendix 8). It was implemented in a timely manner within its original time frame and design framework. Although they were introduced at a slower pace than originally envisaged, policy interventions under the Project (Appendix 4) benefited the country’s overall SME sector, whose contribution to GDP

18

reversed its declining trend and rose from 8% in 1998 to 42% in 2006.54 Thirty-one subprojects financed under the loan generated employment for 8,144 persons (comprising 1,670 direct jobs and 6,474 indirect ones) and exports of $21.98 million in 2006. C. Efficiency in Achieving Outcome and Outputs

52. The Project was less efficient than was envisaged at appraisal in achieving its outcome and outputs (Appendix 8). Eight of the 31 subprojects were successful (by their financial parameters) and were servicing their loans on schedule. Another seven were partially successful. Their financial parameters met the covenanted ratios but they defaulted on debt servicing. The remaining 16 subprojects were unsuccessful as measured by their financial parameters and defaulted in servicing their debt. The overall arrears rate (without allowance for rescheduling) was 53.9% (compared to 21.8% in the REDP). NBU and PB rescheduled some subloans for nonbanking reasons despite their subborrowers’ capacity (based on their financial parameters) to service their loans on schedule. In doing so, PB subsidized defaulting subprojects but did not charge penalty interest rates on rescheduled subloans. Had the PCBs not rescheduled subloans for nonbanking reasons, the arrears rate would have been lower. The PCBs’ financial intermediation was generally less efficient than envisaged at appraisal.55 PB was the only PCB that substantially met ADB’s covenants for solvency, liquidity, and profitability throughout loan implementation. At 33.2%, PB had the lowest rate of arrears. That compares to 43.5% for NBU and 81.2% for AB. NBU’s and AB’s profitability failed to meet the covenanted levels during 2001–2006. NBU’s liquidity failed to meet covenanted levels during 2001–2006. AB met the liquidity measure for the first time in 2006. D. Preliminary Assessment of Sustainability

53. On a preliminary basis, the overall outcome of this Project is less sustainable. Only eight subprojects with subloans totaling $11.4 million (22.8% of the loan amount) were successful. Another seven with subloans totaling $10.74 million (21.5% of the loan amount) were partially successful. Overall, 15 subprojects with subloans totaling $22.1 million (44.3% of the loan amount) are sustainable. Sixteen subprojects with subloans totaling $27.86 million (55.7% of the loan amount) are unsuccessful and unsustainable. The overall arrears rate under the loan is 53.9%. The financial conditions of two of the three PCBs were poorer during 2001–2006 than during 1996–2000. Sustainability of subprojects and PCBs has been lopsided under the Project. E. Overall Assessment

54. Overall, the Project is rated as partly successful with a weighted rating of 1.50 (Appendix 8), in accordance with the definitions and guidelines provided by the Operations Evaluation Department.56 Its design was sound and relevant to both ADB’s and the Government’s goals both at processing and throughout implementation. Neither the Project’s scope nor its implementation arrangements required changes during its implementation. It was implemented within its originally conceived time frame. Policy interventions introduced through policy dialogue under the project addressed certain distortions and created a more enabling environment for SMEs. This facilitated (at the macro level) SMEs’ increased contribution to GDP from 8% in 1998 to 42% in 2006, which demonstrates the Project’s effectiveness.

54 The SME sector’s contribution to GDP had been 9% in 1996 and had slipped to 8% in 1998. 55 This was borne out by their increasing ICRs. 56 ADB. 2006. Guidelines for Preparing Performance Evaluation Reports for Public Sector Operations. Manila.

19

55. That the PCBs’ financial intermediation under the Project was less than efficient is borne out by their willingness to reschedule some subloans for nonbanking reasons even when the subborrowers (judging from their financial parameters) could otherwise have serviced their debt on schedule. In rescheduling subloans without penalties, the PCBs subsidized default. This could be attributable to the credit decisions of PCBs (in certain instances) to remain subservient to national development policies rather than concentrating on their own solvency, profitability, and liquidity. That explains why the overall financial performance of two of the three PCBs was poorer during 2001–2006 than during the preceding 5 years. Only 15 of the 31 subprojects with subloans totaling 44.3% of the loan are prima facie sustainable. F. Lessons

56. Four important lessons emerged from this loan:

(i) ADB should not provide plain credit lines. The achievement of fairly positive outcomes even in a complex environment proves the benefit of policy dialogue at design and during implementation. ADB’s policy dialogue with Government encouraged the introduction of policy interventions which helped to address distortions in the SME sector. An enabling environment is a necessary albeit insufficient condition for the sector’s efficient performance.

(ii) Satisfactory performance of subprojects even in an improved enabling environment should not be taken for granted. The benefits of policy interventions that improved the sector’s productivity did not, however, percolate to all 31 subprojects financed under the loan. This asymmetry is attributable to the PCBs’ less than rigorous initial screening of subprojects’ technical and commercial feasibility and particularly their inability to monitor post-disbursement credit recovery with greater frequency and intensity. A covenant requiring PCBs to monitor subprojects’ financial performance on a quarterly basis and reporting on them to ADB could have provided both ADB and PCBs an early warning tool to deal with potentially problematic subprojects.

(iii) Efficient financial intermediation requires autonomous credit decisions by banks guided purely by sound banking considerations. Uzbek PCBs’ credit decisions by contrast are subservient to the country’s national development policies instead of being autonomous and aimed at maximizing their own profits. ADB loans’ conditions should therefore provide for the rigorous enforcement of sound and autonomous credit policies by PCBs.

(iv) Financial intermediation loans should include adequate and enforceable provisions for ensuring sustained financial and operational performance of PCBs. While the loan established covenants for PCBs’ solvency, liquidity, and profitability, there were no covenants in the Project Agreements to enforce compliance with the covenants established for the above measures. A covenant enabling ADB to suspend loan disbursements to banks whose financial ratios deteriorated and breached covenants could have disciplined PCBs to avoid the moral hazards cited above that were detrimental to their overall financial health.

20

G. Recommendations

57. In future credit lines—and particularly so in transitional economies—it is essential for ADB to ensure that the credit decisions of its selected financial intermediaries are autonomous and not subordinate to state development priorities. ADB should ensure that a country’s banking system through which ADB loan funds are channeled does not become an instrument of a covert fiscal policy. To achieve these three conditions, it would be necessary for ADB to select PCBs with proven track records in efficient financial intermediation while simultaneously maintaining their financial soundness. Moreover, it would be necessary for ADB to have enforceable covenants for maintaining efficient financial intermediation in the delivery and recovery of credit and for safeguarding the intermediaries’ financial soundness.

Appendix 1 21

NATIONAL BANK FOR FOREIGN ECONOMIC ACTIVITY OF THE REPUBLIC OF UZBEKISTAN

A. History

1. The National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) was formed in September 1991 as a wholly state-owned universal commercial bank with a foreign exchange license. NBU is mandated to operate as the Government’s financial agent on domestic and international markets. NBU has four financial affiliates, all of which have complementary relationships with the bank. These comprise partial ownership in two joint-venture banks in Uzbekistan (i.e., ABN-AMRO (Uzbekistan) 1 and UzDaewoo Bank), 2 an investment in a domestic leasing company, and a subsidiary bank in Russia.3 NBU was rated by Thomson Financial BankWatch in 1999, receiving an IC-B/C and LC-I rating.4 This was a factor in the decision by Asian Development Bank (ADB) to include NBU as a participating commercial bank (PCB) in the loan under the Small and Medium Enterprise Development Project (SMEDP). NBU was not rated after 1999. B. Scope of Operations 2. NBU’s main operations include (i) trade finance; (ii) corporate banking; (iii) finance for the foreign exchange needs of export-oriented or import-substituting ventures; (iv) finance for projects involving technology transfer; (v) finance for projects involving value-added agricultural processing and modernizing industrial enterprises; (vi) organization of, and participation, in loan syndications; (vii) provision of export credits and guarantees; and (viii) banking services for payments, settlements, and remittances in local and foreign currencies. 5 NBU has 22,000 corporate clients, most of them in energy, metallurgy, agriculture, petrochemicals, tourism, aviation, and surface transport. NBU acts as a government agent for many projects financed by international credit lines, many of which financed the foreign currency needs of projects in export promotion or import substitution. It also finances subprojects investing in capital goods and technology transfer to add value for production using domestic inputs. 3. To facilitate its international operations, NBU had correspondent banking relationships with 600 banks in 75 countries as of 21 March 2007. On 31 March 2007, it had 16 branches, 76 subbranches, 58 mini-banks and 174 cash point offices. The mini-bank offices offer cash, transfer, and deposit services but no loans and are staffed by 2–6 employees. The cash point offices are housed inside other institutions and serve as cash, deposit, and transfer facilities for individuals within that institution. Each is staffed by 1–2 employees. Cash point offices offer collection and disbursement services only. NBU is a member of the Society for Worldwide Interbank Financial Telecommunication (SWIFT), and it has access to Telerate and Reuters information and dealing systems.

1 The other shareholders of this bank are ABN-AMRO, Bank N.V. of the Netherlands, International Financial

Corporation (IFC), and the European Bank for Reconstruction and Development (EBRD). 2 The Daewoo conglomerate of the Republic of Korea is the other shareholder of this joint-venture bank. 3 This provides NBU’s clients banking services and access to Russia, particularly for trade finance. 4 This means that for local currency operations (intra-country) it had an excellent rating while for international

comparison it had a reasonably good rating in a country of high risk (i.e., C grade). 5 In the past, NBU managed the country’s foreign reserves, a function now handled by the Central Bank of

Uzbekistan (CBU). NBU continues to collect taxes on behalf of the Government, albeit not as a principal operation.

22 Appendix 1

C. Relations with ADB and Other Lenders 4. This loan was the second credit line to Uzbekistan using NBU as an executing agency (EA).6 NBU was also an EA for a component of an ADB loan to Uzbekistan for basic education and textbook development.7 NBU’s allocation under this loan was $20 million. This loan was made from ADB’s ordinary capital resources for a 15-year maturity, including a grace period of 3 years. It has an interest rate determined in accordance with ADB’s pool-based variable lending rate in US dollars and a commitment charge of 0.75% per annum. The Borrower relent the loan funds to NBU on identical terms. The Borrower was also charged a front-end fee equivalent to 1% of the loan amount, which was capitalized into loan. NBU’s share of the front-end fee of this loan was $200,000 (in proportion to its share of the loan). 5. As Uzbekistan’s leading commercial bank, NBU has participated in intermediation of other lenders’ credit lines, including those of the European Bank for Reconstruction and Development (EBRD), the International Finance Corporation (IFC), Kreditanstalt für Wiederaufbau (KfW), Organization of Petroleum Exporting Countries’ (OPEC) Fund for International Development, and the US Export-Import Bank (see Table A1.1). NBU has also been the lead manager in syndicated loans with other commercial banks for financing Uzbekistan Airways’ aircraft purchases and modernizing Uzbekistan’s gold mining and refining activities. 6. NBU’s long-term domestic currency lending has been funded through borrowings from the Government’s business fund8 and other non-budget funds. Pursuant to the Government’s regulations, NBU transfers 25% of its gross profits on a tax-deductible basis to a special fund for financing medium-term investment and working capital loans to SMEs at an interest rate not exceeding 50% of the Central Bank of Uzbekistan’s (CBU’s) refinancing rate.9 This lending is mandatory and follows Uzbekistan development priorities. NBU bears the credit risk for such directed lending at negative real interest rates. NBU’s customers’ deposits have been inadequate to fund its entire lending, which is why its loan to deposit ratio (LDR) has since 2001 exceeded 100%. The low banking penetration in Uzbekistan, manifested by a low M2/GDP ratio of 15% in 2000 and 12% in 2006,10 accounts for bank deposits being inadequate entirely to fund the loan portfolio. D. Lending Policies

7. NBU’s credit and risk management policies were adequate at the time of appraisal. They were strengthened during loan implementation, benefiting from an ADB technical assistance

6 The first was Loan 1504-UZB: Rural Enterprise Development Project, for $50 million, approved on 17 December

1996. 7 ADB. 1997. Report and Recommendation of the President on a Proposed Loan to Uzbekistan for Basic Education

and Textbook Development. Manila. 8 The business fund is a non-budget fund under Presidential Decree No. 25/64 dated 21 March 2000 and Resolution

No. 195 of the Cabinet of Ministers dated 19 May 2000. 9 CBU’s refinancing rate from 13 December 2006 was 14% (IMF: 2006 Article IV Consultation Staff Report–12

February 2007). 10 Consultants Draft Final Report, 16 April 2007, TA 4565-UZB: Financial Sector Infrastructure Development and IMF:

2006 Article IV Consultation Staff Report–12 February 2007.

Appendix 1 23

(TA) project 11 and an NBU board resolution of 2002 consolidating elements of banking legislation with NBU’s earlier established practices. While NBU’s commercial lending remains prudent, it is still subservient to national development policy.12 Generally, NBU’s single-borrower exposure limit is below 15% of tier-one capital. Its lending to the industrial sector has consistently exceeded 20% of its portfolio, however, which is due to the subservience of its lending policy to the country’s overall economic development policies. An increase in NBU’s lending unaccompanied by a corresponding increase in deposits is a factor for its LDR consistently exceeding 100% during 2001–2006. 8. A branch credit committee may approve loans up to a maximum of SUM50 million or a credit limit established by the head office, whichever is lower. NBU’s head office credit committee may approve loans up to 1% of tier-one capital. The credit committee for the whole bank may approve loans up to 15% of the bank’s tier-one capital. Loans of 15–25% of tier-one capital need board approval, and those exceeding 25% need approval from the bank’s council. NBU’s maximum permissible exposure to any sector is limited to 30% of its tier-one capital. Its maximum unsecured loans cannot exceed 5% of tier-one capital. The absolute limits can be exceeded only with specific sovereign guarantees whose values equal or exceed 125% of the loan amount. Use of tier-one capital as the denominator for determining credit limits is conservative. NBU’s procedures for appraising, approving, and monitoring loans are adequate and supported by checks and balances. The committee directly above the one approving a given loan can approve its rescheduling, but loan write-offs can be authorized only by NBU’s council on the specific advice of the board of directors. NBU’s policies for (i) loans to staff, (ii) internal and external audit of its lending policies, and (iii) reporting of its credit operations to its board are comprehensive and transparent. These policies apply to NBU’s normal commercial lending. A breakdown between commercial and directed lending with or without sovereign guarantees is not available. E. Organization, Management and Staffing 1. Apex Management 9. NBU’s apex management since 1999 has followed the bimodal collegiate system (see Figure A1 for NBU’s organizational chart), comprising a supervision council (SC) and a management board.13 NBU’s five-member SC is chaired by the Minister of Finance and has among its other members representatives of (i) Ministry of Foreign Economic Relations, Investment and Trade; (ii) Ministry of Economy; (iii) State Property Committee; and (iv) Central Bank of Uzbekistan. NBU’s 14-member management board comprises its chairperson, four deputy chairpersons, and nine executive directors. The chairperson is answerable to the SC and is the link between the two bodies. NBU’s board consists of four executive committees responsible for (i) asset and liability management, (ii) credit policy, (iii) compliance, and (iv) operational and financial performance. They meet 2–3 times a month. After NBU’s 2003 reorganization, NBU’s four core banking activities have been identified as corporate banking, retail banking, investment banking, and business development. These core activities have been

11 ADB. 1996. Institutional Strengthening of National Bank of Uzbekistan. Manila (TA 2714-UZB). The TA provided

methodologies for better appraisal of SME investment projects and for better benefit monitoring and evaluation of such projects. It also helped to improve the efficiency, transparency, and uniformity of NBU’s credit policy, integrating the bank’s approval system for both foreign and local currency lending for project finance.

12 The aforementioned creation of a fund to finance SMEs at below market interest rates shows how subservient NBU’s credit policy is to state direction.

13 Prior to 1999, NBU had a single board of directors comprising 12 members.

24 Appendix 1

assigned functionally to respective deputy chairpersons who report to the chairperson. NBU’s rationale for such functional reorganization was to improve its decision making and implementation and to peg the performance of each functional group to its compensation. NBU’s chairperson, four deputy chairpersons, and nine executive directors are all highly qualified professionals with postgraduate degrees. 2. Personnel Management 10. On 31 March 2007, NBU had 6,270 employees, 5,282 of whom were based in branch offices and 988 at the head office. Of the total, 5,53014 are support staff and 740 professional staff (known in NBU as leaders). NBU’s management comprises its chairperson and four deputy chairpersons. Each department has seven ranks below the head. The dispersion of its staff between head office and branches, as well as the balance between its executive and nonexecutive staff, appears appropriate to operational requirements. The minimum qualification for entry to professional-grade jobs is a university degree. NBU’s staff remuneration package combines basic salary (which varies by rank and degree of specialization) with bonuses (contingent on performance). NBU’s remuneration package is competitive in Uzbekistan’s context, judging from its ability to attract well educated and qualified individuals to its ranks. Staff are evaluated by their immediate supervisors and referred to the head of the department for final evaluation. A group of subordinate officers and the concerned deputy chairperson evaluate department heads. This allows subordinates an opportunity to evaluate their superiors. Staff are evaluated on performance, character, and capacity to assume higher responsibilities. Poorly performing staff usually have their employment contracts terminated. NBU’s personnel policies are progressive and adequate to operational needs. 11. NBU attaches great importance to training. It has a management development center that trains staff in (i) banking law and practice, (ii) lending operations, (iii) new products, and (iv) the basics of foreign exchange and portfolio management. The average duration of each training program is 10 days. About 203 staff attended in-house training in 2006. Another 61 officers were trained in 2006 at a regional banking training center and 12 at the Banking and Finance Academy. Moreover, 42 of NBU’s high-performing officers were sent out of the country for training in 2006. In-house and external training programs were well-focused and suited NBU’s needs. 3. Lending Operations under the Loan 12. NBU processed eight subloan applications between May 2002 and June 2003. On average, NBU took 33 days to process a subloan application. This is because subproject eligibility criteria under this loan were more focused than under REDP,15 arising from a better understanding of ADB’s subproject eligibility criteria and procurement rules. The information submitted by NBU on subprojects’ technical, environmental, commercial, and financial aspects was generally adequate. The average maturity of NBU’s subloans approved by ADB was 5.9 years. Its repayment record was mixed. NBU’s SME lending authority structure, process, and methodologies were similar to those under the Rural Enterprise Development Project (REDP).16

14 Comprising 2,987 specialists, 1,788 cashiers, and 755 other service personnel. 15 Under the REDP, NBU’s average processing time per loan was 21 days. 16 ADB. 2003. Project Completion Report on the Rural Enterprise Development Project (Loan 1504-UZB) in

Uzbekistan. Manila. See para. 26 of the project completion report (PCR).

Appendix 1 25

13. NBU’s eight subloans totaled $19.5 million. These were made to (i) SC Kattakurgan Meva for $1.759 million, (ii) JV Oshtoq Meva for $1.759 million, (iii) JV Peshkutex for $2.998 million, (iv) SC Rohat Kibray for $2.956 million, (v) JSC Ishonch for $3 million, (vi) JSC Balikchi for $3 million, (vii) SC Oltin Meva for $1.10 million, and (viii) SC Zumrut for $2.968 million. 14. The first three subprojects Katakurgan Meva, Oshtoq Meva, and Peshkutex were successful. They were prompt in repaying their debts (both principal and interest) on schedule. Their financial internal rates of return (FIRR) were equal to or greater than their weighted average costs of capital (WACC) (Appendix 6). Their debt service coverage ratios (DSCRs) and returns on assets (ROAs) were satisfactory. 15. Another three subprojects financed by NBU were partly successful. These were (i) Rokhat-Kibray, (ii) Ishonch, and (iii) Balikchi. Review of their past and projected financial statements showed them having satisfactory FIRRs, DSCRs. and ROAs (Appendix 6). In the Project Completion Review Mission’s assessment, the three subborrowers could have repaid their subloans on schedule. Yet NBU chose to reschedule them and did so without charging penalty interest, which is tantamount to subsidizing default (Appendix 6) and in effect breached Section 2.04(a) of the Project Agreement. NBU defended its credit decision in Rokhat-Kibray (a beer producer), whose cash flows were seasonal.17 For Balikchi and Ishonch, two cotton yarn producers, NBU claimed that they faced increased raw cotton procurement costs (due to the partial decontrol of cotton procurement prices under conditions of a World Bank loan) coupled with reduced export prices for yarn. If this argument was valid, then NBU’s credit decision is tantamount to an indirect subsidy to the cotton production industry through the banking system and thereby vitiates the objective of efficient financial intermediation. However, the validity of such an argument is questionable. Peshkuteks, another cotton yarn producer of approximately the same size, did not face any substantial increase in its raw cotton procurement prices and was a successful subproject in the Mission’s assessment.18 Ishonch’s and Balikchi’s exports in 2006 amounted to $6.6 million, which clearly indicates these subprojects’ viability and sustainability. NBU’s credit decisions in rescheduling these three subloans were imprudent and breaches Section 2.06 of the Project Agreement. This is particularly the case for Balikchi and Ishonch, where NBU extended their (rescheduled) subloans’ maturities from 7 to 9 years, thereby exceeding the maximum maturity of subloans allowed under the Loan Agreement and breaching Section 2.06(b) of the Loan Agreement and Section 2.04(b) of the Project Agreement. NBU claimed that these reschedulings were carried out at the written requests of the subborrowers and in accordance with its policies. NBU also reiterated that its extensions to two subloans beyond 8 years did not impinge upon its debt servicing to ADB. 16. The remaining two subprojects, Oltin Meva and SC Zumrut, were unsuccessful. Oltin Meva’s financial performance was poor. NBU was in April 2007 seeking a court order to attach

17 NBU claimed that Rohat-Kibray otherwise had a good track record of interest payments and its rescheduling

decision was in accordance with its policy. The Project Completion Review Mission noted that this subborrower’s annual cash flow was nonetheless satisfactory. It therefore appears that the subborrower was using its surplus cash flow in the summer months to finance its working capital cheaply rather than to use it to repay its winter installments of the subloan on schedule. In its comments on the draft of this PCR, NBU has stated that after rescheduling, Rohat Kibray is servicing its debt on time.

18 NBU stated in its comments on the draft of this PCR that Peshkutex’s comparison with Balikchi and Ishonch is inappropriate because they produce different types of yarn and that Peshkutex’s lower cost and quality yarn was sold in the domestic market while Balikchi’s and Ishonch’s yarn were sold in export markets. Considering that Uzbek and world prices for cotton yarn were converging (and with cotton prices generally high in 2005 and 2006), the Mission finds such an explanation (that high quality yarn fetches a lower price than low quality yarn) unconvincing.

26 Appendix 1

and foreclose on Oltin Meva’s assets. SC Zumrut had not yet started production due to management problems. Oltin Meva’s and Zumrut’s subloans were not rescheduled by NBU. 17. After rescheduling of three subloans, NBU’s subloan arrears of $3,295,839 were 27.47% of the amount due for repayment of $11,997,189. The Mission calculated that if the installments of the rescheduled loans payable from the date of default up to 1 April 2007 were added back (assuming that those loans had not been rescheduled), the adjusted rate of arrears would have been 43.50% (Appendix 6). 4. Other Operations 18. Taking advantage of its market niche, NBU has embarked consciously on increasing its fee-based income. NBU’s fee- and commission-based activities include (i) foreign exchange trading and settlement; (ii) security transfer and custodial service transactions; (iii) clients’ payroll preparation; (iv) traveler’s checks issue; (v) credit cards issue, clearing, and settlement; (vi) issuing letters of credit and guarantees; (vii) collecting, purchasing, negotiating, and discounting foreign documentary and accommodation bills on behalf of customers; and (viii) arranging for electronic and other fund transfers (through negotiable instruments), both for NBU’s own customers and those of its clients. 5. Financial Performance (Portfolio Distribution and Quality) 19. NBU’s loan portfolio is still weighted heavily in favor of the industry sector which includes SMEs, agro-processing, manufacturing, metallurgy, and petrochemicals. In 2006, the industry sector accounted for 42% of NBU’s total lending. Financing for transport and communications also accounts for a significant portion of lending. NBU’s portfolio is balanced overall. 20. NBU’s portfolio quality is improving but is still a matter of concern. Its combined substandard, doubtful, and bad loans improved from 59.2% in 2004 to 31.4% in 2006 (Table A1.2). The total might have been higher if NBU’s loan portfolio had been classified according to international practice. NBU’s loan loss provisions were lower than required under CBU regulations between 2001 and 2004 (Table A1.2) as well as under international practice.19 NBU also did not make provisions on its sovereign guaranteed debt. In its comments on the draft project completion report, NBU stated that the bank follows a more conservative approach to its loan loss provisioning and from 2005 its estimation of its credit risk is based on international standards.

19 Guidelines from the Basel Committee for Banking Supervision exempt banks that make loans against sovereign

guarantees from Organization of Economic Cooperation and Development (OECD) governments from having to make loan loss provisions. The Basel Committee does not allow this exemption to non-OECD government guaranteed loans. The project agreements required NBU to follow international practices in loan loss provisioning.

Appendix 1 27

6. Financial Performance (Financial Statements and Ratios) 21. NBU’s assets in dollar terms declined from $3.79 billion in 2001 to $2.48 billion in 2006 due to depreciation of the sum against the dollar during this period. During 2001–2003, NBU’s financial statements were prepared according to US generally accepted accounting principles (GAAP) and in 2004 followed International Financial Reporting Standards (IFRS).20 22. Analysis of NBU’s financial statements (Tables A1.3 to A1.6) for 2001–2006 reveal that the bank is (i) comfortably solvent as (judged by its capital adequacy ratio [CAR])21, (ii) tight in liquidity (judged by its loan to deposit ratio [LDR]), (iii) poorly profitable (judged by its low or negative return on assets [ROA]), and (iv) progressively increasing its operations costs (judged by its climbing intermediation cost ratios [ICRs].22 NBU’s CAR declined gradually from 20% in 2001 to 14.6 % in 2005,23 rising again to 18.68% in 2006 due to an increase in its equity but still fulfilling comfortably the Project’s covenant. NBU’s LDR (calculated in accordance with the formula in Section 1.01 (b) of the Project Agreement) increased rapidly from 142% in 2001 to 358.7% in 2004. It improved thereafter to 151.84% in 2006 but still failed to meet the levels covenanted. NBU’s ROA declined from an already low level of 0.08% in 2001 to a negative 3.54% in 2002. It improved marginally to 0.38% in 2003 and to 0.37% in 2004 but declined again to –1.66% in 2005 and improving marginally to 0.08% for 2006. These ratios failed to meet the covenanted minimum ROA of 1%. NBU’s poor profitability is attributable to its (i) increased loan losses, 24 (ii) declining interest spreads, 25 and (iii) increasing administrative expenses (judged by its incremental intermediation cost ratio).26 If (ii) and (iii) are not arrested immediately, NBU’s medium-term profitability outlook appears doubtful. NBU’s single or group borrower exposure did not exceed 15% of its capital, thereby meeting this covenant. NBU’s sectoral exposure in its lending to the industrial sector consistently exceeded 20% of its portfolio, thereby failing to meet this covenant. 7. Conclusion 23. NBU’s subproject selection under this loan was more rigorous than it had been under the REDP. Out of its eight subprojects, three were successful and three partially successful. NBU rescheduled the loans of the latter three for nonbanking considerations, which is why its arrears rate is at 43.5% compared to 21.8% under Loan 1504-UZB. NBU’s rigor in subproject selection was not followed through in subloan recovery. The bank’s overall financial condition during 2001–2006 was poorer than during 1996–2001, particularly in terms of profitability and liquidity. NBU’s declining profitability and tight liquidity are largely attributable to the Government’s

20 In 2004, NBU followed IAS-29: Accounting in Hyperinflationary Economies (which is why its financial statements

were denominated in dollars) and IAS-30: Financial Statements for Banks and Financial Institutions. 21 The CAR is the ratio of equity capital and free reserves to risk-bearing assets as defined by the Basel Committee

for Banking Supervision. 22 ICR measures the ratio of noninterest expenses to average total assets. 23 NBU’s own estimates of its CAR were much higher because, like other banks in Uzbekistan, it treated sovereign

guaranteed loans as risk-free assets, while the Mission treated sovereign guaranteed loans as risk-bearing assets. 24 This has been attributed in part to the large foreign currency loans made by NBU under governmental direction to

Uzbek state-owned enterprises, whose revenues were denominated in Uzbek sums. The sharp depreciation of the sum against the dollar, and even more so against the euro, created massive debt-servicing problems for its borrowers and resulted in loan losses to NBU.

25 The Government’s directive in 2000 requiring banks to lend to SMEs at subsidized interest rates is a cause for the precipitous decline in NBU’s gross interest spread from $79 million in 2001 to $25 million in 2002. Also, NBU’s limited access to customers’ deposits (manifested by a high LDR) deprived it of a pool of low-cost funds.

26 NBU’s ICR increased from 1.6% in 2002 to 1.95% in 2003, to 2.2% in 2004, and to 2.5% in 2005.

28 Appendix 1

interventions and policies in the financial sector The Government’s mandating NBU’s foreign currency lending to Uzbek state-owned enterprises without adequate hedging mechanisms in Uzbekistan exacerbated the exchange losses of NBU’s borrowers and, as a consequence, the bank’s loan losses. NBU’s limited mobilization of customers’ deposits (a low-cost pool of funds) in relation to its lending requirements coupled with high lending targets established by the Government (including subsidized lending to SMEs) lowered NBU’s interest margin and impinged upon its profitability. NBU will need a clear policy mandate from the Government to allow it to function on commercial norms if the institution is sustainably to strengthen itself.

Appendix 1 29

Table A1.1: National Bank for Foreign Economic Activity of the Republic of Uzbekistan’s Participation in Other Credit Lines

Lender Loan EBRD1 ADB1 EBRD2 ADB2 KfW1 KfW2 IFC1 US EXIMBANK

OPEC FUND

Year of Loan 1993 1996 1996 2000 1999 1999 2002 2000 Loan Amount

$60 million $50 million $120 million $50 million €5 million €15 million $25 million $55 million $5 million

Loan Duration

10 years (3 years grace

period)


period)

7 years max (2 years grace

period)


period)


period)

10.5 years (3 years

grace period)

7 years (2 years max grace period)

7 years max (6 months max grace

period)


period)

Interest Charged by Lender

LIBOR+1% LIBOR+24% depending on

bank

EURIBOR+1.5% LIBOR+3.75% (NBU)

LIBOR+4% (Asaka Bank)

LIBOR+0.2% insurance premium=

approx. 9.16%

LIBOR+4%

With or Without Sovereign Guarantee

With With NBU without Asaka Bank 100% with

Pakhta Bank 80% with

Promstroi Bank 80% with

With Without With Without Without

Fees Charged by Lender

Commitment charge: 0.50%

Front-end fee: 1%


Front-end fee: 1%

Commitment charge: 0.5% Front-end fee:

1.5%


Front-end fee: 1%


Front-end fee: 0.75%


Front-end fee: 1%

Front-end fee: 0.0625% from loan amount

in hard currency

Management fee: 0.15% of loan amount

in local currency


Front-end fee: 1.5%

Management fee: 0.15%

Participating Banks

NBU $60 million

NBU $50 million

NBU $60 million

Asaka Bank $15 million

Pakhta Bank $15 million

Promstroi Bank $15 million

NBU $20 million


Pakhta Bank $15 million

NBU €7.4 million

Pakhta Bank €4.1 million

UzJilSber Bank €3.5 million

NBU $15 million Asaka Bank $10

million

NBU $55 million

NBU $5 million

Loan Conditions for Participating

relending terms and conditions identical to

relending terms and conditions identical to

30 Appendix 1

Lender Loan EBRD1 ADB1 EBRD2 ADB2 KfW1 KfW2 IFC1 US EXIMBANK

OPEC FUND

Banks those of borrower

those of borrower

Loan Conditions for Subborrower

equity no less than 25% of original

project cost


project cost

equity no less than 25% of

original project cost

max share of

government in

borrower’s capital:31%,


project cost




project cost, export-oriented

SMEs




project cost

Onlending Rates of Participating Banks

market rates + credit risk

markets rates +

credit risk

9% NBU: LIBOR+3.75%+risk

and 4% Asaka Bank:

LIBOR+4%+ risk 3-4%

4.9 above costs of funds?

LIBOR+4% risk

Loan Amount Disbursed as of 31 Dec 2002

$60 million $45.6 million NBU $50 million


Pakhta Bank $6-7 million

Promstroi Bank $5 million

$10.02 million

€14.97 million

NBU $1.5 million Asaka Bank $10

million

Subloan Size Range

$100,000 (min) up to $5 million

(max)

$50,000 (min)

$3 million (max)

$50,000 (min) $5 million

(max)

$50,000 (min)

$3 million (max) but not more

than 75% of project cost

€2.5 million (max)

NBU $100,000 (min), $2 million

(max) Asaka Bank $1.5 million (max), but

not more than 75% of total project cost

$100,000 (min)

$5 million (max) but not

more than 85% of total project cost

$100,000 (min)

$1 million (max) but not more

than 75% of total project

cost Subloan Duration

10 years max (3

years grace period)

8 years max (3 years max grace period)

7 years max (2 years grace

period)

8 years max (3 years

max grace period)

5 years max (1.5 years max grace period)

7 years (2 years max grace period)

life of equipment, 7

years max


period)

ADB=Asian Development Bank, EBRD=European Bank for Reconstruction and Development, EURIBOR=Euro interbank offered rate (the rate at which Euro currency interbank deposits within the eurozone are offered by one prime bank to another), IFC=International Finance Corporation, KfW=Kreditanstalt fur Wiederaufbau, LIBOR=London interbank offered rate, max=maximum, min=minimum, NBU=National Bank of Uzbekistan, OPEC=Organization of Petroleum Exporting Countries, US EXIM=Export-Import Bank of the United States. Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

Appendix 1 31

Figure A1: National Bank for Foreign Economic Activity of the Republic of Uzbekistan’s Organizational Chart

Council

Deputy Chairman Nurullaev B.U.

Chairman of the Board Rakhimov S.B.

Audit Committee

Board Internal Audit Group

Retail FX Operations Department

Real Estate Maintenance Group

Administration and Logistics Department

Art Gallery of Uzbekistan

Medical Center

Center of Professional Skills Enhancement

Legal Support Group

Secretariat

Global Financial Institutions Group

Human Resource Management Group

Deputy Chairman Khidirov Y.S.

Adviser to the Chairman

Corporate Banking Group

Project Finance Center

Small Business Group

Money Circulation Department

Treasury

Credit Risk Group

International and FX Group

IT Group

Interbank Settlement Center

Financial Management Group

Center of Branches Management

Deputy Chairman (vacant)

First Deputy Chairman Abdullaev M.R.

Committee on L and M

Management

Tashkent and other braches Credit portfolio of the

branches

Capital Construction Group

Main Lending Department

Credit Committee

Security and Information Protection

Department

Division #2

Division #1

Securities Department

Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

32 Appendix 1

Table A1.2: National Bank for Foreign Economic Activity of the Republic of Uzbekistan’s

Loan Portfolio

A. Portfolio Distribution (%)

2001 2002 2003 2004 2005 200650.00 45.00 66.00 66.00 65.00 61.000.00 0.00 1.00 1.00 1.00 2.00

18.00 19.00 16.00 19.00 23.00 22.004.00 3.00 6.00 1.00 1.00 1.002.00 3.00 1.00 1.00 2.00 2.00

26.00 31.00 10.00 12.00 9.00 12.00 Total 100.00 101.00 100.00 100.00 101.00 100.00a Includes light industry, manufacturing, food processing, and energy-related industries.

Sector

Trade and CateringOther

Transport and CommunicationsConstruction

Industrya

Agriculture


B. Portfolio Classification by Quality

(%)

Item 2001 2002 2003 2004 2005 2006

Good 78.80 39.57 31.96 16.61 58.95 52.30 Satisfactory 16.00 28.36 37.84 24.21 16.67 16.30 Substandard 4.40 12.16 7.96 38.98 20.70 27.29 Doubtful 0.80 9.25 17.51 13.26 1.77 3.48 Bad 0.00 10.66 4.73 6.94 1.91 0.63 Total 100.00 100.00 100.00 100.00 100.00 100.00


C. Loan Loss Provisions ($ million)

Item 2001 2002 2003 2004 2005 2006

From Balance Sheet Net Loans 2,223.00 2,135.00 2,358.00 2,219.00 1,945.00 1,722.00Provisions Made 53.00 170.00 179.00 266.00 289.00 255.00Gross Loans 2,276.00 2,305.00 2,537.00 2,485.00 2,234.00 1,977.00Required ProvisionsGood Loans (at 1%) 17.93 9.12 8.11 4.13 13.17 10.34Satisfactory Loans (at 5%) 18.21 32.68 48.00 30.08 18.62 16.11Substandard Loans (at 25%) 25.04 70.07 50.49 242.16 115.61 134.88Doubtful Loans (at 50%) 9.10 106.61 222.11 164.76 19.77 34.40Bad Loans (at 100%) 0.00 245.71 120.00 172.46 42.67 12.46Total provisions required 70.28 464.20 448.71 613.59 209.84 208.19Actual provisions made 53.00 170.00 179.00 266.00 289.00 255.00Shortfall 17.28 294.20 269.71 347.59 -79.16 -46.81 Source: Staff calculation from audited financial statements by National Bank for Foreign Economic Activity of the Republic of Uzbekistan to the Asian Development Bank during 2001 and 2007.

Appendix 1 33

Table A1.3: Consolidated Balance Sheets

($ million)

Item 31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006A. Assets

Cash and Cash Equivalents 550 587 365 330 219 429Due from Other Banks 640 6 33 37 58 71Customer Loans and Advances, Net 2,223 2,135 2,358 2,219 1,945 1,722Premises and Equipment, Net 233 30 209 213 196 179Others Assets 153 145 94 121 94 79

Subtotal (A) 3,799 2,903 3,059 2,920 2,512 2,480

B. Liabilities and Shareholder's Equity Amounts Owed to Government and the Central Bank of Uzbekistan 782 545 396 378 398 380

Amounts Owed to Customers 387 349 442 51 14 56Due to Other Banks 392 13 58 499 542 679Interstate Credits 1,543 1,504 1,622 1,445 1,083 883Other Liabilities 56 83 67 62 37 46

Subtotal (B) 3,160 2,494 2,585 2,435 2,074 2,044

C. Shareholder's Equity Authorized and Contributed Capital 400 380 400 400 400 400

Additional Paid-in Capital 20 20 20 20 20Retained Earnings 219 29 54 65 18 16

Subtotal (C) 639 409 474 485 438 436

Total liabilities and shareholder's equity 3,799 2,903 3,059 2,920 2,512 2,480

Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, based on audited financial statements (in annual reports) submitted to the Asian Development Bank between 2001 and 2007.

34 Appendix 1

Table A1.4: Consolidated Statements of Income ($ million)

Item 31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006Interest Income: Customer Loans and Advances, Net 211 109 101 107 111 113 Other 29 7 2 4 7 12Total Interest Income 240 116 103 111 118 125

Interest Expense: Amounts Owed to Customers

(22)

(14)

(19) (25) (36) (33)

Amounts Owed to the Central Bank of (31) (11) (5) (3) (7) (10) Interstate Credits and Due to Other Banks (108) (66) (54) (48) (48) (45)Total Interest Expense (161) (91) (78) (76) (91) (88)

Net Interest Income before Provision for Loan 79 25 25 35 27 37 Losses(Provision) Benefit for Loan Losses (19) (161) 8 (3) (58) (7)Net Interest Income after Provision for Loan 60 (136) 33 32 (31) 30 Losses

Noninterest Income: Fee and Commission Income 49 45 40 42 48 44 Net (loss) Gain Arising from Foreign Currency (27) (2) (1) (3) 0 3 Other 7Total Noninterest Income 22 43 39 39 48 54

Noninterest Expense: Payroll and Other Staff Costs (12) (10) (12) (12) (16) (17)

Occupancy and Equipment (17) (16) (17) (17) (20) (18) Insurance and Taxes Other than Income Tax (16) (11) (8) (8) (10) (11) Administrative Expenses (4) (4) (4) (3) (4) (6) Fee and Commission Expenses (9) (8) (7) (6) (7) (6) Other (7) (6) (4) (12) (11) (12)Total Noninterest Expense (65) (55) (52) (58) (68) (70)Income before Income Tax Expense 17 (148) 20 13 (51) 14

Income Tax Expense (14) 26 (8) (2) 6 (12)

Net Income 3 (122) 12 11 (45) 2


Appendix 1 35

Table A1.5: Consolidated Statements of Cash Flows

($ million)

Item 31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006 Operating Activities Net Income 3 (122) 12 11 (45) 2 Adjustments to Reconcile Net Income to Net Cash

Provided by (used in) Operating Activities: Depreciation 12 13 14 14 16 18 (Benefit) Provision for Loan Losses 19 161 (8) 3 58 7 Provision for Deferred Income Taxes 5 (79) 8 0 0 (2) Provision for Guarantees Issued 5 (Increase) Decrease in Other Assets (7) 16 10 (30) (58) (5) Increase in Other Liabilities (4) 43 1 (5) 3 (6)

Net Cash Provided by (used in) Operating Activities 28 32 37 (7) (26) 19

Investing Activities (Increase) Decrease in Amounts Due from the Central Bank of Uzbekistan — (Increase) Decrease in Amounts Due from Other Banks 115 590 7 20 (21) (13) (Increase) Decrease in Customer Loans and Advances (15) (60) (201) 139 293 236 Purchase of Premises and Equipment (12) (7) (38) (18) (1) (5) Purchase of Equity Participations — Proceeds from Sale of Equity Participations 2

Net Cash used in Investing Activities 90 523 (232) 141 271 218

Financing Activities Increase (Decrease) in Amounts Owed to Government and the Central Bank of Uzbekistan (72) (219) (167) (18) 13 (18) Increase (Decrease) in Amounts Owed to Customers (53) 2 53 57 41 137 Increase (Decrease) in Amounts Due to Other Banks (60) (315) (19) (7) (38) 42 Increase (Decrease) in Interstate Credits 93 (5) 84 (177) (372) (200) Proceeds from Issue of New Shares — 0 0 0 0 0 Dividends Paid (24) (1) 0 0 0 0

Net Cash used in Financing Activities (116) (538) (49) (145) (356) (39)

Net Increase (Decrease) in Cash and Cash Equivalents 2 17 (226) (11) (111) 198

Cash and Cash Equivalents at Beginning of Year 548 550 567 341 330 219

Cash and Cash Equivalents at End of Year 550 567 341 330 219 417 Supplemental information:

Income Taxes Paid (4) (6) (2) (2) (2) (2) Interest Paid (167) (96) (72) (88) (91) (87) Noncash Dividends Paid (2) (14) 0


36 Appendix 1

Table A1.6: Financial Ratios

(%)

Item 2001 2002 2003 2004 2005 2006Loan-to-Deposit Ratio 142.00 143.20 167.00 358.72 159.20 151.84 Debt to Equity Ratio (times) 1.95 2.43 2.52 2.43 1.95 1.55 Return on Average Assets 0.08 (3.54) 0.38 0.37 (1.66) 0.08 Intermediation Cost Ratio 1.68 1.59 1.95 2.20 2.50 2.54 Capital Adequacy Ratio 20.02 19.06 16.03 15.88 14.60 18.68


Appendix 2 37

ASAKA BANK

A. History

1. Asaka Bank (AB) was incorporated on 7 November 1995 by Decree 424 of the Cabinet of Ministers and obtained its banking license on 1 February 1996. It was originally conceived to finance the country's automobile industry but since 2001 adopted the universal commercial banking model. AB's earlier sector specificity for the automotive sector explains the continuing concentration of its lending in this sector.1 AB is fully state-owned, with the Ministry of Finance constructively owning 98.33% of the bank's equity. Its minority shareholders are the National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU), Narodny Bank, and Uzavtosanvat (the Uzbekistan Automobile Association). With its headquarters in Tashkent, AB has a network of 27 branches and 76 mini-banks spread over all of the country's regions. Since 1998, the bank has undertaken foreign exchange and foreign trade financing. To support these activities, AB has established correspondent banking accounts with 230 foreign banks in 38 countries. It has also opened 23 nostro and 6 vostro accounts with commercial banks in the US, India, Korea, Russia, the UK, Germany, and other European countries. In 1999, AB became a member of the Society for Worldwide Interbank Financial Telecommunication (SWIFT) and of the Reuters and Telerate Services. This network enables AB to provide its clients a full range of services for foreign trade transactions and international payments. The bank received in 1999 a 1C-C/C LC-2 rating from Thomson Financial BankWatch, which is considered satisfactory. Its international credit rating has been a function of Uzbekistan’s overall rating, while its local currency rating is a notch below that of NBU (Appendix 1). B. Scope of Operations 2. Since its evolution to a universal commercial bank, AB obtained a foreign exchange license and an infrastructure necessary to operate in that segment. This also necessitated reducing the skewness of its credit exposure to the automobile industry, to which its lending declined from 50% of its total portfolio in 2000 to 30% as of 31 March 2007. To deliver its retail and corporate customers the benefits of its correspondent banking activities, AB embarked on a domestic branch expansion program. This step was particularly relevant to AB’s finance and microfinancing activities in the small and medium enterprise (SME) sector. 3. AB’s policy statement described its key policy objective to be moving away from an automotive industry focus to become a universal commercial bank. This goal meant reducing its exposure to the automotive industry for both funding and lending, and diversification gave particular emphasis to SMEs. AB envisaged using its correspondent banking network to complement its domestic financing interventions in the automotive and SME sectors. AB also planned to expand its branch network for this purpose, which it believed could broaden its base for domestic currency deposits and find new clientele in diversified subsectors. Analysis of AB’s funding and lending positions during 2001–2006 reveal that while AB’s automotive sector exposure has declined from 50% to 30%, it has made little headway in penetrating other sectors.

1 As of the end of 1999, 60% of AB’s lending had been in the country's automobile and ancillary industries.

38 Appendix 2

C. Relations with Asian Development Bank (ADB) and Other Lenders 4. AB was a beneficiary of ADB technical assistance for strengthening the banking system.2 The loan for that purpose was ADB’s first using AB as an executing agency (EA). AB’s allocation under this loan was $15 million and its terms and conditions were identical to those for NBU (see para. 6 of main text). AB’s share of the front-end fee was $150,000 (at 1% of its loan allocation). AB was also an EA in ADB’s Small and Microfinance Development Project (SMDP). 3 It has participated in credit lines from commercial banks, export credit agencies, European Bank for Reconstruction and Development (EBRD), and International Finance Corporation (IFC). It has not lead managed any syndicate for commercial financing of projects or entities in Uzbekistan (see Table A2.1 for details of AB’s participation in international lenders’ credit lines). 5. Similar to NBU, AB’s domestic lending is funded through borrowings from government non-budget funds (see para. 8 of main text). Pursuant to government policy, AB also undertakes subsidized directed lending to sectors prioritized by the Government. As an EA for the SMDP, AB relent ADB loan funds in local currency without subsidies. Because AB’s deposit base was inadequate to fund its loan portfolio, its loan to deposit ratio (LDR) between 2001 and 2005 was consistently higher than 100% (para. 40 of main text). D. Lending Policies 6. AB’s credit and risk management policies (CRMP) at appraisal were rudimentary.4 AB reported that its credit policy was in accordance with Central Bank of Uzbekistan’s circulars. It was envisaged that AB’s participation in ADB’s technical assistance (footnote 2) and the World Bank’s Financial Institution Building Loan (approved in 1999) would strengthen its project finance appraisal capacity. AB’s new CRMP of 2003 emerged as an outcome of the bank’s participation in this donor assistance. Its features were (i) a ceiling on single-borrower exposure (or that of a group of affiliated borrowers) at 15% of equity, (ii) maximum maturity of term loans (effective 2004) at 7 years, and (iii) limiting its exposure to the automotive sector to 50% of its portfolio. Although these steps were in the right direction, they are of insufficient magnitude. Ideally, AB’s sectoral loan concentration ceiling should have been 20%. Moreover, the aforementioned limits did not apply to its loan refinanced from the state’s off-budget funds. This dichotomy in its CRMP created a dysfunctional portfolio that is manifested by loan to deposit ratios exceeding 100%, except in 2006. This is because AB’s CRMP is subservient to the country’s overall development policy. AB’s CRMP implementation faced challenges in the 2001 reorganization of its credit department, which separated its credit approval and recovery functions (para. 30 of main text). 7. AB’s policy ceilings on lending to the automobile manufacturing sector were lowered from 70% in 2000 to 50% in 2006. AB’s 2003 credit policy statement also stipulated as a result of ADB’s loan covenant that the maximum single-borrower or group exposure could not exceed

2 ADB. 1999. Technical Assistance to Uzbekistan for Strengthening the Banking System. Manila, approved on 20

December 1999 for $1 million (TA 3352-UZB). 3 ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to

Uzbekistan for Small and Microfinance Development Project. Manila, approved on 9 December 2002 for $20 million (Loan 1963-UZB).

4 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to Uzbekistan for Small and Medium Enterprise Development Project. Manila, approved on 11 December 2000 for $50 million (Loan 1799-UZB).

Appendix 2 39

15% of its equity capital. It also stipulated that its exposure to the automotive sector not exceed 25% of its equity. While it curtailed AB’s lending to automobile manufacturers, it did not curb AB’s lending to customers to purchase automobiles or to automobile retailers not owned by manufacturers. AB also decided in 2006 that maturities of working capital loans to trading enterprises should not exceed 1 year, loans for intermediate trade transactions should not be longer than 6 months, and loans to retail enterprises should not exceed 3 months. In 2007, AB stipulated that not less than 50% of its loans shall be long term in nature. Apart from causing liquidity problems, and given that more than three quarters of AB’s deposit base is short term, this stipulation appears to contradict its 2000 credit policy that not less than 65% of its portfolio should be short term. 8. AB’s credit policy of 2006 states those sectors that the bank may finance. These are textiles, pharmaceuticals, processing of agricultural raw materials, mineral extraction, domestic and foreign trade, service industry, and educational loans. Strangely, the credit policy manual does not mention financing of SMEs or microfinance activities, two areas where AB is engaged under ADB credit lines. 9. AB’s credit policy stipulates that the ceilings described above do not apply to its loans refinanced out of government on-budget and off-budget funds and foreign lenders’ credit lines. This dichotomy creates a dysfunctional portfolio that is difficult to administer. 10. The bank’s implementation of its credit policy has been hampered further by its 2004 management changes (para. 13). E. Organization, Management and Staffing 1. Apex Management 11. AB’s apex management follows a bimodal system comprising a five-member supervision council and a seven-member board of directors (see organizational chart in Figure A2). 12. AB’s supervision council is chaired by Uzbekistan’s Deputy Minister of Finance and has among its members the Chairperson of Asaka Bank (chairperson of its board), the Head of Uzbekistan’s Road Transport Authority, and two other nominees of the Government. The SC usually meets every 2 months. AB’s seven-member board comprises the bank’s three deputy chairpersons, its chief accountant, its head of treasury, its head of project finance, and the head of its legal department. AB’s board meets monthly. The board has executive committees on asset-liability management and on credit operations. AB’s board has no independent outside directors. This could inhibit the quality of its corporate governance, as fresh talents and new ideas could improve the bank. 2. Personnel Administration 13. On 31 March 2007, Asaka Bank had 2,508 staff, 2,024 of whom were in its field offices and 484 in its head office. Some 50% of its staff members are under 30 years of age. AB’s management structure appears top heavy, with its human resources, legal, internal audit, and secretariat departments reporting directly to its chairperson. In 2004, an internal reorganization separated its project financing and credit approval functions from its post-approval credit monitoring and recovery functions. This segregation proved detrimental as staff in the former functions were generally younger and better qualified individuals who benefited from training under ADB’s technical assistance (footnote 2), many of whom subsequently resigned from AB.

40 Appendix 2

By contrast, its officers in the credit monitoring and recovery division were generally older, drawn from the bank’s administrative departments, and had little market knowledge or credit analysis experience. This explains their inability to deal with defaulting clients, which is a reason why AB’s loan default was highest (para. 24) among the three banks5 participating in the Small and Medium Enterprise Development Project.6 AB’s reported high staff turnover, particularly during 2004–2007, in its project finance and credit departments suggest either a lack of job satisfaction or inadequate remuneration. 14. AB’s internal and external staff training programs appear satisfactory to its commercial banking needs. AB attaches importance to staff training, which it sees as an activity essential to enhancing staff performance to further AB’s corporate goals. Accordingly, 1,129 staff underwent training in 2006. Thirty-four of these graduated from Uzbekistan’s Banking and Finance Academy and nine others were trained abroad. AB also has a bankers’ training college of its own where both its staff and those from other banks are trained. 3. Lending Operations under the Loan 15. AB on an average took 66 days to process each subloan. AB made eight subloans totaling $14.66 million under this loan. All eight were unsuccessful as measured by their financial internal rates of return (FIRR), debt service coverage ratios (DSCR), and returns on assets (ROA) and were in arrears (Appendix 6). In AB’s case, arrears totaled 81.2% of the loan amounts due. Among the causes for failures of AB’s subprojects were (i) delayed receipt and installation of imported machinery that delayed production, creating time and cost overruns; (ii) management disputes within the companies; (iii) working capital shortages; (iv) poor product designs and products’ inability to compete with cheap imports from the People’s Republic of China; (v) shortage or cost escalation of raw material or machine spare parts; 7 (vi) the subprojects’ locations in the country’s poorer and more remote regions (such as Khorezm or Karakalpakstan) inaccessible to raw materials, markets, transport networks, and factory maintenance services; and (vii) poor post-disbursement credit supervision due to AB’s management changes. 4. Other Operations 16. AB’s main operations other than automobile financing were SME financing and micro credit. The bank was not active in marketing traveler’s checks, factoring, or other financial engineering products. 5. Financial Performance (Portfolio Distribution and Quality) 17. AB’s portfolio distribution is still highly skewed in favor of the automobile sector, its exposure to which declined from 50% in 2000 to 30% in 2006 (Table A2.2). AB’s substandard, doubtful, and bad debts increased from 10% in 2001 to 16.8% in 2006. Its loan loss provisioning was marginally lower than would have been warranted under accepted international principles.

5 The third being Pakhta Bank, which is described in Appendix 3. 6 ADB had advised AB of the pitfalls of such a reorganization in 2005 and requested AB to rectify it, but ADB’s

suggestion was not heeded. 7 Unlike all of NBU’s and the majority of Pakhta Bank’s subprojects that were agro-processing units using

domestically sourced agricultural or horticultural raw materials in which Uzbekistan had a competitive advantage, the majority of AB’s subprojects used petrochemical, polymer, or other imported raw materials whose availability became scarce or whose prices rose between 2001 and 2006.

Appendix 2 41

Its 2006 provisioning was 3.52% for its bad debts, at 43.70% for doubtful debts, and 38.22% for substandard debts (Table A2.2). AB’s portfolio schedule and its loan loss provision thereon for 2001–2006 as reported to the Central Bank of Uzbekistan are denominated in Uzbek sums. AB does not make loan loss provisions on debt guaranteed by the Government. 6. Financial Performance (Financial Statements and Ratios) 18. AB’s financial statements were prepared according to International Financial Reporting Standards. Its balance sheets, income statements, and cash flow statements for 2001–2005 were denominated in US dollars and those for 2006 in Uzbek sums. That is because AB’s management no longer considered Uzbekistan a hyperinflationary economy from 2006 onwards. This makes AB’s 2001–2005 financial statements incomparable with its 2006 statements. Even for 2001–2005, its portfolio schedule and loan loss provisions denominated in sums could not be related to its overall financial statements denominated in US dollars. Therefore, its overall financial statements and its portfolio schedule were reviewed separately. 19. Analysis of AB’s financial statements for 2001–2006 (within the limitations just described) reveals that it is comfortably solvent, tight on liquidity, and declining in profitability. AB’s capital adequacy ratio (as assessed by the Project Completion Review Mission) declined gradually from 30% in 2001 to 29.35% in 2005 and to 18.83% in 2006. Nonetheless, that ratio met the project covenants. Its LDR was consistently higher than 100% during 2001–2005, thereby breaching its covenant. In 2006, the Bank’s LDR improved to 93.07%, thereby meeting the covenant for the first time. Its ROA declined from 0.15% in 2001 to –4.07% in 2002 and improved to 1.86% in 2003. Its ROA declined precipitously from 1.86% in 2003 to 0.20% in 2005 and improved to 0.64% in 2006, thereby falling below the covenanted level. This is attributable to (i) increased loan loss provisions, (ii) extraordinary losses in 2004 and 2005, and (iii) increasing intermediation cost ratio (ICR) during 2002–2005. Fortunately, AB’s interest spread showed an upward trend during 2002–2005, and that has improved its ROA from 0.2% in 2005 to 0.64% for 2006. Therefore, reducing its administrative costs could lower its ICR and hence improve its ROA. As AB’s single or group borrower exposure did not exceed 15%, this covenant was complied with. Its sectoral exposure to the automotive industry declined from 50% in 2000 to 30% in 2006. While failing to meet that covenant, it nonetheless made progress towards it. 7. Conclusion 20. Analysis of AB’s implementation of its eight subprojects reveals that it is not institutionally geared up to intermediate efficiently in the delivery of credit to SMEs. Its poor subproject supervision and poor subloan recovery are attributable partly to its personnel policies. Institutionally, and judging from its financial statements, AB was unprofitable and illiquid during 2001–2005, although some improvements were noted in both areas in 2006.

42 Appendix 2

Table A2.1: Asaka Bank’s Participation in Other Credit Lines

Lender Loan EBRD (USD) IFC-I (USD) IFC-II (USD) ADB (USD) Landesbank (EURO) Kommerzbank AG Dresdnerbank AG Hypovereinsbank

Banco Santander Hispano

Raiffeisenbank Sosiete Generale

Instituto de Credito Officiale

Date of Loan 17-Dec-96 28-Sep-99 29-Nov-02 25-Sep-03 27-Feb-01 8-Jan-01 23-Sep-02 5/11.08.03 20-Nov-03 14.03./10.05.05 28-Aug-02 2-Sep-02Loan Amount (in US$) 30,000,000.00 10,000,000.00 5,000,000.00 6,500,000.00 39,230,899.00 27,636,332.55 5,733,420.00 15,358,625.35 1,550,242.80 943,500.00 8,689,495.19 8,689,495.19Interest Charged by Lender

Libor+1% Libor+4% Libor+5%UZIBOR+0,2%

MOF(margin)+margin of Asaka Bank

EURIBOR+margin of Landesbank

EURIBOR+margin of Kommerzbank

EURIBOR+margin of Dresdnerbank

AGWith/Without Sovereign Guarantee

with without without with without without without without without without with with

Fees Charged by LenderParticipating Banks (PBs)

Asaka Bank, Pakhta Bank, Bank "Ipak Yoli"

Loan Conditions for Subborrowers

Loan amount must not increase 75% from the total cost project; participating in project by the Borrower not

less than 25%

Onlending Rates of PBs

Libor+1%+risk 3-4%

Libor+4%+risk3-4%

Libor+5%+risk3-4%

UZIBOR+0,2% MOF(margin)

Subloan Size Range

$100,000 (min) $5 mln (max)

$50,000 (min) $1.5 mln

(max)

$50,001 (min) $1.5 mln (max)

Up to 10 000 USD in UZB equivalent for entities of

small business and private entrepreneurs, dekhans and farmers, up to 100 000 USD UZB equivalent for financing

of credit unions.

Subloan Duration

For trading up to 6 month for the purpose of

increasing floating assets up to 1 year, for

manufacture of goods and services up to 3 years.

Disbursement as of 31-Dec-06 30,000,000.00 10,000,000.00 5,000,000.00 5,245,000.00 39,111,712.90 27,466,325.70 5,733,420.00 15,358,625.35 1,550,242.80 798,279.00 7,623,038.20 7,623,037.70

Subloan size is determined separately under each project, but not more than 85% from contract cost

EURIBOR+foreign bank's margin Onlending Rates are determined separately on EURIBOR basis

Commitment fee, front-end fee

Bank Asaka Bank Asaka

Sub-loan duration is determined separately on each project

Margin is determined separately on EURIBOR basis

Loan conditions are determined separately under each projectequity no less than 25% of original project cost

Commitment fee: -0,5%; Management fee: 1%

ADB=Asian Development Bank, EBRD=European Bank for Reconstruction and Development, EURIBOR=Euro Interbank Offered Rate (the rate at which Euro currency Interbank deposits within the eurozone are offered by one prime bank to another), IFC=International Finance Corporation, UZIBOR=Uzbekistan Interbank Offered Rate (the rate at which Uzbek currency Interbank deposits within the eurozone are offered by one prime bank to another). Source: Asaka Bank.

Appendix 2 43

Figure A2: Asaka Bank’s Organizational Chart

Supervisory Board

Chairman of the Board

Deputy Chairman Deputy Chairman First Chairman of the Board

Secretariat

ALCO Committee

Human Resources Department

Security Department

Legal Department

Accounting Department

Treasury Department

Corporate Clients Department

Credit Risks Department

Information Technology Department

Department of Monetary Circulation and Cash

Operations

Construction Monitoring Department

27 branches of Asaka Bank

Project Finance Department

Credit Department

Leasing Department

International Collaboration and Export-Import

Operations Department

Currency-exchange operations and money transfer Department

Internal Audit Department

Administrative Department

Interbanking Operations Department

Analysis, Finance and Strategic Development

Department

Training Center

Leasing company “OOO Uzavtosanoatleasing”

Source: Asaka Bank.

Stockholders Meeting

44 Appendix 2

Table A2.2: Asaka Bank’s Loan Portfolio


2001 2002 2003 2004 2005 200680.60 80.58 72.65 70.27 72.37 66.75

1.56 3.41 1.68 1.69 1.36 1.323.50 4.70 3.89 4.37 2.43 3.861.17 3.12 3.13 2.30 1.99 2.314.74 3.01 2.61 1.75 2.14 4.470.00 0.00 0.00 0.00 0.00 0.001.22 0.27 0.27 0.10 0.14 0.22

7.21 4.91 15.77 19.52 19.57 21.07100.00 100.00 100.00 100.00 100.00 100.00

a Includes light industry, manufacturing, food processing, and energy-related industries.

All industriesa

Sector

Trade (including external trade)ConstructionTransport and CommunicationsAgriculture

TotalOther

LogisticsHousing, Communal Services and Consumer Services

Source: Asaka Bank.


(%)

Item 2001 2002 2003 2004 2005 2006

Good 60.93 65.86 80.32 88.11 82.45 69.62Satisfactory 29.01 24.18 9.13 6.24 11.65 13.55Substandard 9.78 8.04 10.09 5.36 5.73 10.63Doubtful 0.04 1.89 0.45 0.03 0.13 5.94Bad 0.24 0.03 0.01 0.26 0.04 0.26 Total 100.00 100.00 100.00 100.00 100.00 100.00 Source: Asaka Bank.

C. Loan Loss Provisions

(SUM ‘000)

Item 2001 2002 2003 2004 2005 2006

Good 196,582 755,150 - 1,596,902 2,800,767 - Satisfactory 2,994,846 3,133,949 - 1,524,754 5,321,960 4,265,585 Substandard 2,565,804 2,419,900 - 7,044,367 6,702,758 11,202,518 Doubtful 18,602 1,149,956 - 42,231 279,307 12,809,508 Bad 208,544 41,096 - 354,407 184,139 1,032,982 Total 5,984,378 7,500,051 - 10,562,660 15,288,932 29,310,593 Source: Asaka Bank.

Appendix 2 45

Table A2.3: Consolidated Balance Sheets

(SUM '000)31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006

A. AssetsCash and cash equivalents 6,089 16,310 24,860 70,624 78,062 222,504,970Mandatory balances with the CBU 2,756 4,620 9,456 12,885 Due from other banks 64,449 78,432 53,875 37,259 15,787 38,637,807 Loans and advances to customers 144,451 138,542 226,534 313,668 363,587 478,890,678Investment securities available for sale 2,570 3,618 3,547 3,835 1,323 3,638,135 Investment in securities held to maturity 1,520 2,534 49,342,083 Investment in unconsolidated subsidiaries 1,369 - - - - 6,448,000 Other assets, including prepaid taxes 7,396 964 1,572 2,259 4,771 19,199,119 Deferred tax asset 1,733 422 - - 1,231,156 Premises and equipment 40,709 42,165 37,103 30,271 28,837 33,832,232

Subtotal (A) 267,033 284,520 352,533 468,892 507,786 853,724,180

B. LiabilitiesDue to other banks 40,602 15,443 12,901 25,592 9,470 29,986,599 Customer accounts 57,071 54,479 89,640 175,827 195,745 464,848,210Other borrowed funds 7,327 63,754 94,747 130,021 165,541 189,433,032Provisions against credit related commitm 1,155 729 155 Other liabilities 2,011 823 892 2,305 1,360 3,185,752 Deffered tax liability 78 1,733 722

Subtotal (B) 108,244 136,961 199,057 333,745 372,116 687,453,593

C. Shareholders' EquityShare capital - ordinary shares 150,000 150,000 150,000 33,556 33,556 39,596,565 Capital reserve 4,060 6,088 7,176 4,603 4,603 7,382,187 Revaluation reserve for premises 10,927 10,640 11,223,709 Retained earnings (deficit) 4,729 (8,529) (3,700) 86,061 86,871 107,402,753Cumulative currency translation reserve 665,373

Subtotal (C) 158,789 147,559 153,476 135,147 135,670 166,270,587

Total liabilities and shareholders' equity 267,033 284,520 352,533 468,892 507,786 853,724,180

($ '000)Item

Sources: Asaka Bank, based on audited financial statements (in annual reports) submitted by Asaka Bank to the Asian Development Bank.

46 Appendix 2

Table A2.4: Consolidated Statements of Income

(SUM '000)31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006

Interest Income:Interest income on loans to customers 18,874 17,483 19,197 31,791 32,749,101 Interest income on loans to other banks 866 893 734 2,067 2,364,050 Investment securities held to maturity 162 368 835,165

Total interest income 21,554 19,740 18,376 20,093 34,226 35,948,316

Interest Expense:Interest expense on due to other banks (1,118) (859) (601) (1,737) (1,588,286) Interest expense on customers accounts (2,903) (3,675) (4,116) (7,187) (11,731,694) Interest expense on other borrowed funds (3,171) (2,446) (3,391) (5,988) (8,385,964)

Total interest expense (6,829) (7,192) (6,980) (8,108) (14,912) (21,705,944)

Net interest income 14,725 12,548 11,396 11,985 19,314 14,242,372 Recovery of Provision/(Provision) for loan impairment (5,181) (8,375) 5,279 (7,934) (12,639) (13,025,785)

Net Interest Income after Recovery of Provision/provision for Loan Impairment 9,544 4,173 16,675 4,051 6,675 1,216,587

Fee and commission income 10,008 5,164 7,008 9,243 13,122 18,438,594 Fee and commission expense (974) (652) (902) (1,296) (1,706) (1,744,338) Gains less losses arising from trading in foreign currencies 341 567 8,327 9,904 1,106,793 Foreign exchange translation gains less losses/(losses net of gains) 237 (4,548) (689) 1,663 1,723 9,221,725 Realized gain less losses/(losses net of gains) arising from securities available for sale 244 (725) 2,149 (808) (353) -Recovery of provision for losses on credit related commitments - 426 574 139 - (450,706) Other operating income 44 624 149 491 564 509,043 Dividend income - 147 42 - -

Operating income 19,103 4,950 25,573 21,810 29,929 28,297,698 Administrative and other operating expenses (15,487) (13,570) (17,642) (16,106) (19,723) (22,935,116)

Operating profit 5,704 10,206 5,362,582 Net monetary loss (4,188) (7,967) -

Profit before tax 3,616 (8,620) 7,931 1,516 2,239 5,362,582 Income tax expenses (3,225) (2,610) (2,014) (384) (1,241) (112,978)

Net profit/(loss) 391 (11,230) 5,917 1,132 998 5,475,560

Item($ '000)

Source: Asaka Bank, based on its audited financial statements submitted to the Asian Development Bank.

Appendix 2 47

Table A2.5: Financial Ratios (%)

Item 2001 2002 2003 2004 2005 2006Loan-to-Deposit Ratio 253.11 254.30 257.72 105.71 162.60 93.07Return on Average Assets 0.15 -4.07 1.86 0.28 0.20 0.64Intermediation Cost Ratio 5.80 4.92 5.54 3.92 4.03 2.69Capital Adequacy Ratio 30.00 33.29 26.23 20.40 29.35 18.83Adjusted CAR (treating sovereign 35.69 31.11 24.64 19.34 27.55 18.01 guaranteed loans as full risk cases)Source: Reports of State Joint-stock Commercial Bank "Asaka".

.

48 Appendix 3

PAKHTA BANK

A. History

1. Pakhta Bank (PB) was established in its present form on 27 July 1995 as a joint-stock commercial bank by a decree of the Cabinet of Ministers. It was created as a spin-off from Uzagroprombank, the Uzbek agricultural development bank. Originally established as a narrowly focused bank to service the cotton sector, PB since 1998 has become a universal commercial bank. In July 1995, PB received a banking license from the Central Bank of Uzbekistan to provide comprehensive financial services. In October 1995, PB received its foreign exchange license to conduct foreign exchange trading for its treasury and documentary credit purposes. As of 31 December 2006, PB’s was 72% owned by private individuals, 19% by the State Cotton Association, and 9% by the State Chemical Association. PB received an IC-C/C LC-2 rating from Thomson Financial BankWatch in 2001. 1 Its overall rating was satisfactory. B. Scope of Operations 2. On 31 March 2007, PB had 186 branches and 665 mini-banks.2 Since PB’s evolution to a universal bank in 1996, it ventured into foreign exchange operations and established the necessary infrastructure for these. For this purpose, it opened correspondent banking relationships with leading commercial banks in Western Europe, North America, Japan, Korea, Turkey, and India. In 1997, PB became a member of Society for Worldwide Interbank Financial Telecommunication (SWIFT) to facilitate easy payments on behalf of itself and its clients. 3. Apart from the foreign exchange business, PB engages in securities’ transactions, custodial services, leasing, and factoring. Additionally, the bank undertakes treasury chest functions for local and regional governments where the Central Bank of Uzbekistan has no office. As an agent of the Government, PB intermediates for its budget and off-budget funds dedicated to the Government’s priority sectors. Since 1998, PB has diversified into corporate and retail banking with a concentration on SME finance. Since 2000, PB has also entered microfinance. Its total exposure to the cotton sector decreased from 50% of its portfolio in 2000 to 42.5% in March 2007. To deliver the benefits of its universal commercial banking activity to its customers, it has improved its outreach through its domestic branch expansion program. 4. PB has since 1998 sought to diversify its portfolio. PB believed that this would help reduce the bank’s credit risk due to overexposure in any one sector. Since obtaining a general banking and foreign exchange license, the bank has targeted small and medium enterprises (SMEs) as its core clientele. The bank rightly views this sector as one with promising growth and whose cultivation can add considerable value to the bank’s operations. Microfinance is another sector (para. 8) where PB believes it has a strategic head start, given its rural branch network. Its operational structure has also been geared to providing its clientele with a complete array of banking services. The bank’s strategy is to adopt the best commercial practices in

1 This indicates that the bank has a reasonable rating for local currency operations and a moderate international one

for a high-risk, C-grade country. Its local currency rating of LC-2 is one notch lower than the LC-1 of National Bank for Foreign Economic Activity of the Republic of Uzbekistan (see Appendix 1).

2 The mini-bank offices offer cash, transfer, and deposit services but no loans and are staffed by 2–6 employees. The cash point offices are housed inside other institutions and serve cash, deposit, and transfer facilities for individuals within that institution. These are staffed by 1–2 employees. Cash point offices offer collection and disbursement services only.

Appendix 3 49

credit appraisal, risk management, and corporate governance. This strategy is consistent with its policy of moving towards universal commercial banking principles. The bank also aims to attract a foreign strategic investor to reap better synergies in exploiting opportunities in the domestic market. By improving the level of its banking efficiency, PB plans to attract more corporate deposits. It plans to have 50% of its deposit base over the next 3 years from such clientele, which the bank believes could help reduce its cost of funds. PB’s deposit mobilization strategies are particularly impressive when considered in the Uzbekistan context. It is indeed one of the few banks in Uzbekistan—and the only one under this loan—to maintain its LDR consistently under 100%. In Loan 1594-UZB: Basic Education Textbook Development Project, approved on 17 December 1997 and financed by ADB, PB entered into banking relationships with several high schools in Uzbekistan that rented textbooks financed under the ADB loan to students whose parents paid the textbook rentals into specially designated accounts with PB throughout Uzbekistan. This contributed to raising PB’s low- or no-cost deposit bases. That improved its liquidity and lowered its funding costs, which in turn improved its profitability and allowed it to earn returns on assets (ROA) generally higher than 1% during 2001–2006. C. Relations with ADB and Other Lenders 5. PB was a beneficiary of technical assistance from Asian Development Bank (ADB) for strengthening the banking system (footnote 15 of main text). This was ADB’s first loan using PB as an executing agency (EA). PB’s allocation under this loan was $15 million and its terms and conditions for participation were identical to those of National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) and Asaka Bank (AB), which banks also participated in ADB’s Small and Medium Enterprise Development Project. Its front-end fee was $150,000 (at 1% of its loan allocation). PB was also an EA for ADB’s Small and Microfinance Development Project (SMDP) (footnote 16 of main text). PB has participated in European Bank for Reconstruction and Development (EBRD), International Finance Corporation (IFC), and Kreditanstalt für Wiederaufbau credit lines (see Table A3.1 for PB’s participation in other credit lines). 6. PB’s domestic lending is funded both by its domestic deposits and recourse to borrowing from government non-budget funds. It uses the latter to fund its directed lending on a subsidized basis. As an EA in ADB’s SMDP, PB has onlent ADB’s loan funds on a nonsubsidized basis. PB’s deposit base has since 2001 been adequate comfortably to fund its lending. Unlike NBU or AB, PB’s loan to deposit ratio (LDR) has since 2001 been under 100%. D. Lending Policy 7. PB’s credit and risk management practices (CRMP) were adequate at appraisal. They were enhanced in 2006 with the creation of a new risk management department comprising divisions for loan portfolio management, problem loans, analytical research, economics, and statistics. This reflects a revised operational structure to monitor risk. PB’s credit policy emphasizes credit principles and focuses on risk management. Its credit procedures have been consolidated into a new normative document that should ultimately constitute a part of its new CRMP manual. This document will provide comprehensive information on PB’s entire portfolio, including records of borrowers, analysis of credit allocation by sector, as well as data and tools for strengthening credit recovery. With the assistance of consultants financed by World Bank, PB is currently preparing a new and revised real-time automated CRMP system. This system can be accessed and monitored by the Internal Audit Department (IAD). Since 2006, IAD simultaneously reports directly to PB’s supervision council. This reflects the importance PB attaches to its CRMP. Despite having to be subservient to the country’s overall macroeconomic

50 Appendix 3

policies, PB’s success in maintaining its LDR under 100% reflects prudence in its credit and liquidity management. PB’s single or group borrower exposure exceeded 15% of its equity and its sectoral concentration for agricultural lending exceeded 20% of its total portfolio. 8. As a means of diversifying its portfolio concentration risk away from the cotton sector, PB entered the microfinance sector and developed technical know-how for efficient microfinance lending under a technical assistance grant from the Japan Europe Cooperation Fund processed in tandem with an EBRD microfinance development loan to Uzbekistan in which PB was a participant. PB’s performance, marketing, credit procedures, management information systems, and institutional strengthening measures in microfinance are highly impressive (paras. 7–26 of Supplementary Appendix A to the RRP of Loan 1963-UZB: Small and Microfinance Development Project approved on 9 December 2002). PB’s microfinance operations under the aforementioned ADB loan were (until February 2006) highly impressive. E. Organization, Management and Staffing 1. Apex Management 9. Pakhta Bank’s apex management follows the bimodal collegiate system comprising a nine-member supervision council (SC) and a seven-member board (see organizational chart in Figure A3). PB’s chairperson of the board is also the chief executive officer of the bank and is assisted by three deputy chairpersons whose responsibilities are divided functionally. Since 2006, PB’s IAD reports directly to the board and simultaneously to the SC. As part of its CRMP enhancement, its credit manual and credit information system is available on a real-time basis to IAD, which indicates a high level of diligence in PB’s credit risk management systems. 2. Personnel Management 10. On 31 March 2007, PB had 8,323 employees, comprising 1,013 professional and 7,310 support staff. A total of 6,242 staff were placed at PB’s field offices and 2,081 at its head office in Tashkent. The minimum entry requirement for recruitment of professional staff is university graduation. Starting salaries depend on qualifications and experience. PB did not have a regular entry level salary scale, but performance-linked bonuses are paid to staff at different levels. Remuneration increments are merit driven. Staff performance evaluation is participatory, democratic, bi-directional, and progressive. Staff are evaluated by both their superiors and subordinates. That PB’s remuneration package is competitive is demonstrated by its ability to attract and retain competent staff in such core areas as its treasury and CRMP functions. 11. PB recognizes the importance of staff training to continuously upgrade its employees’ skills. During 2006, a total of 510 employees (including 87 managers and 59 supervisors) underwent in-house training in various relevant banking disciplines. Eighteen managers were trained externally at the State Society for Finance and a further 44 senior staff at the Banking and Finance Academy. PB financed the education of 1,083 staff studying part-time in various educational institutions in the country. Thirteen selected employees were sent for training abroad in Belgium, Germany, Hungary, India , Russia, and Turkey. 3. Lending Operations under the Loan 12. PB processed 15 subloan applications between November 2001 and July 2004. PB took 37 days on average to process a subloan application. This was PB’s first experience in working with ADB and it therefore took the bank more time (than NBU) to comprehend and adhere to

Appendix 3 51

ADB’s procedures. The information submitted by PB on subprojects’ technical, environmental, commercial, and financial aspects was generally adequate. The average maturity of PB’s subloans approved by ADB was 5.6 years. Its repayment record was mixed. 13. PB financed 15 subprojects with subloans totaling 13.23 million. Of these, five subprojects were successful. One of them, Ilonsay Paranda Ltd., has prepaid its entire subloan. The other four successful subprojects (Khonka Qop, Roison Building Tehn [Dodilnuzmir], Bukhoro Golden Fruit, and Agrar Tehnologiyalari JV) were prompt in servicing their debts (both principal and interest) on schedule and hence did not require any rescheduling of either principal or interest. These subprojects had satisfactory financial internal rates of return (FIRRs), debt service coverage ratios (DSCRs), and returns on assets (ROA) (Appendix 6). 14. Of the remaining 10 subprojects (Appendix 6), four had as of 31 December 2006 FIRRs equal to or higher than their weighted average costs of capital (WACC) calculated by PB. These were: (i) Agrobriks (Aseptic) with an FIRR of 36%, (ii) Osiyo Tijorat Savdo with an FIRR of 28%, (iii) Mega Dry with an FIRR of 30%, and (iv) Zuloiha-J.A. with an FIRR of 38%. Subproject (i) had a debt service coverage ratio (DSCR) of 2.5 in both 2005 and 2006. Subproject (ii) had DSCRs of 3 and 4.7 in 2005 and 2006, respectively. Subproject (iii) had DSCRs of 6.7 and 4. Subproject (iv) had DSCRs of 6.7 and 4. Despite such high FIRRs and comfortable DSCRs, PB nevertheless rescheduled their debts. In its comments on the draft project completion report, Pakhta Bank stated that these financial ratios submitted to ADB were after rescheduling of its loans. The Project Completion Review Mission believes that the mere rescheduling of its subloans cannot improve these subborrowers’ DSCRs and ROAs by the magnitudes reported. 15. PB justified its rescheduling of these four subloans by various reasons. In the case of Agrobriks (Aseptic), PB stated that the original subborrower was Aseptic and its subloan was later reallocated in 2005 by PB to a new subborrower, Agrobriks, which is paying the rescheduled loan according to the revised schedule agreed with Aseptic. ADB had reviewed and approved the subloan to Aseptic and not to Agrobrik. This was a diversion of credit from an approved subloan. PB did not consult ADB before doing so. Therefore, PB’s loan to Agrobriks was not authorized by ADB. In this case, PB breached Section 2.01(b) of the Project Agreement and Section 3.03(b) of the Loan Agreement. Furthermore, judging from Agrobrik’s cash flows and its other ratios shown to the Project Completion Review Mission by PB, the Mission believed that Agrobriks could have repaid the entire subloan without rescheduling. PB defended its decision to reschedule the Agrobriks (Aseptic) subloan because of poor harvests in 2004–2005. PB justified its decision in transferring this subloan to another subborrower for the revival of this subproject. No penalty was charged on the rescheduled loan, an act which is tantamount to subsidizing default. In the case of Osiyo Tijorat Savdo, PB stated that the manufacturer of polypropylene could not obtain raw material and had cash flow problems beginning in 2005, that this necessitated the rescheduling, and that there had been no default since. The Mission noted from the information provided by PB that this subborrower had a return on assets (ROA) of 13% in 2006, a loss of –1% in 2005 and an ROA of 18% in 2006 (Appendix 6). In the Mission’s view, such reasonable profitability did not warrant rescheduling. PB reported that after rescheduling this subborrower is servicing its debt on schedule. In the case of Mega Dry JV, PB advised the Mission that it rescheduled the subloan in 2005 because of delay in the installation of equipment and hence delay in production and lower cash flows. The Mission pointed out that the subloan was approved on 18 March 2004 and in 2004 the subborrower had an ROA of 72% and a DSCR of 21.3. Although in 2005 its ROA declined to 3%, it had a DSCR of 14.1. PB claimed that Megra Dry JV did not default any further in repayments. Given Mega Dry’s 2006 cash flows and its profitability, the Mission believed that Mega Dry could have repaid or even prepaid the entire subloan in 2006 to offset its rescheduling in 2005. PB reduced its interest rate charged to

52 Appendix 3

Mega Dry on its rescheduled subloan to 4% per annum, which was lower than its funding cost. This constituted a violation of Section 2.04(a) of the Project Agreement. PB claimed that it rescheduled its subloan to Zuloiha-J.A. in 2006 because the subborrower experienced production difficulties due to a lack of cotton seed to produce cotton seed oil and hence its inability to service its debt. The Mission noted that Zuloiha J.V. had ROAs of 17% in 2005 and 26% in 2006 (based on information obtained from PB) and had DSCRs of 6.7 and 4, respectively, in these years. Analysis of the financial statements of these four subborrowers indicates that they had the financial ability to service their debts on schedule. PB’s credit decisions in rescheduling them—and so on a subsidized basis—appear to have been taken for nonbanking considerations. 16. The remaining six subprojects (Appendix 6) had either very low FIRRs or no cash flows due to the delays in production. Hence, they needed to have their subloans rescheduled. These were: (i) Food Industry (Quqon non) with an FIRR of 24%,3 (ii) Osiyo Express with an FIRR of 3%, (iii) Surkhan Export with no production and hence no cash flow, (iv) Margilontekstil with an FIRR of 2%, (v) Laser Oqoltin with no production and cash flow, and (vi) Yorqishloq with no production and cash flow. The subloan to subproject (i) was rescheduled for its original subborrower because a lack of raw material meant there was no production. The subloan was then reallocated to another subborrower who agreed to assume the first subborrower’s debt and has been servicing it. Subproject (ii) suffered a shortage of raw materials since 2005 and has been in constant arrears since. Subprojects (iii) and (vi) suffered production due to the unavailability of raw material and hence had no cash flow. Subproject (iv)’s production was delayed because of a dispute with its joint-venture partners and required rescheduling on a one-time basis in 2005. It has been prompt in servicing its debt (both principal and interest) since. Subproject (v)’s production was delayed because the equipment installed was not suited to local materials. The problem was reported to have been rectified and production commenced in February 2007. PB and the subborrower advised the Mission on 24 April 2007 that this subloan would be serviced promptly hereafter. 17. After adding back rescheduled amounts, PB’s arrears under subloans provided out of the loan were 33.21% (Appendix 6). 4. Other Operations 18. Conceived originally as a cotton sector specific bank and which later sought to evolve into a universal commercial bank, PB’s prime customer base in Uzbekistan remains its cotton producers. That is why the bank has a large rural and semi-urban branch network. Given its need to diversify out of the cotton sector, PB tapped the microfinance and SME sectors with determination. PB used its existing branch network to diversify operations into greenfield areas. PB’s headquarters operations in foreign exchange trading and documentary credits are primarily geared toward meeting the needs of its domestic clientele. It is not focused on large state-owned enterprises and did not make significant foreign currency loans to state-owned enterprises whose revenues were in local currency. It therefore did not suffer loan losses arising from its borrowers’ exchange losses. The majority of its borrowers are from the cotton sector, which in March 2007 constituted 42.5% of its portfolio. But since the output of the cotton sector is primarily export-oriented, PB’s profitability, liquidity, and loan quality remained high (albeit

3 In 2004 Quqon non willfully defaulted on repayment to Pakhta Bank despite an ROA of 17% in that year and 2% in

2005, PB advised the ADB Loan Review Mission in May 2005 that it was considering at that time to foreclose on the subloan to Quqon non.

Appendix 3 53

countercyclically) when the Uzbek sum was depreciating against foreign currencies. The increase in world cotton prices during 2004 and 2005 provided an additional cushion to PB’s clients. This also explains why PB’s loan quality did not suffer from the sum’s depreciation during 2001–2004. 5. Financial Performance (Portfolio Distribution and Quality) 19. As of 31 March 2007, 42.5% of PB’s lending was to the cotton sector. This includes cotton cultivation as well as yarn manufacture and export financing for both raw cotton and yarn. Its single-borrower loan concentration ratio exceeded 15% of its equity in 2005 and 2006. PB’s debt quality improved steadily during 2001–2006 (Table A3.2). Its nonperforming loans in 2006 constituted a mere 0.35% of its total portfolio. PB’s loan loss provisioning was in accordance with internationally accepted practices (Table A3.2). Analysis of PB’s portfolio indicates that its sectorally expansive credit policy, as manifested by its highest loan concentration in terms of both sectors and borrowers, is matched by satisfactory post-disbursement recovery. The nonperforming loans ratio is low and financial management is conservative. Loan loss provisioning is adequate and in accordance with internationally accepted practice. 6. Financial Performance (Financial Statements and Ratios) 20. PB’s assets grew from SUM142 billion in 2001 to SUM505 billion in 20064 at an annual compound growth rate of 37.3%. PB, followed International Financial Reporting Standards throughout this period. Analysis of PB’s financial statements during 2001–2006 reveals that the institution is comfortably solvent, safely liquid, and satisfactorily profitable. PB’s capital adequacy ratio declined from 38% in 2001 to 17% in 2006, but it nonetheless met comfortably the project covenants. This decline is attributable to growth in its lending between 2001 and 2006, which increased its risk assets in the ratio’s denominator. Except in 2001,5 PB’s LDR was maintained consistently below 100% during 2001–2006. Its customer deposits rose from SUM53 billion in 2001 to SUM295 billion in 2006 at an annual compound rate of 53.6%. PB’s innovative deposit mobilization measures, and particularly for low-cost deposits is especially impressive in Uzbekistan’s context. Except for 2002,6 the bank’s ROA has been consistently higher than the covenanted level of 1%. Despite higher administrative expenses, manifested by an intermediation cost ratio (ICR) that consistently exceeded 9.5% during 2001–2006, PB’s satisfactory profitability is attributable to (i) comfortable and increasing interest spreads (due to an optimal funding mix with low-cost deposits), and (ii) increasing and impressive net gains from fees and commissions and foreign exchange and securities trading. Reducing PB’s ICR is essential to sustain PB’s otherwise impressive track record of compliance with the three critical covenanted ratios. Fortunately, PB’s ICR declined from 12.8% in 2005 to 10.2% in 2006, which demonstrates the institution’s determination to control administrative costs. PB’s loan concentration ratio to a single borrower or group of related borrowers exceeded 15% of its equity in 2005 and 2006. Its lending to the agricultural sector increased from 42% in 2005 to 50% of its portfolio in 2006. PB maintained that, given its specific history, it is not surprising that the majority of its borrowers are still from the agricultural sector. PB thus failed to comply with project covenants seeking to limit its loan concentration. The bank’s sectoral exposure to the cotton sector declined from 50% in 2000 to 42.5% in 2006. 4 PB’s financial statements were denominated in Uzbek sums during 2001–2006. 5 PB’s LDR in 2001 exceed 100% because of a run on its customers’ deposits in that year that was coupled with its

inability adequately to tap specific nondeposit sources to fund its lending. This incongruity was corrected in 2001 following the introduction of PB’s innovative deposit mobilization measures.

6 PB’s ROA in 2002 fell to 0.87% due to increased loan loss provisions and an extraordinary exchange loss.

54 Appendix 3

7. Conclusion 21. Throughout the implementation of this loan, PB was safely solvent, comfortably liquid, and satisfactorily profitable. Its sectoral credit expansion (resulting in high single-borrower and sectoral loan concentrations) was matched by its (i) rigorous post-disbursement follow-up and recovery that kept its portfolio quality stable, and (ii) conscientious loan loss provisioning consistent with international standards. PB’s investment in technology and human resources in upgrading its CRMP system and in making its system transparently accessible to its internal audit department (for onward reporting to its board and SC) is impressive. It is paradoxical, therefore, that PB did not exercise the same degree of diligence for all of the 15 subprojects financed under this loan (which accounted for less than 5% of its total portfolio), as it did for its overall portfolio. In the Project Completion Review Mission’s assessment, had PB exercised similar standards of rigor, arrears for subloans under the loan could have been far lower.

Appendix 3 55

Table A3.1: Pakhta Bank’s Participation in Other Credit Lines

Lender Loan EBRD EBRD ADB ADB ADB ADB KfW/NBU US EXIMBANK

Term of Loan 10 years 4 years 15 years 15 years 20 years 20 years 10 years 10 yearsLoan Amount 15,000,000.00 7,000,000.00 15,000,000.00 8,300,000.00 7,000,000.00 3,200,000.00 4,167,820 Euro 12,062,580.00

Interest Charged by Lender

EBRD 2%+LIBOR EBRD 1%+LIBOR ADB

0,6%+LIBORUzIBOR + 0,2%

MinFinLibor + 2%

MinFinLibor + 2%

MinFinEurolibor+KfV 1,5%+NBU 2% 4% Eximbank

With/Without Sovereign Guarantee

80% 100% 100% 100% 100% 100% 100% 100%

1% - front-end commission







0,75%-commitment fee

0,5%-commitment fee






0,35% - commitment fee

NBU Ipoteka-bank NBU Pakhta-bank Pakhta-bank Pakhta-bank NBU

Asaka-bank Hamkor-bank Asaka-bank Asaka-bank Pakhta-bank

Pakhta-bank Ipakyuli-bank Pakhta-bank Ipakyuli-bank

Pakhta-bankLoan Conditions for PBs EBRR 2% EBRR 1% ADB 0,6% 0% 0% 0% KfV1,5%+NBU 2% 4% Eximbank

Loan Conditions for Subborrowers

Pakhta bank from 2 up to 5%

Pakhta bank from 14% up to 36%

Pakhta bank from 2% up to 5%

Pakhta bank from 2% up to

6%Pakhta bank 3% Pakhta bank 3% Pakhta bank 2%

4% Eximbank + 0,5% Pakhta

bank

Onlending Rates of PBs

EBRD 2%+Pakhta bank

from 2 up to 5%+libor

EBRD 1%+Pakhta bank

from 14 up to 36%+libor

ADB 0,6%+Pakhta

bank from 2 up to 5%+libor

MinFin 0,2%+Pakhta

bank from 2 up to 6%+libor

Libor + 2% MinFin+Pakhta

bank 3%

Libor + 2% MinFin+Pakhta

bank 3%

Euribor+KfV1,5%+NBU 2%+Pakhta

bank 2%

4% Eximbank + 0,5% Pakhta

bank

Subloan Sizes 38,000 95,000 264,519

Subloan Ranges 980,000 50,000 500,000 10,000 100,000 100,000 2,250,000

Subloan Duration from 0.5 up to 3 years

from 3 up to 5 years

from 4 up to 8 years to 3 years to 10 years to 10 years from 4 up to 5

yearsDisbursement as of 31 Dec 2006 1,807,524 1,900,000 13,169,150 8,300,000 4,225,291 1,102,644 4,167,820 Euro 3,054,002

Participating Banks (PBs)

Fees Charged by Lender

ADB=Asian Development Bank, EBRD=European Bank for Reconstruction and Development, EURIBOR=Euro interbank offered rate (the rate at which Euro currency interbank deposits within the eurozone are offered by one prime bank to another), IFC=International Finance Corporation, UZIBOR=Uzbekistan interbank offered rate (the rate at which Uzbek currency Interbank deposits within the eurozone are offered by one prime bank to another). Source: Pakhta Bank.

56 Appendix 3

Figure A3: Pakhta Bank’s Organizational Chart

Board of the Bank

Chairman of the Board

Liquidity Committee

Credit Committee


First Deputy Chairman of the Board

Deputy Chairman of the Board

Supervision Council

Deputy Chairman of the Board

Treasury


The Main Department of Money Circulation

Accounts Department

Securities Department

Payment Management Unit

Administrative Department

“Pakhta Servise” Depositary

Methodology Department

Bank Coordination and Development Department

Department of Agriculture Crediting and Monitoring

Provision and Distribution Crediting Department

Unit working with Agriculture Support Fund under the

Ministry of Finance

Department of Crediting and Monitoring of Construction

Sector

Credit Security Unit

Leasing Department

Chancellery

Risk Management Department

Finance Management Department

International Banking Department

Project Finance Department

Department of Crediting and Monitoring Industry

and Consumption Market

Information Technology Center

Bank Operations Department

Small Business Crediting and Monitoring

Department

Secretariat

Legal Department

The First Department

Security Department

Personnel Department

Bank Training Center

Execution Control Department

Marketing and Mass Media Division

The Second Division

Cash Operations Department

Department of Financing and Monitoring Projects out of Proceeds of Agriculture

Support Credit Lines

Source: Pakhta Bank.

Appendix 3 57

Table A3.2: Pakhta Bank’s Loan Portfolio


2001 2002 2003 2004 2005 2006

Industry 25.15 30.01 39.42 38.93 29.11 19.29Agriculture 21.79 25.02 23.82 25.00 42.50 49.94Transport and Communications 0.56 0.51 0.40 0.30Construction 4.46 1.57 0.92 1.48 1.60 2.33Trade (excluding external trade) 12.15 8.38 9.08 7.75 5.49 3.33Logistics 20.79 16.97 12.70 16.40Individuals 7.69 9.79

0.09 0.18 0.26 0.41 11.65 14.03Others 15.01 17.36 13.40 9.73 1.96 1.29 Total 100.00 100.00 100.00 100.00 100.00 100.00

Sector

Housing, Communal and Consumer Services



(%)

Item 2001 2002 2003 2004 2005 2006

Good 88.17 88.11 90.28 89.80 90.50 93.35Satisfactory 11.59 11.16 8.88 9.20 9.08 6.29Substandard 0.19 0.41 0.67 0.84 0.38 0.12Doubtful 0.03 0.31 0.13 0.07 0.03 0.23Bad 0.02 0.01 0.04 0.09 0.01 0.01 Total 100.00 100.00 100.00 100.00 100.00 100.00


C. Loan Loss Provisions (SUM ‘000)

Item 2001 2002 2003 2004 2005 2006GoodSatisfactorySubstandard 30,116 87,947 193,465 321,489 205,238 99,836 Doubtful 10,372 134,608 70,857 53,185 37,291 391,371 Bad 12,319 1,155 48,408 142,640 30,949 19,559 Total 783,230 1,175,648 1,334,018 1,935,815 2,212,113 2,639,274

1,938,635 2,128,508 730,423 951,938 1,021,288 1,418,501


58 Appendix 3

Table A3.3: Consolidated Balance Sheets (SUM ‘000)

31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006(Restated) (Restated)

A. AssetsCash and cash equivalents 13,515,495 89,732,751 15,171,980 37,747,102 75,398,127 100,403,491Mandatory balances with the Central Bank of Uzbekistan 345,293 2,968,233 12,935,660 11,497,148 12,616,604 Due from other banks 16,762,754 8,234,661 66,292,896 3,735,919 2,571,301 17,478,725 Loans and advances to customers 71,410,495 88,749,378 115,534,177 157,261,036 211,613,295 329,179,215Investment securities available for sale 2,155,722 805,352 786,725 2,669,296 2,898,344 13,422,444 Investment securities held to maturity 2,105,888 2,981,725 6,900,349 4,731,885 2,936,943 1,835,211 Investment in joint venture bank 1,610,153 2,522,276 2,662,931 2,924,631 2,898,827 3,190,526 Other assets 4,794,394 5,159,241 5,256,126 10,135,299 12,070,493 5,953,086 Deferred income tax asset 397,655 1,880,297 2,136,655 2,185,649 2,060,601 Premises, equipment, and intangible assets 29,280,947 29,606,581 31,201,638 32,921,910 32,249,642 33,208,295

Subtotal (A) 142,378,796 232,640,495 258,879,137 265,809,875 357,314,177 504,670,993

B. LiabilitiesDue to other banks 30,942,113 148,094 258,478 538,800 6,297,060 23,504,473 Customer accounts 53,598,587 135,762,250 153,882,472 119,464,595 186,248,478 295,530,737Other borrowed funds 6,405,951 44,888,029 49,789,907 74,027,296 95,155,297 115,596,911Other Liabilities 296,401 206,616 1,460,996 7,327,122 3,434,743 4,013,788 Deferred income tax liability 5,227,890 4,861,623 3,576,163 4,166,386 2,881,972

Subtotal (B) 96,470,942 185,866,612 208,968,016 205,524,199 294,017,550 438,645,909

C. Shareholders' EquityShare capital 31,018,077 31,808,292 33,327,705 38,332,319 38,851,720 39,351,720 Retained earnings and other reserves 14,889,777 14,965,591 16,583,416 20,516,730 22,745,284 24,824,018 Fair value reserve for investment securities available for sale 1,436,627 1,699,623 1,849,346

Subtotal (C) 45,907,854 46,773,883 49,911,121 60,285,676 63,296,627 66,025,084

Total liabilities and shareholders' equity 142,378,796 232,640,495 258,879,137 265,809,875 357,314,177 504,670,993

Item


Appendix 3 59

Appendix 3 59

Table A3.4: Consolidated Statements of Income (SUM ‘000)

31 Dec 2001 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006(Restated) (Restated)

Interest income on loans and advances to customers 11,060,170 14,588,496 20,568,238 Interest income on financial assets held to maturity - 896,205 1,237,050 Interest income on due from other bank 657,590 584,205 876,572 Interest income on debt securities 437,792 400,724 54,589

Total interest income 12,155,552 16,469,630 22,736,449 25,816,760 31,520,485 43,589,857

Interest expense on customers accounts (2,529,075) (2,910,939) (6,913,343) Interest expense on other borrowed funds (152,653) (2,251,499) (3,078,338) Interest expense on due to other banks (1,318,830) (242,073) (176,954)

Total interest expense (4,000,558) (5,404,511) (10,168,635) (13,515,328) (16,336,602) (27,904,445)

Net interest income 8,154,994 11,065,119 12,567,814 12,301,432 15,183,883 15,685,412

Provision for loan impairment (1,661,662) (2,354,258) (3,065,584) (1,517,716) (3,519,335) (3,125,265)

Net interest income after provision for loan impairment 6,493,332 8,710,861 9,502,230 10,783,716 11,664,548 12,560,147

Fee and commission income 28,962,414 24,441,834 25,529,556 33,667,413 41,352,910 42,818,301 Fee and commission expense (7,085,761) (3,274,809) (3,482,317) (4,823,124) (6,022,358) (8,700,764) Foreign exchange translation gains less losses 465,142 358,600 156,704 409,215 517,029 736,136 Gains less losses on foreign exchange dealing - 752,179 90,287 238,965 266,075 551,499 Losses on initial recognition of assets at rates below market - (302,759) (217,578) (1,300,390) (924,375) (686,744)

- (136,838) (81,046) 1,012,652

Other operating income 72,478 92,721 16,571 24,150 88,903 1,583,440 Provision for other losses (456,664) (426,564) (916,967) Dividend income 229,556 276,175 381,258 705,340 992,678

Operating income 28,680,497 30,491,400 30,978,698 39,705,285 47,935,410 49,874,667 Administrative and other operating expenses (17,820,951) (21,692,999) (23,482,790) (29,724,508) (39,805,255) (43,820,379)

Operating ProfitIncome from investment in joint venture 729,179 385,345 (115,129) 55,057 184,804 488,355 Monetary loss (6,048,782) (6,590,481) (1,125,633) (1,185,997) (1,934,093)

Profit before tax 5,539,943 2,593,265 6,255,146 8,849,837 6,380,866 6,542,643 Income tax expense (3,229,088) (963,664) (1,673,461) (3,095,156) (1,669,747) (980,722)

Profit for the year 2,310,855 1,629,601 4,581,685 5,754,681 4,711,119 5,561,921

Earnings per share, basic and diluted (expressed in SUMs per share) 161 439 492 377 428

Gains less losses/(losses net of gains) arising from investment securities available for sale

Item


60 Appendix 3

Table A3.5: Consolidated Statements of Cash Flows (SUM ‘000)

Item 31 Dec 2002 31 Dec 2003 31 Dec 2004 31 Dec 2005 31 Dec 2006Cash flows from operating activitiesInterest received 17,085,987 21,701,313 23,358,410 31,090,336 45,574,091Interest paid (5,019,650) (9,137,124) (12,789,187) (15,762,518) (27,504,982)Fee and commission received 23,937,894 24,616,359 34,003,736 40,538,034 45,225,204Fee and commission paid (3,274,809) (3,482,317) (4,823,124) (6,022,358) (8,700,764)Income received from trading in foreign currencies 752,179 90,287 238,966 266,075 551,499Other operating income received 92,721 16,571 13,943 19,976 282,112Staff costs paid (13,192,539) (18,862,463) (22,904,347)Administrative and other operating expenses paid (17,347,551) (19,413,551) (10,572,956) (15,526,210) (14,990,074)Income tax paid (3,609,306) (3,238,211) (2,924,244) (2,792,939) (1,962,654)Monetary loss from operating activities

Cash flows from operating activity before changes in operatingassets and liabilities 12,617,465 11,153,327 13,313,005 12,947,933 15,570,085

Net (increase)/decrease on required reserves in CBU (2,960,301) (10,280,420) 2,487,502Net (increase)/decrease in due from other banks (6,358,225) (59,431,005) 68,911,710 887,800 (14,355,680)Net increase in loans and advances to customers (16,308,673) (33,931,694) (36,348,814) (70,371,549) (123,251,766)Net increase on financial assets before repaiment (3,302,261) (4,111,157)Net decrease/(increase) in other assets (334,019) (543,210) (1,274,580) (1,921,967) 2,213,313Net increase in due to other banks 164,015 118,261 265,079 6,021,986 17,207,413Net increase in customer accounts 88,681,200 23,579,968 (47,837,829) 75,552,110 107,437,360Net increase/(decrease) in other liabilities (112,240) 1,287,379 942,118 (3,913,851) 605,619

Net cash from operating activities 72,086,961 (72,158,551) 458,191 19,202,462 5,426,344

Acquisition of premises, equipment and intangible assets (3,633,627) (5,646,868) (2,873,263) (4,976,877) (6,081,573)Proceeds from disposal of premises, equipment and intangible assets 483,552 29,327 66,066 104,243 211,745Acquisition of investments in joint venture bank (739,999) (471,196)Acquisition of investment securities available for sale (206,129) (60,205) (198,310) (10,109,467)Proceeds from disposal of investment securities available for sale 36,362 39,185 61,886 1,012,626Acquisition of investment securities held to maturity (2,062,597) (2,225,101) (2,062,597)Proceeds from redemption of investment securities held to maturity 3,741,177 3,164,330Dividends received from joint venture bank 123,092 196,656Dividends received 552,192 501,994 661,167 869,586 762,200

Net cash used in investing activities (3,544,011) (5,610,586) 3,441,007 (2,301,994) (12,906,080)

Cash flows from financing activitiesIssued ordinary shares 1,012,849 538,644 201,126 228,034Dividends paid (2,885,530) (2,451,815) (3,218,517) (2,164,290) (2,297,667)Proceeds from government, state and international financial organisations 273,283,026 328,283,028Repayments from government, state and international financial organis 6,916,654 6,491,800 20,393,506 (246,103,567) (306,524,051)

Net cash from financing activities 4,031,124 5,052,834 17,713,633 25,216,295 19,689,344

Effect of inflation on cash and cash equivalents (12,161,626) (1,979,963) (1,000,787) (2,718,241)Effect of exchange rate changes on cash and cash equivalents 890,926 135,495 180,808 275,449 179,152

Net increase in cash and cash equivalents 61,303,374 (74,560,771) 20,792,852 39,673,971 12,388,760Cash and cash equivalents as at beginning of the year 28,429,377 89,732,751 16,954,250 48,340,760 a 88,014,731

Cash and cash equivalents as at the end of the year 89,732,751 15,171,980 37,747,102 88,014,731 b 100,403,491

Non cash transactions:capitalised dividends on ordinary shares 506,564 550,925 318,275 271,966capitalised dividends on investment securities available for sale 44,173 61,541new branches 128,139Note: Financial data on cash flows received from auditor's report of PriceWaterHouseCoopers for 2002 to 2006 years.

b Includes mandatory cash balance of SUMs (thousand) 12,616,604 held with Central Bank of Uzbekistan but not shown as cash equivalent in balance sheet.

a Includes mandatory cash balance of SUMs (thousand) 11,497,148 held with the Central Bank of Uzbekistan but not shown as cash equivalent in balance sheet offset by an adjustment made for sums (thousand) 903,490.


Appendix 3 61

Table A3.6: Financial Ratios (%)

Item 2001 2002 2003 2004 2005 2006Loan-to-Deposit Ratio 133.23 65.37 75.08 75.90 62.53 75.22Return on Average Assets 1.62 0.87 1.86 2.19 1.51 1.29Intermediation Cost Ratio 12.52 11.57 9.56 11.33 12.78 10.17Adjusted Capital Adequacy Ratio (treating sovereign guaranteed loans as full risk cases)

38.00 31.60 32.00 27.01 24.05 16.00


62 Appendix 4

RELEVANCE OF DESIGN AND FORMULATION

1. The Project’s rationale, design, and formulation were relevant to and consistent with both the Asian Development Bank (ADB) country operational strategy (COS) for Uzbekistan and the Government’s development objectives. The main goal of ADB’s COS was to assist Uzbekistan’s orderly and sustainable transition to a market economy, with emphasis on supporting the emerging private sector. The COS gave high priority to small and medium enterprise (SME) development as a means to this end. The Government specifically requested ADB’s assistance for developing SME businesses and in building capacities in commercial banks for better SME finance.1 This Project encompassed these objectives. The Project was soundly designed, satisfactorily formulated and relevant to prevailing economic conditions. It was appropriately timed, and incorporated lessons learned. 2. Uzbekistan has an advantageous location in Central Asia, moderate climate, vast natural resources, adequate infrastructure, an educated workforce, and a reasonably developed primary sector. It is relatively less burdened than its neighbors with large-scale industrial complexes that needed to be restructured. Thus, Uzbekistan enjoys a potential comparative advantage vis-à-vis neighboring countries for the development of SMEs. However, Uzbekistan adopted an inward looking industrial strategy with a gradual and cautious approach to economic liberalization. The economic policies emphasized administrative interventions, such as trade and exchange rate restrictions, price controls, government control and intervention in economic and business activities (including centralized resource allocation), and slow privatization of state-owned enterprises. The Government’s preference for gradualism has stemmed from its desire to avoid social disruption and reduce the incidence of poverty. The gradualist approach to economic reforms served Uzbekistan’s interests to some extent, as its gross domestic product (GDP) grew on average by about 2.4% annually during 1996–1999. This was possible because the country is endowed with rich natural resources of exportable commodities, such as cotton and gold. This endowment helped Uzbekistan maintain a comfortable foreign exchange cushion and fiscal position, which enabled it to meet its urgent public expenditure needs. 3. As of 1 October 1999, Uzbekistan had 23,188 small and 8,886 medium enterprises,2 a large number of which are in the Tashkent area. SMEs accounted for about 7.6% of total employment. Officially registered SMEs were engaged in agro-processing, hardware manufacture, container manufacture (from plastic, polyethylene, and glass), electronics, and furniture manufacture. SMEs were also engaged in providing a variety of services. Most SMEs in the urban areas were joint ventures or privately owned. The agro-processing SMEs in the rural areas were largely owned by farmers or rural cooperatives, although some corporate entities and joint ventures have entered the field during the past 3 years. 4. Despite Uzbekistan’s potential comparative advantage in SME development, the sector had languished. Its share of GDP declined from 12% in 1996 to 8% in 1998.3 This decline was attributable to (i) constraints in Uzbekistan’s early post-independence industrial, fiscal, and

1 In Cabinet of Ministers Resolution No. 296, dated 10 June 1999. 2 Ministry of Macroeconomics and Statistics. According to the Government’s definition, a small enterprise employs

up to 40 persons in industry, up to 20 persons in agriculture, 1–10 persons in construction, and up to 10 persons in other subsectors. Medium-sized enterprises employ 41–100 persons in industry, 21–30 persons in agriculture, 11–50 persons in construction, and 11–30 persons in other subsectors.

3 Republic of Uzbekistan, Ministry of Macroeconomics and Statistics.

Appendix 4 63

financial sector policies that impinged upon SME development;4 and (ii) SMEs’ lack of access to investment and working capital (particularly in foreign exchange) to finance their acquisition of capital goods, raw materials, technology, management know-how, and marketing tie-ups. 5. The Government's fiscal preference for large-scale industries, its rigorous bureaucratic registration requirements, and its restrictive trade and exchange policies have worked against SMEs. Entrepreneurs running SMEs did not have the economic or political clout to circumvent the Government's fiscal and industrial policies. These constraints explain the decline of SMEs' contribution to GDP. Nevertheless, overall value added by the industry sector amounted to 14% of GDP,5 and SMEs still accounted for more than half of overall industrial production. This high contribution despite inherent policy biases against SMEs showed the sector's strong competitive advantage. 6. ADB’s first credit line to Uzbekistan, under the Rural Enterprise Development Project (REDP), 6 provided foreign exchange to fund the investment and working capital needs of individual SMEs (albeit only to those in the agro-processing sector). It was not accompanied, however, by adequate policy dialogue with the Government to address structural distortions and legal and regulatory impediments in Uzbekistan’s industrial, regulatory, fiscal, financial sector, trade, and exchange control policies. These distortions created regulatory impediments to the SMEs’ successful operations. Covenants under the REDP were inadequate to measure (i) the soundness with regard to financial solvency, liquidity, and profitability of the National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU), which was the Executing Agency for the project; and (ii) subprojects’ viability in terms of their financial internal rates of return.7 Also, the SMEs financed under the REDP suffered from working capital shortages in local currency because distortions in bank lending policies in Uzbekistan were not addressed. Some SMEs, and particularly those without foreign collaboration, suffered additionally from a lack of technical and managerial know-how. Consequently, ADB loan funds were used to finance subprojects when it was difficult to establish clear criteria and while operating in a distorted macroeconomic environment. 7. Incorporating the lessons learned from the REDP, ADB’s design of this loan sought to (i) create an enabling environment for SME development by addressing the regulatory and policy impediments; (ii) enhance institutional support for nascent SMEs’ access to technology, management, and business plans preparation; (iii) identify viable criteria for suitable subproject selection; and (iv) introduce viable, solvent, liquid, and profitable participating banks (para. 39 of main text and appendixes 1, 2, and 3) to intermediate efficiently in credit delivery from ADB’s loan to those viable subprojects identified. Policy dialogue during loan processing convinced the Government to introduce legislation to address distortions in various policies. New fiscal legislation streamlined SMEs’ taxation, registration, licensing, and inspection regimes and thereby reduced arbitrary bureaucratic delays and corruption. Modest banking sector reforms 4 These policies were biased in favor of larger, state-owned enterprises while creating barriers for SMEs. There were

major distortions in Uzbekistan’s industrial, licensing, registration, fiscal, banking, trade, and foreign exchange management policies, as well as with regard to the regulatory framework, including sanitary and other inspections. These worked to prevent SMEs’ from realizing their potential.

5 Republic of Uzbekistan, Ministry of Macroeconomics and Statistics. 6 Loan 1504-UZB: Rural Enterprise Development Project (REDP), approved on 16 December 1996 for $50 million. 7 The original REDP conditions required every subproject to have a minimum economic internal rate of return of

12%, whose calculation for subprojects in Uzbekistan proved onerous, dilatory, and subjective. This was because the capital goods imported into Uzbekistan from Europe and North America had to be hauled over land across Poland, Ukraine, Belarus, Russia, Kazakhstan, and sometimes Turkmenistan, with each country’s railway system imposing differential and sometimes punitive tariffs on freight bound for Uzbekistan.

64 Appendix 4

facilitated SMEs’ easier access to cash withdrawals from their bank accounts. Most importantly, ADB sought the Government’s approval under this loan for abolishing the mandatory surrender of 50% of SMEs’ export earnings (para. 14) at the overvalued official exchange rate (thereby ending a de facto tax on exports). This was the first step towards Uzbekistan’s eventual exchange rate unification in 2003. By 2006, the SME sector accounted for 42.1% of GDP, employed 7.26 million people and generated exports worth $683 million (10.7% of total exports).8 This reflects the relevance of the Project’s design and formulation in supporting a sector with considerable potential. A. Industrial Regulation and Legal Protection Policy Reform 8. In the legal and regulatory arena, the Government during 2000 introduced legislation to encourage the growth of SMEs. Significant statutes in this area included the following: (i) Law on Guarantee of Freedom to Entrepreneurial Activities (ii) Law on Inspection of Economic Entities, (iii) Law on Licensing of Selected Economic Activities, (iv) Law on Foreign Economic Activity, and (v) Law on Audit. The Law on Guarantee of Freedom to Entrepreneurial Activities was intended to create conditions to encourage the free participation of citizens and entrepreneurs in economic activity. It was designed to prevent unwarranted interference by bureaucrats into lawful business activities. This law was intended to (i) protect the rights of citizens and SMEs in undertaking lawful economic activity not specifically prohibited under any statute; (ii) define entrepreneurial activities and SMEs; (iii) define the rights and obligations of enterprises; (iv) guarantee physical and intellectual property rights to entrepreneurs; (v) offer specific protection against arbitrary nationalization, appropriation, confiscation, or seizure without full compensation; (vi) provide entrepreneurs and SMEs the rights of legal redress and compensation against any illegal act by an organ of the state; (vii) protect intellectual property of enterprises; and (viii) set legal reporting standards for enterprises. These reforms were expected to create a more enabling environment for SME development. 9. The Law on Inspection of Economic Entities combined with the Law on Guarantee of Freedom to Entrepreneurial Activities to define the permissible legality of inspections and introduce transparency and fairness into the verification process. They aimed to replace the Soviet-era physical inspection of production with financial verification of the value of production generated by enterprises and observance of environmental and sanitation standards. The regulations laid down the procedure, timing, certification, and approval measures for inspecting enterprises (limited to no more than twice a year). Specifically, the regulations did not allow inspection of an enterprise without written authorization by the relevant state organization. They laid the basis for enterprises to maintain inspection books, which inspectors were required to sign. Under the law, every enterprise inspected had the right to written information on matters contained in the inspection report within 10 days of the inspection. An enterprise could appeal to a court against any inspection report it considered improper. To protect SMEs against arbitrary bureaucratic inspections, the regulations provided that an SME (as defined in the Law on Guarantee of Freedom to Entrepreneurial Activities) could be inspected only with the mandatory participation of a legal expert from the Chamber of Commodity Producers and Entrepreneurs (CCPE). There were still some inconsistencies between the Law on Guarantee of Freedom to Entrepreneurial Activities and the Circulars on Inspection Regulations. The Ministry of Justice reviewed such circulars and amended them to conform to the law without prejudice to the rights of entrepreneurs. 8 Statistical Review of Uzbekistan by the State Committee on Statistics.

Appendix 4 65

10. The Law on Licensing of Selected Economic Activities stated the conditions for the issue, renewal, suspension, cancellation, or refusal of licenses to business enterprises for undertaking lawful economic activity. The Government drafted an amendment to this law to facilitate one-stop registration procedures for SMEs. Expeditious passage of this amendment helped SMEs considerably. The Law on Foreign Economic Activity was enacted to encourage the integration of Uzbekistan’s economy into the international economic system through increased foreign direct investment (FDI). It was designed to protect the rights of Uzbek entrepreneurs and their foreign counterparts. It guaranteed the dissemination of all information to investors relating to the investment laws of Uzbekistan. The Law on Audit was enacted to ensure that audits of enterprises are carried out only by the auditing profession and not by the state. It set out the rights and duties of auditors as well as penalties for breach of law or professional misconduct. The law safeguarded the professional independence and integrity of the auditing profession, so that its reports may be used as the basis for tax assessments and further supervision. The law formed part of the system for moving from physical to financial supervision. The Law on Audit aimed at introducing international standards of auditing to Uzbekistan. Its intention was to provide comfort to potential foreign investors as well as the tax authorities by moving the accounts of enterprises to international accounting standards based on the double-entry accrual system of accounting. B. Fiscal Policy Reform 11. Uzbekistan's 2000 tax code, which became effective on 1 January 2000, contained many measures aimed at reforming and streamlining tax assessment. The earlier system had been complex and resulted in much arbitrary interpretation of tax liability. The new code defined national taxes (imposed by the national government) and local taxes imposed by local governments. The national taxes were in the nature of (i) income or profit taxes, (ii) value-added taxes, (iii) excise taxes, (iv) taxes levied on the use of natural resources, (v) environmental taxes, and (v) taxes imposed on the use of water resources. Items (i), (iv), (v), and (vi) were direct taxes, whereas (ii) and (iii) were indirect taxes. The local level taxes levied comprised (i) property tax, (ii) land tax, (iii) advertisement tax, (iv) utility tax, (v) registration tax, (vi) motor vehicle tax, and (vii) trade license tax. As per Government Resolution No. 159, dated 20 August 1999, SMEs were given the option from tax year 2000 of paying a simplified and unified income tax rate of 25% of their gross income. If SMEs opted for this simplified tax, they were exempt from liability for local taxes on property, land, and advertisement. They would still be liable to pay their trade, license, motor vehicle, and utility taxes, but these latter taxes could be offset against their gross income for income tax purposes. SMEs exercising such option could not, however, deduct environmental, natural resources, and water use taxes from gross income. The Presidential Decree On Additional Measures to Encourage Export Producers, dated 5 June 2000, provided SMEs with a 100% tax exemption on their export incomes notwithstanding the provisions of the new tax code. This new tax system definitely reduced the multiplicity of taxes and the arbitrariness in their interpretation. The system streamlined tax policy by offering a lower tax rate with fewer exemptions and deductions. C. Banking and Credit Policy Reform 12. In the past, the Central Bank of Uzbekistan had restricted enterprises' right to withdraw cash from their bank accounts, except to pay wages, salaries, and travel expenses in accordance with their quarterly cash plans. This measure impinged on enterprises' ability to withdraw cash for other needs. To ameliorate this problem, a Presidential Decree dated 21 March 2000 allowed SMEs to withdraw cash deposited up to 90 days prior to date in order to pay for raw material supplies. SMEs were also allowed to withdraw cash up to 50% of their

66 Appendix 4

turnover during the last 3 months and deposited into their bank accounts, to a maximum of SUM500,000 in each withdrawal. These steps did not go far enough, however, as they did not erase SMEs' general distrust of banks that has discouraged efficient financial intermediation while promoting instead a parallel and informal market for cash transactions. The unfettered right of cash withdrawal was possible from 2005. 13. To address the distortions in credit mechanisms, as part of the policy dialogue this loan provided for (i) setting onlending rates for ADB’s loan funds in foreign exchange on a market determined basis, (ii) passing the exchange risk to subborrowers, and (iii) determining the subproject eligibility based on objective financial criteria (para. 15). Since the domestic interest rates were administered, ADB’s loan did not finance any local currency lending. These measures sought to eliminate distortions in the pricing and delivery of credit from the ADB loan to the private sector. While the ADB loan made foreign exchange available to SMEs at market interest rates, SMEs also needed timely access to adequate working capital in domestic currency, ideally at market interest rates. Thus, only those viable subprojects having access to adequate domestic currency working capital funds were eligible for financing under the loan. Taking lessons from the REDP, this loan had suitable measures for subproject selection (para. 15). At the SMEs’ micro level, the Government agreed to ADB’s measures (i) requiring banks to finance SMEs’ local currency working capital requirements (if the SMEs could not finance their working capital through equity) to complement the foreign exchange funding from ADB’s loan, and (ii) calculating subprojects’ financial internal rates of return and their debt service coverage ratios at informal exchange rates to determine subprojects’ vulnerability to currency depreciation. D. Exchange Rate Policy Reform 14. To address the distortions in its exchange rate regime, the Government, in consultation with ADB, agreed to a major policy reform. The Government instituted two measures: (i) it required all SMEs in the country (and not merely those financed under the ADB loan) to purchase foreign exchange for their inputs (comprising capital goods, materials, and technology) and make loan repayments at the commercial exchange rate; and (ii) it allowed all SME exporters to surrender the mandatory 50% of export earnings at the commercial exchange rate. The Government guaranteed foreign exchange availability to all SMEs at the prevailing commercial rate. The two measures (i) eliminated the subsidy on capital goods imports and tax on exports for all SMEs;9 (ii) helped create equal opportunities among SMEs in the country; (iii) encouraged SME exporters to (a) not underinvoice their exports, and (b) repatriate their export earnings to Uzbekistan promptly; and (iv) offset the disadvantages and high transaction costs SMEs face (vis-à-vis larger, state-owned enterprises) in their foreign trade operations. This exchange rate policy (agreed under policy dialogue) was consistent with Uzbekistan's overall macroeconomic objectives of current account convertibility and exchange rate unification. Moreover, it complemented important domestic policy reforms already undertaken. The two measures were expected to help Uzbekistan to realize its SME sector’s potential comparative advantage while contributing to greater value addition, employment generation, and exports. The Government agreed to this important policy covenant as a condition of loan effectiveness. This was the first step toward overall exchange rate unification and current account convertibility achieved in 2003.

9 Hitherto SMEs had obtained their foreign exchange at the overvalued official rate and had to surrender 50% of their

foreign exchange earnings also at the official rate.

Appendix 4 67

E. Addressing SMEs’ Internal Constraints 15. To assist SMEs in addressing their internal constraints relating to management, finance, and marketing skills, the Government created several support institutions. These were the Chamber of Commodity Producers and Entrepreneurs (CCPE), Small and Medium Enterprises Development Association, and Market Skills Development Center. The CCPE is a support group that represents the interests of SMEs in policy, institutional, and legal areas. It was created through a government decree in 1996 on a self-sustaining basis with membership fees from its constituents. It functions under the Cabinet of Ministers. It has a network of 14 sub-chambers and 183 regional centers. Market Skills Development Center is an independent center functioning under the overall authority of the Chamber. It specializes in training entrepreneurs in commercial practices, and particularly in assisting SMEs to identify market niches. The Business Communication Center (BCC) is a service organization assisting SMEs to access FDI and negotiate transaction and policy approvals with government agencies. BCC supports SMEs by (i) helping attract FDI; (ii) maintaining an information base of the Uzbekistan industrial, commercial, and legal environment to assist local entrepreneurs and foreign investors; and (iii) identifying export markets for SMEs. It also provides consultancy services to SMEs and foreign investors on technical, legal, financial, and commercial matters. BCC was established by an initiative of European Union Technical Assistance for the Commonwealth of Independent States (EU-TACIS) as a private-sector, self-financing entity without any Government equity financing. These agencies provide information and services to SMEs regarding (i) legal and regulatory policies, (ii) potential export markets for their output, (iii) potential FDI, (iv) negotiations with Government and financial institutions for financial assistance, (v) interface with potential foreign investors and collaborators, and (vi) training of SME entrepreneurs in modern business and commercial practices. Policy dialogue under the loan brought the Small and Medium Enterprises Development Association, CCPE, and BCC into association with the participating banks for helping nascent SMEs in accessing technology, management expertise and in preparing business plans. F. Selection of Viable Subprojects 16. The following financial criteria for subproject selection were applied: (i) at least 25% of subproject costs were to be financed by the subborrowers through equity; (ii) subprojects were required to have estimated financial internal rates of return not less than their weighted average costs of capital in real terms; (iii) subborrowers were required to maintain debt service coverage ratios of no less than 1.5 within 3 years from the date of the subloan’s disbursement or when the subproject’s production reached full capacity, whichever was earlier; (iv) subborrowers were required to have a minimum return on assets of 12% by the time the subproject reached full production capacity; (v) subborrowers were required to earn revenues adequate to service the foreign currency debt repayment on schedule; (vi) subborrowers were required to have collateral of at least 120% of the value of the subloan; (vii) subborrowers were required to have adequate working capital finance in domestic currency, and (viii) state ownership in any SME was not to exceed 25%. 17. The subprojects were required to meet the following social criteria: (i) working hours in factories for workers to be limited to 12 hours a day, (ii) adequate safety and health protection measures to be provided to workers against occupational hazards inherent in the workplace, and (iii) no minors (under 16 years of age) could be employed in any subproject.

68 Appendix 5

SUBLOAN CHARACTERISTICS

1. Thirty-one subloans were financed under the loan. Eight were financed by National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU), eight by Asaka Bank (AB), and 15 by Pakhta Bank (PB). These subloans were widely distributed by loan size, maturity, purpose, region, sector, and subborrower ownership, as discussed below and shown in Table A5.1. 2. Twelve subloans were for amounts below $1 million and represent 13.8% of the loan amount, 10 subloans were for amounts of $1–2 million and constitute 32.8% of the loan, and the remaining nine subloans were for amounts of $2–3 million and total to 53.4% of the loan. Two subloans totaling $0.83 million (1.8% of the loan) were for maturities of 1–4 years, 18 subloans totaling $21.01 million (44.3% of the loan) had maturities of 4–6 years, six totaling $16.76 million (35.4% of the loan), were for tenors of 6–7 years, and the remaining five subloans totaling $8.80 million (18.5% of the loan) were for 7–8 years. 1 Cumulatively, 24 subloans totaling $37.77 million (79.7% of the loan) were for 4–7 years. Since this loan financed only subprojects’ foreign exchange costs, and mainly for purchasing capital equipment, which has a long gestation period, it is understandable that almost 80% of the lending was for periods of 4–7 years. 3. Twenty-four subloans (68.4% of the loan amount) financed new subprojects while seven subloans (31.6% of the loan amount) were to modernize and expand existing undertakings. This is not surprising, as there were relatively few private sector SMEs already in operation when the loan became effective relative to those newly established and in need of financing. 4. Eleven subloans totaling $17.13 million (36.2% of the loan) were made to subborrowers in the Tashkent region, six subloans totaling $9.08 million (19.2%) were to subborrowers in the Ferghana region, and three subloans totaling $7.59 million (16.0%) went to subborrowers in the Bukhara region. The remaining 11 subloans totaling $13.60 million were made to subborrowers in other regions. Regional analysis of subloans’ distribution indicates that 20 of the 31 subloans (72.30%) were made in Uzbekistan’s relatively more fertile and hence affluent regions, where the climate was more favorable than in such arid and poorer regions as Karakalpakstan or Khorezm. 5. Sectorally, 16 of the 31 subloans totaling $20.2 million (42.6% of the loan) were made to agro-processing and related industries, which were situated mainly in the country’s more fertile and relatively affluent regions. Seven subloans totaling $17.5 million (37.0%) were made to subprojects in the yarn, textile, and garment sector, which is understandable considering these industries’ value addition to cotton. The remaining eight subloans totaling $9.6 million (20.4%) were distributed over construction industry sectors. Twelve subloans totaling $14.66 million (30.9%) were made to wholly Uzbek-owned SMEs while 19 subloans (69.1%) were made to joint ventures. These ventures had agreements with their foreign investors to provide equity investment and technology, and in many cases to market the subprojects’ exports. Joint ventures were therefore relatively better placed to manage their exchange risks than wholly domestic-owned entities selling in the domestic market. Given that this project preferred subprojects that could better mitigate their exchange risks, its preference for joint ventures is unsurprising.

1 The loan required that participating commercial banks’ subloans to subborrowers have a maximum tenor of 8 years

inclusive of a grace period not exceeding 3 years.

Appendix 5 69

Table A5.1: General Characteristics

Item Number % Amount ($) % A. Purpose

New Project 24 77.4 32,406,866 68.4 Modernization 4 12.9 9,469,000 12.7 Expansion 3 9.7 5,528,238 11.6

Total (A) 31 100.0 47,404,104 100.0 B. Size

$500,000–$1 million 12 38.7 6,535,126 13.8 $1 million–$2 million 10 32.3 15,562,165 32.8 $2 million–$3 million 9 29.0 25,306,813 53.4

Total (B) 31 100.0 47,404,104 100.0 C. Maturity

1–4 years 2 6.5 832,500 1.8 4.1–6 years 18 58.1 21,016,489 44.3 6.1–7 years 6 19.4 16,758,844 35.4 7.1–8 years 5 16.1 8,796,271 18.5

Total (C) 31 100.0 47,404,104 100.0 D. Region

Tashkent 11 35.5 17,134,536 36.2 Ferghana 6 19.4 9,084,578 19.2 Khorezm 1 3.2 495,000 1.0 Karakalpakstan 1 3.2 337,500 0.7 Samarkand 3 9.7 4,382,818 9.2 Andijan 2 6.5 3,580,450 7.6 Bukhara 3 9.7 7,595,838 16.0 Surkhandarya 1 3.2 557,080 1.2 Kashkadarya 1 3.2 1,100,000 2.3 Djizak 1 3.2 1,836,304 3.9

Total (D) 31 100.0 47,404,104 100.0 E. Subsector

Ladies’ Footwear 1 3.2 2,976,094 6.3 T-shirt Production 2 6.5 3,079,102 6.5 Yarn Production 5 16.1 14,466,778 30.5 Metal and Polyvinyl Chloride (PVC) Panel Window

2 6.5 2,644,699 5.6

Marble Tiles 1 3.2 1,836,304 3.9 Fruit Juices Puree Paste 8 25.8 13,195,239 27.8 Cookies Production 1 3.2 843,430 1.8 Edible Sunflower Seed Oil 3 9.7 1,543,880 3.3 Dried Fruits, Vegetables and Flowers 2 6.5 1,299,920 2.7 Pasta Production 1 3.2 361,998 0.8 Feeds 2 6.5 1,202,318 2.5 Polypropylene sacks 2 6.5 998,580 2.1 Beer 1 3.2 2,955,762 6.2

Total (E) 31 100.0 47,404,104 100.0 F. Ownership

Wholly Uzbek 12 38.7 14,661,057 30.9 Joint Venture 19 61.3 32,743,047 69.1

Total (F) 31 100.0 47,404,104 100.0 Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, and Pakhta Bank.

70 Appendix 5

Table A5.2: General Characteristics Bankwise Breakdown

No. % Amount % No. % Amount % No. % Amount % No. % Amount %

A. PurposeNew Project 5 62.5 10,584,778 54.2 6 75.0 11,168,179 76.3 13 86.7 10,653,909 80.6 24 77.4 32,406,866 68.4Modernization 2 25.0 6,000,000 30.7 2 25.0 3,469,000 23.7 4 12.9 9,469,000 20.0Expansion 1 12.5 2,955,762 15.1 2 13.3 2,572,476 19.4 3 9.7 5,528,238 11.6

Total (A) 8 100.0 19,540,540 100.0 8 100.0 14,637,179 100.0 15 100.0 13,226,385 100.0 31 100.0 47,404,104 100.0

B. Size$100,000-$500,000 1 12.5 337,500 2.3 4 26.7 1,548,348 11.7 5 16.1 1,885,848 4.0$500,000-$1 million 7 46.7 4,649,278 35.2 7 22.6 4,649,278 9.8$1 million-$2 million 3 37.5 4,618,000 23.6 4 50.0 6,415,406 43.8 3 20.0 4,528,759 34.2 10 32.3 15,562,165 32.8$2 million-$3 million 5 62.5 14,922,540 76.4 3 37.5 7,884,273 53.9 1 6.7 2,500,000 18.9 9 29.0 25,306,813 53.4$3 million-$4 million$4 million-$5 million

Total (B) 8 100 19,540,540 100 8 100.0 14,637,179 100.0 15 100.0 13,226,385 100 31 100.0 47,404,104 100.0

C. Maturity1-2 years2.1-4 years 1 12.5 337,500 2.3 1 6.7 495,000 3.7 2 6.5 832,500 1.84.1-6 years 3 37.5 4,618,000 23.6 3 37.5 4,579,102 31.3 12 80.0 11,819,387 89.4 18 58.1 21,016,489 44.36.1-7 years 5 62.5 14,922,540 76.4 1 12.5 1,836,304 12.5 6 19.4 16,758,844 35.47.1-8 years 3 37.5 7,884,273 53.9 2 13.3 911,998 6.9 5 16.1 8,796,271 18.5

Total (C) 8 100 19,540,540 100.0 8 87.5 14,637,179 100.0 15 100.0 13,226,385 100.0 31 100.0 47,404,104 100.0

D. RegionSamarkand 2 25 3,518,000 18.0 1 7 864,818 6.5 3 10 4,382,818 9.2Djizzak 1 12.5 1,836,304 12.5 1 3 1,836,304 3.9Khorezm 1 7 495,000 3.7 1 3 495,000 1.0Syrdariya 1 12.5 1,300,000 8.9 1 3 1,300,000 2.7Tashkent 1 13 2,955,762 15.1 4 50.0 8,994,375 61.4 6 40 5,184,399 39.2 11 35 17,134,536 36.2Bukhara 2 25 5,966,778 30.5 1 7 1,629,060 12.3 3 10 7,595,838 16.0Karakalpakstan 1 12.5 337,500 2.3 1 3 337,500 0.7Andijan 1 13 3,000,000 15.4 1 7 580,450 4.4 2 6 3,580,450 7.6Ferghana 1 13 3,000,000 15.4 1 12.5 2,169,000 14.8 4 27 3,915,578 29.6 6 19 9,084,578 19.2Kashkadarya 1 13 1,100,000 5.6 1 3 1,100,000 2.3Surkhandarya 1 7 557,080 4.2 1 3 557,080 1.2

Total (D) 8 100.0 19,540,540 100.0 8 100.0 14,637,179 100.0 15 100 13,226,385 100.0 31 100 47,404,104 100.0

E. OwnershipWholly Uzbek 3 37.5 7,023,840 35.9 1 12.5 2,169,000 14.8 8 53.3 5,468,217 41.3 12 38.7 14,661,057 30.9Joint Venture 5 62.5 12,516,700 64.1 7 87.5 12,468,179 85.2 7 46.7 7,758,168 58.7 19 61.3 32,743,047 69.1

Total (E) 8 100.0 19,540,540 100.0 8 100.0 14,637,179 100.0 15 100.0 13,226,385 100.0 31 100.0 47,404,104 100.0

Item

TotalNational Bank for Foreign Economic Activity of the Republic of Uzbekistan

Asaka Bank Pakhta Bank

Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, and Pakhta Bank.

Appendix 5 71

Table A5.3: Subloan by Purpose

Subloan Subloan TotalNo. Amount New Project Modernization Expansion

1. SC "Oltin Meva" 010 1,100,000 1,100,0002. JSC "Ishonch" 012 3,000,000 3,000,0003. SC "Rohat Kibray" 016 2,955,762 2,955,7624. JSC "Balikchi" 020 3,000,000 3,000,0005. JV "Peshkuteks" 021 2,998,700 2,998,7006. SC "Kattakurgan-Meva" 025 1,759,000 1,759,0007. JV "Oqtosh-Meva" 028 1,759,000 1,759,0008. SC "Zumrud" 034 2,968,078 2,968,078

Subtotal 19,540,540 10,584,778 6,000,000 2,955,762 19,540,540Percentage 54.2% 30.7% 15.1% 100.0%No. of subloans 5 2 1 8Percentage 62.5% 25.0% 12.5% 100.0%

1. JV "Delta Invest" 003 2,976,094 2,976,0942. JV "BIG" 005 1,500,000 1,500,0003. ООО "Jizzak Mramor" 006 1,836,304 1,836,3044. АООТ "Kuva Koncerva" 011 2,169,000 2,169,0005. JV "El Kol" 022 2,739,179 2,739,1796. JV "Aral Invest" 023 337,500 337,5007. JV "Lola Model" 029 1,300,000 1,300,0008. JV "Shark Model" 030 1,779,102 1,779,102

Subtotal 14,637,179 11,168,179 3,469,000 14,637,179Percentage 76.3% 23.7% 0.0% 100.0%No. of subloans 6 2 8Percentage 75.0% 25.0% 0.0% 100.0%

1. "Food Industry" Quqon Non 002 361,998 361,9982. "Osiyo Express" 008 1,755,000 1,755,0003. "Khonka Qop" 009 495,000 495,0004. "Ilonsay Parranda" Ltd 014 864,818 864,818 5. "Yorqishloq" 017 580,450 580,4506. "Agrobriks" (Aseptik) 018 285,000 285,000

7."Roison Building Tehn." Dudilnozmir 024 1,144,699 1,144,699

8. "Osiyo Tijorat Savdo" 026 503,580 503,5809. "Surkhan Export" 027 557,080 557,08010. "Margilontekstil" 031 2,500,000 2,500,00011. Buhoro Golden Fruit 032 1,629,060 1,629,06012. "Laser Oqoltin" 033 843,430 843,43013. "Mega Dry" 037 550,000 550,00014. "Zuloiha-J.A" 038 406,350 406,35015. "Agrar Tehnologiyalari" JV 040 749,920 749,920

Subtotal 13,226,385 10,653,909 2,572,476 13,226,385Percentage 80.6% 0.0% 19.4% 100.0%No. of subloans 10 0 5 15Percentage 66.7% 0.0% 33.3% 100.0%Grand Total 47,404,104 32,406,866 9,469,000 5,528,238 47,404,104Percentage 68.4% 20.0% 11.7% 100.0%

31 Total Number of subloans 21 4 6 31Percentage 67.7% 12.9% 19.4% 100.0%

JSC=joint stock company, JV=joint venture.

Asaka Bank

Pakhta Bank

PurposeSubborrower

National Bank for Foreign Economic Activity of the Republic of Uzbekistan


72 Appendix 5

Table A5.4: Subloan by Maturity

Subloan Maturity Subloan TotalNo. (years) Amount 1-2 2.1-4 4.1-6 6.1-7 7.1-8 Amount

1. SC "Oltin Meva" 010 5.5 a 1,100,000 1,100,0002. JSC "Ishonch" 012 7 m 3,000,000 3,000,0003. SC "Rohat Kibray" 016 6 m 2,955,762 2,955,7624. JSC "Balikchi" 020 7 m 3,000,000 3,000,0005. JV "Peshkuteks" 021 6 e 2,998,700 2,998,7006. SC "Kattakurgan-Meva" 025 5 a 1,759,000 1,759,0007. JV "Oqtosh-Meva" 028 5 a 1,759,000 1,759,0008. SC "Zumrud" 034 6 e 2,968,078 2,968,078

Subtotal 19,540,540 4,618,000 14,922,540 19,540,540Percentage 23.6% 76.4% 100.0%No. of subloans 3 5 8Percentage 37.5% 62.5% 100.0%

1. JV "Delta Invest" 003 8 s 2,976,094 2,976,0942. JV "BIG" 005 6 m 1,500,000 1,500,0003. ООО "Jizzak Mramor" 006 7 e 1,836,304 1,836,3044. АООТ "Kuva Koncerva" 011 7.75 a 2,169,000 2,169,0005. JV "El Kol" 022 8 e 2,739,179 2,739,1796. JV "Aral Invest" 023 4 S 337,500 337,5007. JV "Lola Model" 029 5.5 r 1,300,000 1,300,0008. JV "Shark Model" 030 5.5 r 1,779,102 1,779,102

Subtotal 14,637,179 337,500 4,579,102 1,836,304 7,884,273 14,637,179Percentage 2.3% 31.3% 12.5% 53.9% 100.0%No. of subloans 1 3 1 3 8Percentage 12.5% 37.5% 12.5% 37.5% 100.0%

1. "Food Industry" Quqon Non 002 4-8 a 361,998 361,9982. "Osiyo Express" 008 5 e 1,755,000 1,755,0003. "Khonka Qop" 009 4 R 495,000 495,0004. "Ilonsay Parranda" Ltd 014 5 m 864,818 864,8185. "Yorqishloq" 017 5 r 580,450 580,4506. "Agrobriks" (Aseptik) 018 4 a 285,000 285,000

7."Roison Building Tehn." Dudilnozmir 024 5 w 1,144,699 1,144,699

8. "Osiyo Tijorat Savdo" 026 5 503,580 503,5809. "Surkhan Export" 027 5 r 557,080 557,08010. "Margilontekstil" 031 5 r 2,500,000 2,500,00011. Buhoro Golden Fruit 032 6 a 1,629,060 1,629,06012. "Laser Oqoltin" 033 6 a 843,430 843,43013. "Mega Dry" 037 8 i 550,000 550,00014. "Zuloiha-J.A" 038 5 r 406,350 406,35015. "Agrar Tehnologiyalari" JV 040 6 l 749,920 749,920

Subtotal 13,226,385 495,000 11,819,387 911,998 13,226,385Percentage 3.7% 89.4% 6.9% 100.0%No. of subloans 1 12 2 15Percentage 6.7% 80.0% 13.3% 100.0%Grand Total 832,500 21,016,489 16,758,844 8,796,271 47,404,104Percentage 1.8% 44.3% 35.4% 18.6% 100.0%Total Number of subloans 2 18 6 5 31Percentage 6.5% 58.1% 19.4% 16.1% 100.0%


Years

Asaka Bank

Pakhta Bank


Subborrower


Appendix 5 73

Table A5.5: Subloan by Region

Subloan Subloan Tashkent Ferghana Syrdariya Khorezm Samarkand Andijan Bukhara Djizzak TotalNo. Amount

1. SC "Oltin Meva" 010 1,100,000 1,100,0002. JSC "Ishonch" 012 3,000,000 3,000,0003. SC "Rohat Kibray" 016 2,955,762 2,955,7624. JSC "Balikchi" 020 3,000,000 3,000,0005. JV "Peshkuteks" 021 2,998,700 2,998,7006. SC "Kattakurgan-Meva" 025 1,759,000 1,759,0007. JV "Oqtosh-Meva" 028 1,759,000 1,759,0008. SC "Zumrud" 034 2,968,078 2,968,078

Subtotal 19,540,540 2,955,762 3,000,000 3,518,000 3,000,000 5,966,778 1,100,000 19,540,540Percentage 15.1% 15.4% 18.0% 15.4% 30.5% 5.6% 100.0%No. of subloans 1 1 2 1 2 1 8Percentage 12.5% 12.5% 25.0% 12.5% 25.0% 12.5% 100.0%

1. JV "Delta Invest" 003 2,976,094 2,976,0942. JV "BIG" 005 1,500,000 1,500,0003. ООО "Jizzak Mramor" 006 1,836,304 1,836,3044. АООТ "Kuva Koncerva" 011 2,169,000 2,169,0005. JV "El Kol" 022 2,739,179 2,739,1796. JV "Aral Invest" 023 337,500 337,5007. JV "Lola Model" 029 1,300,000 1,300,0008. JV "Shark Model" 030 1,779,102 1,779,102

Subtotal 14,637,179 8,994,375 2,169,000 1,300,000 337,500 1,836,304 14,637,179Percentage 61.4% 14.8% 8.9% 2.3% 12.5% 100.0%No. of subloans 4 1 1 1 1 8Percentage 50.0% 12.5% 12.5% 12.5% 12.5% 100.0%

1. "Food Industry" Quqon Non 002 361,998 361,9982. "Osiyo Express" 008 1,755,000 1,755,0003. "Khonka Qop" 009 495,000 495,0004. "Ilonsay Parranda" Ltd 014 864,818 864,8185. "Yorqishloq" 017 580,450 580,4506. "Agrobriks" (Aseptik) 018 285,000 285,000

7."Roison Building Tehn." Dudilnozmir 024 1,144,699 1,144,699

8. "Osiyo Tijorat Savdo" 026 503,580 503,5809. "Surkhan Export" 027 557,080 557,080

10. "Margilontekstil" 031 2,500,000 2,500,000

11. Buhoro Golden Fruit 032 1,629,060 1,629,06012. "Laser Oqoltin" 033 843,430 843,43013. "Mega Dry" 037 550,000 550,00014. "Zuloiha-J.A" 038 406,350 406,35015. "Agrar Tehnologiyalari" JV 040 749,920 749,920

Subtotal 13,226,385 5,184,399 3,915,578 495,000 864,818 580,450 1,629,060 557,080 13,226,385Percentage 39.2% 29.6% 3.7% 6.5% 4.4% 12.3% 4.2% 100.0%No. of subloans 6 4 1 1 1 1 1 15Percentage 40.0% 26.7% 6.7% 6.7% 6.7% 6.7% 6.7% 100.0%Grand Total 47,404,104 17,134,536 9,084,578 1,300,000 495,000 337,500 4,382,818 3,580,450 7,595,838 557,080 1,100,000 1,836,304 47,404,104 Percentage 36.1% 19.2% 2.7% 1.0% 0.7% 9.2% 7.6% 16.0% 1.2% 2.3% 3.9% 100.0%Total Number of subloans 11 6 1 1 1 3 2 3 1 1 1 31 Percentage 35.5% 19.4% 3.2% 3.2% 3.2% 9.7% 6.5% 9.7% 3.2% 3.2% 3.2% 100.0%



Asaka Bank

Pakhta Bank

Karakal- pakstan

Surkhan-darya

Kashka-darya

Subborrower


74 Appendix 6

IMPLEMENTATION AND INTERNAL OPERATIONAL AND FINANCIAL PERFORMANCE OF SUBPROJECTS

Table A6.1: Operational and Financial Performance of Subprojects

A. National Bank for Foreign Economic Activity of the Republic of Uzbekistan

Subloan WACC

Date Sum

National Bank for Foreign Economic Activity of the Republic of Uzbekistan SC “Oltin Meva" 1/ 14 May 02 1,100,000 5.5

ADB interest rate+ NBU margin (4.6%)

23 Jul 02 1,100,000 24.6% 20% 0% 0.00 0.0% 4.13 705.0% 2.04 689.0% 1.72 1069.0% 0.00 0.0%

JSC “Ishonch” 10 Jun 02 3,000,000 7 ADB interest rate+ NBU margin (4.55%)

27 Jan 03 3,000,000 11.5% 27% 39% - -1847.0% 4.48 709.0% 2.01 1406.0% 1.58 1572.0% 2.72 12.0% 1.60 0.0%

JSC “Balikchi” 15 Aug 02 3,000,000 7 ADB interest rate+ NBU margin (4.2%)

06 Aug 03 3,000,000 11.7% 26% 38% 1.98 - 1.11 - 1.29 - 1.39 -1.7% 0.15 18.0% 1.43 20.0%

SC “Kattakurgan-Meva” 03 May 03 1,759,000 5 LBL+ADB interest rate +NBU margin (4,8%)

23 Jun 03 1,759,000 12.0% 25% 81% 0.00 0.0% 0.00 0.0% 0.00 0.0% 0.65 280.0% 1.71 19.0% 1.40 16.0%

JY “Oqtosh-Meva” 08 Jul 03 1,759,000 5 ADB interest rate +NBU margin (4,3%)

17 Jul 03 1,759,000 12.0% 27% 24% 0.00 0.0% 0.00 0.0% 0.00 0.0% 0.16 246.0% 0.00 0.0% 0.00 0.0%

JV “Peshkutex” 20 Sep 02 2,998,700 6 LBL+ADB interest rate +NBU margin (4,18%)

15 Nov 04 2,698,830 12.9% 24% 13% - - - - - - 1.00 - 1.80 18.0% 1.91 9.5%

SC “Zumrud” 30 Jan 04 2,968,080 6 LBL+ADB inerest rate +NBU margin (3,7%)

11 May 04 2,919,150 12.0% 27% 0% - - - - - - 1.00 - 0.0% 0.0%

SC “Rohat Kibray” 09 Jul 02 2,955,760 6 ADB interest rate + 4,79%

18 Jun 03 3,000,000 12.5% 39% 24% 0.00 0.0% 0.00 0.0% 1.40 15.0% 2.30 18.0% 1.20 23.0% 1.10 14.0%

Subborrower

2001 2002 2003 2005Interest

rateAmount disbursed

No financial report. Subborrower was declared bankrupt on 11 July 2006.

DSCR ROAProject FIRR

at Subproject Approval

FIRRa

at PCRtime

DSCRDSCR2004

DSCR ROASubloan Approval

SubloanAmount

Duration (years)

ROA2006

DSCR ROADSCR ROA ROA

a Based on actual cash flows until 2006 and projected cash flows until 2010.DSCR=debt service coverage ratio, FIRR=financial internal rate of return, JSC=joint stock company, JV=joint venture, ROA=return on assets, SC=stock company, WACC=weighted average cost of capital.Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

Appendix 6 75

B. Asaka Bank

Subloan WACC

Date SumAsaka Bank

26 Dec 02 2,453,729

13 Dec 04 285,450

15 Apr 03 303,750

10 Sep 04 33,750

JV "Delta Invest" 25 Jan 02 2,976,094 8.0 ADB margin+4% (Margin of Asaka Bank) 08 Feb 02 2,976,094 13.7% 24.2% 0.0% 0.00 1.0% 0.00 -3.7%

JV "Shark Model" 10 Nov 03 1,779,102 5.5LIBOR + 0,6% (ADB

margin) + 4% (Margin of Asaka Bank)

22 Dec 03 1,827,500 16% 58.6% 0.0% 0.00 7.7%

OOO "Jizzak Mramor" 25 Jan 02 1,836,304 7.0 ADB margin+4% (Margin of Asaka Bank) 22 Jan 02 1,836,304 14.5% 21.3% 0.0% 0.00 0.0% 0.00 0.0% 0.00 0.9%

JV "Lola Model" 10 Nov 03 1,300,000 5.5LIBOR + 0,6% (ADB

margin) + 4% (Margin of Asaka Bank)

22 Dec 03 1,300,000 16% 87% 0.0% - - - - - - (1731.75) -6.0% (309.53) -4.0% (345.21) -4.0%

27 Mar 03 882,000 0.00 1.0% 0.00 0.1% (0.00) -0.1% 0.00 0.0% 0.00 0.0%

26 Jan 04 491,400

25 Aug 05 795,600

15 May 02 323,873 (0.01) -7.0% (0.31) 17.0% (0.37) 15.0% (0.25) -21.0% (0.10) -21.0%

21 Jun 02 427,287

01 Jul 02 442,487

03 Oct 02 306,353

Source: Asaka Bank.

a Based on actual cash flows until 2006 and projected cash flows until 2010.

ADB margin+4% (Margin of Asaka Bank) 53.1%JV "El Kol" 23 Oct 02 2,739,179 8.0 14.8%

DSCR=debt service coverage ratio, FIRR=financial internal rate of return, JSC=joint stock company, JV=joint venture, ROA=return on assets, SC=stock company, WACC=weighted average cost of capital.

0.2%0.0% (0.00)-0.1% -8.0%0.00

JV "Aral Invest" 06 Dec 02 337,500 4.0 ADB margin+4% (margin of Asaka Bank) 36.9% 0.0%

AOOT "Kuva Konserva" 14 May 02 2,169,000 7.75 ADB margin+4% (Margin of Asaka Bank) 33.6% 0.0%

19%

48.8% 0.0%JV "BIG" 25 Jan 02 1,500,000 6.0 12.2%ADB margin+4% (Margin of Asaka Bank)

18%

0.1%

2003 2004 2005DSCR ROA DSCR ROADSCR ROADSCR ROA

Subborrower

Project FIRR at

Subproject Approval

FIRRa

at PCRtime

2001 2002DSCR ROA

2006Subloan Approval

SubloanAmount

Duration (years)

Interestrate

Amount disbursed DSCR ROA

76 Appendix 6

C. Pakhta Bank

Subloan Project FIRR

Subloan Subloan Interest WACC at Subproject DSCR ROA DSCR ROA DSCR ROA DSCR ROA DSCR ROA DSCR ROASubborrower Approval Amount Rate Date Sum ApprovalPakhta Bank"Food Industry" (Quqon non) 21 Nov 01 361,998 8 yrs 6.50% 07 Jul 03 361,998 15% 17% 24% 2.30 2.0% 1.10 4.0%

Osiyo Express 04 Mar 02 1,755,000 5 yrs 9%

23 Oct 02 13 Nov 02 15 Nov 02 20 Dec 02 05 Mar 03

1,755,000 13% 27% 3% 11.00 7.0% 4.50 3.0% 4.00 -4.0% 1.00 12.0%

Khonka Qop 06 Mar 02 495,000 4 yrs 9% 09 Dec 02 495,000 15% 61% 25% 4.00 7.0% 2.00 12.0% 2.10 18.0% 2.40 26.0%

Ilonsay Parranda 11 Jun 02 864,818 5 yrs 7,9%+0,6%+LIBOR

28 Feb 03 09 Jul 03 864,818 13% 28% 2.40 14.0% 3.60 18.0% 4.90 18.0% 1.50 12.0%

Yorqishloq 25 Jul 02 580,450 5 yrs 8.50% 10 Mar 03 13 May 03 580,450 19% 32% 0.00 0.0% 0.00 0.0% 0.00 0.0%

"Agrobriks" (Aseptik) 15 Aug 02 285,000 5 yrs 7% 05 Apr 04 285,000 14% 24% 36% 2.50 4.0% 2.50 28.0%"Roison Building Tehn." (Dudilnozmir) 17 Jan 03 1,144,699 5 yrs 6.50% 26 Sep 03

24 Feb 04 1,144,699 13% 59% 133% 5.70 58.0% 2.20 50.0%

Osiyo Tijorat Savdo 19 Mar 03 503,580 5 yrs 8.50% 01 Dec 04 503,580 13% 50% 28% 7.30 13.0% 3.00 -1.0% 4.70 18.0%

Surkhan Export 15 Apr 03 557,080 5 yrs 8.50% 10 Oct 03 25 Jul 05 557,080 19% 30% 0.00 0.0% 0.00 0.0% 0.00 0.0%

Margilontekstil 08 Dec 03 2,500,000 6 yrs 7.80% 25 Jan 05 07 Mar 05 2,500,000 14% 24% 2% 5.20 -18.0% 0.10 -26.0% 0.70 6.0%

Buhoro Golden Fruit (Fruit World Ltd) 17 Dec 03 1,629,060 6 yrs 8% 06 Apr 04

20 Apr 04 1,629,060 13% 24% 21% 7.20 21.0% 3.00 29.0% 1.50 41.0%

Laser Oqoltin 18 Dec 03 843,430 6 yrs 8.50% 20 Jul 05 843,430 11% 42% 0.00 0.0% 0.00 0.0% 0.00 0.0% 0.00 0.0%

Mega Dry 18 Mar 04 550,000 8 yrs 4% 01 Dec 04 18 Jul 05 550,000 13% 28% 30% 21.30 72.0% 14.10 3.0% 27.00 8.0%

Zuloiha-J.A. 03 May 04 406,350 5 yrs 9% 17 Jun 05 406,350 18% 34% 38% 6.70 17.0% 4.00 26.0%Agrar Tehnologiyalari 23 Jul 04 749,920 6 yrs 8.50% 20 Jul 05 749,920 13% 71% 25% 2.40 -11.0% 3.90 19.0%


2005 2006FIRR at PCR

timeAmount disbursed2003 2004

Duration (years)

DSCR=debt service coverage ratio, FIRR=financial internal rate of return, ROA=return on assets, WACC=weighted average cost of capital.

a Based on actual cash flows until 2006 and projected cash flows until 2010.

20022001

Appendix 6 77

Table A6.2: Repayment Record of Subborrowers as of 31 March 2007

Arrear Principal Interest Total Principal Interest Total Principal Interest Total Rate (%)

A. National Bank for Foreign Economic Activity of the Republic of UzbekistanSC “Oltin Meva 14 May 02 1,100,000 900,000 426,676 1,326,676 51,504 29,359 80,863 848,496 397,317 1,245,813JSC “Ishonch” 10 Jun 02 3,000,000 2,627,273 517,191 3,144,464 990,911 517,191 1,508,102 1,636,362 (0) 1,636,362SC “Rohat Kibray” 9 Jul 02 2,955,760 2,350,000 618,660 2,968,660 1,400,000 618,994 2,018,994 950,000 (334) 949,666JSC “Balikchi” 15 Aug 02 3,000,000 2,900,000 593,981 3,493,981 241,460 593,981 835,440 2,658,540 0 2,658,540JV “Peshkutex” 20 Sep 02 2,998,700 600,000 457,592 1,057,592 600,000 457,592 1,057,592 0 0 0SC “Kattakurgan-Meva” 3 Mar 03 1,759,000 800,001 449,829 1,249,829 800,001 449,829 1,249,829 0 0 0JY “Oqtosh-Meva” 8 Jul 03 1,759,000 800,000 370,509 1,170,509 800,000 370,509 1,170,509 0 0 0SC “Zumrud” 30 Jan 04 2,968,080 530,000 460,020 990,020 320,000 460,020 780,020 210,000 0 210,000

Subtotal (A) 19,540,540 11,507,274 3,894,458 15,401,732 5,203,875 3,497,475 8,701,350 6,303,399 396,983 6,700,382 43.50B. Asaka BankJV "Delta Invest" 25 Jan 02 2,976,094 1,119,215 1,217,320 2,336,535 0 292,903 292,903 1,119,215 924,417 2,043,632JV "BIG" 25 Jan 02 1,500,000 920,000 828,790 1,748,790 191,818 595,342 787,160 728,182 233,448 961,630ООО "Jizzak Mramor" Ltd. 25 Jan 02 1,836,304 650,000 956,561 1,606,561 25,133 162,038 187,171 624,867 794,523 1,419,390АООТ "Kuva Koncerva" 14 May 02 2,169,000 1,167,923 951,412 2,119,335 15,850 486,551 502,401 1,152,073 464,861 1,616,934JV "El Kol" 23 Oct 02 2,739,179 1,362,462 855,419 2,217,881 8,630 164,467 173,097 1,353,832 690,952 2,044,784JV "Aral Invest" 6 Dec 02 337,500 337,500 73,738 411,238 0 29,632 29,632 337,500 44,106 381,606JV "Lola Model" 10 Nov 03 1,300,000 812,500 257,540 1,070,040 70,500 170,352 240,852 742,000 87,188 829,188JV "Shark Model" 10 Nov 03 1,779,102 913,750 384,418 1,298,168 45,688 147,791 193,479 868,062 236,627 1,104,689

Subtotal (B) 14,637,179 7,283,350 5,525,198 12,808,548 357,619 2,049,076 2,406,695 6,925,731 3,476,122 10,401,853 81.21C. Pakhta Bank"Food Industry" (Quqon non) 21 Nov 01 361,998 209,271 159,843 369,114 21,900 95,988 117,888 187,371 63,855 251,226Osiyo Express 04 Mar 02 1,755,000 1,501,300 371,813 1,873,113 406,347 371,813 778,160 1,094,953 0 1,094,953Khonka Qop 06 Mar 02 495,000 495,000 116,729 611,729 495,000 116,729 611,729 0 (0) (0)Llonsay Parranda 11 June 02 864,818 864,818 103,892 968,710 864,818 103,892 968,710 0 0 0Yorqishloq 25 July 02 580,450 325,692 68,151 393,843 197,926 68,151 266,077 127,766 0 127,766"Agrobriks" (Aseptik) 15 Aug 02 285,000 57,000 59,573 116,573 28,500 41,990 70,490 28,500 17,583 46,083"Roison Building Tehn" (Dudilnozmir) 17 Jan 03 1,144,699 1,144,699 280,565 1,425,264 1,144,699 280,565 1,425,264 0 (0) (0)Osiyo Tijorat Savdo 19 Mar 03 503,580 57,008 107,671 164,679 38,900 107,671 146,571 18,108 0 18,108Surkhan Export 15 Apr 03 557,080 366,000 153,712 519,712 34,834 34,834 366,000 118,878 484,878Marg Ilontekstil 08 Dec 03 2,500,000 260,000 553,145 813,145 60,000 279,953 339,953 200,000 273,192 473,192Buhoro Golden Fruit (Fruit World Ltd) 17 Dec 03 1,629,060 595,564 428,325 1,023,889 599,088 428,325 1,027,413 (3,524) 0 (3,524)Laser Oqoltin 18 Dec 03 843,430 169,115 168,526 337,641 1,350 1,350 169,115 167,176 336,291Mega Dry 18 Mar 04 550,000 124,528 59,353 183,881 28,794 28,794 124,528 30,559 155,087Zuloiha-J.A. 03 May 04 406,350 87,075 83,968 171,043 29,025 83,968 112,993 58,050 0 58,050Agrar Tehnologiyalari 23 Jul 04 749,920 38,000 151,285 189,285 38,000 151,198 189,198 0 87 87

Subtotal (C) 13,226,385 6,295,070 2,866,551 9,161,621 3,924,203 2,195,222 6,119,425 2,370,867 671,329 3,042,196 33.21Total 47,404,104 25,085,694 12,286,207 37,371,901 9,485,697 7,741,773 17,227,470 15,599,997 4,544,434 20,144,431 53.90

Amount Due For Repayment Arrears as of 31 March 2007

JSC=joint stock company, JV=joint venture.Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, Pakhta Bank, and Asian Development Bank.

RepaymentSubborrower

ApprovalDate

SubloanAmount

78 Appendix 6

Table A6.3: Summary of Drawdowns

Subborrower Subloan Approval Subloan TotalNo. Date Amount 2001 2002 2003 2004 2005 2006


SC “Oltin Meva 010 14 May 02 1,100,000 646,000 454,000 1,100,000JSC “Ishonch” 012 10 Jun 02 3,000,000 3,000,000 3,000,000SC “Rohat Kibray” 016 9 Jul 02 2,955,762 2,955,762 2,955,762JSC “Balikchi” 020 15 Aug 02 3,000,000 2,500,000 500,000 3,000,000JV “Peshkutex” 021 20 Sep 02 2,998,700 2,698,830 299,870 2,998,700SC “Kattakurgan-Meva” 025 3 Mar 03 1,759,000 1,759,000 1,759,000JY “Oqtosh-Meva” 028 8 Jul 03 1,759,000 1,759,000 1,759,000SC “Zumrud” 034 30 Jan 04 2,968,078 2,968,078 2,968,078

Subtotal (A) 19,540,540 646,000 12,427,762 6,166,908 299,870 19,540,540B. Asaka BankJV "Delta Invest" 003 25 Jan 02 2,976,094 2,976,094 2,976,094JV "BIG" 005 25 Jan 02 1,500,000 1,500,000 1,500,000ООО "Jizzak Mramor" 006 25 Jan 02 1,836,304 1,836,304 1,836,304АООТ "Kuva Koncerva" 011 14 May 02 2,169,000 882,000 491,400 795,600 2,169,000JV "El Kol" 022 23 Oct 02 2,739,179 2,453,729 285,450 2,739,179JV "Aral Invest" 023 6 Dec 02 337,500 303,750 33,750 337,500JV "Lola Model" 029 10 Nov 03 1,300,000 1,165,920 134,080 1,300,000JV "Shark Model" 030 10 Nov 03 1,779,102 1,472,489 306,613 1,779,102

Subtotal (B) 14,637,179 6,312,398 3,639,479 3,129,809 1,081,050 474,443 14,637,179C. Pakhta Bank"Food Industry" (Quqon non) 002 21 Nov 01 361,998 361,998 361,998Osiyo Express 008 04 Mar 02 1,755,000 1,667,250 87,750 1,755,000Khonka Qop 009 06 Mar 02 495,000 495,000 495,000Llonsay Parranda 014 11 June 02 864,818 864,818 864,818Yorqishloq 017 25 July 02 580,450 580,450 580,450"Agrobriks" (Aseptik) 018 15 Aug 02 285,000 285,000 285,000"Roison Building Tehn." (Dudilnozmir) 024 17 Jan 03 1,144,699 978,718 108,746 57,235 1,144,699Osiyo Tijorat Savdo 026 19 Mar 03 503,580 503,580 503,580Surkhan Export 027 15 Apr 03 557,080 532,000 25,080 557,080Marg Ilontekstil 031 08 Dec 03 2,500,000 2,500,000 2,500,000Buhoro Golden Fruit (Fruit World Ltd) 032 17 Dec 03 1,629,060 1,629,060 1,629,060Laser Oqoltin1/ 033 18 Dec 03 843,430 843,430 843,430Mega Dry 037 18 Mar 04 550,000 320,000 230,000 550,000Zuloiha-J.A. 038 03 May 04 406,350 406,350 406,350Agrar Tehnologiyalari 040 23 Jul 04 749,920 749,920 749,920

Subtotal (C) 13,226,385 2,162,250 3,405,734 2,846,386 4,754,780 57,235 13,226,385Total 47,404,104 9,120,648 19,472,975 12,143,103 6,135,700 531,678 47,404,104

JSC=joint stock company; JV=joint venture. Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, Pakhta Bank and Asian Development Bank.

Drawdowns

Appendix 6 79

Table A6.4: Jobs Created by Subborrower

Subborrower SubloanNo.

Direct Indirect Total Direct Indirect TotalA. National Bank for Foreign Economic Activity of the Republic of UzbekistanSC "Oltin Meva" 010 25 25 423 423JSC "Ishonch" 012 98 98 98 915 1,013SC "Rohat Kibray" 016 40 40 47 578 625JSC "Balikchi" 020 98 98 98 429 527JV "Peshkuteks" 021 100 100 97 0 97SC "Kattakurgan-Meva" 025 47 47 43 1,800 1,843JV "Oqtosh-Meva" 028 47 47 47 2,100 2,147SC "Zumrud" 034 98 98 0

Subtotal (A) 553 553 430 6,245 6,675B. Asaka BankJV "Delta Invest" 003 99 84 183JV "BIG" 005 27 4 31 29 4 33ООО "Jizzak Mramor" 006 38 3 41АООТ "Kuva Koncerva" 011 82 82 50 12 62JV "El Kol" 022 39 4 43 39 5 44JV "Aral Invest" 023 21 2 23JV "Lola Model" 029 97 80 177 126 116 242JV "Shark Model" 030 94 75 169 15 2 17

Subtotal (B) 497 252 749 259 139 398C. Pakhta Bank"Food Industry" Quqon Non 002 30 30 34 34"Osiyo Express" 008 93 93 100 20 120"Khonka Qop" 009 84 84 87 87"Ilonsay Parranda" Ltd 014 10 10 13 13"Yorqishloq" 017 31 31"Agrobriks" (Aseptik) 018 17 7 24 40 20 60"Roison Building Tehn." Dudilnozmir 024 20 20 20 20"Osiyo Tijorat Savdo" 026 32 32 68 68"Surkhan Export" 027 26 26"Margilontekstil" 031 98 98 96 96Buhoro Golden Fruit (Fruit World Ltd) 032 28 28 128 128"Laser Oqoltin" 033 17 17"Mega Dry" 037 67 67 307 307"Zuloiha-J.A" 038 27 27 52 52"Agrar Tehnologiyalari" JV 040 49 50 99 36 50 86

Subtotal (C) 629 57 686 981 90 1,071Total 1,679 309 1,988 1,670 6,474 8,144

JSC=joint stock company, JV=joint venture.Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan, Asaka Bank, and Pakhta Bank. All jobs listed were created after this Project began and are therefore incremental.

Jobs CreatedProjected Actual

80 Appendix 6

Table A6.5: Exports Created

Subloan AmountSubborrower No. ($)A. National Bank for Foreign Economic Activity of the Republic of Uzbekistan a

Oltin Meva 010Ishonch 012 3,598,401Rokhat-Kibray 016Balikchi 020 3,085,626Peshkuteks 021 549,196Kattakurgan-Meva 025 3,315,596Oqtosh Meva 028 2,005,727Zumrut 034

Subtotal (A) 12,554,546

B. Pakhta Bank b

Quqon Non 002Osiyo Express 008 744,635Khonka Qop 009Llonsay Parranda 014Yorqishloq 017Aseptic 018 334,685Dudilnozmir 024 6,420,156Osiyo Tijorat Savdo 026Surkhan Export 027Margilantekstil (JV Martex) 031Fruit World Ltd. 032 1,267,225Laser Oqoltin 033Mega Dry 037 206,396Zuloiha-J.A. 038Agrar Tehnologiyalari 040 456,400

Subtotal (B) 9,429,497Total 21,984,043 a National Bank for Foreign Economic Activity of the Republic of Uzbekistan provided data for 6 out of 8 subprojects. Only 1 of its borrower cater exclusively to the domestic market. Borrower for Subloan No. 010 was declared bankrupt on 11 July 2006, hence no financial report was presented. Borrower for Subloan No. 034 has not started production process due to the delay in commissioning equipment. b Pakhta Bank provided data for 10 out of 15 subprojects. Five of its subborrowers cater exclusively to the domestic market. Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan and Pakhta Bank.

Appendix 6 81

Table A6.6: Subloan Processing Date

Date of ADB SubloanSubborrower First Approval Processing

Submission Date (Days)

1. 010 Oltin Meva 18 Mar 02 14 May 02 572. 012 Ishonch 2 Jun 02 10 Jun 02 83. 016 Rokhat-Kibray 8 May 02 9 Jul 02 624. 020 Balikchi 30 Jul 02 15 Aug 02 165. 021 Peshkuteks 31 Aug 02 20 Sep 02 206. 025 Kattakurgan-Meva 4 Feb 03 3 Mar 03 277. 028 Oqtosh Meva 27 Jun 03 8 Jul 03 118. 034 Zumrut 2 Dec 03 30 Jan 04 59

Total 260Average subloan processing time 32.50

1. 003 Delta 25 Oct 01 25 Jan 02 922. 005 Building Industrial 29 Nov 01 25 Jan 02 57

Group3. 006 Djizak-Mramor 25 Jun 01 25 jan 02 2144. 011 Kuva Konserva 2 May 02 14 May 02 125. 022 Elkol 7 Sep 02 23 Oct 02 466. 023 Aral Invest 19 Oct 02 6 Dec 02 487. 029 Lola Model 29 Oct 03 10 Nov 03 128. 030 Shark Model 29 Sep 03 10 Nov 03 42


1. 002 Quqon Non 2 Jul 01 21 Nov 01 1422. 008 Osiyo Express 29 Nov 01 4 Mar 02 943. 009 Khonka Qop 13 Dec 01 6 Mar 02 844. 014 Llonsay Parranda 30 May 02 11 Jun 02 125. 017 Yorqishloq 15 Jul 02 25 Jul 02 106. 018 Aseptic 8 Jul 02 15 Aug 02 387. 024 Dudilnozmir 10 Jan 03 17 Jan 03 78. 026 Osiyo Tijorat Savdo 12 Feb 03 19 Mar 03 359. 027 Surkhan Export 3 Apr 03 15 Apr 03 1210. 031 Margilantekstil 27 Oct 03 8 Dec 03 4211. 032 Fruit World Ltd. 12 Dec 03 17 Dec 03 512. 033 Laser Oqoltin 15 Dec 03 18 Dec 03 313. 037 Mega Dry 2 Mar 04 18 Mar 04 1614. 038 Zuloiha-J.A. 6 Apr 04 3 May 04 2715. 040 Agrar Tehnologiyalari 22 Jun 04 23 Jul 04 31


Total days 1,314Average processing time 42.39

C. Pakhta Bank


B. Asaka Bank

Subloan No.

ADB=Asian Development Bank. Source: Asian Development Bank.

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82

COMPLIANCE WITH COVENANTS

Covenants Reference to Loan Documents Status

1. The Borrower shall furnish, or cause to be furnished, to ADB all such reports and information as ADB shall reasonably request concerning (i) the Loan, and the expenditure of the proceeds and maintenance of the service thereof; (ii) the Project; (iii) the qualified enterprises, the qualified projects, and the subloans; (iv) the administration, operation and financial condition of the Project Executing Agencies; (v) financial and economic conditions in the territory of the Borrower and the international balance-of-payments position of the Borrower; and (vi) any other matters relating to the purposes of the loan.

Loan Agreement, Article 4, Section 4.02

Complied with.

2. Except as ADB may otherwise agree, the proceeds of each part of the loan shall be used only for making a subloan to the qualified enterprise in respect of which such part of the loan was withdrawn from the loan account and shall be applied exclusively to the cost of goods and services required to carry out the qualified project in respect of which such part of the loan was withdrawn.

Loan Agreement, Article 3, Section 3.03 (b) and Project Agreement Article II, Section 2.01 (b)

Pakhta Bank breached this covenant.

3. The Project Executing Agencies shall at all times make adequate provision to protect themselves against any loss resulting from changes in the rate of exchange between sum and the currency or currencies in which the Project Executing Agencies' outstanding money obligations will have to be met.

Project Agreement, Article III, Section 3.02

Complied with.

4. The Project Executing Agencies shall not make a subloan to any qualified enterprise unless such qualified enterprise has at its disposal, or has made appropriate arrangements to obtain as and when required, all local currency funds, including adequate working capital, and other resources which are required by such qualified enterprise for the carrying out of its qualified project in respect of which the subloan is to be made.


Substantially complied with.

5. Each of the Project Executing Agencies shall maintain records and accounts adequate to record the progress of each qualified project (including the cost thereof) it lends to, and to reflect in accordance with consistently maintained sound accounting principles, its own operations and financial condition.


Complied with.

6. (a) ADB and the Project Executing Agencies shall cooperate fully to ensure that the purposes of the loan are accomplished.

(b) The Project Executing Agencies shall promptly inform

ADB of any condition which interferes with, or threatens to interfere with, the progress of the Project, the performance of its obligations under this Project Agreement or the Subsidiary Loan Agreement, or the accomplishment of the purposes of the loan.

(c) ADB and each of the Project Executing Agencies shall

from time to time, at the request of either party, exchange views through their representatives with regard to any matters relating to the Project, the Project Executing Agency and the loan.


Complied with.

7. (a) Each of the Project Executing Agencies shall furnish to ADB all such reports and information as ADB shall

Project Agreement, Article III,

Complied with.

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83


reasonably request concerning (i) the loan and the expenditure of the proceeds thereof; (ii) the project; (iii) the qualified enterprises, the qualified projects and the subloans; (iv) the administration, operations and financial condition of the Project Executing Agency; and (v) any other matters relating to the purposes of the loan.

(b) Without limiting the generality of the foregoing, each of

the Project Executing Agencies shall furnish ADB with quarterly reports on the execution of the Project and on the operation and management of the Project Executing Agency. Such reports shall be submitted in such form and in such detail and within such a period as ADB shall reasonably request, and shall indicate, among other things, progress made and problems encountered during the quarter under review, steps taken or proposed to be taken to remedy these problems, and proposed program of activities and expected progress during the following quarter.

(c) Promptly after the closing date for withdrawals from the

loan account, but in any event not later than three (3) months after the said closing date or such later date as ADB may agree for this purpose, each of the Project Executing Agencies shall prepare and furnish to ADB a report, in such form and in such detail as ADB shall reasonably request, on the utilization of the loan, the execution of the qualified projects, their costs, the performance by Project Executing Agency of its obligations under this Project Agreement and, the accomplishment of the purposes of the loan.

Section 3.06 Complied with. Complied with.

8. Each of the Project Executing Agencies shall have its accounts and financial statements (balance sheet, statement of income and expenses, and related statements) audited annually, in accordance with appropriate auditing standards consistently applied, by independent auditors whose qualifications, experience and terms of reference are acceptable to ADB, and shall, promptly after their preparation but in any event not later than six (6) months after the close of the fiscal year to which they relate, furnish to ADB (i) certified copies of such audited accounts and financial statements and (ii) the report of the auditors relating thereto (including the auditors' opinion on the use of loan proceeds and compliance with the covenants of the loan agreement), all in the English language. The Project Executing Agencies shall furnish to ADB such further information concerning such accounts and financial statements and the audit thereof as ADB shall from time to time reasonably request.

Project Agreement, Article III, Section 3.07, para.(a)

Complied with.

9. Each of the Project Executing Agencies shall enable ADB’s representatives to inspect any qualified enterprise, any qualified project, the goods financed out of the proceeds of the loan, and any relevant records and documents.


Complied with.

10. (a) The Project Executing Agencies shall, promptly as required, take all action within their powers to maintain their corporate existence, to carry on their operations, and to acquire, maintain and renew all rights, properties, powers, privileges and franchises which are necessary in the carrying out of the Project

Project Agreement, Article III Section 3.09 (a)

Complied with. Complied with.

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84


or in the conduct of their business. Except as the Bank may otherwise agree, the Project Executing Agencies shall not sell, lease, transfer or otherwise dispose of any of their assets, except in the ordinary course of their business. The Project Executing Agencies shall immediately inform ADB whenever they establish or acquire any subsidiary, provided that, except as ADB may otherwise agree, the Project Executing Agencies shall seek ADB’s approval prior, to establishing a subsidiary or acquiring any portion of another enterprise for an amount equivalent to at least $3,000,000 in the case of PB and AB, and $5,000,000 in the case of NBU.

Project Agreement

Article III Section 3.09 (c) Project Agreement, Article III Section 3.09 (d)

Complied with.

11. Each of the Project Executing Agencies shall cause each of their subsidiaries (if any) to observe and perform the obligations of the Project Executing Agency under this project agreement to the extent to which such obligations may be applicable thereto, as though such obligations were binding upon each of such subsidiaries.

Project Agreement Article III Section 3.10

Complied with.

12. Except as ADB may otherwise agree, the Project Executing Agencies shall duly perform all their obligations under the subsidiary loan agreements and shall not take, or concur in, any action which would have the effect of assigning, amending, abrogating or waiving any rights or obligations of the parties under the subsidiary loan agreements.

Project Agreement Article III Section 3.11

Complied with.

13. The amount of the loan may be withdrawn from the loan account to finance the reasonable foreign-currency cost of goods and services required for the qualified project, including the initial incremental foreign-currency working capital necessary to operationalize the fixed investment.

Project Agreement Article II Section 2.01 (a)

Complied with.

14. (a) Whenever any one of the Project Executing Agencies proposes to make a subloan, the Project Executing Agency shall, before requesting a withdrawal, submit to ADB an application for approval of such subloan. Such application shall be in a form satisfactory to ADB and shall contain a description and appraisal of the qualified project, the terms and conditions of the proposed subloan and such other information as the Bank shall reasonably request.

(b) No withdrawal shall be made in respect of a Subloan

unless the Bank shall have authorized withdrawals from the Loan Account.

(c) Except as ADB may otherwise agree, the applications and

information required by paragraph (a) of this Section shall be submitted to ADB not later than a date three (3) years after the Effective Date.

Project Agreement Article II Section 2.02

Complied with.

15. Notwithstanding any provision herein to the contrary:

(i) no request for disbursement shall be eligible for financing in respect of amounts expended (for the cost of a qualified. project) more than one hundred twenty (120) days prior to receipt by the Bank of the corresponding


Complied with.

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85


request for withdrawal; (ii) no request for disbursement shall be eligible for financing

in respect of an import letter-of-credit, until the requesting Project Executing Agency shall have paid the amounts under letter-of-credit that are subject of the request for disbursement; and

(iii) no request for disbursement shall be eligible for financing if

made after five (5) years from the Effective Date.

16. (a) Each subloan shall carry interest at a commercial rate that takes into account the cost of funds, administrative costs, credit risk, and a reasonable margin of profit and shall be made on terms whereby the Project Executing Agencies shall obtain, by a written agreement with the qualified enterprise in form acceptable to ADB, rights adequate to protect the interests of the Borrower, the Project Executing Agencies and ADB.

(b) Except as ADB may otherwise agree, the amortization

schedule applicable to each subloan (i) shall not extend beyond eight (8) years, including a grace period not exceeding three (3) years, from the date when such subloan is approved or authorized for withdrawals from the loan account pursuant to Section 2.02(a) or, (b) of this project agreement; and (ii) shall provide for a repayment schedule of principal and interest based on the cash-flow forecasts of the qualified project for which the subloan is made.

Project Agreement Article II Section 2.04 (a)

Loan Agreement Section 2.06 (b) and Project Agreement Section 2.04 (b)

NBU/AB/PB breached this covenant. NBU breached this covenant.

17. Without limiting the, generality of the foregoing provisions of Section 2.04 of the project agreement and in addition to any other provision which a prudent lender would request, each subloan agreement shall include provisions to the effect that: (i) the qualified enterprise shall carry out and operate the

qualified project with due diligence and efficiency and in accordance with sound administrative, financial, business and environmental practices, including maintenance of adequate accounts and records;

(ii) the proceeds of the loan shall be used only.for procurement

in eligible source countries as specified by ADB, in. accordance with procedures acceptable to ADB, of goods produced in, and services supplied from, such countries;

(iii) the goods and services to be financed out of the proceeds

of the loan shall be used exclusively in the carrying out of the qualified project;

(iv) ADB and the relevant Project Executing Agency shall each

have the right to inspect such goods, the qualified enterprise, the qualified project and any relevant records and documents;

(v) the qualified enterprise shall take out and maintain with

responsible insurers insurance against such risks and in such amounts as shall be consistent with sound business practice, and without any limitation upon the foregoing, such


Complied with.

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86


insurance shall cover hazards incident to the acquisition, transportation and delivery of goods financed out of the proceeds of the loan to the place of use. or installation, and for such insurance any indemnity shall be payable in a currency freely usable to replace or repair such goods;

(vi) ADB and the relevant Project Executing Agency shall each

be entitled to obtain all such information as each shall reasonably request relating to the subloan, the goods and services financed out of the proceeds of the loan, the qualified project, the qualified enterprise and other related matters; and

(vii) The relevant Project Executing Agency shall be entitled to

suspend or terminate further access by the qualified enterprise to the use of the proceeds of the loan upon failure by the qualified enterprise to perform its obligations under its agreement with such Project Executing Agency

18. The Project Executing Agencies shall promptly and effectively exercise their rights in relation to each qualified project in accordance with the standards of a prudent lender and in such manner as to protect the interests of the Borrower, the Project Executing Agencies, and ADB.

Project Agreement, Article II, Section 2.06

Not complied. NBU and PB rescheduled subloans when there was no necessity to do so. AB’s subloan monitoring was inadequate.

19. Subsidiary Loan Agreements Except as the Bank may otherwise agree, the terms and conditions for each of the subsidiary loan agreements shall be identical to the terms and conditions of the loan agreement with regard to interest rates, commitment charges, and repayment and grace periods. In addition, the Project Executing Agencies shall pay for, out of the proceeds of their respective subsidiary loans, the front-end fee that is payable on the loan. Each Project Executing Agency shall be liable for such portion of the said front-end fee that is equivalent to its proportionate share in the proceeds of the loan. On or after the Effective Date, ADB shall be entitled to withdraw from the proceeds of the loan and pay to itself, on behalf of the Borrower, the amount of the front-end fee due on the loan. The withdrawal by ADB of loan proceeds in payment for the front-end fee shall be deemed as payment to the Borrower of the front-end fee and performance by the Project Executing Agencies of their obligation under this paragraph.

Project Agreement Schedule, para.1

Complied with.

20. Project Executing Agencies (i) Each of the Project Executing Agencies shall maintain: (i) a

capital adequacy ratio not lower than 12%, calculated in accordance with the formula adopted by the Basle Committee of Banking Supervision, (ii) a loan to deposit ratio not higher than 100%, (iii) a return on assets ratio not lower than 1.00%, (iv) loan loss provisions made in accordance with accepted international practice adequate to cover nonperforming portfolio, (v) a maximum exposure to a single borrower or group of borrowers (excluding loans fully guaranteed by the Borrower) not exceeding 15% of capital resources, and (vi) commencing on 31 December 2002, a maximum exposure to any sector not exceeding 20% of total portfolio.

Project Agreement Schedule, paras. 2-4

Complied with.

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87


(ii) The Borrower and each of the NBU, AB, and PB shall ensure that the Bank is given an opportunity to comment on any substantial amendment that may be proposed to any of the NBU, AB, or PB Charter, respectively. Each of NBU, AB, and PB shall be required to (i) consult with the Bank prior to making a change to any of their Operational Policies that would materially affect Project implementation, and (ii) inform the Bank of any changes in the appointment of their chairperson.

(iii) Each of the Project Executing Agencies shall establish

within the first year of project implementation revolving funds, which shall be funded out of repayment on the subloans, to make fresh subloans to new subborrowers within the overall timeframe of the Project.

21. Qualified Projects and Qualified Enterprises

(i) The Project Executing Agencies shall select and appraise

specific development projects for financing under the loan in accordance with sound banking and financial principles and procedures.

(ii) The Project. Executing Agencies shall appraise proposed

qualified projects in accordance with a standard appraisal report format that shall be agreed upon between the Project Executing Agencies and ADB. The appraisal reports shall include a business plan and projected financial statements (including income statements, balance sheets and cash flow statements) and an explanation of the assumptions on which such statements are based.

(iii) The Project Executing Agencies shall appraise proposed

qualified enterprises on the basis of the enterprise's financial, managerial and technical competence and shall consider the enterprise's marketing and procurement requirements, as well as the enterprise's financial viability, employment and environmental impact.

(iv) Provided they are projected to generate sufficient foreign-

currency revenues adequate to service, whenever due, the subloan proposed to finance them, and, provided further, they do not involve the production of firearms, narcotics, tobacco or spirits, the following shall be considered qualified projects:

(a) projects that are potential export-earners; and (b) projects that save foreign exchange through import

substitution. Subject to the foregoing qualifications, preference shall be given to projects that propose to utilize locally-sourced material inputs and that have a. high job creation impact.


Complied with.

22. Subloans (i) The cost of acquisition of land-use rights, taxes and duties,

and wages shall not be eligible for financing under the loan or any subloan.


Complied with.

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(ii) The minimum subloan size shall be $50,000, and the

maximum subloan size shall be $3,000,000. Whenever necessary, the Project Executing Agencies shall finance such portion of the local currency cost of a qualified project that is in excess of the subborrower's 25% equity contribution.

(iii) Every subloan shall be submitted to ADB for approval, and

every application for approval shall be submitted together with a feasibility report prepared by the relevant Project Executing Agency

(iv) The Project Executing Agencies shall require each of their

subborrowers to meet and maintain the following financial obligations and covenants:

(a) The subborrower shall finance, by way of equity

contribution, at least 25% of the total cost of the qualified project. For this purpose, cash and existing fixed assets that are necessary for the qualified project shall be deemed part of equity contribution;

(b) The subborrower shall maintain, over the subloan

period, a financial internal rate of return (FIRR) that is not less than the weighted average cost of the qualified project's capital in real terms;

(c) The subborrower shall achieve a debt service coverage

ratio of not less than 1.5 times by no later than the earlier of (a) three years after the date of first disbursement under the subloan, or (b) the date when production under the qualified project reaches full capacity, and thereafter maintain it;

(d) The subborrower shall achieve a return on assets ratio

of not less than 12% by no later than the date the qualified project reaches full production capacity, and thereafter maintain it;

(e) The subborrower shall maintain collateral coverage of

at least 120% of the value of the subloan for the term of the subloan; and

(f) The subborrower shall bear the foreign exchange risk

on the subloan.

23. (i) The Project Executing Agencies shall require each of their Subborrowers to comply with the following social-standard covenants:

(a) Working hours on the factory floor shall be limited to a

maximum of 12 hours a day from any worker or group of workers;

(b) Workers shall be provided with adequate safety and

health protection measures to guard against any occupational hazard inherent to the workplace; and

(c) No minors under 16 years of age shall be employed in


Complied with.

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any Qualified Project financed under the Loan. (ii) The Project Executing Agencies shall ensure that Qualified

Projects comply with the requirements of all applicable environmental laws and regulations in force in Uzbekistan from time to time, including compliance with environmental quality standards and requirements for environmental impact assessment, as well as ADB's environmental assessment requirements. The Project Executing Agencies shall also ensure that all local planning and environmental approvals for qualified projects have been obtained and that appropriate environmental safeguards and equipment for compliance are built into each qualified project, as necessary.

24. Monitoring and Evaluation

The Project Executing Agencies shall monitor the financial and economic performance of qualified projects, as well as evaluate their socioeconomic and environmental benefits. In addition, a random sample of six qualified projects shall be selected for ongoing, long-term benefit monitoring and evaluation. Specific data collection and reporting formats shall be developed and implemented in a computerized database. Specific areas to be covered include: (i) financial and operational performance of the qualified projects; (ii) direct employment creation and impact on the poor, women, and other vulnerable groups; (iii) export orientation and import substitution effect of the subprojects; and (iv) indirect employment creation attributable to the qualified projects (e.g., through supply of factors and input).

Project Agreement Schedule, para. 15

Complied with.

25. Procurement (i) For procurement of goods and services to be financed by

subloans made out of the proceeds of the loan, the Project Executing Agencies require their subborrowers to demonstrate that the procurement procedures adopted by them are appropriate in the circumstances, and were conducted in a transparent manner in conformance with the ADB's Anticorruption Policy. Each of the Project Executing Agencies shall ensure and certify to ADB that the goods and services financed by such subloans have been procured from a member country of ADB and purchased at. a reasonable price, taking into account relevant factors such as time of delivery, efficiency and reliability of the goods, their suitability for the qualified project, ,the availability of maintenance facilities and spare parts, and, in the case of services, of their quality and the competence of the parties rendering them.

(ii) The Project Executing Agencies shall require qualified

enterprises to adopt international competitive bidding procedures where the amount of investment is sufficiently large and where it would be in the interest of efficiency and economy to follow such procedures.

(iii) The Project Executing Agencies shall ensure that all ADB

financed goods and services procured (including without limitation all computer hardware, software and systems, whether separately procured or incorporated within other


Complied with.

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goods and services procured) do not violate or infringe any industrial property or intellectual property right or claim of any third party.

(iv) The Project Executing Agencies shall ensure that all Bank-

financed contracts for the procurement of goods and services contain appropriate representations, warranties and, if appropriate, indemnities from the contractor or supplier with respect to the matters referred to in paragraph 18 of this Schedule.

26. Withdrawals from the Loan Account

(i) The Project Executing Agencies shall be responsible for

collecting and furnishing to ADB copies of relevant documents (including contracts, letters of credit, evidence of payment and bills of lading) for the disbursement of loan proceeds.

(ii) The Project Executing Agencies shall retain, until at least

one year after ADB shall have received the report of the auditors for the fiscal year in which the last withdrawal from the loan account shall have been made, all records and other relevant documents which formed the basis for withdrawal from the loan account.


Complied with.

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91

OVERALL ASSESSMENT OF THE PROJECT

Criterion Weight %

Performance Details Rating Description

Rating Value

Weight Rating

1. Relevance 20 The Project’s impact and outcome (goal and objectives) were relevant at the time of its appraisal and throughout its implementation. Its impact and outcome were consistent with the Government’s development goals and with ADB’s country operational strategy (COS) for Uzbekistan approved in March 2000. The main goal of ADB’s COS was to assist Uzbekistan’s orderly transition to a market economy with emphasis on supporting the emerging private sector. The COS gave high priority to small and medium enterprise (SME) development as a means to this end. The Project’s design incorporated the lessons learned from ADB’s earlier loan to Uzbekistan (Loan 1504-UZB: Rural Enterprise Development Project). Through policy dialogue, the Project’s design brought about legal and regulatory reforms to create a more enabling environment for SMEs’ operations in Uzbekistan. It sought to enhance institutional support for nascent SMEs’ access to technology, management, and business plans preparation. Most importantly, the conditionalities for effectiveness of this loan made the first step towards Uzbekistan’s current account convertibility and exchange rate unification. No changes in project scope or implementation arrangements were necessary. Uzbekistan’s SME sector’s contribution to GDP fell from 12% in 1996 to 8% in 1998. In 2006 it accounted for 42% of GDP. The reversal of this declining trend reflects the relevance of ADB’s recommended policy interventions in the design and formulation of the Project.

Relevant 2 0.40

2. Effectiveness 30 The overall outcome of the Project is effective. The loan was committed and disbursed within its schedule. No extensions were necessary. Policy interventions under the Project allowed growth of the SME sector’s contribution to GDP from 8% in 1998 to 42% in 2006 (against a target of 9% by 2002). Policy reforms envisaged under the Project occurred, albeit at a pace slower than envisaged. Uzbekistan acceded to the International Monetary Fund’s Article VIII in 2003, allowing for current account convertibility and exchange rate unification, and thereby ending exchange rate distortions. Beginning in October 2001 when the loan became effective, Uzbekistan abolished the requirement for SME exporters to surrender 50% of their exchange earnings at the overvalued official exchange rate. SMEs’ unfettered right to withdraw cash from their bank accounts was granted, albeit in 2006. The SME sector’s specific legal, regulatory, and policy measures listed in the design monitoring framework were broadly complied. Thirty-one subprojects (against a target of 71) were financed under the loan. Subprojects’ exports in 2006 were $21.98 million against a target of $90.8 million. Direct employment generated was 1,670 against a target of 3,000. Indirect employment generated was 6,474 against a target of 3,000. The quality of financial intermediation was mixed. The financial condition of

Effective 2 0.60

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92

Criterion Weight %

Performance Details Rating Description

Rating Value

Weight Rating

two of the three participating banks deteriorated during the Project’s implementation.

3. Efficiency 30 The Project was less efficient than was envisaged at appraisal in its outcome and outputs. Eight of the 31 subprojects were successful, having (i) financial internal rates of return (FIRR) equal to or higher than their weighted average costs of capital, (ii) debt service coverage ratios at 1.5 or higher, (iii) returns on assets at or higher than 12%, and (iv) repaid their loans on schedule. Seven of the 31 subprojects were partially successful in meeting (i) to (iv) above but defaulted on subloan repayments. Sixteen subprojects were unsuccessful, as their financial performances failed to meet the parameters and they defaulted on their repayments. Overall, the subloan arrears rate under this loan was 53.9%. NBU and Pakhta Bank (PB) in seven cases rescheduled loans for nonbanking considerations (i.e., where the subborrowers’ financial parameters did not necessitate the rescheduling). All eight subloans made by Asaka Bank (AB) were in arrears and failed to meet ADB’s covenants in these areas. NBU’s financial ratios for its liquidity and profitability failed to meet ADB’s stipulated covenants during 2001–2006. AB’s profitability failed to meet the covenanted levels during 2001–2006. Its liquidity met ADB’s covenanted level for the first time in 2006. Only PB maintained a sound financial condition during 2001–2006 in terms of solvency, profitability, and liquidity and met ADB’s covenants in these areas. Overall, financial intermediation of the three PCBs under this loan was less efficient.

Less efficient

1 0.30

4. Sustainability 20 The overall outcome of the Project is less sustainable. Fifteen of the 31 subprojects with subloans totaling $22.1 million (44% of the loan amount) are sustainable, with their FIRRs equal to or greater than their weighted average costs of capital and cash flows adequate to service their debt on time. Of these 15, only eight subprojects were successful in actually servicing their debt on schedule. These eight together generated direct employment for 471 people and indirect employment for 3,950 and accounted for 54.3% of all jobs generated by the Project. Five of these eight subprojects in 2006 generated exports worth $13.96 million (61.9% of the total project exports of $21.98 million). The remaining 16 subprojects with subloans totaling $28 million (56% of the loan amount) were unsuccessful, failing to achieve the financial ratios stipulated in the loan documents and to repay their subloans.

Less likely 1 0.20

OVERALL WEIGHTED RATING 1.50 AB=Asaka Bank, ADB=Asian Development Bank, COS=country operational strategy, FIRR=financial internal rate of return, GDP=gross domestic product, NBU=National Bank for Foreign Economic Activity of the Republic of Uzbekistan, PB=Pakhta Bank, SME=small and medium enterprise.