Document o f The World Bank

FOR OFFICIAL, USE ONLY

Report No: 42806-NI

PROJECT APPRAISAL DOCUMENT

O N A

PROPOSED CREDIT

IN THE AMOUNT OF SDR 12.3 MILLION (US$20 MILLION EQUIVALENT)

TO THE

REPUBLIC OF NICARAGUA

FOR A

MICRO, SMALL, AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

May 14,2008

Poverty Reduction and Economic Management Central America Country Management Unit Latin America and Caribbean Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. I t s contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS (Exchange Rate Effective May 8,2008)

B C N CABEI

CAMIPYME

CDD CETREX

COSUDE

FI FNI

DAF

DFID

DGI

DR-CAFTA

DTNM

EU FIAS

FOGADE

FOGAPE

FNI

FTA

Currency Unit = Cordobas 19.10 Cordobas = US$ 1

0.61467SDR = U S $ l

FISCAL YEAR January 1 - December31

ABBREVIATIONS AND ACRONYMS Central Bank Central American Bank for Economic Integration Support Centers for Micro, Small and Medium Enterprises

Community Driven Development Center for Export Procedures

Swiss Agency for Development and Cooperation Financial Institution Nicaraguan Investment Fund

Department o f Administration and Finance U.K. Department for International Development

Internal Revenue Office

Dominican Republic-Central America Free Trade Agreement

Office o f Technology, Norms and Metrology European Union Foreign Investment Advisory Service

Savings Deposit Guarantee Fund

Small Enterprise Guarantee Fund

Nicaraguan Investment Finance Institution Free Trade Agreement

Banco Central de Nicaragua Banco Centroamericano de Integracidn Econdmica Centros de Apoyo a la Micro, Pequeiia y Mediana Empresa Desarrollo Comunitario Centro de Tramites de Exportaciones Agencia Suiza para el Desarrollo y la Cooperacidn Institucidn Financiera Financiera Nicaragiiense de Inversiones Direccidn General Administrativa Financiera Departamento de Desarrollo Internacional del Reino Unido Direccidn General de Ingresos Acuerdo de Libre Comercial - Amdrica Central y la Republica Dominicana Direccidn de Tecnologia, Normalizacidn y Metrologia Unidn Europea Sewicios de Accesoria en Inversidn Extranjera Fondo de Garantias de Depdsitos Fondo de Garantia para Pequeiias Empresas Financiera Nicaraguense de Inversiones Acuerdo de Libre Comercio

FOR OFFICIAL USE ONLY

GMP

GoN HACCP

IADB

I C A

I C s

IDR IM INATEC

INETER

INTUR

I S 0

MAGFOR

MARENA

MHCP

MIFIC

MINSA ONA

PAIT

PAP

PCRG

PFI

PND PROMIPY ME

RAAN

R A A S

SAT

Good Manufacturing Practice

Government o f Nicaragua Hazard Analysis Critical Control Point

Inter-American Development Bank

Investment Climate Assessment

Investment Climate Survey

Institute for Rural Development Institutional Manual National Technology Institute

Nicaraguan Institute for Land Studies

Nicaraguan Tourism Institute

International Organization for Standardization Ministry o f Agriculture and Forestry

Ministry o f Environmental and Natural Resources Ministry o f Finance

Ministry o f Economy

Ministry o f Health National Accreditation Office

Technology Innovation Support Project

Procurement Action Plan

Partial Credit Risk Guarantee

Participating Financial Institution

National Development Plan Micro, Small and Medium Enterprise Development Program

North Atlantic Autonomous Region

South Atlantic Autonomous Region

Safeguards Advisory Team

Buenas Practicas Manufactureras Gobierno de Nicaragua Analisis de Peligros y Puntos Criticos de Control Banco de Desarrollo Interamericano Analisis de Clima de Inversidn Encuesta de Clima de Invers idn Instituto de Desarrollo Rural Manual. Institucional Instituto Nacional Tecnoldgico Instituto Nicaragiiense de Estudios Territoriales Instituto Nicaragiiense de Turismo Organizacidn Internacional de Estandardizacidn Ministerio Agropecuario y Forestal Ministerio de Ambiente y Recursos Naturales Ministerio de Hacienda y Crkdito Publico Ministerio de Fomento, Industria y Comercio Ministerio de Salud Ojkina Nacional de Acreditacidn Proyecto de Apoyo a la Innovacidn Tecnoldgica Plan de Accidn de Adquisiciones Garantia Parcial de Riesgo Crediticio Institucidn Financiera Participante Plan Nacional de Desarrollo Programa de Desarrollo de la Micro, Pequerla y Mediana Empresa Regidn Autdnoma Atlantico Norte Regidn Autdnoma Atlantico Sur Equip0 de Salvaguardas

This document has a restricted distribution and may be used by recipients only in the performance o f their off icial duties. I t s contents may not be otherwise disclosed without Wor ld Bank authorization.

SEPA

SIBOIF

SIICAR

MSME

SNIP

SWAP

UGA

uniRSE

Execution System for Procurement Plan

Superintendence o f Banks and Other Financial Institutions

Integrated Cadastral and Registry Information System

Micro, Small and Medium Enterprise

National Public Investments System

Sector wide Approach Program

Environmental Management Unit o f MIFIC Nicaraguan Union for Corporate Social Responsibility

Sistema de Ejecucidn de Planes de Adquisiciones Superintendencia de Bancos y Otras Instituciones Financieras Sistema Integrado de Informacidn Catastral y Registro Micro, PequeZa y Mediana Empresa Sistema Nacional de Inversiones Publicas Programa de Enfoque Sectorial Unidad de Gestidn Ambiental

Unidn Nicaragiiense para la Responsabilidad Social Empresarial

Vice President: Pamela Cox Country Director: Laura Frigenti Sector Director: Marcelo Giugale Sector Manager: Lily L. Chu

Task Team Leader: M ichae l Goldberg

Acknowledgements

The project team i s led by Michael Goldberg (Senior Private Sector Specialist) and includes: Thomas Haven (Private Sector Specialist), Carlos Siezar (Project Officer), Carlos Arce (Matching Grants Specialist), Ilias Skamnelos (Financial Sector Specialist), Tanja Faller (Private Sector Specialist), Sunita Varada (Consultant), Rosa Estrada (Procurement Specialist), Alejandro Alcala (Counsel), Patricia Hoyes (Disbursement Officer), and Enrique Roman (Financial Management Specialist). Patricia Melo provided enormous assistance in all administrative aspects o f the preparation o f the project.

The project was prepared under the sectoral management o f Lily Chu and under the general guidance o f Marcelo Giugale (Director, LCSPR), Joseph Owen (Country Manager, LCCNI) and Pamela Cox (LCSVP). The L A C Quality Team, especially Glenn Morgan, Anjali Acharya, Josefina Stubbs, Kennan Rapp, and Alan Carroll provided significant support to the project throughout i t s development. Pierre Olivier Colleye, Greta Bull (IFC), and Ahmet Soylemezoglu served as peer reviewers. The team i s grateful for the inputs o f al l involved.

NICARAGUA Micro. Small and Medium Enterprise Development Project

CONTENTS

Page

A . STRATEGIC CONTEXT AND RATIONALE .................................................................... 1

2 . Rationale for Bank Involvement.. .......................................................................................... 4 3 . Higher level objectives to which the project contributes ....................................................... 5

1 . Country and Sector issues ...................................................................................................... 1

B . PROJECT DESCRIPTION ................................................................................................... 5

Project Development Objective and K e y Indicators ........................................................... 5

Lessons learned and reflected in the project design ............................................................ 9

1 . 2 . 3 . 4 . 5 .

Lending instrument ............................................................................................................. 5

Project components ............................................................................................................. 6

Alternatives considered and reasons for rejection ............................................................ 11

C . IMPLEMENTATION .......................................................................................................... 11 1 . Partnership arrangements ..................................................................................................... 11 2 . Institutional and implementation arrangements.. ................................................................. 12 3. Monitoring and evaluation o f outcomes/results., ................................................................. 12 4 . Sustainability and Replicability ........................................................................................... 13 5 . Critical risks and possible controversial aspects ................................................................... 14 6 . Loadcredit conditions and covenants., ................................................................................ 14 . .

D . APPRAISAL SUMMARY ................................................................................................... 15 1 . Economic and Financial Analysis ........................................................................................ 15 2 . Technical .............................................................................................................................. 15 3 . Fiduciary ............................................................................................................................... 16 4 . Social ................................................................................................................................... 16 5 . Environment ......................................................................................................................... 16 6 . Safeguard Policies ................................................................................................................ 17 7 . Policy Exceptions and Readiness ....................................................................................... 17

Annex 1: Country and Sector Background .............................................................................. 18

Annex 2: Major Related Projects Financed by the Bank and/or other Agencies ................. 24

Annex 3: Results Framework and Monitoring ........................................................................ 29

Annex 4: Detailed Project Description ...................................................................................... 34

Annex 4a: Lessons Learned from the Competitiveness LIL .................................................. 46

Annex 5: Project Costs ............................................................................................................... 48

Annex 6: Implementation Arrangements ................................................................................. 49

Annex 6a: Coordination with IFC ............................................................................................. 51

Annex 7: Financial Management and Disbursement Arrangements ..................................... 55

Annex 7a : External Donor Funds MIFIC Manages ............................................................... 61

Annex 8: Procurement Arrangements ...................................................................................... 64

Annex 9: Economic and Financial Analysis ............................................................................. 71

Annex 10: Safeguard Policy Issues ............................................................................................ 75

Annex loa: Social Inclusion Strategy ........................................................................................ 78

Annex lob: Indigenous Peoples Planning Framework Summary .......................................... 82

Annex 11: Project Preparation and Supervision ..................................................................... 88

Annex 12: Documents in the Project Fi le ................................................................................. 90

Annex 13: Operations Portfolio (IBRD/IDA and Grants) ...................................................... 92

Annex 14: Statement o f IFC’s Held and Disbursed Portfolio ................................................ 93

Annex 15: Nicaragua at a Glance .............................................................................................. 94

Annex 16: Map ............................................................................................................................ 96

List o f Tables. Boxes and Figures

Table 1: Doing Business 2008 Indicators ....................................................................................... 2 Table 2: Enterprise Survey data 2006 reveals concerns with corruption and electricity ................ 3 Table 3 : Sources o f Funds for Sample o f Nicaraguan Firms ......................................................... 4 Table 4: Estimated Project Costs by Components (US$ million) ................................................... 9 Table 5: Data Sources for Project Monitoring .............................................................................. 12 Table A1.1: Major Obstacles for Doing Business ........................................................................ 18 Table Al.2: Regulation o f Business Operations ........................................................................... 19

Table A1.4: Private Sector Sources o f Finance ............................................................................ 21 Table Al.5: Loan Portfolio Quality o f Commercial Banks, 2005-2007 ....................................... 22 Table Al.6: Private Sector Innovation and Quality Compliance ................................................. 23 Table A2 . 1: Summary o f SWAPS ............................................................................................... 25

Table Al.3: Municipal Rankings for Operating and Construction Licenses ................................ 20

Table A2 . 2: Projects Summary .................................................................................................... 27

Table A6A . 1: IFC Advisory Services .......................................................................................... 54 Table A7 . 1 - Audit Report/MIFIC DAF ..................................................................................... 56 Table A7.2 Risk Assessment and Mitigation Measures ............................................................... 58 Table A7 . 3 Action Plan for MIFIC-DAF .................................................................................... 60

NICARAGUA

NI MICRO, SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT

PROJECT APPRAISAL DOCUMENT

LATIN AMERICA AND CARIBBEAN

LCSPF

Date: May 13,2008 Country Director: Laura Frigenti Sector Director: Marcel0 Giugale Sector Manager: Lily Chu

Project ID: P109691

Team Leader: Michael J. Goldberg Sectors: General industry and trade sector (60%); Central government administration (20%); Micro and SME finance (20%) Themes: SME support ( S ) Environmental screening category: B

[ ]Loan [XI Credit [ ]Grant [ ]Guarantee [ ]Other:

For Loans/Credits/Others: Total Bank financing (US$m.): 20.00

ASSOCIATION Total: 15.00 5.00 20.00

Borrower: Ministry o f Finance and Public Credit Avenida Bolivar, fiente Asamblea Nacional Managua, Nicaragua Edward Jackson edward.j ackson@mhcp.gob.ni

Implementing Agency: Ministry o f Development, Industry and Commerce Managua, Nicaragua Veronica Rojas veronicaroj as@mific. gob .ni

7Y k u a l hmulat ive

Ref: PAD D. 7 Have these been approved by Bank management?

09 10 11 12 13 2.50 3.00 4.50 6.20 3.80 2.50 5.50 10.00 16.20 20.00

I s approval for any pol icy exception sought from the Board? [ ]Yes [ IN0 [ X I Y e s [ ] N o Does the project include any critical r isks rated “substantial” or “high”?

Ref: PAD C.5

[ X I Y e s [ ] N o Does the project meet the Regional criteria for readiness for implementation? Ref: PAD D. 7 “

Project development objective Ref: PAD B.2, Technical Annex 3 The objective o f the Project i s to improve the competitiveness o f micro, small, and medium enterprises (MSMEs) and the business climate that affects those firms.

Project description [one-sentence summary of each component] Ref: PAD B.3.a, Technical Annex 4 Component 1 Business and Investment Climate Improvement. This component will remove administrative and regulatory obstacles for MSMEs, based on the IFC municipal scorecard. Component 2. Matching Grants for MSMEs. The component wil l increase firm level productivity and increase value chain efficiency through the provision o f matching grants. Component 3: Increased Access to Financial Services for MSMEs. This component would improve the access o f MSMEs to affordable, reliable, and appropriately designed financial products, providing a Partial Credit Risk Guarantee (PCRG) for loans by regulated financial institutions to MSMEs. Component 4: Institutional Strengthening of MIFIC. The component will strengthen M I F I C as project coordinator, SWAP manager, and strategic leader in private sector development. Which safeguard policies are triggered, if any? Ref: PAD 0.6, Technical Annex 10 Environment; Indigenous Peoples (See Annexes 10, 10.a. and 10.b.) Significant, non-standard conditions, if any, for: Ref: PAD C. 7 Board presentation: None

Loadcredit effectiveness: Signed Subsidiary agreement (MIFIC-FNI) and adequate staffing o f project unit in M I F I C Covenants applicable to project implementation: N o later than one month after the Effective Date, M IF IC shall have put in place adequate financial management and disbursement arrangements for the provision o f Matching Grants (Component 2), acceptable to the Bank. Disbursement condition: Bank acceptance o f detailed financial management and disbursement procedures for partial credit r isk guarantee.

A. STRATEGIC CONTEXT AND RATIONALE

1. Country and Sector issues

1. During the past six years, Nicaragua has experienced macroeconomic stability with steady positive GDP growth, l o w inflation, stable exchange rates and declining interest rates. Foreign investment has climbed to levels not seen since the 1970s and annual GDP growth averaged 3.2 percent between 2001 and 2006. However, this level o f economic growth i s inadequate to ensure long term economic growth and poverty alleviation, and the sustainability o f these positive tendencies i s not clear. Growth in GDP per capita averaged only 2.1 percent between 2001 and 2006 and after remaining in the single digits between 2001 and 2005, consumer price inflation jumped to an estimated at 17 percent in 2007 (IMF), largely driven by high o i l prices and the effect o f Hurricane Felix.

2. In November o f 2006, the Frente Sandinista de Liberacidn Nacional (FSLN, the Sandinista Party) was elected after more than 15 years o f Liberal Party rule. The current Government has confirmed the importance o f private sector development in national economic development, particularly with micro and small businesses. In the past three years, the Government has demonstrated its commitment to maintaining fiscal discipline. The enactment o f the Public Financial Administration Law in August 2005 was an important step toward putting public finances in order. While delays in paying government treasury bills have surfaced recently, the overall fiscal and monetary approach seems to be sound.

3. Free trade agreements represent a major challenge for the private sector in Nicaragua to grow, modernize and become more productive-or be left behind in the evolving regional trade regime. With the signing o f CAFTA in 2006, Nicaragua has gained favorable and permanent access to the US. market. Other fkee trade agreement partners include Panama, Mexico and the Republic o f China (Taiwan). However, for these openings to turn into economic gains, Nicaraguan firms must improve the quality o f products (meeting international quality and process standards, such as international organization standards (ISOs) and Hazardous Analysis and Critical Control Point certification), and provide products o n time and in large quantities. Forty-one percent o f exports with revealed comparative advantage to the rest o f the wor ld cannot enter the United States market, mainly for reasons related to food sanitation.'

4. The private sector i s dominated by micro and small businesses, and a large informal sector. The recently passed M S M E law defines microenterprises as having one to five workers, with small enterprises employing six to 20 employees, and medium sized businesses with up to 150 workers. Schneider (2002) reported that Nicaragua's private sector was characterized by high levels o f informality (estimated at 45 percent o f the Gross Domestic Product). At the urban level, MSMEs are accountable for approximately 247,660 jobs or 74 percent o f the total. About 56 percent o f urban MSMEs are involved in commerce and services, 17 percent in manufacturing and the rest are spread across other sectors.* Urban areas are characterized by non-agricultural business activities.

' World Bank. 2005. DR-CAFTA: Challenges and Opportunities. 32953. Washington, DC. Van der Kamp, et al. 2

1

Business Climate

5. While Nicaragua does wel l by some o f the standard business climate indicators compared to regional averages, i t s ranking has dropped from 87th to 93rd in the world in terms o f Doing Business 2008 benchmarking indicators (World Bank-IFC, September, 2007). Table 1 reveals that this l ow ranking i s due to slow processing for property registration and high costs associated with starting a business, getting licenses, and paying taxes. Doing Business indicators reflect administrative procedures in Managua, and are complemented by the IFC Municipal Scorecard work in eight municipalities. The 2007 scorecard shows great variability across the municipalities in terms o f administrative procedure efficiency and costs (See Annex 1).

Table 1: Doing Business 2008 Indicators , Nicaragua Nicaragua Region Indicator

Doing Business (out of 178) Starting a Business (out of 178) Procedures (number) Time (days) Cost (% o f income per capita) Dealing with Licenses Cost ('33 o f income per capita) Registering Property Procedures (number) Time (days) Paying Taxes

Payments (number) Time (hours)

2007 87 60 6

39 131.6

1056.5 126 8

124 155 64

240

2008 93 70 6

39 119.1

898.6 130 8

124 156 64

240

2008

9.8 68.3 43.6

268.2

6.6 72.8

39.4 406.6 I Total tax rate (% o f profit) 63.2 63.2 48

Source: Doing Business 2008-ratings using the revised methodology adopted by Doing Business; ranking covered 178 countries

6. The World Bank's 2006 Enterprise Survey data based on interviews with 478 f i r m s identifies corruption as a major problem for a majority o f the firms (Table 2). Corruption l ikely contributes to high levels o f i n f ~ r m a l i t y . ~ In other countries, a one-stop shop for licensing and other business requirements has addressed such concerns effectively. The national data does not differentiate between municipal and central government corruption issues.

According to Doing Business 2006 (based on Schneider, 2002), the informal sector was estimated at 45 percent o f the economy. In comparison, the informal sector was estimated to be 50 percent o f the economy in Honduras and Guatemala, 36 percent in the Dominican Republic, and 26 percent in Costa Rica.

2

Table 2: Enterprise Survey data 2006 reveals concerns with corruption and electricity Percent of f i r m s that identify problem as major constraint

Corruption (70.6) Crime, Theft, Disorder (1 8.3) Electr ici ty (57.8) Legal System (1 1.9) Access to Financing (23.2) Customs and Trade Regulations (12.3) Labor Skill Level (22.7) Labor regulations (4.3)

Source: Nicaragua Enterprise Survey data 2006.

Access to Financing 7. There are no interest rate pol icy distortions (subsidies or controls), and interest rates and lending margins continue to decline. As a result o f the 2000-2001 banking crisis, bank supervision has improved considerably and i s now risk-based. The legal and regulatory environment has strengthened through the passage o f several laws in 2005 such as a banking law (which increases capital requirements above Base1 I and addresses issues related to bank secrecy, transfer o f share ownership and corporate governance), a deposit insurance law, and a law for Nicaragua’s Supervision and Regulatory Institution. More recently there have been further gains with a credit bureau on financial transactions and a credit information system within the Superintendency o f Banks and Other Financial Institutions (SIBOIF). Nicaragua also has one o f the strongest microfinance industries in the region, with 19 microfinance institutions providing 327,500 loans worth US193.7 mi l l ion as o f June, 2007. The recent establishment o f a new f i rst tier government rural bank has not led to any interest rate or pol icy distortions.

8. Despite these improvements, the Enterprise Survey data indicates that access to financing i s a major constraint for firms. The combination o f guarantee requirements, costs, and a conservative banking sector has limited access severely to micro, small and medium enterprises. Commercial banks and finance companies in Nicaragua have stated that they have available liquidity and could lend under certain circumstances to micro, small and medium enterprises (MSMEs). However, the unique lending methodologies that best serve the needs o f MSMEs are not understood by the commercial banks and finance companies.

9. Consultations with private sector chambers and associations also confirmed that the lack o f affordable and reliable access to financial services i s a major constraint to growth. According to the 2004 ICA, firms rely heavily o n retained earnings, while bank finance provides less than 15 percent o f working capital for small and medium enterprises (SMEs) and less than 20 percent o f their investment finance needs (Table 3). Consumer lending is the only part o f commercial banks’ portfolios that has been growing in real terms. The I C A points out that commercial bank margins are high by regional standards (over 11 percent, higher than other Central American countries). About 80 percent o f the f i r m s that could use external financing consider interest rates for working capital and investment credit so high that they do not apply for loans. The 2006 Enterprise Survey data confirms this trend since the percent o f firms using banks to finance investment has dropped from 16.6 percent in 2003 to 13.0 percent in 2006.

3

Sources o f funds Working capital

Retained earnings Supplier credit Banks Equity All Other Sources

Retained earnings Banks Other sources

Investment capital

2. Rationale for Bank Involvement

Small f i r m s (%) Medium f i r m s (%) Large f i r m s (%)

56.9 56.2 50.7 17.8 18.8 23.0 11.3 14.5 21.4 0.1 1.4 0.7 13.8 9.0 4.1

71.4 70.1 64.7 11.9 16.5 27.7 16.7 13.7 7.6

10. The project supports the update o f the Government’s Poverty Reduction Strategy under the National Human Development Plan, which has an emphasis o n private sector development. The National Human Development Plan calls for maintaining support to the private sector in seven specific areas: (i) a more efficient regulatory framework; (ii) enhanced recognition o f property rights; (iii) improved access to financial services; (iv) export and investment promotion; (v) increased productivity through value chains and clusters; (vi) rural development; and (vii) environmental sustainability. I t highlights the role o f micro, small and medium enterprises in stimulating national growth and creating jobs.

11. This project builds upon recent Bank operations and studies in Nicaragua. The Bank and MIF IC completed the implementation o f the Competitiveness Learning and Innovation Project in 2006. As a follow-up, the Bank and M I F I C developed a competitiveness project in 2006 (later approved by the Board but cancelled after discussions with the newly elected Ortega Government). Based o n the Bank’s experience In October 2007, the Ministry o f Finance requested a new Bank project with important changes to complement a new government strategy called the Micro, Small and Medium Enterprise Development Program (PROMIPYME by i t s Spanish acronyms). PROMIPYME i s a Sector Wide Approach (SWAP) that strives to harmonize and align the different programs and projects that donors are implementing in Nicaragua. The PROMIPYME i s working towards eight objectives: (1) Business climate enhancement and formalization promotion, (2) Institutional Capacity Building, (3) Partnership and intra-business cooperation promotion, (4) Human resource upgrade and capacity building, (5) Productivity, quality and market enhancement, (6) Technological innovation, (7) Export development, and (8) Access to financial services. The current MSME operation will develop important tools for one o f the most important objectives o f the PROMIPYME, i.e. Access to Financial Services, with i t s pi lot partial credit guarantee component, which i s described in Annex 4.

12. The Bank has played a leading role in M S M E development, thanks to its work through the Competitiveness Learning and Innovation Credit (#3456-N1) executed by the Presidential Competitiveness Commission and the Ministry o f Economy (MIFIC). Also, the focus on MSMEs complements the Bank’s important role in microfinance, with the Broad Based Access to Financial Services Project (#3903-N1). Through the Poverty Reduction Support Credit (PRSC) discussions, the Bank maintains close relationships with leading donors on private sector

4

development issues in Nicaragua (COSUDE, DFID, USAID, IADB, and the EU).4 The Bank also has a unified strategy with the IFC for private sector and financial sector work in the country (See Annex 6a).

13. The new project is structured to take advantage o f possible synergies between different components. The business climate work complements improved financial sector stability, enabling the project to address two key issues highlighted as constraints to growth by the private sector in the 2004 Investment Climate Assessment. This wil l help institutions such as M I F I C and the Financiera Nicaragiiense de Inversiones (FNI) to coordinate more closely than if they were supported by different Bank operations.

3. Higher level objectives to which the project contributes

14. The project responds to Government priorities found in the National Development Plan and the World Bank’s Country Partnership Strategy (October 11, 2007; Report No. 39637-NI) to support the private sector. The project supports the National Development Plan by (i) facilitating business management with regard to paperwork and bureaucracy and (ii) improving equity by expanding access to financial services, especially for small and medium businesses. The project contributes to the Country Partnership Strategy objective o f “reactivating the economy, stimulating productivity and competitiveness”. In addition, the matching grants fund will support human capital development, by increasing opportunities for training. The Project wil l also decentralize government systems and strengthen municipal capacity, helping to modernize state institutions. Special outreach strategies for women and indigenous groups also contribute to the strategy.

B. PROJECT DESCRIPTION

1. Lending instrument

15. This credit is an SDR 12.3 mi l l ion (US$20 mi l l ion equivalent) Specific Investment Loan (SIL) to be implemented over five years. A SIL is the appropriate instrument, due to the combination o f reforms, capacity building and investment activities to be included in the project. Linking Bank knding to specific activities wil l ensure the project’s technical, financial, economic, environmental, and institutional viability and enable the counterparts to measure specific costs and benefits from innovative activities supported by the project.

2. Project Development Objective and Key Indicators

16. The objective o f the Project i s to improve the competitiveness o f micro, small, and medium enterprises (MSMEs) and the business climate that affects those f i rms.

17. Key Indicators will include the following:

Overall project outcome indicators include the following: (i) MSMEs receiving matching grants introduce new products or processes and (ii) the decrease in time needed to start a business. At the component level, the following indicators wil l be tracked.

See Acronyms and Abbreviations l i s t for the names of these institutions. 4

5

Component 1 : Improvement of Business and Investment Climate 0

0

0

0

Time needed to start a business Time to obtain food and health permits Yearly increase in the number o f newly registered businesses in targeted municipalities Number o f f i r m s served by the Support Centers for Micro, Small and Medium Enterprises (CAMIPYMEs)

Component 2: Matching Grants for MSMEs 0 Number o f grants awarded 0 Number o f grant-recipient firms that implement product or process quality enhancement

projects (including international certifications) 0 Number o f grant-recipient firms that introduce new products andor processes 0 Number o f grant-recipient firms that obtain access to commercial bank financing

Component 3: Increased Access to Financial Services for MSMEs 0 Number o f outstanding M S M E loans extended by the financial institutions participating

in the partial credit risk guarantee at the end o f the project. 0 Number o f financial institutions that participate in the partial credit r isk guarantee 0 100% coverage o f operating costs and Partial Credit Risk Guarantee (PCRG) payouts by

the guarantee fees, the fund estimated investment proceeds and the loss recuperations at the end o f the project.

Component 4: Institutional Development of MIFIC MIF IC maintains adequate technical and fiduciary staff and systems to manage the project efficiently, as measured by supervision missions, audits and other reviews

3. Project components

18. The project would be implemented over five years and improve the quality and affordability o f services to MSMEs through four components: (i) improvements to the business and investment climate for MSMEs; (ii) matching grants for MSMEs to support, inter alia innovations, environmental improvements, and forward and backward linkages; (iii) innovative financial services such as a pi lot partial credit risk guarantee system for MSMEs in coordination with regulated financial institutions; and (iv) improved strategic, technical and coordination abilities o f M IF IC in the f ield o f competitiveness. The components have been designed to maximize complementarity. However, if the implementation o f one component lags, this wil l not have a significant negative effect on the other components. The primary focus o f the project’s interventions wil l be on urban MSMEs.

6

Component 1: Improvement o f Business and Investment Climate

-? I I I

Component 2: Matching Grants for M S M E s

I ,--------------------- I Component 1 facilitates i i formalization o f I

I M S M E s to enable them I I to access matching I I

I grants in component 2. I

I

I I I I I I I I I I I I I - - - - - - - - - - - - - - - - - - - -1

Component 3: Increased Access to Financial

Enterprise Growth

I Component 2 assists 1 enterprises with I business plans and I feasibility studies to I enable them to apply I for commercial credit, i in component 3. I I--________________

Financial institutions ready to offer credit t o “bankable” enterprises based o n p i lo t partial credit guarantee in component 3.

I I I I I I I I I I I I I I I I I I

- A

19. Component 1: Business and Investment Climate Improvement (US$4.11 million): The objective o f this component i s to remove administrative and regulatory obstacles for MSMEs, especially in eight municipalities that have completed the IFC municipal scorecard diagnosis. In close coordination with the IFC, three sub-components wil l be carried out.

20. Subcomponent 1 : Business Process Simplification and Decentralization This subcomponent would finance the municipal scorecard action plans, including the digitalization and decentralization o f procedures for MSME registration. Activities would also increase the range o f one-stop shop (“ventanilla unicas”) services, including tourism, worker safety, and sanitary (food and health) permits.

21. Subcomponent 2: Strengthening pol icy and technology frameworks for MSMEs Activities in subcomponent 2 wil l address key bottlenecks in the area o f pol icy formulation, and IT infrastructure. At an analytical level, a new proposal to improve the current policies will be developed in accordance to international best practice. In terms o f IT infrastructure, activities wil l target selected key areas, where a lack o f adequate technology i s causing a negative impact on the business and investment climate for MSMEs, i.e. supporting a simplified system linking the central tax agency (DGI) and the export-accreditation agency (CETREX).

22. Subcomponent 3: Access to Ouality-Assurance and Certification The project would finance quality and certification services, and work regulation improvements. The national quality control laboratory and Ministry o f Health certification office would be modernized, supporting MSME I S 0 accreditation.

23. Component 2: Matching Grants for MSMEs (US$8.36 million). This component would finance matching grants for MSMEs. Grants would finance pre-investment and investment activities and be awarded competitively through a series o f rounds with different technical focus (such as quality enhancements and certification, innovation, labor training, clean technologies, or resolving value chain bottlenecks for a specific sector). Rounds would be regular and predictable, allowing firms to plan ahead for participation in subsequent rounds. Pre-investment

7

activities include development o f business plans and feasibility studies that would allow MSMEs to apply for commercial credit. The grants would not substitute for commercial credit; instead, they would develop a large number o f “bankable” MSMEs. Likewise, matching grants for investment activities would complement commercial credit by focusing o n themes where bank financing i s not viable. Grants recipients would be selected by a committee that includes independent, private sector representatives to ensure that the selection criteria are applied fairly and transparently to al l applicants. The names o f grant recipients would be publicized on MIFIC’s website, as wel l as the grant value and a short summary o f what the grant was for.

24. In line with the Government’s strong push for capacity building within the line ministries, the Project would build upon an existing specialized unit within M P I C that wil l administer the matching grants program. This effort would build o n experiences with previous M I F I C grants programs, such as the Proyecto de @yo a la Innovacidn Tecnoldgica (PAIT) financed by the Inter-American Development Bank (IADB). After the program has been operating for 18 months, this unit would be evaluated by independent reviewers. If the evaluation reveals structural issues, design changes or alternative matching grant delivery channels would be identified.

25. Component 3: Increased Access to Financial Services for Micro and Small Enterprises (MSMEs) (US$4.8 million): This component would improve the access o f MSMEs to affordable, reliable, and appropriately designed financial products, providing a pi lot Partial Credit Risk Guarantee (PCRG) for loans by regulated financial institutions to MSMEs. This component will be disbursed gradually based o n documented losses, with no init ial capitalization with IDA funds. During annual and midterm reviews, funds may be moved to other components if there has been insufficient demand. Two commercial banks have already provided letters o f interest, demonstrating market demand for this pi lot facility. The component has been designed based on the experiences o f BancoEstado o f Chile, which runs one o f the most successful Partial Credit Risk Guarantee (PCRG) in the region (FOGAPE), as wel l as lessons from India, Ghana, and Madagascar PCRGs. The FNI Special Credit Committee (Guarantee Committee) wil l review al l applications for the PCRG, both prior to loan approval and when financial institutions call a guarantee. The guarantees would complement the pre-investment matching grants in Component 2, making it easier for commercial banks to provide loans to MSMEs with improved business and feasibility plans. Extensive consultations with commercial banks were held and they expressed an interest in participating in the program.

26. The pi lot PCRG addresses a specific set o f barriers faced by financial institutions considering lending to MSMEs. It wil l share the credit risk with financial institutions during the learning curve o f downscaling their lending to MSMEs. Banks will carry out the due diligence review o f potential M S M E borrowers, and request the partial guarantee to cover the credit r isk and relieve the high collateral requirement. The pi lot PCRG wil l allow some MSMEs to gain access to credit, while even those with credit will benefit - through longer maturities and larger amounts that complement the working capital loans. Over the l i fe o f the project, the planned US$4 mi l l ion would provide sufficient liquidity, credibility and stability to the pi lot PCRG to leverage the high degree o f liquidity in the commercial banking system and take advantage o f the opportunity resulting from the competitive pressures building because o f the entry o f new regional banks. The remaining US$800,000 investment will cover training for the banks,

8

assistance in improving internal systems related to lending to smaller firms, and set-up and operational expenses for management o f the pi lot PCRG by FNI.

Components Component 1 : Improvement o f Business and Investment Climate ComDonent 2: Matching Grants for MSMEs

27. After 18 months o f operation (or at a later date accepted by the Bank), a review o f the pi lot PCRG could lead to changes, including the reallocation o f the component hnds or the decision to begin to capitalize the fund. Until that time, the outstanding loan portfolio disbursed by participating financial institutions and covered by the pi lot PCRG wil l not exceed the total funds available for the PCRG component, nor wi l l the maturity o f bank loans extended and guaranteed by the PCRG exceed the project closing date. If the decision to capitalize i s taken, based on fund performance and management capacity, the government should decide whether i t agrees to assume part o f the risk involved in leveraging the guarantee find to cover a larger portfolio and loan maturities beyond the closing date o f the project. In addition, an appropriate investment scheme for the funds up to and beyond the project closing date should be established in accordance with generally accepted best practices and in accordance with FNI's investment systems.

Total Cost 4.1 1 8.36

28. Component 4: Institutional Strengthening of MIFIC (US$1.48 million): The objective o f this component i s to improve the institutional capacity o f M I F I C in its role as project coordinator, Sector Wide Approach (SWAP) manager, and technical and strategic leader for private sector development. National M S M E surveys would be undertaken to better inform public pol icy discussions. Marginal costs incurred by M I F I C (such as procurement and financial management) would also be covered.

" Component 3: Increased Access to Financial Services for MSMEs Component 4: Institutional Development o f M I F I C

Unallocated Total Proiect Cost:

Table 4: Estimated Project Costs by Components (US$ million)

4.8 1.48 1.25

20.00

4. Lessons learned and reflected in the project design

29. The lessons from the World Bank's recently-closed Competitiveness Learning and Innovation Project in Nicaragua and inputs from a small DFlD grant for PCRG design have provided important lessons for the design o f this project. Additional lessons have been learned through implementation o f the Poverty Reduction Strategy Paper (PRSP), the results o f the Nicaragua Investment Climate Assessment, other Bank-financed competitiveness projects in the region, and discussions with the Government, private sector, and donors.

30. Business climate improvements are important, but not suficient to improve private sector efficiency and competitiveness. Investments in registries, permit procedures, tax and export administration at the central and municipal levels have enabled countries to improve the competitiveness o f the private sector by lowering procedural costs (for business registration,

9

business operation, import, export, tax payments, and other business requirements). The Doing Business indicators are an effective means o f measuring such gains.

31. Quality and certifxation are the keys to opening doors in the new free trade environment. Countries that invest in these services, such as metrology infrastructure, laboratories, and certification programs, are in a better competitiveness position over time.

32. If public agencies are operating matching grant programs, specijic public sector administrative procedures should be adapted to increase efficiency and improve responsiveness to private sector demand. The Bank’s experience with matching grants has been mixed. In several cases, slow implementation and low disbursement rates in the early phases o f implementation were caused by government requirements. These experiences suggest that governments should consider adapting their internal procedures to ensure prompt evaluation o f projects and rapid processing o f disbursement requests by beneficiaries. Whether privately or publicly managed, the matching grant fund should be evaluated based on its efficiency, disbursement, transparency, monitoring and specific impact at the firm level (including environmental benefits and externalities).

33. Matching grants experiences reveal that there are three factors that characterize high- performing matching grants systems: (i) an agile matching grant promotion and selection mechanism, (ii) an experienced management firm or agency; and (iii) a supportive business environment. Based o n these conditions and a realistic plan and strong promotion, matching grants systems can reduce the risk o f adverse selection, capture by private parties, long delays, and detailed documentation.

34. Free trade agreements present special challenges to governments, the private sector and civil society. In many cases, FTAs lead to employment dislocations that require labor retraining. Labor training can be achieved using private and public service providers, and matching grants can finance these for firms and sectoral associations. At the same time, foreign direct investment can increase, bringing new know-how and management practices as they create jobs.

35. Partial credit risk guarantees can leverage loans to MSMEs from commercial banks with high liquidity when they offer the right incentives and have streamlined payment processes. For this project design, the incentives are based o n lessons from (i) past PCRG schemes in Nicaragua, (ii) emerging market experiences with PCRG, in particular the experience o f FOGAPE, Chile, (iii) recent Bank projects with PCRG schemes in India (Small and Medium Enterprise Financing and Development Project, PO865 1 S), Madagascar (Integrated Growth Poles Project, P083351) and Ghana (Micro, Small and Medium Enterprise Project, P085006). Guiding principles based on international best practice include: (a) share risk on a partial basis with the participating financial intermediaries, to provide the appropriate incentive to minimize moral hazard and maximize the ability o f the guarantee to ensure that productive assets are booked; (b) establish an autonomous, professional and technically capable administration; (c) focus on the operator and leverage i ts strengths- the financial institutions oriented to MSMEs and their commercial incentives to apply due-diligence o n the borrower; (d) establish ex-ante eligibility criteria for financial institutions’ participation; (e) use a streamlined portfolio approach (versus credit by credit guarantee); (f) establish a “stop loss” mechanism to prematurely terminate a poorly performing program; (8) establish a streamlined approach to ensure utilization by the

10

local banks; (h) make available pre-financing TA on the usage o f the PCRG to participating banks; and (i) establish appropriate performance monitoring.

36. Donor activities in the je ld of competitiveness are growing rapidly in the region as a result of CAFTA, and coordination wi l l play an increasingly important role. The Government has begun to work on projects with the European Union, USAID, DFID, Holland and the IADB. Many o f these projects offer synergies and can increase the impact o f the proposed project. To avoid duplication, constant project coordination and fol low up i s maintained by the M S M E donor group.

5. Alternatives considered and reasons for rejection

37. The project team and the counterparts considered and discarded alternative approaches. The Government did not want a technical assistance credit (TAL), preferring an SIL. A TAL would not support the wide range o f investments required for project activities. The Government encouraged the Bank to j o i n the MSME-oriented PROMIPYME Sector-Wide Approach (SWAp), but al l o f the Bank fiduciary and technical requirements were not met by the SWAp. Therefore, i t was agreed that the project would be aligned with the SWAP programmatically, but officially remain outside o f the SWAp.

38. The project was originally conceived as a means to help Nicaragua overcome problems caused by the DR-CAFTA agreement. However, the current Government decided to focus more tightly on M S M E needs, rather than a focus o n trade and the internal agenda. Also, the Pro-Rural SWAP and Rural Development Institute (IDR) already provide grants for dislocated workers and negatively affected households.

39. The Bank sought a competitive selection process for the matching grants facility. However, in keeping with the Government’s strategy to strengthen ministries, the project will support MIFIC’s management o f the matching grants facility. MIFIC’s previous facility, PAIT, was not able to reach a large number o f MSMEs effectively, requiring major changes in the mechanisms for promotion, selection, and monitoring o f such grants. Eighteen months after Effectiveness, an evaluation wil l determine if the government-managed system has been effective.

C. IMPLEMENTATION

1. Partnership arrangements

40. The success o f the project will depend o n the participation o f the private sector, including commercial banks and other financial institutions, MSMEs, chambers, and sectoral organizations. In addition, public sector agencies (DGI, Ministry o f Health), laboratories, and eight municipalities wil l be involved in project implementation. There will be a special role for FNI, which wil l execute and monitor the innovative partial credit risk guarantee. The National Association o f Banks wil l also play a promotional role. MIFIC’s ability to coordinate these efforts, reorient them as experience grows, and evaluate effectively wi l l be strengthened by the project. M I F I C also has relationships with several donors, including the IADB, COSUDE (Switzerland), the European Union, the IFC, Holland, DFID (UK), Danida (Denmark) and Central American Bank for Economic Integration (CABEI). Finally, the IFC has agreed to

11

jo int ly supervise the project during implementation. (See Annex 6 A for more detailed description o f the strategy and operational links.)

Data source

2. Institutional and implementation arrangements

Data description I Frequency

41. MIFIC, through the General Management o f Planning Programs and Projects unit (DGPP) will be responsible for overall project coordination and will execute the matching grants component. M F I C will lead the implementation o f the business climate activities (including the CAMIPYMEs) and will support eight municipalities in carrying out the municipal scorecard action plans. M F I C will also be responsible for the interaction with other government institutions that handle private sector concerns, including the Ministry o f Health (MINSA), Nicaraguan Institute o f Tourism (INTUR), Center for Export Procedures (CETREX), and others. M IF IC has implemented several large donor projects, some o f which have had similar elements to the proposed project (See Annex 7a). FNI will be responsible for the execution o f the pilot PCRG facility. FNI i s a state second tier bank whose main role i s to provide on-lending financial instruments to the commercial banking sector. FNI is currently implementing the Bank’s Broad Based Access to Financial Services Project in Nicaragua and has proven its capacity for managing programs aimed at increasing access to finance. Because o f this experience and i t s ongoing collaboration with private financial institutions, FNI i s the most appropriate entity to manage the pilot PCRG facility. The responsibilities and corresponding financial support will be set out in a subsidiary agreement between M F I C and FNI.

targeted survey Participating financial institutions’ portfol io summaries, supervision visits C A M I P Y M E s Client Satisfaction Survey

42. The Administrative and Financial Department o f M I F I C (DAF) will be in charge o f al l fiduciary responsibilities, including procurement, disbursement, designated account management, audit coordination, project documentation, and other related tasks for the project. Project funds wil l be used to pay for a small number o f consultants for DAF, goods, equipment and operating costs.

. . . - - registry, business registry and cadastres. Financial information o n scale, sustainability o f new M S M E portfolios under the guarantee

summaries Ongoing with annual summaries

Survey o f enterprises that used CAMIPYME services to determine satisfaction with services and effects o n enterprise activities

Annual

3. Monitoring and evaluation of outcomes/results

43. MIF IC will monitor the project on two levels: (i) component activities (based on performance indicators and specific annual and project-end targets, see Table 5 below and Annex 3) and (ii) improvements in the competitiveness o f f i r m s and associations o f f i r m s participating in the project by sector, region and size (compared to baselines developed through the matching grants system). These activities wil l be complemented by international benchmarking by the Bank (Doing Business) and other studies (such as Investment Climate Assessments, whether funded by the Bank or other sources).

Table 5: Data Sources for Project Monitoring

12

4. Sustainability and Replicability

44. The sustainability o f the project can be seen at two levels: (i) the improved performance o f national firms and (ii) the technical and administrative abilities o f MIFIC. By modernizing production processes and gaining certifications to meet international standards, Nicaraguan firms will be able to take full advantage o f the opportunities o f free trade agreements, becoming more sustainable. Technically sound business plans wil l enable firms to gain better access to financing. Firms wil l be able to access bank financing to invest in labor training, environmentally sound practices and other enhancements. Improvements in the business and investment climate supported by the project wil l reduce the time that managers spend on permit and asset registry processes, enabling them to focus on the challenges o f new processes and practices.

45. The PCRG scheme is designed to be operated on a commercial basis aiming at controlling costs, charging appropriate fees, and subject to prudent management o f i t s funds. Set-up costs (principally the cost o f software and technical assistance for FNI and commercial bank capacity building) wil l be fully covered by the project. Early coverage o f administrative costs wil l be phased out to provide incentives for efficient cost control. Guarantee charges (up-front fees, commitment fees, guarantee fees, and so on) wil l be set based on the due diligence o f the M S M E loan portfolio o f participating commercial banks and finance companies to be selected and at levels to reflect market conditions, the program management expenses to be incurred, and the development nature o f the PCRG Program. Bank staff wil l work with IFC and FNI in determining the level, as IFC-estimated charges could form a good basis for market pricing.

46. The project development objective reflects the importance o f enhancing MIFIC’s institutional capacity. MIFIC’s institutional capacity and sustainability will be improved by project activities. M I F I C spearheads programs designed to promote sustainable economic development and supporting the private sector to become more competitive. Through this project, M I F I C wil l improve i ts understanding o f private sector needs, as well as i t s capacity as SWAP and project coordinator and technical and strategic leader for private sector development.

13

5. Critical risks and possible controversial aspects

Critical Risk

Institutional capacity, strategic leadership, coordination, and overlap issues Matching grants: transparency and efficient dissemination and environmental risks

Procurement management Financial management

Guarantees and other financial products for MSMEs do not attract commercial financial institution participation; become politicized

Political commitment

Private sector participation

Overall Risk

Risk Rating

Moderate

Moderate

High

Substantial

Moderate

Moderate

Moderate

Possible Mitigation Measures

MIF IC w i l l be strengthened in terms o f technical capacity and project management ability, allowing i t to take a leadership role in the field o f competitiveness. The matching grants facility w i l l be run by MIFIC. After 18 months o f operation, a special evaluation w i l l take place to measure efficiency and identify any political tendencies that may affect equal access. If the matching grants facility i s not performing well, adjustments andor alternative mechanisms would be identified. The operating manual would prohibit projects with substantial negative environmental impacts from receiving funding, and w i l l encourage “clean technology” processes. - MIFIC (DAF) wi l l receive ongoing technical training

-

~- and w i l l hire at least one procurement specialist. MIF IC (DAF) w i l l receive high quality technical training for the execution o f the project in fiduciary systems and increases the number o f trained staff wi th fiduciary responsibilities Discussions have already taken place with the National Bankers’ Association and some individual banks to understand their reluctance to lend to MSMEs, and what i t would take to gain their participation. Product offering and pricing o f the guarantee w i l l be on the basis o f commercial criteria and on feedback from potential participating financial institutions throughout the design process and the l i f e o f the pi lot PCRG. In the case o f a l ow market response for the guarantee, provisions w i l l exist to discontinue the component and reallocate the proceeds to the matching grants component. Ministry o f Finance has confirmed adequate fiscal space for the l i fe o f the Project. The government has confirmed its commitment to private sector development through i t s SWAP program. Ongoing dialogues (such as the November 14-15, 2007 Foro Industrial) have helped to improve the relationship between the public and private sectors. Two banks have already writ ten letters o f interest in

Residual Risk Rating Moderate

Low

Substantial

Substantial

Moderate

Low

Moderate

pi lot PCRG. Moderate

6. Loadcredit conditions and covenants

47. There are two conditions o f Effectiveness: (i) the Subsidiary Agreement has been duly executed on behalf o f the Recipient and FNI, and (ii) Financial management, procurement and technical specialists for the Project have been employed by MIFIC under terms and in a manner acceptable to the Association. The additional legal matters to be included in the opinion or opinions to be furnished to the Association consist o f the following: (i) that the Subsidiary

14

Agreement has been duly authorized or ratified by the Recipient and FNI and i s legally binding upon the Recipient and FNI in accordance with i t s terms; (ii) that FNI has the legal and corporate capacity, pursuant to FNI’s Law and other applicable laws o f the Recipient, to carry out Part 3 o f the Project; and (iii) that the Guarantee Facility to be created within FNI in order to carry out Part 3 o f the Project has been legally established to the satisfaction o f the Association, pursuant to the Partial Guarantee Operational Manual, FNI’s Law and other applicable laws o f the Recipient.

48. N o withdrawals for payments shall be made: (i) prior to the date o f this Agreement, except that withdrawals up to an aggregate amount not to exceed $1,000,000 equivalent may be made for payments made prior to this date but on or after M a y 12, 2008, and in no case more than 12 months before the date o f signature o f this Agreement, for Eligible Expenditures under any Category except Category (4); and (ii) under Category (4) until the Recipient has put in place, and has caused FNI to put in place, adequate financial management and disbursement procedures for the operation o f the Guarantee Facility under Part 3 o f the Project, pursuant to the Operational Manual and the Partial Guarantee Operational Manual, in a manner satisfactory to the Association.

D. APPRAISAL SUMMARY

1. Economic and Financial Analysis

49. Given the diverse set o f competitiveness-related activities and the focus on institutional capacity building, it is not possible to carry out a global economic and financial analysis o f the project. (This has been the practice with several competitiveness projects in the region.)

50. Nonetheless, there i s a considerable body o f literature that shows that improvements in the business climate contribute to improved firm competitiveness (see Annex 9). Access to affordable credit and other financial services can contribute directly to firm improvements, including a transformation from artisan level production to specialized assembly l ine production with quality control, resulting in economies o f scale and improved product quality.

2. Technical

51. For matching grants, the best practices generated by Bank and other projects have been taken into account (and will benefit from a regional learning grant on matching grants program best practices due to be completed in early 2009). In addition, several Wor ld Bank studies o f value chains (Subramanian (2005a, 2005b)) have contributed to the development o f the matching grants component (See Annex 4). Doing Business reports and the Investment Climate Assessment (2004) produced by the Bank have played an important role in discussions with counterparts. Discussions with the IFC during project development have led to technical improvements in business simplification activities. Finally, the lessons generated by the Bank’s recently-closed Competitiveness Learning and Innovation project (LIL) in Nicaragua have provided a strong base for developing the new project.

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3. Fiduciary

52. In coordination with the DGPP, the Administrative and Financial Department (DAF) o f M I F I C wil l be responsible for carrying out al l fiduciary responsibilities (including procurement, disbursement, and financial management) for the duration o f the project. A revised Institutional Manual (IM) has been issued by M I F I C to incorporate the DGPP as the principal unit in charge o f project administration. A description o f the DGPP’s fiduciary responsibilities i s included in the IM. For FNI, fiduciary responsibilities wil l be carried by the institutional DGAF; activities that are already in implementation for the Access to Financial Services Project. A Procurement Action Plan (PAP), agreed upon at negotiations, wil l be in place during the f i rst 18 months after project effectiveness to ensure appropriate launching and implementation o f institutionalized procurement functions. The PAP focuses on strengthening competencies o f project staff to monitor and supervise the Procurement Plan, and to ensure smooth management o f individual project consultants both in M I F I C and FNI (For information on institutional fiduciary arrangements, thresholds, reporting requirements and related information, see Annexes 7 and 8).

4. Social

53. Based on the assessment o f the L A C Safeguards Advisory team (SAT), the project triggers the Bank’s Operational Policy 4.10. The project i s committed to an ongoing process o f local consultation with al l stakeholders. Specific components will target women and regions with large populations o f indigenous peoples. Indigenous peoples are prone to managing micro-scale, informal enterprises and could benefit from opportunities to expand their activities beyond their immediate communities through the matching grants component o f the project. (For a summary o f the Indigenous Peoples Planning Framework, see Annex lob.) Women make up a significant share o f managers o f f i r m s and wil l be encouraged to both apply for matching grants for M S M E development and to take advantage o f business improvement services. In some cases, women’s groups and associations wil l be asked to promote the project’s services. Also, the matching grants facility wil l offer competitive rounds which wil l be adjusted to provide opportunities to MSME managers in marginal regions (such as the Atlantic coast regions, RAAN and RAAS), particularly if there i s little ini t ial response from those areas. Finally, the partial credit guarantee mechanism wil l encourage financial institutions to expand their services in these marginal regions. (For more information on the findings o f the Social Assessment conducted as part o f project preparation, see annex 1 Oa.)

54. The project wil l not support any activity that entails involuntary displacement and resettlement. In order to ensure that resettlement-related actions are formally excluded, standard language to this effect will appear on the negative list developed for the project (see below) and incorporated into the operational manuals.

5. Environment

55. Without adequate safeguards in place, the project could potentially have negative effects on the environment and has therefore been categorized as a “B”. The counterparts and the Bank are committed to establishing safeguards to prevent any adverse environmental effects o f the project. A negative l i s t o f activities has been developed for the matching grants facility and the partial credit guarantee mechanism, to ensure that activities supported by the project have neutral or

16

positive environmental impacts. Participating private financial institutions and MSMEs will be informed in writing o f the negative l is t . The Environmental Management Unit (UGA) o f M I F I C and the Ministry o f Environment and Natural Resources (MARENA) will be involved in the screening and monitoring process for matching grants proposals to ensure that no inappropriate investments are supported. UGA in collaboration with MARENA will also perform periodic (annual) reviews to ensure the project i s not supporting activities that are harmful to the environment. It i s anticipated that many o f the matching grants activities would have a positive impact, helping f i r m s to meet domestic environmental regulations and sanitary and phyto-zoo- sanitary requirements in foreign markets. Many grants will be to microenterprises which present no significant environmental risks. Many grants will be for commercial and service sector f i rms, also representing no significant environmental risks. A streamlined approach will enable M I F I C and MARENA to focus on those f i r m s that present serious environmental concerns. (See Annex 10 for the safeguards management framework and examples o f matching grants.)

56. For the partial credit risk guarantee, the same negative l i s t o f activities will be applied by FNI, with support from MARENA. The participating financial institutions would in turn apply the negative l i s t to potential borrowers. A detailed description o f the negative l i s t o f activities wil l be available in the operational manual.

6. Safeguard Policies Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OP/BP/GP 4.0 1) [XI [I Natural Habitats (OP/BP 4.04) [I [XI Pest Management (OP 4.09) [I [XI Cultural Property (OPN 1 1.03, being revised as OP 4.1 1) [XI Involuntary Resettlement (OPBP 4.12) [I [XI Indigenous Peoples (OD 4.10) [XI [I Forests (OP/BP 4.36) [I [XI Safety o f Dams (OPBP 4.37) [ I [XI Projects in Disputed Areas (OP/BP/GP 7.60)' [I [XI Projects on International Waterways (OPBP/GP 7.50) [I [XI

11

7. Policy Exceptions and Readiness

57. N o policy exceptions have been identified. There i s an acceptable degree o f readiness in project administration, including strategic and technical leadership (MIFIC) and FNI has the requisite financial experience and relationships with commercial banks to carry out the PCRG.

* By supporting the proposedproject, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas

17

Annex 1: Country and Sector Background NICARAGUA: Micro, Small, and Medium Enterprise Development Project

Country Background

According to Doing Business 2008, Nicaragua outperformed Costa Rica, Guatemala and Honduras for “ease o f doing business”, coming in 93rd in the world (total 178 countries). Other international benchmarks highlight deficiencies in protection o f property rights, financial institutions, the judiciary system, and political stability. Transparency International ranked Nicaragua 123 out o f 179 on i t s corruption perceptions index in 2007. The World Economic Forum also found that corruption was a major impediment for doing business in Nicaragua (Global Competitiveness Report, 2007-08). They found that corruption ranked third among respondents, after policy instability and access to financing, as a major obstacle to doing business (See Table Al . 1).

Table A1.1: Major Obstacles for Doing Business 0 5 10 15 20 25

Political Instability

Access to Financing

Corruption

Inadequate Supply of Infrastructure

Inefficient Government Bureaucracy

Tax Rates

Government Instability

Tax Regulations

Inadequately Educated Workforce

Poor Work Ethic

Crime and Theft

Inflation

Restrictive Labour Regulations

Foreign Currency Regulations

Source: World Economic Forum, Global Competitiveness Report 2007-2008

Sector Background

The project will respond to issues in the following sectors: (i) MSMEs, (ii) business and investment climate, (iii) access to finance, and (v) institutional development o f l ine ministries.

Micro, Small and Medium Enterprises (MSMEs). The policies underlying the National Human Development Plan provide special support to MSMEs, while establishing a framework o f ongoing public-private dialogue and coordinated international cooperation. The government

18

recognizes that MSMEs represent a large share o f the country’s overall business activity. According to the last census o f the Central Bank (2000), Nicaragua has registered 112,922 non- agricultural f i r m s o f which 99 percent are SMEs (including registered microbusinesses), generating 234,093 jobs (70 percent). A 2004 study (Fundaci6n Friedrich Ebert) estimated that 69 percent o f MSMEs face competition from imported goods, and may face stiffer competition with the implementation o f DR-CAFTA. The I C A shows that small and medium enterprises (SMEs) face generally worse investment climate conditions than large f i rms. These vulnerabilities may constrain SMEs to exploit the export opportunities and maximize the net benefits o f DR-CAFTA and other free trade agreements.

Table A1.2: Regulation of Business Operations Doing Business Indicator Nicaragua Region

Starting a Business Procedures (number) Time (days) Cost (% o f income per capita) Min. capital (% o f income per capita)

Procedures (number) Time (days) Cost (% o f income per capita)

Procedures (number) Time (days) Cost (% o f property value)

Documents for export (number) Time for export (days) Documents for import (number) Time for import (days)

Procedures (number) Time (days) Cost (% debt)

Closing a Business Time (years) Cost (% o f estate) Recoverv rate (cents on the dollar)

Dealing with Licenses

Registering Property

Trading Across Borders

Enforcing Contracts

2007

6 39

119.1 0

17 219

898.60

8 124 3.5

5 36 5

38

35 540 26.8

2.2 15

34.6

11 60.7 36.9 9.2

16.9 238.6 268.2

8.2 58.9

5

6.7 22.6 7.7 24

37.7 754 30.3

3.2 16.4 25.9

Source: World Bank, Doing Business in 2008

Business climate issues. Nicaragua’s relatively l o w ranking on the “Ease o f Doing Business” from the 2008 Doing Business indicators i s due primarily to slow processing for property registration and high costs associated with starting a business, getting licenses, and paying taxes. The government’s response to burdensome procedures has been spearheaded by the one-stop

19

shop for investments (the “Ventanilla Unica de Inversion” (VUI)), as wel l as import and export permits and licenses on-line offered by the Center for Export Procedures (Cetrex). Parallel to the legal effort, there are on-going efforts to modernize municipal public registries and one-stop shops for commercial registration and import and export permits and licenses. The Doing Business indicators verify the improvements -- the number o f procedures for starting a business decreased from 8 in 2005 to 6 in 2007, the number o f days required dropped from 42 to 39, and the cost went down from 139 percent o f income per capita to 119 percent (See Table A1.2). However, the VU1 has two remaining problems: (i) it does not involve al l the agencies required in business registration and investment processes (only covering business, tax, investment, and municipal registrations); and (ii) there remains a lack o f coordination in some areas. Despite the noticeable gains, doing business in Nicaragua remains a challenge due to some remaining archaic bureaucratic processes (FIAS, June 2004).

Due to methodology constraints, Doing Business Indicators only reflect administrative procedures in Managua. The IFC Municipal Scorecard project conducted in 2007 shows high variability in the level o f difficulty o f obtaining operating licenses and construction licenses across the municipalities (See Table A1.3). For instance, the municipalities o f Esteli and Chinandega perform relatively wel l on both rankings, while Granada and San Juan del Sur are ranked poorly on both. The Municipal Scorecard report concludes that although overall Nicaraguan municipalities rank slightly better on most regional indicators o f performance measures, such as number o f days to obtain a license, the municipalities need to work on process indicators, such as efficiency o f inspections and providing feedback mechanisms for f i rms. O f the municipalities, only Esteli and Masaya have implemented any programs to improve these processes. Further work to make the procedures for obtaining licenses more transparent and less costly wil l encourage firms to formalize.

Table Al.3: Municipal Rankings for Operating and Construction Licenses

Municipality Country Ranking Regional Ranking Country Ranking Regional Ranking Operating License Ranking Construction License Ranking

Esteli 1 5 1 5 Jinotega 2 6 8 16 Chinandega 3 7 3 8 Matagalpa 4 8 6 11 Managua 5 11 7 12 Leon 6 14 4 9 Rivas 7 20 5 10 Granada 8 21 10 47 San Juan del Sur 9 24 9 26 Masaya 10 30 2 6

Note: The regional ranking covers 65 municipalities in Bolivia, Brazil, Honduras, Nicaragua, and Peru. Each ranking i s based on a several measures including time needed to obtain an operating license and number o f inspections for a construction license. Source: IFC Municipal Scorecard, 2007

Access to Finance. Both the 2006 Enterprise Survey data and the I C A 2004 identified access to financing as a major constraint to firms’ growth. Commercial banks and finance companies in Nicaragua have stated that they have available liquidity and could lend under certain

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circumstances to small and medium enterprises (SMEs). However, the unique lending methodologies that best serve the needs o f SMEs are not understood by the commercial banks and finance companies. As o f the end o f 2006, 3 1 percent o f commercial banks’ total assets were highly liquid. The I C A identified collateral as an important constraint for SMEs to gain access to financing. Although collateral requirements have decreased significantly, from 223 percent in 2003 to 129 percent in 2006, the share o f f i r m s in the survey with access to commercial bank financing for investment decreased from 16.6 percent to 13.0 percent over the same period (Enterprise Survey Data 2006). A World Bank Land Titling project, Proyecto de Ordenamiento de la Propiedad (PRODEP), is developing efforts to enhance public registries and land registries which wil l provide clear titles to assets that can be pledged as collateral. In Nicaragua, the burdensome processes and lack o f an appropriate regulatory framework make asset pledging difficult. A Cadastre L a w and a Registry Law were recently passed, but the regulations are not yet fully developed. The Competition Law provides the creation o f an independent agency to enforce consumer protection rules, intellectual property rights and regulations against anti- competitive behavior. The National Assembly passed a new Bank Law, Superintendency o f Banks Law, and a Deposit Guarantee Law, but there i s a lag in the preparation o f norms and capacity in each o f the cases.

The financial sector indicators from the Doing Business data base corroborate the ICA’s findings regarding l o w credit services. As the table below illustrates, Nicaraguan f i r m s rely more heavily on retained earnings, particularly for new investments, than their counterparts in Guatemala and Honduras. Access to banks (lines o f credit, working capital, investment loans) and the use o f supplier credit also lag behind the rates in nearby countries (Table A1 -4). Firms rely heavily on retained earnings, while credit from commercial banks makes up less than 15 percent o f working capital and less than 20 percent o f investment finance. The Doing Business 2008 data indicates that a private credit bureau opened in 2007 and now provides risk information for 100 percent o f the adult population. This should expand access to credit as i t permits lenders to assess credit risks more efficiently.

Table A1.4: Private Sector Sources o f Finance Nicaragua Honduras Guatemala Nicaragua

Small Medium Large Share o f f i rms with audited f inancial statements 30.2 43.2 34.2 27.4 48.7 79.3 Share o f f i rms with overdraft or l ine o f credit Share o f credit currently unused

30.7 42.7 49 25.3 40.5 63.8 55.5 61 60 50.3 63.7 52.8

Share o f f i rms with loan from bank or other f inancial inst. 43.7 51.2 43.5 45.2 39.2 58.6 Sources for working capital

Retained earnings 57.6 49.2 59.2 56.9 56.2 50.7 Banks 14 25.9 13 11.3 14.5 21.4 Supplier Credit 16.3 13 18.3 17.8 18.8 23 Equity 0.4 0.6 1.4 0.1 1.4 0.7 In fo rmal sources 0.8 1.5 0.8 1.1 0.1 0 All others 10.9 9.8 7.4 12.7 8.9 4.1

Retained earnings 68.6 52.7 59.4 71.4 70.1 64.7 Banks 17 27.9 19.5 11.9 16.5 27.7 Supplier Credit 3.7 5.7 8.4 5 4.8 3.9 Equity 0.8 2.2 1.4 0 2.5 1.8 In fo rmal sources 0.1 1.4 0.7 0.1 0 0

Sources for n e w investments

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Source: World Bank, Nicaragua Investment Climate Assessment (2004)

Despite the inconsistent access to finance for firms, the banking sector is showing signs o f increasing health. Although the number o f banks has not increased, their coverage across the country has, with an almost 20 percent increase in the number o f bank branches between 2006 and 2007. The loan portfolio i s also growing annually at a rate o f about 30 percent. The portfolio at risk is high but decreasing. (Table Al.5)

Source: Central Bank o f Nicaragua statistics

Qualify issues. The number o f Nicaraguan firms adopting computerized equipment reflects a l o w level o f technology adoption, despite significant upgrading o f products and acquisitions o f machinery as reported by the firms. Only 11 percent innovate by introducing computerized equipment, which ranks l ow even when compared to Guatemala (24 percent) and Honduras (21 percent). Very few Nicaraguan f i r m s have international quality certifications (3.3 percent) and mostly large firms meet any other kind o f quality certification. This is the result o f immature markets, a weak infrastructure network for quality certification and few recognized laboratories o f which none are I S 0 certifiers. The ICA recommends adopting international quality standards, encouraging technological innovation and up-grading workforce skills as key factor to increase competitiveness, productivity and growth.

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Table A1.6: Private Sector Innovation and Oualitv ComDliance ndicator Nicaragua Honduras Guatemala

;inns Introducing a technological innovation in the last two years 67.9 67.3 80.9 Embodied in new machinery or equipment 71.6 79.2 73.9 By hiring key personnel 45.3 49.5 49.5 Licensing or turnkey operations from international sources 1.7 3.3 4.1 Licensing or turnkey operations from domestic sources 0.7 1.7 1.4 Developed or adapted within the establishment locally 44.9 39.9 46.2 Transferred from parent company 4.4 7.6 5.2

Developed with equipment or machinery suppliers 16.2 20.1 18.2

Trade Fairs and/or Study Tours 16.9 18.2 16.8 Consultants 5.7 7.3 6.8 From universities, public institutions 4.4 3 3

Share o f Firms with a Foreign License 9.1 15.2 19.6 Share o f Firms with I S 0 Certification 3.3 5.4 3.3 Share o f Firms with Other Quality Certification 20.3 17 11.9 Share o f Firms with Computerized equipment 11.1 21.4 23.5

Share o f Firms that Upgraded an existing product line 85.1 72.3 81.5

Source: World Bank, Nicaragua Investment Climate Assessment (2004)

Developed in cooperation with client firms 9.8 11.2 12

From a business or industry association 5.7 3.3 7.9

Major new product line since 2002 47 46.5 53

Introduced new technology since 2002 52.5 45.2 43.3

Ministry ofEconomy (MIFIC’): The mission o f the Ministry o f Economy (MIFIC) is to develop strategies and encourage policies that contribute to the sustainable economic development o f Nicaragua, helping the private sector be more competitive. I ts objectives include: (i) promoting access to external markets; (ii) promoting free competition; (iii) achieving a greater presence in the world economy; (iv) protecting consumers’ rights; (v) easing investment and; (vi) supporting the private sector so that i t can take advantage o f opportunities in international markets. MIFIC, in coordination with representatives o f the private sector and public institutions, has elaborated a comprehensive program to strengthen MSMEs. The program i s known as ProMIPYME, and it calls for $186 mi l l ion in total investment between 2008 and 2012 to be financed by multiple donors. The program will be realized as a Sector Wide Approach (SWAP) o f which the Government aims to contribute US$2.05 million-about 1% o f the total-in 2008. The M S M E Project will be aligned with the SWAP, but wil l not take part in the SWAP due to World Bank requirements for SWAP participation and on technical grounds related to some o f the SWAP initiatives.

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Annex 2: Major Related Projects Financed by the Bank andor other Agencies

NICARAGUA: Micro, Small and Medium Enterprise Development Project

The Nicaraguan government, in coordination with public and private sector representatives and through a constant dialogue with the donor community, has elaborated a Sector Wide Approach (SWAP) mechanism whose objective is to strengthen MSMEs. This business development program i s called ProMIPYME. The SWAP should channel funds up to US$186 mi l l ion for 2008-2012 and wil l be financed by multiple donors. Due to internal World Bank policies, the Bank wil l not be a formal part o f the ProMIPYME SWAP, but the activities that this project will support through i t s components will be aligned with an important number o f ProMIPYME’s sub- programs which include, inter alia, Business Climate and Access to Financial Services.

There are several donors that support Nicaragua’s MSMEs sector. Important interventions are being undertaken in the field o f business competitiveness constraints (i.e. infrastructure, administrative simplification, financial services, or property rights), enhancing productivity, investments, and export growth. Nine o f the donors have projects related to competitiveness in the areas o f business and value chain development and exports and investments promotion. The Bank has four active projects in the areas o f land administration, public sector institutional strengthening, micro finance, and rural electrification.

Other donors’ projects

International Finance Corporation (IFC). The IFC started advisory services operations in Nicaragua in 2004 through the multi-donor funded L A C Technical Assistance Facility to support SMEs’ capacity building and access to finance (See Annex 6 A for further detail). The Facility seeks to improve the business enabling environment for SMEs and to simplify administrative procedures through the Municipal Scorecard project undertaken in eight municipalities (Masaya, Leon, Chinandega, Granada, Matagalpa, Rivas, Managua and Somotillo). This project provided a diagnosis and recommendations o n how to facilitate licensing o f new businesses and provision o f construction permits. Additionally, with the World Wildlife Fund (WWF), the Facility strengthens the competitiveness o f the wood sector. The IFC i s also a partner with the local Chamber o f Commerce (CACONIC) and the Association o f Municipalities (AMUNIC). The IFC plans to expand its operations in the country by supporting investment operations in physical infrastructure and improvements in key sectors (energy, seaports, industry and services).

Inter-American Development Bank (IADB). IADB is strengthening Nicaragua’s innovation and quality capacity, improving the export capacity o f specific clusters, and supporting the establishment o f new businesses. IADB has (i) a project o f US$40.24 mi l l ion for 2006-2010, seeking to improve infrastructure for the coffee, dairy, beef, and tourism clusters and to support institutional and investment climate improvements to encourage investments in these clusters; (ii) a US$980,000 operation with the Ministry o f Economy to implement a one-stop shop for new investments; and (iii) a US$817,000 operation to support SMEs in the tourism sector by developing training processes for tourism, implementing a national tourism quality-control system (SNCT), and strengthening o f CANTUR (Nicaraguan Association o f Small and Medium- sized Tourism Enterprises and Micro-enterprises).

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European Union has a US$7.9 mi l l ion project for 2008-2012 to support the enhancement o f the Business Climate in Nicaragua. Additionally, the EU is planning a US$32.0 mi l l ion budget support operation earmarked for SME development for 2009-201 2

Sector

Austria has a cluster development project (ONUDI) o f US$1.9 mi l l ion for 2005-2007. I t seeks to strengthen the coffee, dairy, forestry, flowers, and shoe-leather clusters in specific localities. Their operations are located in Masaya, Granada, Carazo, and Chontales. The components include workforce training, quality requirements, and value chain development.

Formal Government Common Plan of Common Donors Involved Policy/Strategy/Plan Activities? Expenditure

USAID has a project o f US$44 mi l l ion for 2005-2010 for commerce and competitiveness o f the banana cluster.

No Public Sector Management

The United Kingdom Department for International Development (DFID) has a US$4 mi l l ion project to strengthen SMEs and support business climate improvements from 2008 to 2010. A Good Governance initiative o f up to US$250,000 is also under consideration.

1 Frhmework? I Bank, Netherlands,

Yes

The Government of the Netherlands has US$9 mi l l ion for different project interventions for 2004-201 0 in collaboration with important stakeholders to improve inter alia business export capabilities, access to finance and business services.

Health

Education

Agriculture

The Swiss Agency for International Development in Nicaragua (COSUDE) has a US$6.5 mi l l ion operation to support micro-enterprises and SME development in the ago-food industry and tourism during 2001-2012. COSUDE has another project o f US$3 mi l l ion to support training services for SME’s in 2006-2008.

Plan Nacional de Bank, Sweden, Salud Code o f Conduct, No Finland, Plan Quinquenal de Jan. 2005 Netherlands, Salud (2005-2009) Austria, IADB Plan Nacional de Common work plan Denmark, Canada, Educacidn signed

Pro-Rural memorandum o f No Denmark, FAO,

EU Finland, Sweden, Code o f conduct and

understanding IFAD, Switzerland

The Norwegian Agency for International Development (NORAD) has a US$1 mi l l ion project for land titling.

Bank projects

The four Sector-wide Approaches (S WAPs) in Nicaragua cover public sector management, health, education, and agriculture. K e y characteristics o f the SWAPS are provided below.

1 Yes Denmark, Sweden, I DFID I

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Land Administration Project (PRODEP). From 2003 to 2008, this US$32.6 mi l l ion project i s supporting activities related to land titling, a small cadastre pilot, improvements in the Public Registry, and research studies. The project is being implemented in three selected territories: Esteli, Madriz, and Chinandega. The expected result is the adoption o f a methodology for a property registration system. The project counterpart i s the Ministry o f Finance. The Development Objective and the Implementation Progress ratings are both rated as marginally satisfactory.

Public Sector Technical Assistance Investment Project. This i s a US$23.5 million project that was implemented in period 2004-2007 and i s s t i l l part o f the new Country Partnership Strategy with Nicaragua. The operation includes three components: (i) strengthening the government fiscal and financial management; (ii) advance in the implementation o f the c iv i l service law; and (iii) strengthening o f participatory public pol icy planning and monitoring. The counterparts are the Ministry o f Finance. The Development Objective and the Implementation Progress ratings are both marginally satisfactory.

Broad-Based Access to Financial Services Credit. This is a US$7 mi l l ion project being implemented in the period 2004-2009. The project seeks to improve the financial access o f micro and small enterprises and poor households by improving the regulations and supervision o f microfinance operations by SIBOIF and assisting other microfinance institutes. The project counterpart i s Financiera Nicaraguense de Inversiones (Nicaraguan Investment Finance Institution (FNI)). The Development Objective rating i s satisfactory and the Implementation Progress rating i s marginally satisfactory.

The Off-Grid Rural Electrification Project (PERZA). This i s a US$12 mi l l ion project with an integrated approach to off-grid electrification, including a microfinance component. PERZA facilitates loans to households and micro-businesses in project sites to hook up to the new electricity systems and to finance productive investments. The Development Objective and the Implementation Progress ratings are both marginally satisfactory.

Second Agricultural Technology Project. This i s a US$12 mi l l ion project to be implemented in 2006-2009. The project aims at providing rural households with broad access to sustainable agricultural, forestry and natural resource management practices and to increase productivity. This project supports the Pro-Rural SWAP.

MIGA activities in Nicaragua include three projects for a total o f US$107.3 million. Two o f the projects totaling 99 percent o f total portfolio are in the power sector. In technical assistance, MIGA has provided intensive support to ProNicaragua, the national investment promotion agency, which was remarkably successfid in attracting over US$88 mi l l ion in new investments in 2003-2004.

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Table A2.2: Prc

Simplification

!cts Summary GON PROJECTS MIFIC: US$0.38 mi l l ion administrative simplification program for new business registration

ProMIPYME SWAP US$186M (2008-2012). Project seeking to encourage development o f MSMEs by financing services needed by enterprises.

Services to Production US$145.35M 1. Associativity: SPAR

(Sector Publico Agricola), FUNICA

agribusiness: WAFOR, INTA, IDR (Instituto de Desarrollo Rural -1DR)

3. PRORURAL: Poverty Reduction Program. I t includes 7 components and among them: 1) support to 25,000 producers/families for technological innovation on agricultural production; 2) support to 7,000 indigenous families and 3,200 producers/families to promote ago-forestry systems; 3) Support to 19,000 producers/families to improve efficiency o f their production activities, including promoting financing services, business

2. Developing

BANK PROJECTS 1. PRODEP: a US$32.6 million, project include land titling, a small cadastre pilot, improvements in the Public Registry, and research studies.

1. PERZA US$12 mil l ion project facilitates loans to households and micro-businesses in project sites to hook up to the new electricity systems and to finance productive investments.

2. MIGA has 3 projects for US$107.3 million, including two large projects in power sector.

OTHER DONORS 1. IFC: Municipal scorecard

developed in-the municipalities o f Leon, Masaya, Granada, Chinandega, Matagalpa, Managua, %vas y Somotillo to facilitate obtaining licenses to open a new business and construction permits.

a one-stop shop for new investment.

3. NORAD: a US$1 mil l ion project for land titling.

1. IADB: a US$40.24 mil l ion project, seeking to improve infrastructure for coffee, dairy, beef, and tourism clusters

2. Austria: a US$1.9 mil l ion project to strengthening the local f i rms in the coffee, dairy, forestry, flowers, and shoe-leather clusters in specific localities. Their operations are located in Masaya, Granada, Carazo, and Chontales. The components include workforce training, quality requirements, and value chains development.

3. USAID: US$44 mil l ion in 2005- 2010 for commerce and competitiveness o f the banana cluster

4. DFID-FINNIDA: US$4 mil l ion project to strengthen an important number o f productive value chains.

5. The Netherlands: a US$3 mil l ion project business environment and export promotion in 5 regions

6. COSUDE: a US$6.5 mil l ion operation to support micro- enterprises and SME’s development in the agro-food industry and tourism.

2. IADB: US$980,000 to implement

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Table A2.2: Pro COMPONENT

Business Services

Quality

Finance

xts Summary GON PROJECTS I BANKPROJECTS

partnerships, integrating producers to markets.

Plan for government matching grants system (MIFIC, based on PAIT

3. BROAD BASED ACCESS TO FINANCIAL SERVICES US$7.0 mil l ion project to improve the access o f micro-businesses to financial services by improving the regulatory framework for MFIs and financial cooperatives, supervision o f micro finance providers, and the efficiency and products o f those providers.

OTHER DONORS

1. IADB: a US$ 817,000 operation to support SME’s in the tourism sector by the development o f training processes for tourism

2. COSUDE: a US$3 mil l ion to support training services for SMEs

mi l l ion from 2007-2010 for business development services.

1. IADB: a US$6.79 mil l ion project supporting matching grants for technological innovation in SMEs and strengthening technology service laboratories and the national innovation system (NIS);

2. EU: a US$6.5 mil l ion project to support exports promotion designed to improve quality laboratories for coffee, cacao,

3. NETHERLANDS: US$4

organic beef, and shrimp. 1. COSUDE: Three-year technical

assistance facility for MFIS 2. IADB: US$30 mil l ion credit l ine

to Financiera Nicaraguense de Inversiones and US$0.7 mil l ion for TA

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Annex 3: Results Framework and Monitoring

NICARAGUA: Micro, Small and Medium Enterprise Development Project

Project Development Obiective (PDO) To improve the competitiveness o f micro, small, and medium enterprises (MSMEs) and the business climate that affects those firms.

Intermediate Results Component 1 Business and Investment Climate Improvement (US$4.1 million)

Component 2 Matching Grants for MSMEs (US$8.36 million)

Results Framework Outcome Indicators

MSMEs receiving matching grants introduce new products or processes

Decrease in time needed to start a business

Results for each ComDonent Component 1

(i) Decrease in time needed to start a business

(i) Decrease in the time to obtain food and health permits

(i) Increase in the number o f newly registered businesses

Component 2

:i) Increased number o f f i rms that implemented product or process quality enhancement projects (including international certifications)

[ii) Increased number o f f i rms that introduced new products and/or processes

.... 111) Number o f firms awarded

matching grants that obtain bank financing

Use of Outcome Information

Improvements in private and public services provided to MSMEs to improve their competitiveness

Use of Results Monitoring. Component 1

Policymakers could increase investment in CAMIPYMEs and expand number o f local agents based on positive results

Positive results could confirm that the right set o f incentives and sanctions i s in place to promote formality. If negative results, new incentives may be required.

Component 2

MIFIC and Bank staff use information to improve matching grants efficiency; if results are not positive, a different institutional arrangement (such as a private sector matching grants facility) could be considered.

29

Component 3

Access to Financial Services (US$4.8 million)

Component 4

Institutional Development o f MIFIC (US$1.48 million)

Component 3

(i) Interest o f participating financial institutions (PFIs): Number o f financial institutions participating in the Pilot PCRG.

(ii) Number o f M S M E loans extended by PFIs

(iii) Sustainability o f the Pilot PCRG: Coverage o f administrative costs by guarantee fees and estimated investment proceeds, on average over a period o f years. Component 4

(i) Adequate technical and fiduciary staff in place; clean audits

(iii) Operational and Procurement plans presented before start o f calendar year

Data Sources for Proiect Monitoring

Component 3

MIFIC and Bank staff use the information to monitor project activities, identify shortcomings, and improve design o f PCRG

Component 4

Bank able to confirm efficient, timely use o f project hnds.

summaries Ongoing with annual summaries

30

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Annex 4: Detailed Project Description

NICARAGUA: Micro, Small and Medium Enterprise Development Project

Component 1 : Business Climate Improvement (US$4.11 million)

This component wil l improve key elements o f Nicaragua’s investment climate including: (i) reducing the time and cost o f business registration; (ii) reforming the current regulatory framework for MSMEs; (iii) reducing key-bottlenecks in technological and information technology (IT) infrastructure to monitor development o f the sector and to increase the efficiency o f administrative procedures in applying for tax breaks and strengthening the national quality s ys tem .

A major objective o f this component i s to support expansion o f the coverage o f the above government services by reducing time and simplifying procedures at the central and departmental levels. The Government has addressed administrative barriers in i t s national plan, and has taken some steps towards adjusting the legal framework and implementing some initiatives. PROMPYME, the government plan to foster the development o f MSMEs in Nicaragua, i s dedicating a separate component to the problem o f the investment and business climate for MSMEs. At a municipal level, the IFC has completed “Municipal Scorecard” studies indicating the weaknesses and bottlenecks in 10 municipalities. In addition, The European Commission has approved a EUR 5.4 M i l l i on project involved in business climate improvement that i s expected to start in the first ha l f o f 2008. While there is progress, regulatory and administrative barriers st i l l constitute a major concern for M S M E development.

The activities wil l address some key administrative barriers affecting Nicaraguan M S M E costs o f operation. The criteria for choosing concrete interventions have been highlighted by the I C A and the Doing Business reports (2004, 2005 and 2006). Interventions have also been selected based on the government priorities outlined in the PROMIPYME program. The PROMIPYME program was designed in consultation with the private sector. Activities have also been selected based on their feasibility (e.g., legal framework, cost involved, and capacity and commitment o f related agency), and their expected impact and visibility.

Subcomponent 1: Business Process Simplification and Decentralization The activity wil l build on the IFC’s efforts to strengthen the decentralized services in at least 8 municipalities in Nicaragua as wel l as the IDB’s engagement in establishing a one-stop shop for business registration (Ventanilla Unica de Inversion- VUI) in Managua. The proposed interventions wil l include: (i) implementation o f VUIs in at least 5 municipalities; (ii) increasing the number o f services offered by the VUIs by including tourism investment procedures; (iii) implementing the action plans developed by the IFC’s “Municipality Scorecard” study in at least 6 municipalities; (iv) increasing transparency in business registration for MSMEs by implementing guided, decentralized access and promotion o f e-regulations in at least 8 regions and financing the inclusion o f MSMEs’ relevant procedures in the e-regulations platform. E regulations is an online transparency information system that allows i t s users to understand business registration and its costs. E-regulations has been developed by UNCTAD; and (v) ensuring decentralized access to MIFIC’s services in providing information about formalization and related administrative procedures. Decentralized access would finance 5 centers - Centros de

34

Apoyo a la Micro y PequeZa Empresa (CAMIPYMES) - for assistance to MSMEs. The support for the C A M P Y M E S would be initiated in phases in order to allow for adaptation and re-design o f the mechanism. The interventions would finance two centers in the f i rs t year o f the project and, based o n the results, finance 3 additional centers starting from the second year o f the project.

Subcomponent 2: Strengthening policy and technology frameworks for MSMEs The Government i s planning to address key challenges in the analytical and technological framework. On an analytical level, there i s a need to include international lessons learned and their possible implications in the Nicaraguan context. Therefore, the activity wi l l support the revision o f the regulatory framework and the administrative disposition to necessary changes in the areas o f (i) tax breaks for newly established MSMEs, (ii) contracting o f MSMEs for government services and supplies, and (iii) labor market regulations. On a technological level, there are IT bottlenecks in the Nicaraguan administration causing delays in key areas o f the business and investment climate. The activity will eliminate these bottlenecks by providing an adequate IT and technological infrastructure to public agencies. The proposed intervention wil l include: (i) Establishment and implementation o f a monitoring system for assessing the impact that national policies have on the business and investment climate for MSMEs and (ii) Implementation o f new online modules to ease the process o f accessing tax-breaks in the areas o f export.

Subcomponent 3: Access to Quality Assurance and Certiflcation This activity will address the supply side o f standards and labor certification. The objective i s to improve the National Quality System’s implementation (in l ine with the importance given to this in the National Development Plan). The activity wil l tackle key bottlenecks in accreditation and certification. The proposed interventions wil l include: (i) improving the infrastructure in MIFIC’s laboratory to increase i t s quality delivery and to initiate the ISO-accreditation process o f the laboratory; (ii) strengthening the human resources in the laboratory to allow for a more efficient analysis o f quality; (iii) strengthening the human resources in the Ministry o f Health (MINSA) to increase their efficiency in issuing foodhealth permits and executing inspections; (iv) strengthening the institutional capacities inside the regulatory bodies; and (v) strengthening the technical capacity o f the National Accreditation Office (ONA). This would include the acquisition o f equipment in metrology and standards and the renovation o f the laboratory.

Component 2: Matching Grants for MSMEs (US$8.36 million)

This component would finance matching grants for MSMEs. Grants would finance pre- investment and investment activities and be awarded competitively through a series o f rounds with different themes. Pre-investment activities include development o f business plans and feasibility studies that would allow MSMEs to apply for commercial credit. The grants would not substitute for commercial credit; rather they would aim to develop a large number o f “bankable” MSMEs. Likewise, matching grants for investment activities would complement commercial credit by focusing on themes where bank financing i s not viable. Themes would be geared toward areas with the potential to generate public goods and positive spillovers/externalities. Possible themes include: (i) resolving bottlenecks in value chains and forward and backward linkages; (ii) improving product quality, e.g. by obtaining internationally

35

recognized quality certifications; (iii) addressing environmental issues, such as when firms want to adopt “clean technologies”; and (iv) technological innovation to improve productivity and employment generation.

Financing for pre-investment activities would complement the partial credit risk guarantee facility supported by Component 3. Financial institutions have indicated that there i s a lack o f MSMEs with credible business plans seeking financing. By providing matching grants to allow firms to build business plans backed by solid research and feasibility studies, the component would increase the pool o f potentially bankable MSMEs.

The rationale for grants to reduce bottlenecks in value chains is that the social return to such investments i s higher than the private return to the individual investor. In other words, if one firm makes an investment that eliminates a bottleneck, other firms in that sector can also benefit without having to contribute anything. Investments in quality improvements, quality certifications, and innovation have similar characteristics. When a given firm successfblly upgrades the quality o f i t s products or innovates, other f i r m s can often learn from and copy such efforts. The “copying firm” i s spared the risk o f investing in a new product or process with unproven results. For example, if a firm obtains a quality certification allowing i t to export an agro-industry product to European markets-thereby surmounting a technical barrier to trade- other firms could learn from this demonstration effect. When such positive externalities and spillovers exist, there i s a strong case for public support. Without public support, a firm might not have enough incentive to make a risky investment where much o f the benefit could be captured by others. Investments in clean technologies and things that improve environmental management also can have positive spillovers. For instance, if a tannery changes its processes to reduce the amount o f chemical waste being dumped in a river, the benefits accrue much more to society (and people down river) than to the firm itself.

The matching grant concept i s different from most traditional approaches to helping f i r m s in that i t is deliberately temporary and the support is partial. MSMEs are expected to make a significant financial contribution to demonstrate commitment and ownership. Detailed eligibility criteria and selection and evaluation processes are described in the matching grants operational manual; below i s a br ief summary.

Eligibility and Selection. MSMEs and associations o f f i r m s would be eligible for matching grants. Quality and certification service providers would also be able to eligible. For example, laboratories, inspection services, certification trainers, general quality training providers, and certifiers could apply for matching grants to improve their capacity and service offerings to reach a greater number o f f i rms. Firms or groups o f f i r m s would be selected through distinct, competitive rounds. After al l the proposals are received for a given round, they would be evaluated and ranked by an independent committee with strong representation from the private sector. This would help ensure that the selection criteria are applied fairly and transparently to al l applicants. Grants would be awarded to f i r m s based on their rankings until the funds were exhausted for that round. Every round would be theme specific (i.e. product innovation, food quality, certification, clean technology, etc.), aiming at focusing investments to cause impact in a large pool o f MSMEs that share the same constraints, and where that impact i s easier to evaluate. An ini t ial round may be available to associations to complete publicly available studies on sector

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bottlenecks; these studies would then inform themes for subsequent rounds. Rounds could also potentially focus o n disadvantaged regions, such as the Atlantic coast ( R A A S and RAAN). Efforts would be made to ensure that rounds are regular, predictable, and wel l publicized, allowing f i r m s to plan their participation with ample notice. Grant recipients would also be publicized on MIFIC’s website and on the radio, including a short summary o f what the grant was for.

Payments. Grant recipients would be required to contribute a fixed percentage o f their own f inds toward the proposed activity. Percentages rates are defined in the matching grants operational manual. As every round i s theme specific, percentages rates could vary by round or theme. Higher financing percentages could be allowed for investments with higher positive externalities (e.g. clean technologies). Contributions from grant recipients are critical to ensuring that recipients have a strong interest in the success o f the proposed activity.

Grants would be paid using one o f two schemes: reimbursement or advance payment. SMEs would only be eligible for reimbursement, based on proof o f expenditure and verification that the activities were completed. Recent experience from the Program to Support Technological Innovation (Programa de Apoyo a la Innovacidn Tecnoldgica, PAIT, financed by the IDB and administered by MIFIC) suggests that lack o f working capital was a significant constraint for some firms. Therefore, advance payments would be possible for microenterprises (i.e. firms with 1-5 employees). Advances would follow a pre-defined disbursement schedule, and each subsequent disbursement would be conditional o n proof that the previous disbursement had been adequately spent.

Institutional arrangements. In line with the Government’s strong push for capacity building within the l ine ministries, the Project would build a unit within M I F I C to administer the matching grants program. The unit would draw on lessons learned and some o f the institutional infrastructure from the PAIT. The PAIT recently closed and valuable lessons were learned in terms o f the resources needed to execute a matching grants program.

Evaluation. After the program has been operating for 18 months, it would be evaluated by independent reviewers. If i t performs satisfactorily, the program would be scaled up. Otherwise the design would be adjusted or alternative mechanisms sought. The efficiency and fairness o f the recipient selection and evaluation process, as well as the impact o f the grants on the recipient MSMEs, would be evaluated. To evaluate the impact on MSMEs, firms would have to submit basic financial data with their funding applications to provide a baseline. They would also have to submit periodic progress reports after receiving financing. The evaluation would then compare the “before” and “after” data for f i rms . The evaluation would likely complement this analysis with interviews with select beneficiaries.

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Component 3: Increased Access to Financial Services for MSMEs (Total US$4.8 million)

This component wil l improve the access and terms o f MSME credit by providing an appropriately designed Partial Credit Risk Guarantee (PCRG) mechanism for loans provided by regulated financial institutions to MSMEs. The pi lot PCRG wil l aim to improve the incentive structure for financial institutions (FIs) towards eliminating the impediments to the efficient resource mobilization and allocation to MSMEs. This component wil l be disbursed gradually, with no init ial capitalization o f the fund. During annual and midterm reviews, there wil l be an option to move the funds to other components if there has not been sufficient demand for the guarantee. The design has benefited from the technical assistance provided by the BancoEstado o f Chile, which runs a successful PCRG in the region (FOGAPE). Among other products, leasing, factoring and warehouse financing were explored, but leasing and factoring are problematic due to their dependence on passing relevant laws, while warehouse financing i s already well developed.

Nicaraguan financial institutions exhibit significant amounts o f liquidity and are currently facing increased competition in established markets due to foreign bank entrance, increasing their incentives to explore the untapped MSME segment. Banks, which represent 58.5% o f the financial sector in terms o f assets to GDP, held 3 1 percent o f total assets in liquid assets as o f end o f 2006, while year-on-year real private credit growth reached 24 percent in 2006. The ongoing consolidation o f the last years based on mergers and acquisitions with foreign entities (2006 shows the entry o f HSBC acquiring Banistmo and Citigroup Inc. acquiring Grupo Financier0 Uno), has resulted in increased efforts by FIs to downscale their technology towards the MSME sector. An interesting example is offered by BanPro, which has begun a new SME division with specialized training for i t s credit officers, and BanCentro, whose new SME division has grown in 10 months (since M a y 2007) to 4,036 borrowers, with an average credit o f US$ 3,600 and average loan maturity o f 18 months. Hence, given the high liquidity in the system, increasing cash in the system would not necessarily increase lending to SMEs. Instead, a mechanism to encourage banks to lend their existing cash was needed.

Nicaragua’s banking sector, despite its current stability, has developed over a decade o f volatility and a difficult investment climate, creating an environment o f high risk aversion towards MSME lending and resulting in high liquidity among banks. The reluctance in moving down-market i s reflected by bank requirements that go beyond the business’ capacity for future cash flows and rely on the borrower’s ability to provide collateral, sometimes above 100 percent o f the loan principal for a new loan. This requirement exceeds the total assets o f many smaller borrowers, with the consequence that creditworthy and potentially creditworthy borrowers are unable to gain access to finance. Furthermore, even small enterprises with access to credit are constrained in terms o f the size and the maturity o f the loan, which in some cases may decrease their chances for success.

A PCRG could motivate private financial institutions to move down-market and invest in local MSME development, increasing access to finance and long-term financing. A PCRG is a tool that allows the mobilization o f private sector resources by sharing the risk with financial institutions and investors to encourage lending where access to credit i s limited or unavailable. The pi lot PCRG design to be explored in Nicaragua wil l allow financial institutions to perform the due-diligence o n the borrower and request partial support (at the portfolio level) to alleviate

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the lack or l ow availability o f guarantees. By alleviating this impediment to the flow o f hnds, the PCRG allows banks to explore new markets and their risks, while developing the necessary methodology for serving MSMEs and resulting in a market demonstration effect that can act as the catalyst for growth o f the local credit markets. Importantly, the pi lot PCRG, due to its sector and not individual FI orientation, i s designed to avoid giving an unfair advantage to any FI. Recent PCRG schemes in Nicaragua (US250 thousand by Holland, U S $ 5 mi l l ion per institution by U S AID) have met mixed success, with underutilization cases attributed primarily to design flaws, l ike the requirement o f a concluded judicial process prior to disbursement. The pi lot PCRG builds on lessons from these schemes. For example, on the issue o f sustainability, past scheme's limited success, l ike USAID programs, i s attributed to their design in having impact only during the duration o f the project, while the pi lot PCRG is designed to be sustainable past the project's l i f e cycle through gradual capitalization.

Bank and IFC staff have coordinated during the identification stage o f the pi lot PCRG component. The team met with IFC staff (at HQ and the field office) during the identification stage for consultations on the justification o f the pi lot PCRG and possibilities o f Bank-IFC cooperation. IFC staff concurred on the importance o f a PCRG at the sector level (as opposed to individual FIs) to alleviate market imperfections precluding FIs from expanding in the MSME sector.

The Bank, with technical assistance provided by the Banco del Estado o f Chile, has assessed the preconditions for a viable pi lot PCRG to be satisfactory and the market's receptivity to be positive. The preconditions for a successhl p i lot PCRG to alleviate the identified constraints include a stable financial sector, a strong interest by highly liquid banks (established through interviews) and the government (in the form o f a strong init ial proposal by FNI), and the positive reaction by the supervisor, SIBOIF.

Design and Implementation Arrangements

The mission o f the pi lot PCRG wil l be to encourage or enhance access to finance for MSMEs with a lack o f or insufficient guarantees for access to the formal financial system. The expected impact o f the pi lot PCRG wil l be to (i) increase financing and improve its terms through the availability o f collateral; (ii) allow new customers to enter the formal financial system; (iii) allow financial institutions to explore and learn about the M S M E segment o f the market.

There are a number o f potential benefits o f the pi lot PCRG for banks. Among them, the PCRG expands the risk frontier o f banks; frees up banks' r i s k capital from the regulatory and internal standpoint; lowers provisioning requirements; expands the fee and transaction based business with MSMEs; offers a demonstration effect for the banking sector.

The design o f the guarantee wil l minimize moral hazard by providing incentives to participating banks to conduct proper borrower credit appraisal and monitoring. To overcome the perception o f MSMEs as higher risk borrowers and the lack or limited availability o f collateral by MSMEs, the pi lot PCRG wil l cover 50 percent o f net outstanding principal amount o f new loans originated by participating banks, o n a pari passu basis with the participating banks. The partial r isk sharing and guarantee charges ensure that participating banks are exposed to borrower

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default and provide incentives to conduct due diligence on prospective borrowers. The design follows the FOGAPE model o f allowing the financial institutions to evaluate, decide upon and extend loans. Importantly the guarantee will be paired with capacity building for the participating banks on the use o f the pi lot PCRG.

The PCRG will be created within FNI, with IDA funds acting as guarantee reserves passed on by MHCP based on a subsidiary agreement. The diagram below describes the f low o f funds, TA and reporting, while defining the legal agreements among relevant parties. A special credit committee within FNI wil l review al l applications for the PCRG, both prior to loan approval and when financial institutions would l ike to call a guarantee. The FNI Special Credit Committee wil l be the operational administrator o f the PCRG using the funds as guarantee reserves to underwrite partial credit guarantees issued on a portfolio basis for commercial bank loans to MSMEs. Each PCRG facility with a PFI is expected to be non-revolving.

The pi lot PCRG i s designed to be self sustaining in the long run. The PCRG will aim for the estimated income from the simulated investment o f the funds5 and the guarantee charges (the two income sources) to be able to cover al l operating and due diligence expenses, as wel l as the payouts on defaults to preserve i ts capital reserves. Setting up costs (principally the cost o f software and TA for capacity building) wil l be part o f the TA, but the early coverage o f administrative costs wil l be phased out to provide incentives for efficient costs control. Thus the pi lot PCRG wil l be operated on a commercial basis aimed at controlling costs, charging appropriate fees and maintaining prudent treasury management.

FNI will not be investing IDA funds. In order to evaluate the potential sustainability o f the PCRG, the average return FNI receives from other investments w i l l be calculated for the PCRG funds.

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Partial Credit Guarantee: Implementation Arrangements

I M H C P M I F I C I Capacity! I Building: I

MSMEs Loan to 1 A

Reporting Flow - - - - - - - TA Flow

The legal agreements among relevant parties are: (i) a Subsidiary Agreement between the MHCP/MIFIC and FNI that will define the roles and responsibilities o f each and the operational mechanics for payments to FNI's account. The FNI Special Credit Committee wil l administer the pi lot PCRG, subcontracting, as necessary, part o f i t s functions; (ii) a Guarantee Agreement between FNI and each PF I wil l define the terms and conditions o f the PCRG. Each Participating Bank would be responsible for conducting due diligence o f M S M E borrowers and loan usages, underwriting M S M E loans to be guaranteed, and monitoring and reporting the performance o f the loan portfolio. Safeguard provisions in the Guarantee Agreement wil l define triggers in terms o f cumulative amounts paid to meet guarantee calls to require remedial action plans by the PFI, which may include (a) reduction o f the unused facility amount, and (b) the suspension o f the issuance o f new guarantees under the program.

The Guarantee Agreement wil l define the guarantee call conditions in case o f a loan default. The guarantee will be called no more than once a quarter to pay an amount equivalent to the aggregate amount o f defaults net o f al l amounts recovered by the PFI. The PFI wil l be allowed to make a guarantee call: (a) no fewer than an expected period o f 90 to 180 days after the occurrence o f such loan default, during which the PFI wil l be obliged to make recovery efforts to cure such default; (b) with a written guarantee cal l notice with documents required under the Guarantee Agreement including certification o f the amount o f loan principal guaranteed and due

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but unpaid and evidence that the demand notice has been made to the borrower and due efforts have been made to demand payments.

The Operating Manual will establish minimum pre-established eligibility criteria for participation based on the following:

(i) The eligibility o f participating banks wil l be subject to OP8.30 and will include their credit management policies, procedures, standards, and historical experience/exposure to M S M E lending or strategy/commitment o f entry and expansion o f lending to MSMEs. In particular, eligible participating banks must (a) be supervised by SIBOIF and must meet financial sector prudential requirements; (b) have access to adequate liquidity; (c) demonstrate a commitment to strengthening institutional MSME finance capabilities and expanding their MSME credit portfolios. The quality and reliability o f financial reporting and audited statements i s high in Nicaragua. Nevertheless, some PFIs may need to adapt their internal systems to the reporting requirements for participation. PFIs will be obliged to report on a quarterly basis details o f the loan portfolio covered under the PCRG, including the composition o f loans outstanding, terms o f individual loans and performance o f the loan portfolio under the facility.

(ii) The eligibility o f M S M E borrowers is based on the M S M E definition o f the project. The pi lot PCRG wil l not address any priority to a specific borrower category or sectors to allow participating banks in conducting the necessary due diligence and to be entrepreneurial in cultivating new M S M E business. Minimum criteria for eligible MSMEs will include: (a) exclusion o f MSMEs engaged in the project negative list; (b) achievement o f adequate turnover levels appropriate by business type; (c) less than 10 percent o f capital held in the aggregate by the participating bank or related entities; and (d) compliance with the Bank’s environmental guidelines.

(iii) The eligibility o f participating banks’ M S M E loan portfolio must meet pre-established criteria in terms o f credit quality and diversification, as wel l as: (a) Only new loans extended by the Participating Banks upon the effectiveness o f the Guarantee Facility; (b) Participating banks wil l be given considerable flexibility, based o n their internal prudent loan criteria, in extending new loans to existing borrowers and new M S M E borrowers to be covered under the Program; (c) Loans that would not benefit from any other third-party guarantees; (d) The maximum aggregate o f loans to any one borrower would not exceed X equivalent; (e) The minimum and maximum maturity o f each loan would be six months and 5 years respectively. Although the PCRG will seek to diversify its exposure into multiple sectors and regions, the loan portfolios eligible wil l include loans to MSMEs across al l sectors, cover a variety o f loan types including working capital loans, factoring o f receivables, and term loans for capital investment. The eligibility o f the underlying loans will be verified ex-post upon the guarantee call.

The guarantee program pricing wil l depend o n the due diligence o f the M S M E loan portfolios o f PFIs, but a draft financial model i s being explored (see below). Early estimations and best practice guidance would suggest a maximum leverage o f 10 times (prudently increased over time), a maximum coverage o f 70%, charges to reflect market conditions, program management expenses and the development nature o f the program (with fees estimated approximately at 2-4% o f outstanding guarantee amount in U S dollar terms). Bank staff wil l work with IFC in determining the guarantee pricing, as IFC estimated charges could form a good basis for market

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pricing. The guarantee charges could potentially be differentiated based o n bank performance at later stages o f implementation.

After 18 months o f operation (or at a later date accepted by the Bank), a review o f the pi lot PCRG could lead to changes, including the reallocation o f the component funds or the decision to begin to capitalize the fund. Until that time, the outstanding loan portfolio disbursed by participating financial institutions and covered by the pi lot PCRG will not exceed the total funds available for the PCRG component, nor wil l the maturity o f bank loans extended and guaranteed by the PCRG exceed the project closing date. If the decision to capitalize i s taken, based on fund performance and management capacity, the government should decide whether i t agrees to assume part o f the risk involved in leveraging the guarantee fund to cover a larger portfolio and loan maturities beyond the closing date o f the project. In addition, an appropriate investment scheme for the funds up to and beyond the project closing date should be established in accordance with generally accepted best practices and in accordance with FNI’s investment systems.

FNI wil l prepare annual supervision reports and quarterly credit risk assessment reports. The main indicators would include: (i) Interest o f PFIs: Number o f PFIs participating in the PCRG. Growth rate in number and volume o f MSME loans by PFIs, guaranteed by the PCRG; (ii) Access to Finance by MSMEs: Number o f active borrowers, outstanding loan portfolio, number o f municipalities with active borrowers. Percentage o f new borrowers versus the share o f follow- on loans in the PFIs guaranteed portfolio; (c) Improvement in M S M E loan terms: Percentage o f follow-on loans in the PFIs guaranteed portfolio showing an increase in size and/or maturity o f MSME lending; (d) Quality o f M S M E loans: The cumulative loan loss amount versus cumulative loan amount in the PFIs guaranteed portfolio; (e) Utilization o f the PCRG: Percentage o f the cumulative amount o f claims made and paid over the cumulative loan amount in the PFIs guaranteed portfolio; (0 Operational efficiency and sustainability o f the PCRG: Administrative costs over average outstanding loan portfolio. Percentage coverage o f administrative costs and guarantee pay-out by guarantee fees and estimated funds investment proceeds.

Conditions: For negotiations, the following wil l be needed: a legal opinion concerning the establishment o f the fund, the operating manual for Component 3 acceptable to the Bank, as well as a finalized format o f the guarantee agreement between FNI and participating commercial banks and finance companies. After 18 months o f operation, there would be an independent evaluation o f the pi lot PCRG before additional disbursements could be provided.

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Component 4: Institutional Development of MIFIC (US$1.48 million)

The objective o f this component i s to improve the institutional capacity o f M I F I C in its role as project coordinator, SWAP manager (even though the project i s not participating in the P R O M P Y M E SWAP, it wi l l s t i l l develop MIFIC’s capacity to manage the SWAP, since its objectives are important for private sector development), and technical and strategic leader for private sector development. National MSME surveys wil l be undertaken to better inform public pol icy discussions. Marginal costs incurred by M I F I C (such as procurement and financial management) would also be covered. This component would build capacity within M I F I C to prepare annual operating plans and annual procurement plans in a timely way, for submission to the Bank for review, discussion and no objection before the start o f the calendar year covered by the plans.

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Annex 4a: Lessons Learned from the Competitiveness LIL The Competitiveness Learning and Innovation loan (LIL) which closed in 2006 and preparation o f the Enhanced Competitiveness project (which was approved by the Bank in 2006 but cancelled by the Government in 2007) have contributed important lessons to the technical design o f this project. Additional lessons have been learned through implementation o f the PRSP and the ICA.

A traditional cluster development approach is not as effective as a cross-cutting approach to business bottlenecks linked to value chains. In the national context, clusters have become a horizontal integration approach, limiting the participation o f MSMEs in some cases. The new project wil l support value chains (from suppliers o f raw materials to producers, processors, transport f i rms, and brokers), increasing a sector’s overall efficiency, integration, and exports. This is consistent with the findings o f the FIAS sector value-chain studies for beef, textiles, and coffee. With co-financing from private sector partners, M I F I C could finance part o f the small investments required to resolve these bottlenecks through market intelligence services and technical assistance for specific sectors.

While there have been improvements in the business climate, certain under-developed services remain important barriers to improved private sector performance. Registries, cadastre, tax and export administration at the central and municipal levels are frequently cited as areas that need to be improved (see Doing Business). Jointly with the IFC’s municipal administrative strengthening work, and based on the lessons o f the LILY the new project would invest in systems development, training and capacity building to improve services in these and other core areas.

Quality and certification are the keys to opening doors in the new free trade environment - but national services are of poor quality andfirms are unable to pay for them. For that reason, the matching grants component would have rounds focused on fostering supply and demand for quality infrastructure services.

Public agencies are not ideal managers of matching grant programs unless public sector administrative procedures are adapted to increase efficiency and improve responsiveness to private sector demand. Moreover, the Bank’s experience with matching grants has been mixed. In several cases, slow implementation and low disbursement rates in the early phases o f implementation were caused by government requirements. These experiences suggest that if governments are not outsourcing the management o f matching grant programs to private institutions, they should adapt their internal procedures to ensure prompt evaluation o f projects and rapid processing o f disbursement requests by beneficiaries. Whether privately or publicly managed, the matching grant fund should be evaluated based o n i t s efficiency, disbursement, transparency, monitoring and specific impact at the firm level (including environmental benefits and externalities).

Greater integration in international markets could mean displacement of some workers - and mechanisms are needed to provide compensation and retraining. While M I F I C and the task team considered including a large labor retraining component, other donors and government agencies have already established short term compensation and retraining mechanisms.

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Value chains can be effective in the national context, with greater support. The Competitiveness LIL supported value chain work in the light manufacturing, coffee, milk, meat, fish and shrimp, tourism and forestry sectors. An example o f the usefulness o f the approach i s in the fish sector, where the value chain participants jo int ly invested in technological changes in the management o f the tank conditions to improve the efficient use o f productive inputs such as lime, nutrients and disinfectants. The f i r m s meet regularly to share experiences and market information, and to address concerns about government requirements and unfair competition. But more work i s required, as the forestry and wood furniture cluster demonstrates. The f i rms need to obtain certification by international conservation institutions. The group needs to address problems in the existing legal framework, and could benefit from joint market research and a more complete understanding o f new international market requirements.

Partial credit risk guarantees can leverage loans from commercial banks with high liquidity to MSMEs when they offer the right incentives and have streamlined payment processes. For this project design, the incentives are based on lessons from (i) past PCRG schemes in Nicaragua, (ii) emerging market experiences with PCRG, in particular the experience o f FOGAPE, Chile, (iii) recent Bank projects with PCRG schemes in India (Small and Medium Enterprise Financing and Development Project, PO865 19, Madagascar (Integrated Growth Poles Project, PO8335 1) and Ghana (Micro, Small and Medium Enterprise Project, P085006). Guiding principles based on international best practice include: (a) share risk o n a partial basis with the participating financial intermediaries, to provide the appropriate incentive to minimize moral hazard and maximize the ability o f the guarantee to ensure that productive assets are booked; (b) establish an autonomous, professional and technically capable administration; (c) focus on the operator and leverage i t s strengths- the financial institutions oriented to MSMEs and their commercial incentives to apply due-diligence on the borrower; (d) establish ex-ante eligibility criteria for financial institutions’ participation; (e) use a streamlined portfolio approach (versus credit by credit guarantee); (f) establish a “stop loss” mechanism to prematurely terminate a poorly performing program; (g) establish a streamlined approach to ensure utilization by the local banks; (h) make available pre- financing TA on the usage o f the PCRG to participating banks; and (i) establish appropriate performance monitoring.

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Annex 5: Project Costs

ComponentsISubcomponents

1. BUSINESS AND INVESTMENT CLIMATE IMPROVEMENT

1.1 Business Process Simplification and Decentralization 1.2 Strengthening policy and technology frameworks for MSMEs 1.3 Access to Quality Assurance and Certification

Sub-total 2. MATCHING GRANTS FOR MSMES

2.1 Matching Grants for MSMEs 2.2 Technical assistance, systems development and operational costs

Sub-total 3. INCREASED ACCESS TO FINANCIAL SERVICES

3.1 Partial Credit Risk Guarantee Fund 3.2 Technical assistance, systems development and operational

NICARAGUA: Micro, Small and Medium Enterprise Development Project

Foreign Local TOTAL

0.43 1.78 2.21

0.1 1 0.44 0.55 0.27 1.08 1.35 0.81 3.30 4.11

1.24 4.96 6.20

0.44 1.72 2.16

' 1.68 6.68 8.36

3.20 0.80 4.00 0.64 0.16 0.80

Sub-total 4. INSTITUTIONAL DEVELOPMENT OF MIFIC

4.1 Institutional Capacity Building 4.2 Monitoring and Evaluation

Sub-total

Unallocated

Grand Total

costs

3.84 0.96 4.80

0.24 0.94 1.18 0.00 0.30 0.30

0.24 1.24 1.48

1.25 1.25

6.57 13.43 20.0

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Annex 6: Implementation Arrangements

NICARAGUA: Micro, Small and Medium Enterprise Development Project

Implementation and Institutional Arrangements

Component Implementation Responsibilities. M I F I C would be responsible for overall coordination and execution o f the project. M I F I C would directly execute Component 1 (Improvement o f Business and Investment Climate). For Component 2, a specialized unit would be built within MIF IC to administer the matching grants program. This effort would build on experiences with previous M I F I C grants programs, such as the Proyecto de Apoyo a la Innovacidn Tecnoldgica. After the program has been operating for 18 months, this unit would be evaluated by independent reviewers. If the evaluation reveals structural issues, alternative matching grant delivery channels would be identified. If an alternative delivery channel is necessary, M IF IC wil l sign a Matching Grants Management Agreement with at least one experienced private sector matching grants facility, and wil l participate o n the board and in review panels o f matching grant proposals.

For Component 3, M I F I C would assign execution responsibilities for financial sector activities to the Financial Investments Institution o f Nicaragua (FNI). These responsibilities and the financial support would be set out in a subsidiary agreement between M I F I C and FNI. Finally, M I F I C would be responsible for donor coordination in the area o f competitiveness, as part o f its work under Component 4. I t i s wel l suited for this coordination role, given existing and planned relationships with the IADB, USAID, the European Union and the Bank.

Technical and Coordination Activities. The project would support a group o f technical consultants to assist M I F I C with the execution o f project activities. I t i s expected that experienced consultants would be hired for the following roles: (i) a Project Coordinator, (ii) two component coordinators (for the business climate component and for matching grants work), and (iii) at least two administrative staff for the matching grants program. Consultants to assist execution o f Component 3 in the FNI could also be financed.

Fiduciary responsibilities. The Administrative and Financial Department o f M I F I C (DAF) would be in charge o f al l fiduciary responsibilities, including procurement, disbursement, designated account management, audit coordination, project documentation, and other related tasks. The Project would finance the fiduciary services consultants necessary to assure efficient and appropriate use o f project resources. The project would provide the following three consultants to MIF IC DAF to execute the project: (i) a procurement official, (ii) an accountant, and (iii) a financial management consultant.

Under Component 4, funds would be used to strengthen the institutional capacity o f M I F I C by providing consultant services, equipment, goods, consulting services, training, operating costs, and non-consultant services. In addition, project funds would cover the marginal costs incurred by M I F I C as wel l as costs associated with improving the capacity o f M I F I C DAF to manage the fiduciary responsibilities.

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Designated Account. In accordance with practices in Nicaragua, the designated account would be maintained in the Central Bank o f Nicaragua. (See Annex 8 for more information.)

Sustainability ofthe Institutional Arrangements. Recent important changes in the organization and staffing o f MIFIC DAF demonstrate the commitment of the Government to sustainable institutional arrangements for project activities.

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Annex 6a: Coordination with IFC

NICARAGUA: Micro, Small, and Medium Enterprise Development Project

The IFC and the Bank have agreed to have a single strategic statement o n private sector development in Nicaragua, which wil l be shared with Government representatives, private sector business associations, and donors active in this field. This strategy incorporates inputs from IFC and Bank experts in the areas o f municipal simplification, access to financial services and country-level competitiveness issues.6 Specifically, the joint strategy covers three areas: (i) business simplification (at the national and municipal levels), (ii) access to financial services for micro, small and medium enterprises (MSMEs), and (iii) sectoral development efforts (ranging from specific sectoral investments to more general matching grants facilities to support MSME efficiency, certification and innovation). As part o f this strategy, this project will capitalize on the IFC’s expertise in these three areas. The IFC will be an active participant in this project by joint ly supervising its implementation. To build this strategy, each institution has shared its recent experiences in Nicaragua and generally in Lat in America in these technical areas.

Business Simplijkation

The Doing Business project, executed joint ly by the Bank and IFC, illustrates the relationship between government regulation, private sector development, and economic growth. Due to i t s methodology, the Doing Business project only measures regulations and administrative procedures in capital cities. To complement this work, the IFC started the Municipal Scorecard Project to measure bureaucratic barriers across municipalities. They have also used the municipal findings to create action plans to diminish these barriers and facilitate formalization o f MSMEs. The IFC has led the efforts for municipal simplification o f key business registration and licensing processes, with activities in three municipalities: Granada, Masaya, and Le6n. In al l three municipalities, high levels o f informality were directly related to the difficulty o f registering a business. With technical assistance from the IFC and funding from the Swiss Secretariat for Economic Affairs, the reforms reduced the number o f days to register a business by an average o f 80 percent, from 18 days to one. In Masaya, the number o f registered businesses jumped from 89 in 2005 to 300 in the f i rs t four months o f 2006.

The Bank brings competitiveness experience from the Competitiveness Learning and Innovation Loan (LIL, #3456-NI), which was executed by the Presidential Commission for Competitiveness and the Ministry o f Economy (MIFIC). The project helped to create employment, increase exports, and promote M S M E adoption o f new technologies in various sectors using the cluster methodology. An objective o f the LIL was to promote administrative simplification, which it did by supporting various measures, including the digitalization o f commercial registry records. Through i ts efforts, the project successfully assisted in dropping the time to register a business from 71 days in 2001 to 39 days in 2006 and a drop in licensing and inspection times (Doing Business Indicators).

Participants included Rick van der Kamp, Greta Bull, Juan Gonzales Flores, Ernest0 Martin-Montero (IFC) and Lily Chu, Mike Goldberg, Tanja Faller, and Carlos Siezar (Bank), as well as Stefia Slavova (Doing Business).

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Working closely with the IFC, the project wil l finance action plans from the Municipal Scorecard project in the ten municipalities. This wil l include, among other activities, the implementation o f one-stop shops for business-related government procedures.

Access to Finance

IFC’s Access to Finance Program for Latin America focuses o n four main product lines to broaden access to finance in the region:

MSME Finance: supporting banks and non-bank financial institutions to build the systems needed to downscale to serve micro and small businesses; Microfinance: working with relatively strong microfinance institutions to support transformations to more formal institutional status (e.g. NGO to specialized finance company, and from specialized finance company to commercial bank) and to support the development o f innovative new products; Housing Finance: supporting increased access to housing finance for low income households by improving mortgage origination and servicing standards, supporting securitization o f mortgage portfolios to ease hnding constraints and working with microfinance institutions to create shorter term home improvement products that are suitable for MF borrowers;

iv) Credit Bureau: supporting the creation and improvement o f credit reporting mechanisms.

i)

ii)

iii)

IFC’s projects are delivered at the level o f individual institutions and aim to build the systems, products, human resources and incentives to serve target segments profitably and therefore sustainably over time. Advisory support covers a variety o f areas, including but not l imited to: strategic planning, benchmarking o f existing operations against global best practice, institutional diagnostics, business planning, organizational change, market research, product development, risk management, sales and marketing, improving operating efficiency, novel distribution channels, human resources and staff development and ITLMIS system development.

In Nicaragua, IFC i s currently engaged in three advisory projects, with one other in the pipeline. The f i rs t is a sectoral-level project focusing on creating a regulatory and legal framework for developing the financial leasing industry in close coordination with the Nicaraguan Chamber O f Commerce (CACONIC). This project was launched after conducting a diagnostic o f the current legislation and a market study to determine i t s potential, but i t is facing lack o f political support to see i t through. The other active project the I F C is supporting i s institutional strengthening to support the transformation o f FINDESA, one o f the leading MFIs in the country, to a bank. The third project is a diagnostic exercise with Banco de Finanzas to define an action plan for improving its lending in the housing and M S M E segments. IFC i s also in discussions with FAMA, a leading Nicaraguan MFI, to strengthen their housing finance offerings, both in terms o f mortgage origination and servicing and home improvement financing.

The Bank has played an important role in building access to financial services and brings experience from the Broad Based Access to Financial Services Project (#3903-N1) in Nicaragua. This project i s improving access to financial services for MSMEs by improving the regulatory framework for MFIs and cooperatives, the supervision o f microfinance providers, and the efficiency and products o f those providers.

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The Bank wil l draw upon IFC expertise in the access to finance work, particularly with regard to MFIs and commercial banks. The work done by IFC wil l better prepare financial institutions to manage and channel the matching grant and credit guarantee component for maximum developmental impact.

Sector Development Efforts

The IFC i s implementing work specifically designed to build sustainable value chains in the region. The programs aim to strengthen MSMEs by building skills and sector-level linkages. Programs include indigenous enterprise development, wood product SME value chain enhancement, and supplier development in specific sectors. This work includes improving product quality and building access to international markets for small firms.

Specifically in Nicaragua, the IFC, working with the World Wi ld l i fe Fund and Jagwood, i s strengthening the sustainable wood supply chain in the North Atlantic Autonomous Region (RAAN). The region has the largest block o f tropical forest in Central America but exports little o f i t s wood, the majority o f which i s unprocessed. The project provides technical assistance to wood-processing SMEs in the region o n a variety o f aspects, including how to upgrade product quality to meet with international standards. The project has been successful in increasing exports from the region and is currently scaling up efforts and expanding i t s technical assistance to more forest communities. The IFC is also currently working with small scale coffee suppliers in developing the sector.

The Bank’s experience in sector development in Nicaragua includes i t s work on the Competitiveness LIL. The LIL promoted well-functioning and inclusive business clusters in diverse sectors including coffee, tourism, light manufacturing, wood, shrimp, dairy products, and beef. These clusters went beyond existing arrangements, becoming geographic concentrations o f businesses and organizations in related industries, including competitors, producers, buyers, suppliers o f specialized services, financial institutions, specialized universities, research centers, and policymakers. During the implementation period between 2001 and 2006, these clusters were effective in making significant export and employment achievements including: a 23 percent increase in coffee exports; an 85 percent increase in cheese exports; and a 67 percent increase in employment in light manufacturing.

The Bank and IFC wil l lend their expertise gained through these projects to the Matching Grants component o f the project, particularly for identifying value chain “bottlenecks” such as those associated with quality and certification.

IFC Advisory Services Contribution

In addition to technical expertise, the IFC Advisory Services unit will provide parallel financing to the M S M E Project through programs i t has planned for implementation between 2008 and 2013. The IFC wil l continue its practice o f helping financial institutions in Nicaragua adjust their internal systems through a cost-sharing mechanism. The Bank will also contribute to this effort

53

with the technical assistance provided through Component 3, the PCRG. These programs complement the Project’s activities in achieving the development objective o f improving the set o f services needed by MSMEs to be more competitive, efficient, and integrated into the national economy. These programs will increase access to finance for and add value to MSMEs. Total investment from the IFC, clients, and other donors wil l equal U S $ l .18 million.

Project 1

Table A6A. 1: IFC Advisory Services

520,000 I 290,000 I 230,000 I

BEE (Business Enabling Environment) No confirmed projects after the Municipal Scorecard work at this time

Project 2 Project 3 A2F Total

290,000 290,000

858,000 31 3,000 255,000 290,000 48,000 23,000 25,000

Project 1 102,500 I 102,500 I

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Project 2 83,439 I 41,720 I 41,720 I Project 3 131,922 I 131,922

Annex 7: Financial Management and Disbursement Arrangements

Nicaragua Micro, Small and Medium Enterprise Development Project

A financial management assessment was carried out to determine Financial Management (FM) implementation risk and help establish adequate FM arrangements for the proposed Credit. Based on the assessment, recommendations and complementary actions have been provided to ensure that the Project i s implemented within a sound fiduciary environment in compliance with Bank requirements.

The M I F I C through its Direccion General Administrativa Financieru (DAF) will implement the Project components. MIFIC-DAF has some experience managing external donor funds (see Annex 7a), but has never implemented a Bank-financed project. In the special case o f Component 3, M IF IC would assign execution responsibilities for financial sector activities to the Financial Investments Institution o f Nicaragua (FNI). These responsibilities and the financial support would be set out in a subsidiary agreement between M I F I C and FNI. I t also should be mentioned that FNI is currently executing the Broad Based Access to Financial Services Project (IDA-39030) based on a Fiduciary Assessment conducted by the Bank

The present FM assessment also identified some institutional weaknesses o f MIFIC. Accordingly, an Action Plan (detailed below) has been agreed to with DAF to help strengthen its financial management capacity.

Staffing

Currently, the staff in the DAF includes a General Director, Financial and Budget Director, Administrative Director and a Financial Project Director. The Financial and Budget Director i s responsible for three areas: Budgeting, Accounting and Treasury. Budgeting has a Coordinator and two Analysts. Accounting has a General Accountant and five accountants and Treasury has a Coordinator, an Assistant and two Cashiers. Final ly the Financial Project Director has under his supervision an Analyst and a Secretary. The mentioned staff has no direct experience with Bank- financed projects, although over the last few years they have been managing externally-financed funds and have become familiar with general external funds procedures. Before effectiveness, M I F I C DAF will contract a Disbursement Officer with experience in Bank-financed projects. Specialized training for the staff dealing with FM and disbursements wil l be delivered once the additional personnel are in place.

Accounting System

MIF IC DAF will use the Project Financial Management Information System (SIGFAPRO) and wil l report based o n cash basis. SIGFAPRO i s currently being implemented in the DAF. Meanwhile, M I F I C DAF will use a basic accounting system to record and report the financial operations.

SIGFAPRO is hosted by the M H C P and includes modules for planning, budgeting, procurement, treasury, accounting, and reporting. Monitoring and evaluation o f physical and financial progress wil l be done using M S Project.

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Proiect Financial Reporting. On a quarterly basis, M I F I C DAF will prepare and submit to the Bank Interim Financial Reports (IFRs) containing: (i) Statement o f Sources and Uses o f Funds (with expenditures classified by disbursement category) and Cash Balances; (ii) Statement o f Budget Execution (with expenditures classified by subcomponent); along with the reconciliation o f the segregated account with project records and with the Budgetary execution in SIGFA. The IFRs wil l be submitted to the Bank not later than 45 days after the end o f each quarter. This review wil l enhance FM supervision, enabling a periodic control over project accounts that wil l complement the planned supervisions, thus helping to mitigate fiduciary risk.

1) Project Financial Statements 2) Special Opinions

Summary Reports (UIFRs) (used for disbursement purposes)

Desimated Account (SDecial Account)

External Audit

June 30 June 30 June 30

June 30

An external, independent, private firm acceptable to the Bank will be contracted not later than six months after Credit effectiveness to cover al l the components o f the Credit execution. The reports wil l cover the calendar year. The fiscal period i s the calendar year. The audited financial statements shall be presented to the Bank not later than six months o f the end o f the fiscal period that coincide with the calendar year.

Internal Control

MIF IC i s subject to the control o f the Internal Audit Department and the Country’s General Comptroller (Contraloria General de la Republica). Under international standards, i t i s expected that the IA Unit include the revision o f the financial documentation o f this Project in the internal audit plan.

Table A7.1- Audit ReDort/MIFIC DAF I Audit Reaort I D u e D a t e I

Flow of funds

The Recipient wil l open a Designated Account (DA) in the Central Bank o f Nicaragua, to be used exclusively for deposits and withdrawals o f Credit proceeds for eligible expenditures. The DA will be held in U S dollars with a proposed ceiling o f $500,000. Note that the ceiling can be amended, v ia an amendment to the Disbursement Letter (DL) during project execution to accommodate changes in the liquidity needs o f the Project. Funds advanced to the DA will be requested via withdrawal applications (Form 23 80) supported by Statement o f Expenditures (SOEs) and records for payments that exceed the thresholds established in the DL. Furthermore, the funds in the DA will be transferred to MIFIC-DAF’s operative account (Fondo Rotatorio) to finance expenditures made or to be made within 30 days. The limit for th is advance is 5 percent o f the given annual budget.

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The recipient may also request Direct Payments to third parties and Reimbursement for eligible expenditures paid with Project or counterpart funds. The minimum amounts to request this form o f disbursement wil l be established in the DL.

Matching Grants

Sub-Component 2 (b) ($6.2 million) o f the project wil l provide matching grants to M S M E to finance pre-investment and investment activities and partially finance initiatives to improve, inter alia, their products, production efficiency, packaging, quality control and sanitary practices in accordance with national norms where applicable. Grants would be awarded competitively through a series o f rounds and recipients would be selected by a committee that includes independent, private sector representatives to ensure that the selection criteria are applied fairly and transparently to al l applicants. The names o f grant recipients would be publicized o n MIFIC’s website, as wel l as the grant value and a short summary o f what the grant was for. Recipients could be individual enterprise or holdings. For each grant assigned, a contract between M I F I C and the recipient should be signed. Disbursements will only be made o n the basis o f signed grant agreements.

Detailed financial procedures related to the administration and disbursements o f Matching Grants are included in the Operational Manual, which has been reviewed by the Bank fiduciary team. MIFIC-DAF wil l be responsible for obtaining and maintaining al l related supporting documentation for ex post control purposes.

For disbursement purposes, a customized SOE wil l be prepared for this category. Reconciliations reports o f these funds should be incorporated in the M I F I C IFRs to be sent to the Bank and the use o f the grant funds should be included in the project’s annual audit.

Disbursements under this component will be subject to a dated covenant which will require that no later than one month after the Effectiveness Date, the Recipient shall have put in place adequate financial management and disbursement arrangements for the provision o f Matching Grants under Part 2.B o f the Project and that said arrangements wil l have been reviewed and found acceptable by the Association prior to the carrying out o f any activities under Part 2.B o f the Project

Guarantee Facility

Component 3 (US$4.8 million) o f the project wil l finance Partial Credit Risk Guarantee (PCRG) to Participating Financial Institutions in respect to their lending to Eligible MSMEs This component wil l be disbursed gradually based on documented losses and signed guarantee agreements., with no init ial capitalization with IDA funds. During annual and midterm reviews, there will be an option to move the funds to other components if there has not been sufficient demand for the guarantee. Two commercial banks have already provided letters o f interest, demonstrating market demand for this pi lot facility. Banks will carry out the due diligence review o f potential M S M E borrowers, and request the partial guarantee to cover the credit r isk and relieve the high collateral requirement. Recipients will be individual commercial banks. For each guarantee assigned, a contract or an Agreement between FNI and the recipient (the participating financial institution) should be signed.

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This component requires further refinement o f some detailed financial procedures, which wil l need to be in place prior to any disbursements, including any applicable threshold for the Guarantee Fund. These details will need to be reviewed by the Bank’s fiduciary teams and included in the Operational Manual for the Guarantee Facility. MIFIC-DAF wil l be responsible for obtaining and maintaining al l related supporting documentation for ex post control purposes.

Risk

A customized SOE will be prepared for this category. Reconciliations reports o f these funds should be sent quarterly to MIFIC. These funds should be audited once a year. A special audit wil l be conducted after six months o f project implementation.

Risk Risk Mitigating Measures Rating

Disbursements under Category 3 should be subject to a Withdrawal Condition in the legal agreement which wil l limit disbursements under this category until the Recipient has put in place, and has caused FNI to put in place, adequate financial management and disbursement arrangements for the operation o f the Guarantee Facility under Part 3 o f the Project, in a manner satisfactory to the Association.

Country Level S Entity Level M 0

Project Level S 0 Contract an Accountant and a Disbursement Officer under DAF 0 Prepare chapter o n FM procedures to be included in the

Operations Manual including the Matching Grants procedures 0 Relevant staff to attend specific FM & Disbursement training -

Disbursement Deadline Date. Four months after the Closing Date specified in the Financing Agreement.

Retroactive Financing. It was agreed that up to five percent o f the credit could be used during the period from M a y 12, 2008 to effectiveness, in the form o f retroactive financing (an amount o f U S D 1 million), as long as it was not for activities which have another condition attached (such as Component 3, Guarantee Fund). . Risk Assessment and Mitigation

Risk Rating

Overall FM risk is rated as Substantial. The FM design, which includes a series o f additional measures, responds to the identified r isk and proposes a suitable supervision strategy. The adequacy o f FM arrangements would be continuously monitored during project supervision, and adjustments made when necessary to ensure fiduciary compliance. Table A7.2 presents the risk assessment and mitigating measures incorporated into Project design and the FM implementation arrangements.

Table A7.2 Risk Assessment and Mitigation Measures

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Contract external audit for the entire implementation period o f the project

Budgeting, Accounting, Internal Control Funds Flow

Financial Reporting, Auditing

M I 0 Implementation o f SIGFAPRO

S 0 Segregated account in dollars, under traditional mechanism o f replenishment by SOE method

0 For Matching Grants, funds transfer mechanisms should be cleared and detailed in the operations, accountability, and number and nature o f subprojects

M Quarterly Reports. 0 Annual Audit Financial Statements.

Financial Management Action Plan

An Action Plan has been agreed to with MIFIC-DAF to ensure that adequate FM systems are in place before implementation begins. The detailed activities are presented in Table A7.3.

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Action Responsible Entity

1. Contract an accountant and a Disbursement MIFIC-DAF Officer

o f the Operations Manual including Matching Grants

2. Finalize the modifications to the FM section MIFIC-DAF

Completion Date'

April 2008

April 2008

World Bank FM Supervision Plan. A World Bank FM Specialist may perform a supervision mission prior to effectiveness to verify the implementation o f the unit and the FM system. After effectiveness, the FM Specialist must review the annual audit report, should review the financial sections o f the semestral IFRs, and should perform at least one supervision mission per year.

3. Finalize draft TORS for External Audit 4. Implement SIGFAPRO

5. Contract external auditors, based on short l i s t satisfactory to the Bank for the entire implementation period o f the project. 6. Provide specific training in FM & Disbursements: for project FM Staff

_ _ _ _ _ ~ ~

This column presents the estimated completion date, and i s not an indication o f legal conditions.

MIFIC-DAF May 2008 DEGETECKF- June 2008

MIFIC-DAF June 2008 MIFIC-DAF

World Bank June 2008

60

I I

0 0

m a 3 8-

rn FA

9 Y .- *

8 c

c c

w

I

Annex 8: Procurement Arrangements NICARAGUA: Micro, Small and Medium Enterprise Development Project

A. General

1. Procurement for the proposed project would be carried out in accordance with the World Bank’s “Guidelines: Procurement under IBRD Loans and IDA Credits” dated M a y 2004, Rev. Oct. 2006, “Guidelines: Selection and Employment o f Consultants by World Bank Borrowers” dated M a y 2004, Rev. Oct. 2006, and the provisions stipulated in the Financial Agreement. The various items under procurement categories, including CDD, are described in general below. For each contract to be financed by this operation, the required procurement or consultant selection methods, estimated costs, Bank review requirements, and time frame for contracting will be agreed between the Borrower and IDA in the Procurement Plan (specific) for 18 months (PAC-18). The PAC-18 wil l be updated at least annually or as required to reflect actual project implementation needs and improvements in institutional capacity. Bank may require that the Procurement Plan be prepared and submitted by the Sistema de Ejecucibn de Planes de Adquisiciones - SEPA, an institutional tool designed to promote planning, efficiency and transparency o f al l procurement activities financed by IDA.

2. Procurement of Works: N o I C B or N C B contracts are expected in the project. Small works contracts required in Components 1 and 4, estimated to cost less than US$50,000, include renovation o f MIFIC’s National Accreditation Office’s laboratory and M I F I C offices up to an aggregate value o f approximately US$300,000 equivalent carried out following shopping procedures, using a simplified model to call for quotations. Small works may also be required under the initiatives submitted by MSMEs (Matching Grants Component 2), with procedures following competitive commercial practices, if contracted by MSMEs. Details o f applicable procedures would be included in the OM (Fiduciary Management Chapter).

3. Procurement of Goods: Goods procured under this project would include procurement o f computing, office, laboratory, metrology and standards equipment, vehicles for supervision activities o f MIFIC; software (licenses), and office and lab furniture for M I F I C and its decentralized offices participating in project activities. Goods wil l be procured using procedures detailed in the PAC-18, using the Bank’s Standard Bidding Documents (SBD) for al l I C B and SBDs agreed with the Bank with Nicaragua for NCB, and shopping (model Request for Quotations - RQ). Grouping o f similar goods into I C B packages would be required whenever possible within a calendar year. Direct contracting may be required to procure specialized equipment in the National Accreditation Office’s laboratory. Competitive commercial practices wil l be used by MSMEs to procure goods in their approved initiatives. Details o f on applicable procedures would be included in the OM (Fiduciary Management Chapter).

4. Procurement of Non-Consulting Services: N o I C B contracts are expected in the project for this category. Non-consulting services required for printing or reproduction o f training materials, for public information activities in the project, and for logistics for training events, such as hotel, food and transport services, as wel l as other non-technical services in the PAC-18, may be procured following procedures agreed in the PAC-18, using a model SBD for

64

N C B or RfQ for non-consultants services, as it may be applicable. Commercial practices will be used by MSMEs to procure non-consultant services i n their approved initiatives. Details o f applicable procedures would be included in the OM (Fiduciary Management Chapter, and Matching Grants Manual).

5. Selection of Consultants: Technical assistance includes contracts with f i r m s and individuals to assist M IF IC and FNI on project activities involving advisory or specialized services to project management, technical support to components, studies, provision o f training, and monitoring and evaluation activities, including financial and procurement audits. Both executing agencies wil l do every effort to package critical tasks to be assigned to national or international f i rms. Short l i s ts o f consultants for services estimated to cost less than $150,000 equivalent per contract may be composed entirely o f national consultants, in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines. Individual consultants wil l be hired to advise or assist planning and fiduciary areas, deliver training to project beneficiaries and staff, and support other technical activities in the project, including preparation o f specs or TORS for project procurement and in the supervision o f project implementation. Procedures to hire these consultants will fol low procedures described in Chapter V o f Consultants’ Guidelines and the provisions agreed in the Procurement Action Plan referred to in the FA.

6. Operational Costs: Operating costs refer to reasonable recurrent expenditures that would not have been incurred by the M I F I C and FNI in the absence o f the Project. These expenditures may include office rent and basic services o f facilities when project activities are required to operate outside MIFIC’s or FNI’s facilities; operation, insurance and maintenance o f office equipment, and vehicles purchased under the project at the central level; non- durable/consumable office and lab materials, excluding salaries o f public sector servants; and costs o f travel and accommodations to conduct project supervision by M I F I C staff. All these activities would be eligible for financing under the credit and would be procured using M I F I C and FNI’s administrative procedures, which were reviewed and found acceptable to the Bank.

7. Matching Grants. Procurement o f physical inputs and technical assistance o f individual consultants included in MSMEs’ initiatives wil l be contracted directly by the MSMEs using commercial practices. MSMEs wil l sign special agreements with M I F I C to participate in the award process for grants to finance their initiatives, as detailed in the OM and the Matching Grants Manual - MGM. In view o f the size, nature and contract value o f the purchases expected, the MSMEs would follow competitive commercial practices for purchases less than $30,000. Contracts for technical assistance and other physical inputs valued above $30,000 as wel l as collective training events and other collective activities that may be required in the MSMEs’ initiatives wil l be contracted by M I F I C following competitive procedures described in the Procurement Chapter o f the OM, as they may apply.

8. Training: Based on a detailed annual Training Program agreed with the Bank, M I F I C and FNI wil l make every effort to call for bids under I C B or N C B procedures for activities involving printingheproduction o f training materials, and for logistics required to deliver training events. Qualified service providers would be sought annually (hotels, travel agenciedprinting firms) to quote regional per capita unit costs (concurso de precios) for training logistics services to be provided to M I F I C or FNI, o n call, during a year; this measure to promote efficiencies and economies o f scale, and to limit the amount o f shopping in the PAC. Similar procedures would

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be used to call for bids or quotations for printingheproduction o f training materials from firms. All contracts following these procedures would be reported in the PAC-18 as non-consultant services. Expenditures related to TA contracts for training activities (firms and individuals) would be detailed in the consultants’ services procurement category and, as such, identified in the PAC-18. Other training expenditures may include small value purchases (less than US$2,500 equivalent) to contract training facilities in distant or remote areas where there i s not sufficient availability o f these services. M I F I C and FNI would fol low institutional procedures used to contract similar inputs. This expenditure category may also include per diem o f trainees to be paid directly by M I F I C or FNI to participants.

9. conducted using SBDs and other model documents agreed with IDA.

Project Procurement Documentation. Procurement activities in the PAC-1 8 wil l be

10. Procurement Thresholds. Thresholds recommended for the use o f each procurement method are identified in the table below and will be used by the Procurement Unit in M I F I C and FNI to prepare the init ial Procurement Plan for 18 months (PAC-18) agreed with IDA at the time o f negotiations. These thresholds wil l be reviewed annually, or at any time after the fiduciary capacities o f M I F I C and FNI have been reassessed during procurement post-review supervision missions. As indicated in paragraph 1 above, the agreed Procurement Plan (PAC-18) wil l determine which contracts wil l be subject to IDA’S prior review.

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Thresholds for Procurement Methods and Bank’s Review

procedures

Procurement Category

Works

Goods and non- consulting services

Consulting Services (firms)

Consulting Services (individual)

MSMEs Matching Grants

Contract value threshold a

(US$ thousands) >1,500 150 to 1,500 < 150 ...............................................................

Regardless o f value >150

10 to 150

< I O

Regardless o f value

> 100 < 100 < 50 Regardless o f value > 50 < 50

Regardless o f value >30 Small works, goods, non-consultants services, and technical assistance

4 0 Small works, goods, non-consultants services, and technical assistance

Contracts subject to prior Procurement method review’

I C B (not expected) All First contract I First contract

................................................................................................................................................................................................. NCB (not expected) Shotwing Direct Contracting All I C B All

NCB First contract I Shopping First contract

Direct contracting All

QCBS/QBS/FBS/LCS/ All contracts QCBS/QBS/FBS/LCS .................................................................................................

First contract

Single Source Selection Section V in the Consultants Guidelines

Single Source Selection

Al l contracts

Competitive Commercial Practices, if procured by MSMEs.

None

Note: QCBS = Quality- and Cost-Based Selection QBS = Quality-Based Selection FBS = Fixed Budget Selection CQS = Selection Based on Consultants’ Qualifications

LCS = Least-Cost Selection

B. Assessment of the apency’s capacity to implement procurement

1 1. An Institutional Procurement Capacity Assessment was conducted in Nicaragua by Rosa Valencia de Estrada, Procurement Specialist (Accredited Consultant, LCPST) on Nov. 2007, updated in January 2008.

12. Executing Agencies. MIFIC and FNI w i l l be the executing agencies involved in project procurement activities, in addition to the MSMEs that would conduct purchase o f inputs in their initiatives, using commercial practices. In the case o f MIFIC, the Direccidn Administrutivu-

All other contracts shall be subject to Bank’s ex-post review. 8

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Financiera (DAF) will lead procurement activities, supported by the institutional Procurement Unit. In close coordination with the newly established Direccidn de Planeacidn, Programas y Proyectos (DGPP), the DAF wil l be responsible for preparation, monitoring, update, publication, and yearly assessment o f the PAC-18 for the project, including reporting in SEPA as Bank may require. The Direccidn General Administrativa Financiera (DGAF) in FNI, showing substantially less procurement activities in its PAC during the l i fe o f the project (mostly TA), wil l carry out similar activities for i t s PAC and report via SEPA as required. All other beneficiary agencies under the project wil l contribute with technical inputs to the contracting process in the form o f terms o f reference, criteria for evaluation, short lists, and technical specifications for goods or non-consultants services.

13. Institutionalization of Fiduciary Project Activities. M I F I C and FNI wil l conduct fiduciary activities in the project using their institutional structures. For this purpose, M I F I C delivered to the Bank an institutional proposal to guarantee coordination and execution o f fiduciary activities, supported by the creation o f the Divisidn General de Planeacidn y Proyectos (DGPP) that reports directly to the Minister. The DGPP has the same hierarchical level as the DAF under the institutional structure. The Institutional Manual (IM) issued in January 2008 details the structure, organization, functions and control systems under the reorganized fiduciary structure. FNI already conducts fiduciary activities under Broad Based Access to Financial Services (PAGSF), after i t assumed leadership for this project after the 2007 amendment. I t s organizational structure, functions and control systems were assessed satisfactory at the time o f updating its capacity with no major issues.

14. Procurement Action Plan (PAP). The PAP will be agreed to at negotiations and included in its Minutes. The PAP details the specific institutional strengthening actions to be taken by M I F I C within 18 months o f project effectiveness, and other provisions that both M I F I C and FNI will follow with regards to hiring and management o f project long-term consultants. The PAP also includes anti-corruption measures to manage project consultants for both M I F I C and FNI, including the adoption o f a prototype contract with fraud and corruption and conflict o f interest clauses, and performance evaluations, among other measures.

15. rating and mitigating measures are described blow:

Overall Risk Assessment. Project risk assessment i s high. The factors used to assign this

For MIFIC:

a) M IF IC moves into fully fledged project implementation with a fiduciary institutional team that, although presently handles a value o f approximately US$l.O mi l l ion o f contracts under i t s regular budget, is not yet ready to conduct procurement activities under Bank Guidelines and SBD procedures.

Mitigating measures: (i) PAP includes a provision to hire specialized procurement consultants to assist the Procurement Unit in DAF; and (ii) to strengthen the institutional capacity o f MIFIC, the PAP was agreed to between the Bank and MIFIC, included as an attachment to the Minutes o f Negotiations; and (iii) to contract qualified procurement advisory services at least during the first 18 months o f project life.

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DGPP and DAF's teams, while showing high interest in conducting quality project management and fiduciary leadership and while being knowledgeable o f the National Procurement Law, are s t i l l learning to build competencies and skills that would empower them to coordinate and supervise international and national procurement using Bank Guidelines.

Mitinatinn measures: (i) Procurement advisory services to be retained immediately after negotiations throughout the f i rst 18 months o f the implementation period; and (ii) hands-on support and mentoring by a long-term Procurement Consultant working in the Procurement Unit.

L o w init ial level o f technical competency in procurement represents a risk to the project. This has already been discussed with MIF IC and an action plan has been developed. This action plan has been incorporated into the Financing Agreement.

Mitinatinn measure: A certified procurement specialist consultant (national or international) wil l become an integral part o f the MIF IC DAF team and wil l train the DAF staff.

Internal control and support systems are not yet tested under MIFIC's reorganization, and specifically after the creation o f the DGPP.

Mitinatin? measures: (i) Close IDA supervision for the f i rst 18 months after project effectiveness, including a supervision mission every six months; (ii) enforcement o f measures agreed to in PAP; and (iii) provision o f continued technical assistance by IDA's procurement specialist in the Nicaragua Office, including delivery o f institutional strengthening training events.

Private sector (MSMEs) participates as a partner in the project; for the f i rst time MSMEs are expected to conduct their procurement for inputs under matching grants initiatives.

Mitigation measures: (i) Close supervision o f MSMEs by MIFIC; (ii) contracting the services o f a procurement auditor (firm) to assess yearly contracting procedures used by MSMEs.

For FNI

f) While well staffed and more mature in project administration due to its recent experience in managing the Broad Based Access to Financial Services Project, its DGAF is st i l l in the process o f implementing its f i rst Procurement Plan and advancing in complying with covenants o f institutional fiduciary implementation, including migrating to M a y 2004 Bank Guidelines.

Mitinatinn measures: (i) Close IDA supervision for the first 18-month period after project effectiveness, including supervision mission every six months, and enforcement o f measures agreed to in the PAP; and (ii) continued technical assistance by IDA's Procurement Specialist in the Nicaragua Office, including delivery o f institutional strengthening training events.

For both M I F I C and FNI

g) General procurement environment in Nicaragua i s st i l l weak, without clear aim to implant a culture o f accountability, or to reduce political interference,

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Update o f risk assessment to be conducted at least 6 months after project effectiveness.

C. Global Procurement Plan (GPAC)

16. MIF IC and FNI have prepared a final draft o f the Global Procurement Plan (G-PAC) showing expected contracts during the l i fe o f the project. The G-PAC wil l provide the basis for the selection o f procurement methods and timeframes for the specific PAC-18. Comments to G-PAC were provided during negotiations to MIFIC, FNI, and IDA. Based on this G-PAC, the Procurement Plan for 18 months would be revised before the Board presentation and i t wil l include al l contracts required under retroactive procurement, as agreed during negotiations. The Procurement Plan wil l be updated periodically (at least every quarter during the first 18-year period) or as required, to reflect the actual project implementation needs and improvements in institutional capacity.

D. Freauencv of Procurement Supervision

17. Once every six months, until r isk assessment upgrades to “Average”. In addition to the prior review supervision to be carried out from IDA’S office located in Nicaragua, an annual evaluation would be made for purposes o f PSR ratings on procurement based on the outcome o f the ex-posts reviews carried by IDA missions, and outcome o f measures agreed to in the PAP.

Post Review Ratio: One in five contracts.

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Annex 9: Economic and Financial Analysis NICARAGUA: Micro, Small and Medium Enterprise Development Project

Given their catalytic role and diverse activities, projects o f this nature typically do not require economic and financial analysis. Nonetheless, i t i s useful to look at recent literature on economic growth to appreciate the l ikely impact o f this project.

ComDonent 1 : Business Climate Improvement: The recent academic literature in institutional economics has found that badly designed government regulations affect macroeconomic performance such as economic growth and its volatility negatively, especially in countries with weak institutions (see Loayza, Oviedo and Serven (2005)). Disaggregated indices o f regulation o f business entry, regulation o f contract enforcement, business licensing, and the number o f procedures in paying corporate taxes adversely affect new firm entry, increase bribes, and, in general, lead to worse rather than better economic outcomes (for detailed analysis see Doing Business reports, Djankov et al. (2002), (2003) and (2005)). In this regard, Sub-component 1 on Administrative Simplification, which wil l aim to reduce the time and cost o f firm registration by making i t electronic, allow for taxes to be paid online, and speed up export procedures through their online execution, i s wel l grounded in empirical research in this area. In fact, the 2006 Doing Business report lists the implementation o f online tax payments as one o f the reforms that could reduce the number o f times taxes are paid, and considerably speed up the payment process. In a similar fashion, the pol icy recommendations on firm entry, licensing and trade procedures call for more procedures available to be completed online as a way to reduce waiting times as wel l as interactions o f firms with government officials.

ComDonent 2: Matchinp Grants. There i s a strong economic and financial rationale for using public funds to correct market failures and promote activities with positive externalities. Support for innovation-one o f the key themes o f the matching grants-is a classic example. Public investments related to innovation are warranted on the basis o f several failures in the market for knowledge and technology, including:

Knowledge is not appropriable. As a result, f i r m s that invest in knowledge generation cannot privately absorb al l the benefits resulting from their activities, and they tend to invest less than what would be socially optimal. This reasoning applies not only to the generation o f knowledge that i s new from a global perspective, but also to the first introduction o f foreign ideas in a country where they have not been tested on a commercial basis. In particular, Hausman and Rodrik (2003) point to the fact that while in the case o f new products, patents may allow for the realization o f private benefits, such protection mechanisms do not exist for the case when an existing product i s f irst produced in a country. Thus, the full cost o f failure i s assumed by the innovative entrepreneur but if successful the company i s forced to share the benefits with imitators. This reduces the incentive to invest both in the development o f new products and processes, as wel l as in the search for technologies in which a country might have an untested comparative advantage.

- Knowledge and innovation generate signijkant positive externalities and spillovers. As suggested by Griliches (1992) and others, the social rate o f return o n R&D expenditures

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i s often three times as large as the private rate o f return.’ In other words, the return to R&D raises several fold when taking into account the impact o f a f i rm ’s R&D on the economy through knowledge spillovers improving other companies’ products and production techniques. This suggests that there is significant scope for public interventions to align social and private returns.

- Investments in R&D can be large, long-term, and risky. Less developed financial markets seldom provide adequate instruments and term structures for financing R&D expenditures. Moreover, many R&D operations have increasing returns to scale and large sunk costs, making it hard for smaller firms to invest in R&D departments.

These market failures imply that an unregulated and purely privately funded market for knowledge produces sub-optimal outcomes. To counter this, governments intervene in various ways in the market for knowledge, for example by establishing intellectual property r ights systems. But regulations alone do not align private returns to knowledge creation with social returns, which is why many governments in developed nations invest close to 1 percent o f GDP in science, technology and innovation. These funds finance universities, technology transfer centers, metrology institutions, venture capital funds, private sector R&D, and knowledge sharing activities.

Besides addressing market failures, the matching grant scheme makes sense from an economic perspective because it i s demand driven. Companies wil l invest a substantial share o f their own resources in projects o f their own design. For that reason, f i r m s wil l have a strong incentive to work hard to achieve successful and profitable outcomes for each project.

In the area o f quality, in an effort to offset the init ial setup costs o f quality systems and promote diffusion through demonstration effects, countries have often provided matching grants to individual firms for technical assistance and training to enhance productivity and quality (Goel et al, 2004). A matching grant instrument is commonly used to foster quality adoption to leverage funds from firms that find it too risky to invest in quality certification given the perceived benefits.

Component 3: Increased Access to Financial Services. Despite a significant debate in the literature regarding the role fulfil led by credit guarantees, governments across the wor ld are increasingly utilizing credit guarantee schemes to support MSMEs. This credit rationing i s typically justified based on information asymmetries, the high costs o f processing smaller credit transactions, and constraints in the enforcement o f contracts. Levitsky (1 997a) and de l a Torre et a1 (2006) summarize some o f the debate issues. Despite these theoretical considerations, public credit guarantee systems are widespread. Graham Bannock and Partners (1 995) show at least 85 countries with some type o f government credit guarantee program. Herrero Calvo and Pombo Gonzalez (2001) provide an overview o f public credit guarantee systems around the world, while Llisteri et a1 (2006) explore the current situation in Lat in America. The largest and more established guarantee schemes are mostly in developed countries, including Canada, Japan, the U.S., and several European countries.

See also Jones and Williams (1998) for a discussion o f social returns to R&D. 9

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Recent success stories, l ike FOGAPE o f Chile, have generated renewed interest in the field. Bennett et a1 (2005) analyze some recent successful experiences o f credit guarantee systems in developing countries and demonstrate that financial sector deepening has occurred in the case study countries and that it can reasonably be attributed in part to the operations o f credit guarantee schemes. D e la Torre et a1 (2006) identify FOGAPE among the main pro-market interventions using traditional government instruments that has been considered a success story in terms o f fostering market activity while minimizing the problems that have characterized previous guarantee schemes. Benavente et a1 (2006) develop a theoretical model showing that under certain conditions, l ike in FOGAPE’s case, credit guarantee systems can improve access to credit for borrowers with viable projects that would otherwise be excluded due to lack o f collateral, without increasing moral hazard. See L l is ter i (2007b) on viewpoints held with respect to the role o f credit guarantee programs and a review o f best practices in operating guarantee schemes, in addition to Levitsky (1997b).

References

Barth, James, Gerard Capri0 Jr. and Ross Levine (2004), “Bank Regulation and Supervision: What Works Best?” Journal of Financial Intermediation 13, pp. 205-248.

Beck, Thorsten, Ross Levine, and Norman Loayza (2000), “Finance and the Sources o f Growth”, Journal of Financial Economics, 58 pp.261-300

Benavente, J. M., A. Galetovic, and R. Sanhueza, 2006. Fogape: An Economic Analysis. Mimeo, World Bank.

Bennett, F., H. Billington, and A. Doran, 2005. D o Credit Guarantees Lead to Improved Access to Financial Services? Recent Evidence from Chile, Egypt, India, and Poland. Department for International Development, London, Financial Sector Team, Policy Division Working Paper.

D e la Torre, August0 and Segio Schmukler, 2005. Innovative Experiences in Access to Finance: Market Friendly Roles for the Visible Hand. Latin America Regional Studies Series, World Bank.

Demirguc-Kunt, Asli, and Enrica Detragiache (2002), “Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation, Journal of Monetary Economics, 49(7), pp. 1373-1406.

Djankov, Simeon, Caralee McLiesh and Andrei Shleifer (2005) “Private Credit in 129 Countries”, M E R Working Paper No. 11078.

Djankov, Simeon, Rafael L a Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2002) “The Regulation o f Entry”, Quarterly Journal of Economics, 117, pp. 1-37.

Djankov, Simeon, Rafael L a Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2003) “Courts”, Quarterly Journal of Economics, 118, pp. 453-5 17.

Goel, K. et a1 (2004). Innovation Systems: World Bank Support of Science and Technology Development. World Bank Working Paper No.32. Washington DC.

Graham Bannock and Partners Ltd., 1997. Credit Guarantee Schemes For Small Business Lending - A Global Perspective, Volume I - Main Report.

Griliches, Z. (1992). “The Search for R&D Spillovers.” NBER Working Paper 3768. Cambridge, United States: National Bureau o f Economic Research.

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Hausmann R. and D. Rodrik (2003). “Economic Development as Self-Discovery.” Journal of Development Economics, Volume 72.

Herrero Calvo, A. and P. Pombo Gonzalez, 2001. Los Sistemas de Garantia para la Micro y la PYME en una Economia Globalizada.

Jones, C. I. and J.C. Williams (1998). “Measuring The Social Return To R&D,” The Quarterly Journal of Economics, MIT Press, vol. 113(4), pages 11 19-1 135, November

King, Robert G. and Ross Levine (1993), “Finance and Growth: Schumpeter Might Be Right”, Quarterly Journal ofEconomics, 108, pp. 717-738.

Levine, Ross, and Sara Zervos (1998), “Stock Markets, Banks, and Economic Growth”, American Economic Review 88, pp. 537-558.

Levitsky, J., 1997a. SME Guarantee Schemes: A Summary, The Financier - Analyses o f Capital and Money Market Transaction 4,5-11.

Levitsky, J., 1997b. Best Practice in Credit Guarantee Schemes, The Financier - Analyses o f Capital and Money Market Transaction 4, 86-94.

Llisteri, J.J., 2007. Alternativas operativas de sistemas de garantias de crkdito para la mipyme. Sustainable Development Department Best Practices Series, Banco Interamericano de Desarrollo.

Llisteri, J.J., Rojas, A,, Manueco, P., Sabater, V.L., and Tabuenca, A.G., 2006. Sistemas de garantia de crCdito en Amkrica Latina: Orientaciones Operativas. Banco Interamericano de Desarrollo.

Loayza, Norman, Ana Maria Oviedo and Luis Serven (2005), “Regulation and Macroeconomic Performance”, World Bank Policy Research Working Paper No. 3469

Subramanian, Uma (2005a and b) Value Chain Studies for Apparel, Coffee and Beef Sectors in Nicaragua, 2005 (World Bank).

World Bank. 2005. DR-CAFTA: Challenges and Opportunities. 32953. Washington, DC.

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Annex 10: Safeguard Policy Issues

NICARAGUA: Micro, Small and Medium Enterprise Development Project

Without adequate safeguards in place, the project could potentially have slightly negative effects on the environment and therefore a “B” categorization has been agreed upon. The Government and the Bank are committed to implementing safeguard measures to prevent any adverse environmental and social effects o f the project. A standard negative l i s t o f activities wil l be developed for the matching grants facility and the partial credit guarantee mechanism, to prevent undue negative social impacts and ensure that activities supported by the project have neutral or positive environmental impacts. Participating private financial institutions and MSMEs would be informed in writing o f the negative list. The Environmental Management Unit o f M I F I C (UGA) and the Ministry o f Environment and Natural Resources (MARENA) would be involved in the screening and monitoring o f matching grants proposals to ensure that no inappropriate investments are supported. Many o f the matching grants applications would, in fact, have a positive impact from an environmental standpoint, helping firms to meet domestic environmental regulations and sanitary and phyto-zoo-sanitary requirements in foreign markets.

Potential Risks: Potentially slightly adverse environmental effects o f this project could occur with Components 2 and 3 if proper safeguards are not implemented.

Component 2: Matching grants. The matching grants mechanism in this component was designed to promote positive spillover effects, such as encouraging f i r m s to adopt clean technologies. Grants would finance pre-investment and investment activities and be awarded competitively through a series o f rounds with different technical focus (such as quality, certification, labor training, or resolving value chain bottlenecks for a specific sector). The matching grants offered in this component could lead to some adverse environmental effects if the grants funded investments o f activities with negative spillover effects. However, this wil l be avoided through the use o f a negative l i s t o f activities that cannot be financed with matching grants.

’

Component 3: Partial Credit Risk Guarantee. Similar to Component 2, Component 3 could indirectly encourage adverse environmental effects if adequate safeguards are not implemented. This component would improve M S M E access to affordable, reliable, and appropriately designed financial products, providing a Partial Credit Risk Guarantee (PCRG) for loans by regulated financial institutions to MSMEs. Since private financial institutions would ultimately determine which enterprises benefit from the PCRG, they could choose MSMEs that engage in activities with negative environmental effects in the absence o f proper controls.

Planned Risk Mitigation Measures: There are various risk mitigation mechanisms in place to identify and resolve the environmental issues o f economic activities supported by the project.

Component 2. The matching grants would be provided to qualified individual businesses, groups o f businesses (such as associations, clusters, chambers, and cooperatives), and quality and certification service providers. Since this i s a competitive matching grants mechanism, it i s not possible to identify ex ante the specific uses o f the funds by qualified MSMEs and groups o f businesses. Therefore, a standard negative list o f activities would be developed and reviewed by

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the Bank before Negotiations and would be included in the selection criteria and included in project promotional materials and the operational manual. Since this component aims to promote the adaptation o f cleaner technologies, an exception would be included in the negative l i s t to permit enterprises that engage in “polluting” activities be eligible for the program, but only if they intend to use the matching grants to adapt cleaner technologies. The negative l i s t wil l include investments that physically displace and resettle people among the types that are ineligible for support.

The M I F I C matching grants facility wil l develop an operational manual with selection criteria (including environmental risk assessments o f specific proposals) and monitoring systems. Also, as every round adjusts to cover different technical themes, there would be flexibility in the percentage covered by the matching grant when clean technologies are the focus o f a round. Examples o f possible projects with positive environmental effects include:

0 A matching grant o f US$20,000 to a group o f small furniture producers in northern Nicaragua for training and technical assistance to change processing practices to qualify for Rainforest Alliance Smartwood certification.

A matching grant o f US$15,000 to a furniture producer in a neighborhood o f Managua to purchase an extractor fan installed inside the plant. This fan reduces sawdust generated by production by 95 percent, dramatically lowering the risks o f worker safety and health problems.

0

Component 3. The same negative l i s t developed for Component 2 wil l be applied to the PCRG and therefore shared with FNI (the executing agency o f the component) and participating private financial institutions. The participating financial institutions would in turn apply the list to potential borrowers. A detailed description o f the negative list o f activities wil l be available in the operational manual. The list wil l include activities that physically displace and resettle people among the types that cannot be covered by the PCRG.

Institutional Capacity. The Ministry o f Economy, MIFIC, i s the coordinating agency o f the project. UGA will work with MARENA to ensure al l executing agencies are dealing responsibly with environmental issues. MARENA will provide input into the negative list o f activities for Components 2 and 3. Consultations with MARENA will be important as M I F I C develops its own institutional capacity for evaluating the environmental impact o f project activities. As part o f Component 4, Institutional Strengthening o f MIFIC, the agency wil l build this capacity. This strengthening could be achieved through training and the hiring o f an external expert consultant.

Funding. Funding from Component 4 wil l be allocated to either provide training to cultivate an understanding o f environmental concerns at stake in the project or to hire a consultant that already has this experience.

Supervision. MIF IC wil l be primarily responsible for monitoring and supervising the project to ensure safeguards are implemented properly. UGA will participate in the technical committee that reviews matching grant proposals to ensure that investment activities do not have adverse environmental effects. If the technical committee finds subproject proposals indicate a potentially strong risk to the environment, they wil l be reviewed by MARENA and an

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environmental analysis and a mitigation plan may be necessary. UGA and MARENA will provide periodic (annual) reviews to ensure the project i s not supporting activities that are harmful to the environment.

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Annex loa: Social Inclusion Strategy

NICARAGUA: Micro, Small and Medium Enterprise Development Project

The purpose o f this annex i s to establish a strategy with the Micro, Small, and Medium Enterprise (MSME) Development Project to encourage active participation from al l stakeholders, including women and indigenous peoples. The project triggers the Bank’s Operational Policy (OP) 4.10 and the project i s committed to ensuring that project activities reach excluded populations. This annex has two parts: (a) encouraging women’s participation and (b) encouraging indigenous peoples’ and afro-descendants’ participation. In order to comply with the requirements in OP 4.10, an Indigenous Peoples Planning Framework i s included in part B o f this annex.

In order to determine which groups are marginalized in the development o f the Nicaraguan private sector, a social assessment was completed that showed that the project should pay particular attention to the inclusion o f women and Afr ican descendant and indigenous groups. This social assessment was commissioned to examine issues related to M S M E development, with a focus o n gaps in financial services and geographic distribution o f services, particularly as related to women and indigenous peoples. This assessment was based on statistics from the Central Bank o f Nicaragua and from consultations with over 25 authorities on M S M E development, including representatives from ASOMIF, Pana Pana, MIFIC, IMPYME, CONIMIPYME, CONAPI, INATEC, and the Government o f the North Atlantic Autonomous Region (RAAN). Consultations also included discussions with small business owners and community leaders. Specific recommendations from this assessment include:

0 Offering credit guarantees to help microfinance institutions (MFIs) expand their operations; Reducing administrative barriers for MSMEs and offering micro and small enterprises technical assistance with administrative procedures; and

0 Elevating the level o f quality certification so that MSMEs and cooperative groups can operate in international markets.

Also, a significant consultation process with financial institutions and other key stakeholders in RAAN was undertaken as part o f the Nicaragua Broad Based Access to Financial Services Project. These institutions include BANPRO, AMICA, Pana Pana, CARUNA, the Government o f RAAN (GRAAN), and some cooperative associations. These authorities identified obstacles for M S M E development. This Project’s strategy will build o f f o f recommendations from the social assessment and the Inclusion Strategy o f the Nicaragua Broad Based Project, which i s currently under implementation.

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A. Encouraging women's participation

Background Information"

Estimates suggest that approximately 35 percent o f households are headed by women in Nicaragua. O f those households, about 80 percent operate in the informal sector. For these reasons, it i s important that women-owned enterprises receive technical assistance to formalize and grow.

Estimates put ownership o f retail MSMEs (commercial shops) by women at about 50.6 percent. These businesses frequently are in need o f credit and women have a strong tradition o f repayment o f loans. Given this tradition, over 62 percent o f clients o f institutions associated with ASOMIF are women. However, from these same institutions, women are only receiving 44.4 percent o f the total portfolio.

Chart A 1 OA. 1 : Distribution o f ASOMIF Clients and Funds by Gender ASOMIF: Microcredit Clients - %

ASOMIF: Distribution of Portfolio by gender- %

Women, 62.5

Men, 55.6 44.4

Source: Ortega, Marvin. Evaluacion Social - Nicaragua Proyecto: Apoyo a1 Desarrollo de la Micro, Mediana, y Pequeiia Empresa. Banco Mundial. 9 de enero de 2008

The average loan women receive equals US $426, while the average for men i s almost double at US $854. Even with a focus on women, Pana Pana, an N G O in M A N , has a similar lending strategy to ASOMIF institutions with women representing 61 percent o f the clients but receiving only 45 percent o f the total lending funds.

This project will attempt to address some o f the barriers that are preventing women from developing their MSMEs. Further details on the delivery elements o f the inclusion strategy are provided in the next sections.

Objective of Inclusion Strategy

The Inclusion Strategy i s an extension o f the project development objective: to improve the competitiveness and efficiency o f micro, small, and medium enterprises (MSMEs) by strengthening public and private service providers and improving the business climate. The strategy i s intended to be consistent with the principles o f Bank's Operational Policy on Indigenous Peoples and on Gender and Development. In addition, the strategy builds on the

lo Most information in this section from: Ortega, Marvin. Evaluacion Social - Nicaragua Proyecto: Apoyo a1 Desarrollo de la Micro, Mediana, y Pequeiia Empresa. Banco Mundial. 9 de enero de 2008

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existing methodologies o f local and regional institutions and programs that are already serving these marginalized populations, thus creating synergies.

Project Design

Given the project’s background and contacts, as well as experiences from other Bank projects and the advice o f regional experts in indigenous peoples, this strategy builds on those experiences and consultations. In implementing it, the project wil l work closely with MFIs and organizations such as Pana Pana and A M I C A that specialize in providing technical assistance and financial services to women, indigenous peoples, and afro-descendants. This strategy will focus on Component 1 (Business and Investment Climate Improvement) and Component 2 (Matching Grants for MSMEs), but wil l likely provide some important inputs into Component 3 (Increased Access to Financial Services for MSMEs) as well.

Component 1: Improvement of Business and Investment Climate (US $4.1 1 million). This component aims to remove administrative and regulatory obstacles for MSMEs. One aspect o f this simplification i s increasing the services and reach o f one-stop-shops that assist f i r m s with regulations and permits. Another wil l be to decentralize MIFIC’s assistance in certification and quality assurance to the regions. The activities o f this component wil l ease procedures allowing MSMEs to formalize and potentially become eligible for pre-investment technical assistance and matching grants.

Component 2: Matching Grants for MSMEs (US $8.36 million). Grants would finance pre- investment and investment activities and be awarded competitively through a series o f rounds with different technical focus (such as quality, certification, labor training, or resolving value chain bottlenecks for a specific sector). Pre-investment activities include development o f business plans and feasibility studies that would allow MSMEs to apply for commercial credit.

Component 3: Increased Access to Financial Services for MSMEs ( U S $4.8 million). This component would improve M S M E access to affordable, reliable, and appropriately designed financial products, providing a Partial Credit Risk Guarantee (PCRG) for loans by regulated financial institutions to MSMEs. The guarantees would complement the pre-investment matching grants in Component 2, by making it easier for commercial banks to provide loans to MSMEs with improved business and feasibility plans.

Measures to Include Women

Women, who make up a large share o f managers o f MSMEs, wil l be encouraged to partake in program activities, particularly through Components 1 and 2. The project design promotes the inclusion o f women through the following measures

Component 1. As mentioned above, MSMEs owned by women are largely informal and therefore wil l benefit strongly from easing formalization procedures as designed in Component 1. Women’s companies wil l therefore have increased access to services offered to registered MSMEs such as tax breaks and export permits. This is expected to allow women-owned MSMEs to grow. In addition, information programs about certification wil l be offered in decentralized M I F I C centers in the regions (CAMIPYMES). These programs wil l make a special effort to

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reach women-owned MSMEs by identifying and addressing the particular obstacles that female owners face and through public campaigns specifically targeted at women.

Component 2. Female managers o f MSMEs will be encouraged to apply for matching grants. Measures to specifically address women-owned enterprises will include: (i) competitive rounds to target key clusters dominated by women; (ii) a governing principle that in case o f two proposals being equal in quality, the proposal that is presented by a woman-owned company would be preferred; and (iii) quotas for awards allocated to women-owned enterprises in specific rounds. For measure (i), an assessment wil l be undertaken during the f i rst stages o f the project to identify those key clusters. The project wil l work closely with MFIs and organizations that work primarily with women so that they can assist in raising awareness o f the programs and provide technical assistance for women to access these programs.

Component 3. The PCRG wil l be designed as a second tier instrument, with the decision on M S M E loan extension handled by the private financial institutions (PFIs) according to their due diligence processes that typically entail cash flow and risk estimations. Gender wil l not be part o f the selection criteria. However, women have a strong track record for credit repayment in Nicaragua and enterprises managed by women wil l be equally and possibly better positioned to benefit from the component. Also, the project will a im to sensitize FNI and PFIs on social screening, including issues o f gender, through the technical assistance training provided on the fwnction and use o f the PCRG.

Supervision. A member o f the team at M I F I C or a local consultant would monitor the results o f this strategy. The social assessment included input from women who own enterprises and female community leaders. The project would continue to consult with these leaders and others identified during project implementation. The project would also consult with organizations that support women's issues and with the Nicaraguan Institute for Women (INIM), an autonomous Government agency that is the country's leading women's rights body.

Key Indicators

Specific targets would be identified during the first stage o f the project. Indicators would include:

0

0

Proportion o f enterprises receiving technical assistance from Component 1 that are managed by women; Proportion o f enterprises applying for matching grants that are managed by women; Proportion o f enterprises receiving matching grants that are managed by women. Proportion o f enterprises receiving complementary guarantees from the PCRG that are managed by women.

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Annex lob: Indigenous Peoples Planning Framework Summary l1

1. Introduction

Micro, small, and medium enterprises (MSMEs) in Nicaragua play an important role for generating employment and the production o f goods and services for consumption and export. Their contribution to Gross Domestic Product (GDP) i s estimated at around 40 percent. They are present across the country and distributed in al l sectors o f the economy. MSMEs represent an integral part o f social and organizing capital in Nicaragua; their expansion and strengthening contribute to social and geographic cohesion.

The M S M E Development Project financed by the World Bank will support the efficient and competitive development o f MSMEs and their integration into the national economy. Access to credit and technical assistance for improvements to processes and production and access to markets are fundamental in the development o f MSMEs.

The Government o f Nicaragua and the World Bank are committed to ensuring that the benefits o f this project reach the most excluded populations, particularly women and indigenous groups. Education, support, and technical assistance services that are provided by the project to these populations wil l be culturally appropriate and in accordance with their demands and necessities.

This Indigenous Peoples Planning Framework proposes the principles and mechanisms - which are an integral part o f the project - that guarantee active, informed, and culturally appropriate participation from indigenous and afro-descendant groups in Nicaragua. This framework complements the activities o f other efforts under implementation and financed by the World Bank, such as the Broad-Based Access to Financial Services Project.

2. Ethnic Groups o f Nicaragua

The census o f 2005 confirmed the existence o f 157,000 Nicaraguans that identify themselves as part o f an indigenous or afro-descendant people. Of those, almost ha l f l ive on the Caribbean Coast o f Nicaragua and belong to the Miskitus, Mayagna, Creole, Garifuna, and Rama peoples. Outside o f the Caribbean coasts, indigenous peoples l ive together with poor Mestizos in rural zones o f the Nueva Segovia, Madriz, Jinotega, Matagalpa, and Rivas departments.

In economic terms, indigenous and afro-descendant populations l ive in conditions o f extreme poverty; o f the 33 municipalities with populations living in conditions o f severe poverty, 16 o f them have indigenous populations.

3. MSMEs and Ethnic Groups

The departments where indigenous and afro-descendant populations are concentrated have the smallest number o f registered MSMEs in proportion to the departmental populations. R A A S and

The statistics contained in this document are from the Social Assessment camed out for this Project. See Evaluacibn Social. Nicaragua Proyecto: Apoyo al Desarrollo de la Micro, Mediana y Pequeiia Empresa (p109691). Marvin Ortega. Enero, 2008

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RAAN, multi-ethnic regions where hal f the ethnic population o f the country and al l o f the Miskitus, Mayagnas, Ramas, Garifuna, and Creole peoples live, have an imbalanced relationship between the population and MSMEs, with the percent o f the national population being 5 times that o f the percent o f the total M S M E S ' ~ . The lack o f technical assistance and l imited access to credit - and its high costs - limit the opportunities o f ethnic groups to create, consolidate and/or expand their micro and small enterprises.

The principal efforts o f community-based enterprises have focused on creating a solidarity economy, starting from a local rural economy that permits strong ties between producers and consumers. In practice, however, few or no micro and small rural enterprises, especially in indigenous territories, have the possibility o f competing in the globalized market, let alone in their own municipal markets. They primarily operate in the local markets o f the communities where they were founded. In the majority o f cases, this type o f community-based entity i s organized around natural resources, individual or shared, especially for the production, collection, and commercialization o f forest or sea products.

But these community entities do not constitute formal enterprises. In general, they do not have forms o f organization that transcend the community itself, except in commercial activities, and the majority remain as groups or collectives linked to development projects run by national and international NGOs. The poorest demand credit linked to technical assistance to produce, analyze demand, organize, and manage their businesses without incurring additional costs. The characteristics o f these enterprises are difficult to quantify, but estimates indicate that the vast majority are in the category o f micro-enterprises (0-5 employees). A few fal l into the category o f small enterprises (6-20 employees); this i s the case o f community forest enterprises. None o f those that are officially registered fal l into the category o f medium enterprises (21-50 employees).

To improve the business climate, micro and small enterprise owners in the regions where there is a high ethnic concentration have suggested reducing the administrative barriers at the central and municipal government levels. They also suggest the provision o f technical assistance in establishing businesses. This i s o f particular importance for enterprises dedicated to forestry and wood working and fishermedwomen since they constitute the major type o f enterprise run by indigenous and afio-descendant peoples.

4. Access to Credit in Ethnic Communities

In the regions and in the municipalities, the poorest groups receive the least credit.

Of the total loans lent f rom institutions belonging to the Nicaraguan Association o f Microfinance Institutions (ASOMIF), 57.2 percent o f the number o f loans and 39.4 percent o f the total funds went to the Pacific region, the least poor in the country. In the Caribbean coast (RAAN, RAAS, and Rio San Juan), where 13.2 percent o f the population live, they received only 5.4 percent o f the total loans. In municipalities with severe poverty, only 0.4 percent o f the population

Chinandega, Leon y Masaya, with 1 9.6 %, 8.7 % y e l 7.7 %, respectively, ocupy the three places after Managua, and all of them have, 12

percentage wise, more MSMEs than population. 42.6% of MSMEs are based in Managua, although this department only represents 25.6% o f the country's population. Source: Social Assessment.

83

accessed credit. In municipalities with high poverty, 4.9 percent have access to credit, in those with moderate poverty, 6.65 percent have access, and in those with low poverty, 6.6 percent have access.

In the Caribbean Coast, there are few microfinance institutions with programs directed toward indigenous communities. In Bilwi, Siuna, and Rosita (RAAS), two finance institutions are operating, one associated with ASOMIF, ACODEP, and one cooperative that is part o f CENACOOP, CARUNA. These institutions are dedicated to urban enterprises and they may assist rural groups with administrative funds. Neither has policies specifically dedicated to indigenous communities. In RAAN, in the municipalities o f Puerto Cabezas (comprising 22 Miski tu and Mayagna communities) and Waspan (comprising 16 Miski tu communities), an NGO, Pana Pana, provides microcredit to indigenous communities. Pana Pana does not offer subsidized credit but offers recipients parallel training and technical assistance, particularly for indigenous communities and women. This training and technical assistance come included as a cost o f the credit, but only for clients that work in agricultural, forest, or fish production.

In RAAN, two other local NGOs manage small credit funds: AMICA13 and the Nidia White Association (ANW). ANW has agents in the Mining Triangle o f RAAN: Rosita and Siuna. The fimds managed by both institutions are very small.

Three severely poor municipalities belong to Jinotega, where there i s a strong presence o f indigenous Miskitus and Mayagnas that l ive in the depths o f the Bosawas reservation. In these communities there are also credit funds that offer credit primarily to the mestizo population. In the department o f Madriz, where there i s a strong indigenous contingent living side by side with the mestizo population, only one municipality has any credit funds.

At the institutional level, financial services should at once promote technologies that improve environmental management and the rational use o f natural resources. In this way, credit becomes an instrument for development management, encouraging rural and urban MSMEs to be responsible with regards to the environment.

5. Proiect Benefits for Participating Ethnic Groups, by Component

With the aim o f informing the preparation o f the project design, an extensive social evaluation was implemented. The social evaluation was carried out in December 2007 and January 2008 and included consultations with indigenous leaders from the Caribbean Coast o f Nicaragua (RAAN and RAAS) and meetings with government representatives from RAAN (Bilwi). A special discussion with representatives from the Mayagna people was organized at the same time that bilateral meetings with representatives f rom the Ministry o f Affairs for the Nicaraguan Atlantic Coast took place.

In addition to the inputs generated through consultations and the recommendations from the social assessment, lessons learned from similar projects have been incorporated into the design o f this Indigenous Peoples Planning Framework.

l3 Asociacion de Mujeres Indigenas de la Costa Atlhntica.

84

Component 1 In spite o f the l ow presence o f MSMEs in regions with high concentration o f indigenous peoples, this component wil l contribute to facilitating the formalization o f micro and small entreprises that exist in indigenous communities or territories, which for reasons o f cost or distance have not been able to formalize.

The decentralization o f registry services o f firms, certification, and quality control will especially benefit small forestry firms managed by groups in the Bilwi region and the communities o f Mayagna (Sumus) where there are small community-based enterprises involved in the sustainable management o f forest resources. O f equal importance, the activities o f this component wil l facilitate the formation o f small and medium enterprises o f the fishing sector in RAAN, many o f which are forming with help from the Hurricane Felix Emergency Reconstruction Project supported by the Wor ld Bank.

The Project will work closely with regional Government authorities o f RAAN and R A A S to advance the decentralization o f these services to points o f access in the region. For example, the project will finance one o f five Centers o f Support for Micro and Small Enterprises (CAMIPYMES) in Bluefields in R A A S . This Center wil l provide technical assistance and information to enterprises about formalizing and administrative procedures. At the same time, with the goal o f ensuring these services are used, informational materials for indigenous communities in their respective languages wil l be prepared. For this, the project wil l work in coordination with NGOs that work with ethnic groups, municipalities, and local authorities in intermediary cities and/or in indigenous communities.

Component 2 This component i s o f high importance for the most excluded groups due to the limited opportunities o f obtaining grants or technical assistance in support o f their micro and small enterprises. In coordination with NGOs that work with indigenous peoples, municipalities, and local authorities, the project will promote the activities o f this component extensively. The project wil l offer informational materials and applications for indigenous communities in their respective languages. If there i s not sufficient interest from indigenous communities or if these groups do not receive any grants in the init ial rounds, there wil l be a special round for regions with large indigenous populations or for economic sectors where indigenous peoples are most l ikely to work. In this way, indigenous peoples will be able to present proposals in more favorable conditions than if they had to compete with enterprises with more solid and greater experience in the preparation o f proposals and competitive processes.

The implementing agency, MIFIC, will work in coordination with local organizations and specialized institutions (such as URACAAN) so as to offer technical assistance to these groups in preparing their proposals. The calls for presentation o f projects, in addition to the established channels to announce the rounds, wil l make use o f radio for a special convocation aimed at regions with large indigenous populations.

Component 3 Under this component, the Project wil l stimulate the expansion o f financial entities, particularly in the commercial banking sector. Particularly in the RAAN and RAAS, the efforts o f the

85

Broad-Based Access to Financial Services Project (PAGSF), which i s supported by the Bank, wil l complement and reinforce activities and goals o f this component. The activities for the Inclusion Plan o f PAGSF are under implementation and include offering technical assistance and training to organizations working in RAAN (i.e. Pana Pana and A M I C A ) so that they can expand their financial services without a major risk.

6. Mechanisms for Consultations and Support for Greater Participation o f Indigenous Peoples in the Proiect

For the design o f the project and the preparation o f the social assessment, bilateral consultations were held with leaders from indigenous communities, microfinance institutions established in regions with concentrations o f indigenous peoples, and local and central government authorities in charge o f matters related to the Atlantic Coast.

During the appraisal o f the project, consultations wil l be held with leaders and representatives from indigenous communities, microfinance institutions, governments, and regional and national authorities with the aim o f refining the mechanisms and proposed actions o f this framework.

Also during appraisal, toward the end o f aiding the implementation o f the project, an agile mechanism o f monitoring the participation o f indigenous peoples in the project will be designed. This wil l focus specifically on their participation in the matching grant rounds, the provision o f technical assistance, and the formalization o f enterprises that meet the necessary requirements for the process.

If it is necessary, the project wil l hold a special selection round o f proposals for regions with large ethnic populations and it wil l expand the selection committee with the aim o f integrating at least two organizations or individuals with experience working with indigenous communities. The results o f the selection process will be made public through the webpages o f the central and regional Government authorities, as wel l as o f the project itself.

In coordination with the corresponding regional and municipal governments, the project will provide support to the registry process and the dissemination o f information o f documents and necessary conditions for said processes. This mechanism wil l be designed and implemented in coordination with similar tasks under projects financed by the Bank: Hurricane Felix Emergency Reconstruction Project and PAGSF.

The proposed mechanisms and details o f operation wil l be integrated into an Operations Manual o f the MSME Development Project and should be evaluated during the mid-term review o f the project.

7. Resolution o f Conflicts

Given the objectives o f the Project components and the activities that wil l be supported, the implementation o f these activities should not cause conflicts. The project wil l not have a negative effect o n the rights andor assets o f the ethnic communities (indigenous or afro-

86

descendant) in Nicaragua. The principles, objectives, or activities financed by the project will not undermine the cultural values and practices o f indigenous and afro-descendant peoples.

On the contrary, the Project wil l provide support to the economic development o f the communities through the support o f formalization o f enterprises managed by ethnic groups, the provision o f technical assistance, and potentially the expansion o f financial services in their regions.

In addition, the Bank and the Government o f Nicaragua have agreed to special affirmative actions that promote equality o f opportunities, including special rounds focused o n regions with large ethnic populations for the matching grants. Within this context, the selection o f proposals submitted will be competitive.

However, in case o f conflict, if community authorities are unable to resolve them, the project wil l establish a mechanism for receiving complaints through regional authorities, particularly in RAAN and RAAS, which wil l go to the coordinating unit o f the project in MIFIC. For other regions, complaints wil l be sent directly to the project coordinating unit.

The project will finance the preparation o f brochures in the principal ethnic languages with information about the project, i t s objectives, activities, mechanisms for coordination with local and central authorities, and details about where to go with complaints and opinions.

8. Consultation and Supervision

The social assessment o f December 2007 was a product o f consultation with indigenous leaders, organizations that work with indigenous people, and representatives from the governments o f the Atlantic Coast, GRAAN and GRAAS. During implementation, the project will continue to consult with these groups and with the expert that completed the social assessment. In addition, consultations will be held with the Office o f Development for the Caribbean Coast. If there is insufficient interest from indigenous groups, these consultations will serve to find out the reasons and determine next steps.

9. Indicators o f Participation for Ethnic Groups in the Proiect

Similar to plans to ensure that project benefits are reaching women, the project has defined quantitative indicators specifically for ethnic groups that wil l be integrated into the results matrix for the project. These indicators refer to: (i) number o f indigenous-run micro/small enterprises benefiting from the Matching Grants; (ii) number o f indigenous-run micro/small enterprises that receive technical assistance - for formalization, improvements in quality standards, and preparation o f business plans, among other things. In qualitative terms, the mid-term review o f the project will evaluate: (i) the knowledgehformation indigenous groups and leaders have about the project and i t s facilities; (ii) the relevance o f the prepared informational materials in supporting the participation o f ethnic groups; and (iii) the functioning o f coordination mechanisms between the project, local authorities, and social organizations that wil l provide technical assistance to groups and enterprises owned by indigenous peoples that have requested this assistance.

87

Annex 11: Project Preparation and Supervision NICARAGUA: Micro, Small and Medium Enterprise Development Project

Planned Actual PCN review November, 2007 December 4,2007 Initial PID to PIC Initial ISDS to PIC Appraisal March 2008 April 2008 Negotiations April 2008 May 2008 BoardRVP approval Late May, 2008 July 2008 Planned date o f effectiveness August 2008 September 2008 Planned date o f mid-term review Planned closing date December 201 3 December 20 13

January 201 1 January 201 1

Key institution responsible for preparation o f the project: Ministry o f Economy (MIFIC)

Bank staff and consultants who worked on the project include:

88

Sunita Varada Ilias Skamnelos Patricia Hoves

Consultant LCSPF Financial Sector Specialist LCSPF Senior Finance Officer

I KennanRapp I I ET Consultant I LCSDE

Enrique Antonio Roman Aleiandro Alcala Gerez

Financial Management Specialist LCSFM Counsel LEGLA

Alvaro Larrea Anjal i Acharya Rick Van der Kamp

Procurement Spec LCSPT Environmental Spec LCSEN Operations Officer C L A L A

Cidalia Brocca

Josefina Stubbs Regis Thomas Cunningham

I I Components 1 and 3

Finance Analyst LOADM Senior Finance Officer LOAFC Senior Social Develonment Snecialist LCSSO

Bank funds expended to date o n project preparation (as o f April 22,2008): $95,000 1. Bank resources: US$ 84,000 2. Trust hnds (DFID): US$ 14,000 3. Total: US$ 98,000

Rosa G. Valencia D e Estrada Peer Reviewers: Ahmet Soylemezoglu

Estimated Approval and Supervision costs: 1. Remaining costs to approval: us$$20,000 2. Estimated annual supervision cost: US$lOO,OOO

Consultant LCSPT

Financial sector consultant, OP 8.30 and LCSPF

89

Pierre Olivier Colleye

Greta Bull

Component 3 reviewer Senior Microfinance Specialist, Peer ECSSD Reviewer Components 1 and 2 Program Manager, Peer Reviewer C L A L A

Annex 12: Documents in the Project File NICARAGUA: Micro, Small and Medium Enterprise Development Project

Draft Manuals and Plans

Draft Operational Manual Draft Matching Grants Manual Draft Procurement Plan

World Bank Publications and other Studies

Arauz, Alejandro L. May 2004. Impact0 del CAFTA sobre 10s sectores sociales menos favorecidos en 10s paises centroamericanos (cas0 de Nicaragua). Fundacidn Friedrich Ebert, Representation in Nicaragua. Managua, Nicaragua.

Barth, James, Gerard Capri0 Jr. and Ross Levine (2004), “Bank Regulation and Supervision: What Works Best?” Journal of Financial Intermediation 13, pp. 205-248.

Beck, Thorsten, Ross Levine, and Norman Loayza (2000), “Finance and the Sources of Growth”, Journal of Financial Economics, 58 pp.261-300

Butcher, Arona M., et. al. August 2004. US.-Central America-Dominican Republic Free Trade Agreement: Potential Economywide and Selected Sectoral Effects. US. International Trade Commission, Investigation No. TA-2104-13. Publication 717. Washington DC.

Comisidn Presidencial de Competitividad. 2005. Plan de Accibn 2005 para Mejorar el Clima de Negocios a travks de la Reduccibn de Barreras Administrativas.

Demirguc-Kunt, Asli, and Enrica Detragiache (2002), “Does Deposit Insurance Increase Banking System Stability? An Empirical Investigation, Journal of Monetary Economics, 49(7), pp. 1373-1406.

Djankov, Simeon, Caralee McLiesh and Andrei Shleifer (2005) “Private Credit in 129 Countries”, NBER Working Paper No. 11078.

Djankov, Simeon, Rafael L a Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2002) “The Regulation of Entry”, Quarterly Journal of Economics, 117, pp. 1-37.

Djankov, Simeon, Rafael L a Porta, Florencio Lopez-de-Silanes and Andrei Shleifer (2003) “Courts”, Quarterly Journal of Economics, 118, pp. 453-517. Economist Intelligence Unit. Nicaragua. Country ProBle 2005.

FIAS. June 2004. Aide Memoire. Creating a Reform Program to Remove Administrative Barriers to Investment in Nicaragua.

FIAS. May 2003. Nicaragua: Competitividad, Atraccibn de Inversiones Extranjeras Directas y Rol de la Politica de Competencia. G r C Jaime. Febrero 2005. Simplijkacibn de Tramites Empresariales en Nicaragua. International Monetary Fund. 2005. Nicaragua: Poverty Reduction Strategy Paper.

King, Robert G. and Ross Levine (1993), ‘<Finance and Growth: Schumpeter Might Be Right”, Quarterly Journal ofEconomics, 108, pp. 717-738.

Levine, Ross, and Sara Zervos (1998), “Stock Markets, Banks, and Economic Growth”, American Economic Review 88, pp. 537-558.

90

Loayza, Norman, Ana Maria Oviedo and Luis Serven (2005), “Regulation and Macroeconomic Performance”, World Bank Policy Research Working Paper No. 3469

Lopez Carrion, Nehemias Obed (coord). October 28-29, 2003. Politica laboral y de migraciones comun y Tratados de Libre Comercio en Amkrica Central. Fundaci6n Friedrich Ebert, Representation in Nicaragua. Informe de Seminario Regional, Managua, Nicaragua.

Monge-Gonzblez, Ricardo, Claudio GonzLlez-Vega and Francisco Monge-AriAo. Efectos Potenciales de un tratado de libre comercio entre USA y Centro Amkrica sobre el sector agropecuario y agroindustrial de Costa Rica y E l Salvador. (mimeo) Monge-Gonzalez, Ricardo, Miguel Loria-Sagot and Claudio Gonzalez-Vega. June 2003. Retos y oportunidades para 10s sectores agropecuario y agroindustrial de Centro Amkrica libre comercio con 10s Estados Unidos. Unpublished paper prepared for the World D C . Republic o f Nicaragua. July 4,2005 .National Development Plan 2005-2009. Taylor, J. Edgar, Antonio J h e z Naude and Nancy Jeserum-Clements. October 10,

ante un tratado de Bank. Washington,

2005. Los posibles efectos de la liberalizacibn comercial en 10s hogares rurales de E l Salvador, Honduras, Guatemala y Nicaragua a partir de un modelo desagregado para la economia rural In forme final. (mimeo)

Todd, Jessica, Paul Winters and Diego Arias. December 2004. CAFTA and the Rural Economies of Central America: A Conceptual Framework for Policy and Program Recommendations. Inter-American Development Bank. Washington, DC.

The World Bank. April 2,2004. Nicaragua Investment Climate Assessment.

The World Bank. July 6, 2005, The International Development Association. The International Finance Corporation. Nicaragua Interim Strategy Note, Washington, D C

Wor ld Bank’s Country Partnership Strategy (October 11,2007; Report No. 39637

The World Bank. June 7, 2005. DR- CAFTA: Challenges and Opportunities for Central America. World Bank Report No. 32288-LAC. Washington, DC.

The World Bank. 2007. Doing Business in 2008. Washington, DC.

91

m

U .. 2 s 4

9

Annex 14: Statement of IFC’s Held and Disbursed Portfolio

CAS Annex B8 IFC- Nicaragua

88 (IFC) for Nicaragua

Nicaragua Committed and Disbursed outstanding Investment Portfolio

AS Of 03/31/2006 (In USD Millions)

Committed Disbursed Outstanding

“auasl - Partlci “Quasi FY ADDrOVal CornDany - Loan Eauitv *GT/RM Loan ‘GTIRM Dant

08/08/2008/08 Bcodefinanzas 80 0 0 0 0 0 0 0 0 0 04/04/2004/04 Confia 7.5 0 0 0 0 7.5 0 0 0 0 08/08/2006/08 Findesa 8 0 12 0 0 8 0 12 0 0 o/oo/oo/oo International ... 31.08 0 0 0 0 31.06 0 0 0 0 o/oo/oo/oo Monte rosa 200 0 0 0 0 100 0 0 0 0 07/07/2007/07 Nicaragua sugar 100 0 0 0 48 100 0 0 0 48

-- - -

Total Portfolio: 406.56 0 12 0 46 248.56 0 12 0 4 8

Denotes Guarantee and Risk Management Products ** Quasi Equity includes both loan and equity types.

93

Annex 15: Nicaragua at a Glance

General gov't final consumption expenditure -15.1 2.0 1 .o 5.7 Gross capital formation 1.2 0.8 5.8 -0.5

POVERTY and SOCIAL Nicaragua

-10

-Expods +Imports

2006 Population, mid-year (milfions) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billions)

Average annual urowth, 2000-06

Population (%) Labor force (%)

Most recent estimate (latest year available, 2000-06)

Poverty (% of population below national poverty line) Urban population (% of total population) Life expectancy at birth (years) Infant mortality (per 7,000 live blehs) Child malnutrition (% of children under 5) Access to an improved water source (% ofpopulation) Literacy (% ofpopulation age 15+) Gross primary enrollment (% of school-age population)

Male Female

KEY ECONOMIC RATIOS and LONG-TERM TRENDS 1986

GDP (US$ billions) 2.9 Gross capital formation1GDP 16.9 Exports of goods and services1GDP 12.8 Gross domestic savingsIGDP 8.8 Gross national savingsIGDP 6.6

Current account balanceiGDP -24.5 Interest payments1GDP 0.7 Total debVGDP 234.6 Total debt servicelexports 14.3 Present value of debVGDP Present value of debVexports

1966-96 1996-06 (average annual gmwth) GDP 0.8 3.7 GDP per capita -1.6 2.3 Exports of goods and services 2.4 8.7

5.2 980 5.1

1.1 2.3

59 70 30 10 79 77

112 113 110

1996

3.3 25.6 20.0

6.5 1.3

-24.9 2.2

179.5 26.4

2005

4.3 3.8 9.5

Latin America B Carlb.

556 4,767 2,650

1.3 2.1

78 73 26

91 Bo

118 120 118

2005

4.9 29.6 29.1 -0.1 14.3

-15.4 0.9

105.9 6.7

41.3 77.5

2006

3.7 1.7

10.5

Lower. middle- income

2,276 2,037 4,635

0.9 1.4

47 71 31 13 81 89

113 117 114

2006

5.3 29.4 31.1 -0.5 13.3

-16.1

2006-10

4.5 1.4 7.6

Development diamond'

Life expectancy

T GNI Gross per primary capita enrollment

Access to improved water source

Nicaragua Lower-middle-income gmup

-

Economlc ratlos'

Trade

1

Domestic Capital savings formation

Indebtedness

Nicaragua Lower-middle-income crmuo

-

STRUCTURE of the ECONOMY

(% of GDP) Agriculture 28.6 25.0 Industry 42.9 27.1

Manufacturing 35.4 18.0 Services 58.4 50.5

Household final consumption expenditure .. 82.9 General gov't final consumption expenditure 91.2 10.6 Imports of goods and services 20.8 39.2

16.7 18.5

11.2 11.9 58.8 61.0

(average annual gmwth) Agriculture Industry

Services Manufacturing

1986-96 1996-06 2005 2006

-0.3 3.8 3.9 4.2 -2.4 4.5 5.7 2.5 -3.8 4.7 6.5 5.3 0.8 4.1 3.7 4.6

Household Rnal consumption expenditure 6.6 4.1 3.5 3.5

94

Nicaragua

PRICES and GOVERNMENT FINANCE

Domesfic prices (% change) Consumer prices Implicit GDP deflator

Government finance (% of GDP, includes current grants) Current revenue Current budget balance Overall surplus/deficit

TRADE

(US$ millions) Total exports (fob)

Coffee Shrimp and lobster Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (2000=100) Import price index (2000= 100) Terms of trade (2000=100)

BALANCE of PAYMENTS

(US$ millions) Exports of goods and services Imports of goods and services Resource balance

Net income Net current transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ millions) Conversion rate (DEC, local/US$)

EXTERNAL DEBT and RESOURCE FLOWS

(US$ millions) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net resource flows Official grants Official creditors Private creditors Foreign direct investment (net inflows) Portfolio equity (net inflows)

World Bank program Commitments Disbursements Principal repayments Net flows Interest payments Net transfers

1986

600.0 281 5

1986

248 110

9 33

756 98

127 218

0 0

136

1986

277 836

-559

-149 0

-708

505 203

3.02E-8

1986

6,771 200

60

40 0 0

61 766

6 0 0

0 0 0 0 0 0

~

1996

11 6 9 6

17 2 3 8

-2 4

1996

467 116 75

137 1,154

241 176 290

72 65

110

1996

723 1,375 -652

-324 150

-826

079 -53

197 8 4

1996

5,961 44

335

219 22

4

619 105

-4 120

0

61 69 18 51

8 43

2005

9 4 9 4

18 1 4 4

-5 2

2005

864 126 86

423 2,623

640 544 509

137 156 87

2005

1,960 3,404

-1,444

-127 824

-747

793 -46

727 16 7

2005

5,144 0

1,136

172 0 7

468 164

17 241

0

11 63 0

63 7

56

2006

10.6

18.8 3.4

-3.9

2006

1,027 201

86 490

2,988 735 681 550

152 176 86

2006

2,319 3,905

-1,586

-124 856

-855

986 -132

922 17.6

2006

0 256

0 10

0 52

5 47

5 42

I - * * "GDP deflator -CPi I

Export and import levels (US$ mill.) i r i 3 000

1

/2 Oo0

I' Oo0 ' 0

O6 I , 00 01 02 03 04 05

ei Exports a Imporis

Current account balance to GDP ( O h )

Composltlon of 2005 debt (US$ mill.)

G 538

F 599

E 1014

D 1656

4 - iBRD B - IDA D. Other multilateral F . Pnvate C - I M F G - Short-term

E - Bilateral

Note This table was produced from the Development Economics LDB database 9/28/07

95

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CHONTALES

R Í OS A N

J U A N

CARAZOGRANADA

MASAYA

L É O N

CHINANDEGA

MADRIZ

E S T E L Í

NUEVASEGOVIA

MANAGUA

San Benito

Rama

Lagunade Perlas

NuevoAmanecer

Punta Gorda

El Castillo deLa Concepcíon

Prinzapolka

Kukalaya

Leimus

Bonanza

Bocay

La Rosita

Somotillo

Sébaco Muy Muy

Rio BlancoEl Sauce

Corinto

Potosi

PuertoSandino

WiwilíQuilalí

San Sebastiánde Yali

Siuna

La Cruz deRío Grande

San Juan del Norte

NuevaGuínea

SanMiguelito

Lóvago

Peñas BlancasSan Juan del Sur

Masachapa

Waspam

Matagalpa

Granada

JuigalpaBluefields

Puerto Cabezas

San Carlos

Léon

Estelí

Somoto

Jinotega

Jinotepe

Boaco

Masaya

Ocotal

Chinandega

Rivas

MANAGUA

EL SALVADOR

H O N D U R A S

C O S T A R I C A

Wawa

Kukalaya

Bambana

Prinzapolka

Grande de Matagalpa

Kurinwás

Mico Escondido

Siquía

San Juan

Río Indio

Turna

Coco

B o

cay

Am

aka

Gulf ofFonseca

PaharaLagoon

KarataLagoon

Punta Gorda

PACIFIC OCEAN

LakeNicaragua

C a r i b b e a nS e a

LakeManagua

WaniLagoon

WountaLagoon

PerlasLagoon

BluefieldsBay

PuntaGordaBay

To Tegucigalpa

To Auasbila

To SanMiguel

To San José

Cabo Graciasa Dios

Punta Cosigüina

Cayos Miskitos

I. de Ometepe

C o r d i l l e r a

I sa

be

l la

C o r d i l l e r a Ch o

nt a

l en

na

M

os

qu

it

o

C

oa

st

Mogoton(2,438 m)

15ºN

13ºN

15ºN

14ºN

13ºN

12ºN12ºN

11ºN

87ºW 86ºW 85ºW 84ºW 83ºW

86ºW 85∞W 84ºW 83ºW

NICARAGUA

This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other informationshown on this map do not imply, on the part of The World BankGroup, any judgment on the legal status of any territory, or anyendorsement or acceptance of such boundaries.

0 20 40

0 10 20 30 40 50 Miles

60 Kilometers IBRD 36139

MAY 2008

NICARAGUAMSME DEVELOPMENTPROJECT (P109691)

SELECTED CITIES AND TOWNS

DEPARTMENT CAPITALS

NATIONAL CAPITAL

RIVERS

MAIN ROADS

RAILROADS

DEPARTMENT BOUNDARIES

INTERNATIONAL BOUNDARIES