Document of

The World Bank

FOR OFCIAL USE ONLY

Report No. 5058-PAK

STAFF APPRAISAL RE PORT

PAKISTAN

SEC)ND SMALL INDUSTRIES PROJECT

May 11, 1984

Industrial Development and Finance DivisionSouth Asia Projects Depar tment

|hi document has a resticted distribution and my be used by recipients nly in the performance oftheir offica dutie It contens amy net odrwise be disclosed without World Bank autoizatio

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CURRENCY EQUIVALENTS

Currency Unit = Pakistan Rupees (Rs)US$1 = Rs 13.5Rs 1 = US$0.0741

ABBREVIATIONS USED

ABL - Allied Bank of Pakistan LimitedDSI - Directorate of Small IndustriesGOP - Government of PakistanUBL - Habib Bank LimitedIACP - Investment Advisory Center of PakistanIDBP - Industrial Development Bank of PakistanIIC - Industrial Investment CreditMCB. - Muslim Commercial BankNBP - National Bank of PakistanNWFP - North West Frontier ProvincePBC - Pakistan Banking CouncilPSIC - Punjab Small Industries CorporationSBP - State Bank of PakistanSIC - Small Industries CorporationSID - Small Industries DepartmentSIDB - Small Industries Development BoardSIRD - Small Industries Refinance DepartmentSSI - Small Scale IndustriesSSI I - First Small Industries Pro'ectSSI II - Proposed Second Small Industries ProiectSSIC - Sind Small Industries CorporationUBL - United Bank Limited

FISCAL YEARS

Government of Pakistan : July 1-June 30Commercial Banks : January 1-December 31

FOR OMCIAL USE ONLYPAKISTAN

APPRAISAL OF SECOND SMALL INDUSTRIES PROJECT

Table of Contents

Page No.

CREDIT AND PROJECT SUMMARY .................................. iii

I. INTRODUCTION .................................... . .. ......... 1

II. SECTORAL FRAMEWORK ................................ *... 3A. Economic Setting ........................................ 3B. Industrial Sector ..... ................................. 4C. Financial Environment .. ............. .................. * 5D. Small Scale Industries Sector ........................... 7

- Characteristics and Performance .... .................. 7- Policy Environment and Development Strategy .... ...... 8- Credit Demand (FY85 and FY86) ..... ................... 10- Sixth Five-Year Plan Obiectives ...................... 11

III. THE PROJECT ................................................. 12A. Obiectives and Scope ................ .. .................. 12B. Proiect Costs and Financing Plan ........................ 13C. Lending Component ................. .. .................... 14

- Role of Commercial Banks in SSI Financing ............ 14- Participating Institutions ........................... 14- Refinance and Monitoring Agencies .................... 15- Subproiect Eligibility Criteria ...................... 16- Subloan Terms and Conditions ......................... 17

D. Technical Assistance Ccmponents ........ 17- Technical Assistance Program for SSI .17- Investment Promotion and Proiect Development

for Baluchistan .................................... 18- Proiect Identification and Development for NWFP ...... 19- Management Training Program for SSI ............... ... 20- Subproiect Preparation Fund ....... ................... 21- Subcontracting Study ........................... ... 21

IV. THE CREDIT .................................................. 22A. Terms and Conditions ............... .. .................. 22B. Administrative Procedures ............................... 23

V. BENEFITS AlTD RISKS . .................................... 25- Benefits ............................ ........ ....... 25- Risks ................................................ 26

VI. RECOMMENDATIONS .............................................. 26

This report was prepared by Messrs. J. Pernia and G. Vivado (ASPID),H. Qureshi (Res. Mission), and L. Chico (Consultant) following an appraisalmission to Pakistan in October 1983. The report was finalized after apost-appraisal mission in March 1984, consisting of Messrs. J. Pernia,C. Punsalan, G. Vivado (ASPID), and H. Qureshi (Res. Mission).

Ihbis document has a restrited distribution and tnay be used by recipients only in the performance oftheir official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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LIST OF ANNEXES

1. Profile of Subprojects Under Credit 1113-PAK2. Profile of Commercial Banks3. Comparative Capital Intensity, Capital Productivity and

Labor Productivity of SSIs4. Organizational Profile of SICs5. Subloan Pipeline of Commercial Banks6. Estimated Project Costs and Financing Plan7. Small Industries Refinance Department of IDBP - Strategy Statement,

Policies and Procedures, Work Program and Organization8. Implementation Timetable for the Technical Assistance Components9. Estimated Schedule of Disbursements10. Documents Available in Project File

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PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

CREDIT AND PROJECT SUMMARY

Borrower: Islamic Republic of Pakistan

Beneficiaries: Allied Bank of Pakistan Limited (ABL)Habib Bank Limited (EEL)Muslim Commercial Bank (MCB)National Bank of Pakistan (NBP)United Bank Limited (UBL)Industrial Development Bank of Pakistan (IDBP)Federal Ministry of IndustriesProvincial Small Industries Corporations (SIC)Pakistan Banking Council (PBC)

Amount: SDR 47 million (US$50.0 million equivalent)

Terms: Standard

OnLending Terms: The Government would relend the proceeds of theCredit through the Industrial Development Bank ofPakistan to the five participating commercial banksat terms which would provide a spread of 4%-5.25% tothe banks and an administrative fee of 1.5% to IDBP,with an onlending rate of llZ to the finalsubborrowers. The Government would bear the foreignexchange risk. The participating banks would repaytheir loans over 12 years, including a grace periodof five years. The proceeds of the Credit to be usedfor technical assistance would be passed on to theexecuting agencies at IDA terms.

Project Description: The Proqect would provide credit to promote invest-ments in promising small scale industries (SSI)subsectors and to accelerate modernization andimprove productivity of existing SSI units. Tocomplement the credit scheme, technical assistancewould be provided to SSIs through the provincialSmall Industries Corporations and the federalMinistry of Industries in proiect identification andinvestment promotion, project preparation and exten-sion services, and management training. PresentGovernment policies augur well for continued growthin the industrial sector generally and among SSIs in

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particular. The main risk is that adverse politicalor external econom1c factors could affect growth inthe sector and demand for SSI credit. The technicalassistance component is vulnerable to institutionalweaknesses. The experience accumulated under thefirst Project, together with strong institutionbuilding inputs through training and consultancyservices, should reduce this risk.

Estimated Costs: Local Foreign Total-- USS million-

Lending Component 86.00 30.00 116.00Technical Assistance

Components 2.36 0.92 3.28Total 88.36 30.92 119.28

Financing Plan: Local Foreign Total-US$ milion--

IDA 19.08 30.92 50.00Participating Commercial Banks 21.54 - 21.54Subproject Sponsors 47.00 - 47.00GOP 0.74 - 0.74

Total 88.36 30.92 11928

Estimated Disbursements: IDA FY 85 86 87 88 89 90-US$ million- - --

Annual 2.60 12.00 14.00 14.00 5.00 2.40Cumulative 2.60 14.60 28.60 42.60 47.60 50.00

PAKISTAN

STAFF APPRAISAL REPORT

SECOND SMALL INDUSTRIES PROJECT

I. INTRODUCTIONT

1.01 The Government of Pakistan's (GOP) Sixth Five-Year Plan (FY84-88)stresses the contribution of small scale industries (SSI) in achieving thetargets for industrial employment, exports and output. This is expected tobe realized through private investment and activity, with Government provid-ing support through expanded financial, technical and infrastructure servicesfor SSIs. The first SSI Credit (SSI I) of US$30 million, which became effec-tive in October 1981 and has been fully committed and about 80% disbursed,has supported GOP's SSI objectives and strategy by improving institutionalarrangements for channeling credit and technical services to SSI. Theproposed Second SSI Project (SSI II) would continue this support by buildingon institutional capabilities developed in SSI I and expanding the credit andtechnical assistance schemes to meet increasing demand from SSI. An IDACredit of US$50 million equivalent (SDR 47 million) in support of a US$120million project is recommended.

1.02 The First SSI Project. In the past, SSI lending was carried outjointly by the Small Industries Corporations (SIC) and the commercial banks,but this arrangement resulted in overlapping responsibilities, frictionbetween institutions, delays in loan processing and, finally, poor loanrecovery performance. Moreover, concerns with lending drew the SICs awayfrom the other important functions of SSI promotion and extension. The FirstSSI Project has succeeded in rationalizing institutional roles by assigningthe lending function completely to the commercial banks and reorienting theSICs toward technical assistance. Through training and organizationalarrangements, the Project assisted the commercial banks in organizing andstaffing appropriately for project-based SSI lending. At the headquarters ofeach bank, a Small Industry Department (SID) was formed to undertake projectappraisal. Key officers of the SIDs received an intensive five-week trainingon SSI project appraisal and supervision. About 400 branches were designatedby the five banks to process IDA subloans; managers of these branches under-went training on SSI lending policies and procedures. With these prepara-tions, the five banks, with the Industrial Development Bank of Pakistan(IDBP) as refinance and monitoring agency and the Pakistan Banking Council(PBC) as coordinator, have demonstrated their capability for SSI lending byfully committing the US$26 million subloan component of the Credit more thanone year ahead of schedule. Disbursements to subprojects have reached US$21million and full disbursement is expected by December 1984. Subloans averag-ing US$48,000 have been approved for 646 subprojects with fixed cost per jobof US$3,250. Major subsectors financed have been agro-industries, light

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engineering, textiles and garments, and wood products. While most sub-projects are still under construction and subloans have not yet matured, arandom sample of subprojects already operating indicates that lending deci-sions being made under the scheme are sound, with rigid sponsor screening andsolid appraisal techniques (Annex 1).

1.03 To reorient the SICs toward promotion and extension services,implementation of the technical assistance components was made their soleresponsibility. To promote coordination between the SICs and the commercialbanks, a subproject preparation fund was established under which SICs couldassist sponsors in preparing subproject proposals for appraisal by the com-mercial banks. This fund will be increased under SSI II. Implementation ofthe other technical assistance components, however, has been delayed, due toproblems with civil works for the service centers, difficulty in locating andhiring appropriate consultants for the export promotion and project promotioncomponents, and indecision regarding on-lending terms by GOP for the subsec-tor studies fund. Except for identification of consultants for subsectorstudies, these problems have been resolved and new target completion dateshave been agreed with the concerned agencies. These dates are well withinthe original appraisal estimate of project completion, December 31, 1985.However, these delays mean that technical service elements of SSI II will belimited to "software" components, to provide time to evaluate the "hardware"facilities financed under SSI I.

1.04 The Proposed Second SSI Project would provide expanded credit andtechnical assistance to SSIs to promote investments in promising subsectorsand accelerate modernization of existing SSI units to improve productivity.IDA would provide US$48 million equivalent for on-lending by the five commer-cial banks to SSIs, which is expected to result in investments of aboutUS$115 million and about 35,000 full time jobs in about 1,450 units. Techni-cal assistance amounting to US$2 million would support elements of the SICtechnical assistance program related to investment promotion and projectdevelopment in the less-developed provinces of Baluchistan and North WestFrontier Province (NWFP); subproject preparation to assist subborrowers inproject formulation and loan application; a training program to improveoverall management performance of SSIs; and a study on subcontracting toidentify policy measures and technical assistance required to promote sub-contracting between large and small industries. SSI II also would continueto assist the participating commercial banks in reinforcing organization andstaffing for SSI lending, through training and systems improvements, espe-cially at the branch level, as decentralization is increased, and withemphasis on end-use and project supervision, as subloans under SSI I startmaturing.

1.05 Other Bank Group Operations. The Bank Group strategy for industry inPakistan has focused on effective transfer of financial resources to theprivate sector through institution building of financial intermediaries,coupled with project promotion and subsector analyses. Aside from SSI I,other Bank Group operations in the industrial sector of Pakistan have con-sisted of 14 loans and credits to three development finance institutions foronlending to medium and large industrial projects, of which 13 operationstotaling US$324 million were for the private sector and one amounting toUS$30 million was for public sector projects. The recently approvedIndustrial Investment Credit (IIC) of US$100 million for financing of medium

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and large projects in the private sector will be channelled not only throughthe traditional developmeat finance institutions, but also through two com-mercial banks with a view co broadening and improving credit channeling toindustry. Work on the overall policy framework was furthered under the firstStructural Adjustment Loan; within industry, the SAL focused on movementsin the reform of the incentive structure, improvements in the efficiency ofthe public manufacturing sector, and streamlining of investment licensingprocedures.

II. SECTORAL FRAMEWORK

A. Economic Setting

2.01 During the past five years, Pakistan's economy developed favorablydespite adverse international economic conditions and high demands fordefense expenditure and refugee assistance related to the Afghan situation.Since 1977, GDP has grown at an average annual rate of 6.3% in real terms.Growth rates in both agricultural and industrial production were substan-tially above those achieved in the 1970-78 period and compare favorably withthe performance of other developing countries in recent years. Exports grewby 9.2% p.a. in volume and 15.3% p.a. in value; the current account deficitin the balance of payments declined significantly relative to GDP; the for-eign exchange reserves of the country rose from the equivalent of 1.2 monthsof imports in 1978 to 3.5 months in 1983. Conservative fiscal policiesreduced the budget deficit relative to GDP and government borrowing from thebanking system. Similarly, conservative policies were pursued in creditexpansion with the result that, with the real gains in production, inflationwas reduced to an annual rate of about 6% in 1983, in spite of upward adjust-ments in the administered prices of energy and higher prices of tea, wheatand rice.

2.02 For the period 1984-88, the Sixth Five-Year Plan projects a similarlypositive performance. Important increments are envisaged in agriculturalyields which would result in greater self-sufficiency in food products, aswell as in export surpluses, particularly in wheat, rice, fruit, vegetables,poultry and other meats. The Plan contemplates the modernization of tradi-tional manufacturing activities and the rapid development of the engineeringand agro-processing industries. These objectives are conceived within anoverall strategy in which the private sector is assigned the primary role inproduction and the public sector is charged with providing adequateinfrastructural facilities and social services. Continued growth in excessof 6% p.a. is expected through 1988. This expectation appears reasonable inrelation to the economy's recent performance and present potential. However,several important factors may affect GOP's ability to provide the infrastruc-tural, financial, and fiscal support implicit in the Plan's projections.These include: the unfavorable terms of trade for traditional Pakistanexports; the country's continued dependence on imports; the low internallevel of savings; and increased demands on GOP's budget for recurrent expen-ditures. Of particular importance will be GOP's resource mobilizationefforts. As a result of restraints on current and capital expeaditures tomeet fiscal discipline objectives in recent years, there is now built-uppressure for higher GOP allocations in many areas. Without a substantial

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resource mobilization effort, it will be difficult for GOP to make the expen-ditures on economic and social infrastructure commensurate with the projectedGDP growth rates.

B. The Industrial Sector

2.03 In FY83, industry accounted for about 23% of GDP, employed 19% of theeconomically active population, and contributed 57% of total exports. Since1977, real annual growth has averaged 9% for industrial value added, 10% forprivate fixed industrial investment, 10% for manufactured exports, and 4% forindustrial employment. The expansion of the sector has been across allestablished subsectors, led by the production of sugar and mild steel. Thepositive performance of the industrial sector was possible due to GOP'sattitude and actions favorable to the promotion of the private sector. Start-ing in 1977, GOP reversed earlier government measures by denationalizing mostagricultural processing and a few industrial units, introducing a constitu-tional guarantee against nationalization, and widening areas open to privatesector activity. More recently, GOP has streamlined investment sanctioningprocedures and has granted a series of fiscal and credit incentives foriavestments and exports. GOP also has taken initial steps to liberalizeimports, in the context of a wider revision of its trade policies and regula-tions. Public sector involvement in industry has been reduced systematically(except in some key areas such as steel and fertilizers) and the managementpractices, productive efficiency, and financial performance of publicindustrial corporations are more closely monitored. These measures have beensupported by Bank Group sector work, the Structural Adjustment Loan, andindustrial development projects.

2.04 The Sixth Five-Year Plan assigns a prominent role to industry, withreal growth in industrial output expected to average 9% and the volume ofmanufactured exports 11% annually. The targeted sectors for higher growthand output are: engineering products, agro-processing industries, andagricultural inputs. Exports of manufactured goods will be promoted, withparticular emphasis on non-traditional, labor-intensive products. Investmentwill be encouraged through government measures on deregulation, rationaliza-tion of the incentive structure, and improvements in infrastructure. Con-tinued investor confidence is expected to result in increased industrialinvestments from 4.0% to 5.3% of GDP during the Plan period. In totalfigures, industrial investment for the five years is projected at Rs 83billion, of which Rs 62 billion is expected to be contributed by the privatesector.

2.05 GOP's plans for the industrial sector in the coming years sustainthe policies and strategy pursued since 1977: a premier role for the privatesec.or in investment and production; promotion of efficient import substitu-tion industries; and a rapid growth in exports of manufactured items. GOPplans to continue improvements in the efficiency of public enterprises and toprovide the infrastructural facilities and services required by both privateand public industrial enterprises. The success of the Plan, with respect toindustry, will depend largely on GOP's ability to continue to addressweaknesses in industrial policy, regulations, and procedures. The system ofincentives still favors import substitution rather than export-oriented

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enterprises. The tariff structure requires rationalization to provide a moreuniform degree of effective protection. Procedures for investment sanction-ing, imports, access to foreign exchange, incorporation, and pricing alsohamper the normal functioning of industries in various subsectors. It isexpected that GOP's initial measures to address these issues (para. 2.03)will be followed by additional steps in the same direction.

C. Financial Environment

2.06 Financial Sector. Pakistan's financial system consists of fivenationalized commercial banks, 18 foreign commercial banks, four specializedbanks, eight development finance institutions, several insurance companies, ahousing finance corporation, and two stock exchanges. The system is regu-lated and supported by the State Bank of Pakistan (SBP) which is thecountry's central bank. The activities of the nationalized commercial banksare coordinated by the Pakistan Banking Council (PBC), which also monitorstheir performance. The commercial banking sector is the most important partof the financial system, with total assets as of June 1983 of Rs 212 billion,or about 90% of the total assets of the system. Commercial banks are alsoimportant in terms of geographic coverage, with 7,000 branches throughout thecountry, and in terms of their varied financial services. Within commercialbanking, the five nationalized banks account for 89% of deposits, and 87% ofadvances (Annex 2). Although the established foreign banks are allowed toperform all banking functions and services, as a matter of policy, they haveconcentrated most of their activities in foreign trade financing.

2.07 Credit Allocation and Islamization. In recent years, the financialsector has expanded rapidly at an average annual rate of 16% in currentvalues. However, its long term development is constrained on the resourceside by the low level of domestic savings, which recently has been counter-balanced by the inflow of foreign remittances from Pakistani workers abroad.On the lending side, two important guvernment policies are influencing thedevelopment of the sector. The first is the use of commercial banks toprovide term financing to agriculture and industry through credit targetting.The second factor relates to GOP's stated policy of Islamization of theeconomy which, aside from some tax measures, aims principally at a reform ofthe financial system. The eventual objective is the abolition of "riba", orinterest, and its replacement by a system operating on the principle ofprofit and loss sharing (PLS). The specific changes that GOP has introducedin the system to date have been: (a) the introduction of PLS short termworking capital loans (Musharika); (b) authorization to issue participationterm certificates based on the PLS principle to replace debenture financing;(c) authorization to set up :4odaraba companies, which operate as investmentsfunds in accordance with Islamic tenets; and (d) conversion of the operationsof some non-bank financial institutions to a non-interest earning basis.

2.08 The move toward Islamization has blurred the immediate relevance oftwo important issues in the financial sector - interest rate levels andcentralized credit allocation. Since the process aims at replacing interestby profit and loss participation as a return to capital, GOP has decided, forthe moment, not to address directly the interest rate issue. However,indications are that, where Islamic financial instruments have been used,

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they have had a positive impact by making rates of return to capital moreresponsive to market conditions. At present, however, most of the financialsystem continues to operate on the basis of established rates of interest,leaving room for arguments in favor of partial and selective credit alloca-tion as a necessary instrument to meet the country's developmental objec-tives. These arguments would lose substance as rates of return on capitalare further liberalized, but so far Islamization is being implementedgradually and it is still too early to evaluate its full implications. Forthe present and foreseeable future the PLS concept and the interest ratepractice will co-exist within the system. In particular, GOP is committed tomaintain interest-based financing for operations involving foreign funding.As the process is extended and more experience is gained, closer analysis ofthe system may be required to evaluate whether substantial mcdifications havetaken place and whether it is necessary to adopt Bank Group financing tothese changes.

2.09 Interest Rates and Inflation. To date, all lending for SSI has beenmade on traditional interest-based arrangements. The interest rates cur-rently charged are 11% p.a. for term loans for fixed investments and 14% p.a.for short-term working capital loans which rates apply also to medium andlarge industries. These rates have been established by GOP through SBP.Foreign currency term loans for medium and large industries, which areprovided mainly by development finance institution and under the recentlyapproved Industrial Investment Credit are also at 11% p.a., with a 3% p.a.foreign exchange risk fee, payable to Government which carries the exchangerisk. Under the first SSI Credit, subloans carried an interest rate of 11%p.a. in line with the general term loan rate for industry. However, subbor-rowers were not required to pay the standard exchange risk fee of 3% p.a.,since the expectation was that most of the lending would be for rupee pur-chases as the foreign content of SSI in Pakistan is low. Experience underthe first SSI Credit has confirmed this assumption since only 10% of subloanswere used as foreign currency subloans for direct imports by subborrowers.Most subloans were applied to rupee expenditures for local equipment andlocally available imported equipment (55Z), factory buildings (20%) andpermanent working capital (15%). A similar pattern of expenditures isexpected under the proposed Credit. While strictly speaking, subborrowersshould pay an exchange fee for the portions of subloans used for directimports, it is administratively difficult to separate these costs for manysmall subloans. The proposed final lending rate under this Project is 11%p.a. without an exchange fee to which GOP has agreed. Given the inflation of6% in 1983 (para. 2.01) and against the rate of 10.5% in 1982, this raterepresents a positive return to capital. The average inflation rate for 1984may oe higher, as excernal resource flows in the latter part of 1983 con-tributed to monetary expansion which translated into higher prices in thefirst quarter of the year (11% on an annual basis). With GOP's proposedreduction in monetary expansion down to 13% from 26%, and no visible struc-tural inflationary pressures, it is likely that inflation in the medium termwill remain below 10% and that the proposed lending rate would remain posi-tive in real terms. To ensure that the lending rate under this Projectremain positive in real terms, a provision in the legal documents for regularreview and, as necessary, periodic adjustments of interest rates was agreedon during negotiations (para. 6.01).

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D. Small Scale Industries Sector

Characteristics and Performance

2.10 GOP traditionally has attached importance to the SSI sector. Alreadyin 1959, a committee was formed to examiae means to promote small industrialand agricultural activities and in the sixties, institutions were establishedto serve the needs of small enterprises. More recently, following theseparation of East Pakistan, Small Industries Corporations were formed at theprovincial level to channel government assistance to the sector. Aside fromthe obvious social objectives of these measures, considerations of industrialdevelopment also have been important in GOP support of SSI. Generally, smallfirms are less affected by economic variations, as they have greaterflexibility with respect to production schedules and employment of labor.Similarly, small investors are less vulnerable and sensitive to politicalchanges. Moreover, SSIs geaerate a good portion of their capital needs fromthe informal capital markets and require less infrastructural support than dolarger firms. These factors help explain why small scale industries con-tinued to grow during the difficult years of the seventies, while output fromlarger firms declined. Investments in small firms represented 20% to 30% oftotal industrial investments in the seventies vs. 10% to 14% in the sixties.In recent years, SSIs have constituted close to 4.7% of GDP, 27% ofindustrial value added, and 30% of manufactured exports. SSIs employ abouttwo million workers in about 80,000 establishments. 1/

2.11 The majority of SSIs are located in the proviaces of Punjab and Sind,with a smaller proportion in NWFP and Baluchistan. This geographic distribu-tion reflects population concentrations, availability of raw materials andinfrastructure, access to markets and local entrepreneurship. Traditionally,SS1 units concentrated on processing local raw materials, such as cotton andother agricultural products. More recently, expansion has been notable infood processing, engineering products and construction materials. Other keySSI activities focused on exports on the basis of adding value to importedraw material, and are characterized by carpets, sports goods, cutlery andsurgical instruments.

1/ An Asian Development Bank report, *"An Analytical Study on Small-ScaleIndustries in Pakistan", puts SSI's share of industrial value addedcloser to 40%. These figures, however, must be taken only as indicativeof trends and relative contributions, as only limited and not fullyreliable data on SSI are available in Pakistan. The most recent SSIcensus was conducted in the mid-seventies and was restricted to thePunjab. Since then, tile sector has expanded significantly and thedefinition of small industries has been revised recently. Some of thedata on the sector are based on the application of notional growth ratesto 1969-70 figures, which may well underestimate the size and contribu-tion of the sector, particularly in the case of value added and invest-ment. The recent growth in non-traditional exports, most of which havecome from the sector, must be the result of greater investment in SSIthan is reflected in the published figures.

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2.12 Efficiency. SSIs in Pakistan are more labor intensive and,generally, more efficient users of capital than large scale units; investmentcost per job is about US$1,800 compared with US$21,000 for a sample of largerprivate projects financed by the Pakistan Industrial Credit and InvestmentCorporation. The average capital-output ratio of SSIs was 0.8 compared tobetween 1.0 and 1.5 for large scale industries. SSIs also proved to be moreefficient producers of goods, especially for the rural markets, where qualityrequirements are less stringent. For example, small powerloom units werefound to produce grey cotton fabrics at a third of the production cost of themill sector; however, due to quality differences, the powerloom fabricfetched only 80% of the price of the mill cloth. Compared to selected EastAsian developing countries, 1/ SSIs in Pakistan are more labor intensive andmore efficient users of capital, but have the lowest labor productivity(Annex 3). These characteristics suggest that, compared to SSIs in theseAsian countries, Pakistan SSIs utilize less capital intensive traditionaltechnoLogy, with substantial room for appropriate modernization to improvelabor productivity without sacrificing their labor intensity and capitalproductivity.

2.13 Potential. Agro-industries, selected textile products and lightengineering are expected to continue to be growth areas in the medium term.In the recent past, agro-industries accounted for about 30% of SSI invest-ments. This subsector is expected to continue to be of major importance assustained expansion in farm output generates bigger agricultural surplusesfor processing. Substantial capacity increases are expected in rice andflour milling, oil extraction and ice and cold storage for the fishing,poultry and cash crop sectors. Also, project opportunities in the handling,storage and processing of fruits and vegetables for domestic and exportmarkets could be numerous. Growth in the powerloom sector, which accountedfor about 15% of past investments, is expected to continue in response toexpanding domestic demand for fabrics, particularly in catering to ruralrequirements. Initial estimates place the capacity requirements at about50,000 new looms at the cost of US$120 million for the Sixth Five-Year Planperiod. 2/ Investments in garment manufacturing for exports based on localcotton fabrics as well as imported blend fabrics are expected to increasesubstantially. Potential in light engineering, which accounted for about 20%of past investments, probably will continue to be mainly in engineeringworkshops, in response to maintenance requirements of agricultural equipment,faster urbanization, and industrialization. Another growth area, at least inthe short term, would be re-rolling mills, in connection with the fast grow-ing ship-breaking industry.

Policy Environment and Development Strategy

2.14 GOP's policies for industrial development do not differentiatebetween large and small industry. Rather than protecting or subsidizingsmall firms, the Government has maintained a strategy of increasing SSIs'

1/ Philippines, Thailand, Malaysia and Singapore.

2/ World Bank Report Nc. 4346-PAK, "Pakistan: Textile Industry Study",August 16, 1983.

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access to credit and technical services. SSIs are allowed to set up andoperate with little regulation, and market signals are the main determinantsof SSI investments and their viability. GOP's policy provides that all SSIsbe in the private sector. Subsectors with strong potential, high valueadded, and limited economies of scale are promoted-but not reserved-for SSIproduction. There is a push to develop SSIs in more remote urban and ruralareas, but this objective again is pursued by promotion and provision ofservices, rather than through subsidization. Thus, SSIs are allowed toprosper or decline with the market.

2.15 SSI Financing. With the introduction of the lending scheme underthe First SSI Project, GOP abolished the special credit scheme through theSICs. Now commercial banks have sole responsibility for SSI lendingactivity. To ensure SSI's access to credit, annual targets for loans to thesector, expressed as net increments to the amount of outstanding SSI loans,axe set by the State Bank of Pakistan based on GOP's Annual Development Planprojections for SSI investments and value-added growth. These are thendivided among the five banks on the basis of deposit size. Achievement oftarget levels is monitored monthly; the targets themselves are revised duringthe year in reaction to actual credit demand from SSI for investment andworking capital. Since these targets have been quite conservative in rela-tion to SSI needs, contributing about 40% of SSI requirements, they have notresulted in undue allocation to SSI. On the other hand, they do not repre-sent a constiaint since they can be exceeded, as they have been in recentyears. Since IDA funds were made available in FY82, the SBP targets havebeen increased accordingly. Total commercial bank SSI loans increased sub-stantially in the last two years, reflecting additionality of IDA funds(para. 2.20). Moreover, with the availability of long term resources fromIDA, fixed investment loans have increased. Also, IDA's first Project rein-forced the banks' capabilities in project-based term lending to SSIs.

2.16 Technical Assistance for SSI. The promotional and technical assis-tance activities in support of SSI are a provincial government respon-sibility, carried out by the Punjab Small Industries Corporation (PSIC), theSind Small Industries Corporation (SSIC), the Small Industries DevelopmentBoard (SIDB) of NWFP, and the Directorate for Small Industries (DSI) inBaluchistan. 1/ These organizations used to be area offices of the WestPakistan Small Industries Corporation, established in 1965 in Lahore anddivided along provincial lines in 1972. Consequently, their policies, out-look, organizational structure, and programs of assistance are similar,although PSIC is the best organized and has the largest technical staff.PSIC has directed most of its assistance to the organized small industrysector in the Lahore, Gujranwala, and Sialkot districts. The Punjab is thecenter for the manufacture of sports goods, cutlery, and surgical instrumentsand also has a large concentration of small manufacturers of other engineer-ing products. Annex 4 presents a profile of the four SICs.

2.17 To a large extent, the SICs have focused their assistance to thesector on providing physical facilities, developing industrial estates,

1/ The acronym SIC in this report refers to all of these agencies.

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building and equipping service centers, and establishing training and produc-tion centers for handicrafts. Insufficient attention has been given tobuilding effective programs to promote viable new enterprises and to provideextension services to existing firms. The first SSI Project encouraged theSICs to develop these services through subsector studies, project develop-ment, and practical export promotion componeats (para. 3.10). The SICs willneed to continue to build their capabilities in these and other "soft-ware"aspects of SSI promotion. The technical assistance components of SSI I1 aredesigned to assist them further in these areas.

Credit Demand (FY85 and FY86)

2.18 Past Investments in SSI. Investments in SSI grew from Rs 725 millionin FY79 to Rs 1,337 million in FY83, at an average annual rate of 17%. Whilethis rate was slightly slower than growth of investments in larger privateindustry, which averaged 23% p.a., SSI investment growth compares favorablywith total investments in large industry which stagnated due to contractionin iavestments in public enterprises.

Table 2.18: INDUSTRIAL INVESTMENTS(FY79-83)

SSI Private LSI Public LSI Total LSI Total

1979 725 1,755 6,659 8,414 9,1391980 819 2,591 6,593 9,184 10,0031981 1,069 3,291 4,836 8,127 9,1961982 1,221 3,596 4,684 8,280 9,5011983 1,337 3,877 4,579 8,456 9,793

2.19 The Sixth Five-Year Plan envisages Rs 9.4 billion of private sectorinvestment in the SSI sector. Compared to the actual growth of 17Z p.a, inthe last five-year plan period, this target, which implies an annual averagegrowth of 12%, appears conservative and attainable. This investment fipeis consistent with economy-wide growth objectives, SSI potential, anticipatedinflation, and current interest in SSI investment as reflected in creditdemand at the commercial bank level. Under the Plan, SSI investments wouldbe about Rs 1,500 million in FY85 and Rs 1,700 million in FY86.

2.20 SSI Loans. The growth trend in SSI investments is confirmed by thepattern of bank credit to SSI. Kost SSI financing is provided by the fivenationalized commercial banks. Commercial bank SSI loans grew from Rs 815million in FY79 to Rs 1,537 million in FY83 at an average rate of 22% p.a.and at substantially higher levels in the last two years. On the average,about 70% of SSI loans were for working capital and 30% for fixed invest-ments. Loans from the commercial banks accounted for about half of theworking capital requirements and about a third of fixed investments of SSI.For FY84, the State Bank of Pakistan target figures for net additionallending to SSIs total Rs 1.6 billion for investment and working capitalfinancing.

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Table 2.20: COMMERCIAL BANK SSI LOANS(Net Increase in Outstanding)

(FY79-83)

(Rs million)FY ABL HBL MCB NBP UBL Total

1979 71 339 132 32 241 8151980 53 265 109 314 154 8951981 60 335 134 152 127 8081982 118 596 165 257 331 14671983 83 499 98 234 623 1537

2.21 Subloan Pipeline. Recent levels of financing by the banking systemand their pipeline of projects suggest continuing strong credit demand bySSI. Since full commitment of the subloan component of SSI I in September1983, the five commercial banks have sanctioned 277 more subloans amountingto US$14.5 million. These, together with a pipeline of about US$20 million,provide the proposed Credit with a strong start-up (Annex 5). At the presentsubloan commitment rate of over Rs 35 million per month and factoring outexpected cancellations of about 15Z, the banks would have firm subloan com-mitments of about Rs 195 million by June 1984, which would require IDAfinancing of US$10 million at the proposed refinancing rate of 70%.

2.22 Taking the conservative Sixth Plan projections and using the pastfinancing pattern for SSI investments and working capital needs, the demandfor institutional credit by the sector for FY85 and FY86 would be aboutRs 1.1 billion for fixed investments and Rs 2 billion for working capital,assuming a conservative 7X real annual rate of growth in output. On thisbasis, if IDA were to finance 30% of the credit demand for fixed investmentsand 10% of that for working capital, a pattern which seems reasonable basedon the experience of the first Project, the requirement for IDA funds wouldbe about US$20 million per year.

Table 2.22: CREDIT DEMAND FOR FY85 AND FY86(Rs Million)

InstitutionalTotal Credit Demand IDA Share

Fixed Investments 3,200 1,100 (33% 330 (30%)Working Capital 4,000 2,000 (50%) 200 (10%)

Total 7,200 3,100 530

Sixth Five-Year Plan Objectives

2.23 Recognizing the importance and potential of the sector, the SixthFive-Year Plan envisages a continuing prominent role for small industry,notably in export growth in such subsectors as engineering andagro-processing. The Plan projects Rs 9.4 billion of direct private invest-ment in the small scale sector during the five-year period, which isprojected to result in 350,000 new jobs, 7.3% real annual growth in output,

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and 15% p.a. growth in export volume. To attain these objectives, the Planplaces great emphasis on (a) the expansion of agro-processing, to add valueto exportable surpluses, (b) the forward integration of the textile industryto produce high value articles for export, such as ready-made garments andspeciality cloth, and (c) the adoption of subcontracting arrangements withSSI units by the large engineering manufacturers. There is already somesuccess in these areas as evidenced by increasing export volumes of processedagricultural products and made-up textile products. However, much more needsto be done to develop projects along these lines, especially in the area ofsubcontracting. A study on subcontracting will be undertaken under theproposed Project to identify incentives and technical assistance needed toincrease subcontracting between large and small firms. Overall, the SSIsector encounters problems in production methods, labor skills, managementcapacity, technology modernization, product quality, and effective marketing.Increased technical assistance and extension service efforts will have to bemade by SICs and closer attention paid by the banks to investor identifica-tion and project preparation. The proposed Project is designed to assist thebanks and the SICs in responding adequately to these requirements.

III. THE PROJECT

A. Objectives and Scope

3.01 The objective of the proposed Project is to increase SSIs' contribu-tion to industrial employment, exports and output by providing expandedfinancial and technical services, utilizing institutional arrangements andbuilding on assistance programs developed under the first Project. Thegeographic scope would be nation-wide, as in the first Credit. The secondProject includes technical assistance, especially in project promotion, forBaluchistan and NWFP, to help increase their share of SSI investments andcredit. All SSI subsectors would be eligible for financing on the basis ofestablished subproject eligibility and viability criteria. For selectedpromising subsectors, particularly in new areas of investments and forBaluchistan and NWFP, project development would be accelerated through theformulation of project profiles. Major subsectors demanding credit wouldcontinue to be agro-industries, light engineering, textile products. Subsec-tor studies to be completed under the first Project would be used in promot-ing investments in new areas such as in more advanced agro-processing andengineering activities and new manufactured exports. The proposed Projectwould serve all SSIs as defined by GOP, i.e., units with fixed assets exclud-ing land and buildings of not more than Rs 5 million (US$370,000); however,the majority of units probably would be much smaller, with fixed assetsexcluding land and buildings below US$70,000. Assistance would promotemodernization of SSIs to improve productivity and growth of efficient smallscale production. Technical assistance would be provided to improve technol-ogy through programs for technical information disseminatiou, project iden-tification and preparation and management training.

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3.02 Components. The major components of the project would be:

(i) term loans to SSIs for fixed investments and permanent workingcapital through the five commercial banks, with review and partialrefinance by the Industrial Development Bank of Pakistan andcoordination by the Pakistan Banking Council;

(ii) training for the commercial banks to improve the quality of theirSSI loan officers, increase delegation of the appraisal functionoutside of headquarters and build systems for end-use andproject supervision;

(iii) assistance to Baluchistan and NWFP in project promotion;

(iv) a training program to improve SSI management performance;

(v) assistance to subborrowers in project preparation; and

(vi) a study on subcontracting to identify measures for expandingsubcontracting linkages between large and small industries.

B. Project Costs and Financing Plan

3.03 Costs of the proposed Project are estimated to total about US$120million, of which IDA would finance US$50 million equivalent (SDR 47 million)or about 40Z. IDA financing would cover 70% of subloan amounts while thecommercial banks would provide the other 30%, up from the 20% provided bycommercial banks in the first Credit (para. 3.09); sponsors would contribute,on the average, 40% of subproject cost. Thus, IDA's share in financing asubproject would decline from about 50% in SSI I to about 40%, resulting inan increase in domestic resource mobilization, consistent with country objec-tives. For the technical assistance components, IDA financing would covercapital costs, training and consultancy amounting to about US$2 million; GOP,the SICs and the banks would fund local administrative and staff costestimated at US$1.3 million. The components, cost estimates and financingsources are summarized below: 1/

1/ Detailed cost estimates can be found in Annex 6.

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Commercial SubprojectIDA Banks Sponsors GOP/SIC Total

(in US$ million)

A. Lending Component 48.00 21.00 47.00 -- 116.00

B. Technical AssistanceComponents1. Training for

Commercial Banks 0.15 0.15 - - 0.30

2. Baluchistan - DSI 0.38 -- - 0.23 0.613. NWFP - SIDB 0.15 -- - 0.12 0.27

4. M{anagement TrainingProgram for SSIs 0.74 0.39 - 0.39 1.52

5. Subproject Prepara-tion 0.20 - - - 0.20

6. Subcontracting Study 0.05 - - 0.057. Contingencies 0.33 - - - 0.33Subtotal 2.00 0.54 - 0.74 3.28

GRAND TOTAL 50.00 21.54 47.00 0.74 119.28

C. Lending Component

Role of Commercial Banks in SSI Financing

3.04 The five commercial baaks have been heavily involved in financingSSIs, particularly for their seasonal working capital needs. SSI financingby the commercial banks reached Rs 1.5 billion in FY83 of which about 70Z wasfor working capital finance, accounting for about half of the working capitalrequirements of the sector. While commercial banks traditionally have focasedon short term requirements, fixed asset financing has increased recently,with the availability of long term funds under the first SSI Project. Fixed

investment loans were about Rs 450 million accounting for about a third oftotal fixed investments in SSIs in FY83.

3.05 The lending component of SSI II aims to enhance the commercial banks'role in SSI financing. As in SSI I, the objective would be to improve SSI

lending by: improving subproject selection through sharpened appraisals;increasing investment lending by providing matching long-term resources; and

improving SSI lending policies, systems aad procedures, by complementing the

commercial banks' strengths in credit analysis and geographic coverage withproject-based lending methodology.

Participating Institutions

3.06 The five commercial banks would continue to be responsible for

appraisal, supervision, and collection of subloans under the proposed Projectand would continue to bear the credit risks. Under Credit 1113-PAK, thesebanks have demonstrated capabilities for selecting sponsors, and for apprais-ing and implementing SSI subprojects. At the headquarters of all banks,

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Small Industry Departments (SID) were established to undertake projectappraisal, and about 400 key branches were designated to process IDA subloanapplications by undertaking credit analysis, forwarding applications to theSIDs for appraisal, disbursing approved subloans, and maintaining subloanaccounts. Under the proposed Project, appraisal will be decentralized tocircle offices 1/ where smaller SIDs staffed with a credit/financial analystand an engineer/technical person are already being organized. The 400 desig-nated branches will continue to undertake the same functions as under thefirst Credit. However, as subloans under the first Credit start to mature,special attention will be placed on organizing the systems for end-use andproject supervision and completion, and on appropriate training for thebranch stafi concerned. A training program on project appraisal for CircleSID officers and on end-use and project supervision for staff of L.signatedbranches was prepared by PBC and IDBP, in consultation with the participatingcommercial banks, and discussed during negotiations. Details of the trainingprogram as well as adequate staffing patterns were agreed on at negotiations.

Refinance and Monitoring Agencies

3.07 The Small Industry Refinance Department (SIRD) of IDBP, which hasfunctioned effectively in subproject review, refinance, coordination andmonitoring under SSI I, will continue to undertake the same functions underSSI II. In addition, it will develop project profiles based on subprojectsalready approved, which profiles would be used in reviewing future sub-projects in the same subsector as well as in monitoring overall subsectorperformance and problems. SSI I has proved that using the commercial banksas the "retailers" and a development bank as the "apex" has resulted in agood blending of commercial and development banking, with the commercialbanks providing geographic coverage and good credit analysis and the develop-ment bank providing orientation in project-based lending. As the SIRD isalready fully organized functionally, an appropriate increase in staff is allthat is required under SSI II. Based on discussions during the appraisalmission, SIRD would need to recruit four professionals, one for the sub-project review and monitoring section, two for the finance and disbursementsection, and the fourth for the research and training section, withappropriate supporting staff. The expansion of the finance and disbursementsection would allow increased attention to the end-use function, especiallyex-post review of commercial bank disbursement and procurement documentation(paras. 4.07-4.08). SIRD's strategy, policies and procedures, work programand staffing pattern were discussed and confirmed during negotiations(Annex 7). PBC will assist in coordinating training and reporting, andmonitoring the performance of the commercial banks; these are functions whichPBC has performed not only under the first Project but also for the generaloperations of the commercial banks.

1/ The five commercial banks have more than 7,000 branches. Branches aregrouped for administrative purposes under zonal offices and, in turn,zonal offices under circle offices. There are 45 circle offices outsideKarachi.

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Subproject Eligibility Criteria

3.08 The proposed Project would continue to use eligibility criteria as ameans for improving subproject selection. Experience under SSI I has shownthat appropriate eligibility criteria can serve as a good proxy for economicappraisal for small subprojects (free limit) for which detailed economicanalysis would be impractical. For subloans above the free limit, the com-mercial banks would be required to calculate domestic resource cost (DRC) asa measurement of economic viability. 1/ Criteria under the first Projectwill be utilized with some modifications. The National Credit ConsultativeCouncil has revised the definition of small industry from Ks 3 million toRs 5 million in fixed assets excluding land and buildings. This definitionis now the one accepted by the financial sector, the Provincial Governments,the Federal Government, and will be used in SSI II. Future adjustments byGOP in the definition of SSI will not automatically change the definition ofSSI under this Project but will be considered by IDA. To avoid promotingartificial smallness, the definition would be considered on a before-the-loaninstead of after-the-loan basis so that, under this Project, a small firm canuse the loan to graduate to a larger scale. However, a subloan would belimited to a maximum of Rs 5 million to keep the leading principally for SSIas defined. The fixed cost per job criterion would be increased fromRs 60,000 to Rs 100,000 to accommodate subloans for balancing and modern-ization, which may have low employment generation potential but are importantin improving productivity and assuring permanent workplaces. Moreover, sincemost SSIs in Pakistan are labor-intensive (para. 2.12), this criterion wouldbe used as a flexible guideline, reflected in the strategy statements of thebanks rather than as a requirement in the legal documents. The free limitwould be increased from Rs 800,000 to Rs 1.5 million in recognition ofappraisal quality demonstrated under the first Credit, and to align with thecommercial banks' internal "free-limit" structure. Based on experience underSSI I, the other on-lending terms are considered adequate and are proposed toremain the same:

(i) subloans would be for the establishment of new units or forbalancing, modernization, replacement or expansion (BMRE)of existing ones in the manufacturing sector, includingindustrial services and agro-industries;

(ii) working capital financing would be allowed only as a part of afixed investment subloan, for permanent working capital needs;

(iii) a minimum of 30% of subproject costs would be provided by thesponsor in the form of equity; and

(iv) at least 50% of the credit would be allocated to subloans of lessthan Rs 1,500,000.

I/ Participating bank loan officers would compare a subproject's DRC withthe official exchange rate and get an indication of its economicviability.

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Subloan Terms and Conditions

3.09 Sublending terms and conditions would be similar to those underSSI I, with IDBP receiving a 1.5% fee, the commercial banks a 5.25% spreadfor free-limit and a 4% spread for above free-limit subloans, and a finallending rate of 11%, which is the current rate for term loans to industry,regardless of size (para. 2.09). Under SSI II, the proportion of subloanamounts financed by the commercial banks would be increased from 20% to 30%,to spread IDA funds to more subprojects and increase local resource mobi-lization. IDA's contribution would be roughly equivalent to the foreignexchange requirements of the whole SSI subsector. Subloans would be appliedto finance plant and equipment, factory buildings and permanent workingcapital. However, for factory buildings, only a maximum of 15% of a subloancan be applied in order to discourage over-investment in buildings. IDAfunds may not be used to finance land. Subloan maturities would be at least3 years and up to a maximum of 10 years, with a grace period of up to 24months, as in SSI I. As in the first Project, lending targets by provincewould not be resorted to since lack of infrastructure, skills and rawmaterials, and other disadvantages will continue to constrain SSI lending inthe less developed provinces. However, the strategy statements of the par-ticipating banks would include notional targets for lending outsid- thePunjab in order to signal to the branch officers the need for greater promo-tional efforts in the other provinces.

D. Technical Assistance Components

Technical Assistance Program for SSI

3.10 Promotion and extension services for SSI are the responsibility ofthe SICs (para. 2.16). A basic shortcoming of the past SIC approach wasinsufficient interaction with the private sector with SIC activities tendingto run parallel to the private sector and become commercial rather thanpromotional activities. Under SSI I, the technical assistance componentswere designed to avoid this problem. The service centers were structured tohave strong management input from the private sector through the creaticn ofmanagement committees in which the officers of relevant private sectorassociations were represented. This has proved to be a useful experiraent sothat the practice has been extended by the PSIC to all its service centers.Emphasis was placed on using the service centers as a tool for developing anassistance program for the private sector rather than for commercial produc-tion. The primary target group for the service centers was defined andtechnical assistance needs identified beforehand to ensure relevance. Theproject and export promotion components and the general project preparationfund of SSI I also were designed to benefit the private sector. While theseprograms under SSI I have not been completed (para. 1.03), preparation fortheir implementation has resulted in increased interaction between theprivate sector and the SICs and has helped in reorienting the latter's out-look. Under the project preparation fund, the SICs have assisted 630 privatesector loan applicants prepare their project proposals for presentation tothe commercial banks. Under the export promotion program, the SSIC and theExport Promotion Bureau have identified about 100 private firms as par-ticipants and have started working with them in preparation for the planned

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marketing activities. Under the project promotion program in Baluchistan,DSI has identified several private entrepreneurs as potential project spon-sors, matching them with the opportunities identified.

3.11 Characteristics of SSI II Components. The technical assistancecomponents of SSI II are designed to continue re-orienting the SIC programstoward private sector assistance and to support elements of SIC programs inwhich SICs appear to have comparative advantage. The proposed components arefocused on easier rather than more involved aspects of SSI technical assis-tance strategy in which the SICs have greater chances of becoming effective;these are investment and project promotion, technology information dissemina-tion, project preparation and management training.

3.12 These components would follow through on activities initiated underSSI I, to ensure effective dissemination of services. Capabilities to imple-ment the investment promotion program undertaken by the Investment AdvisoryCenter of Pakistan (IACP) for DSI under SSI I will be built within DSI, underSSI II, to ensure continuity of this important program for Baluchistan. Asimilar capability will be built within the Small Industries DevelopmentBoard of NWFP, which is the other less developed province. The subprojectpreparation fund by which the SICs assisted more than 600 subborrowers underSSI I will be continued under SSI II. Finally, the TA components of SSI IIare software-oriented and would require less time to become operational thanthe hardware components of SSI I. During negotiations, agreement was reachedon a timetable for implementation of the various technical assistance com-ponents (Annex 8). The proposed components are expected to cost GOP, theSICs and the banks about US$1.3 million in staff and administrative costsfo: a three-year period. IDA would finance about US$1.85 million for equip-ment costs, consultancy services and training.

Investment Promotion and Project Development for Baluchistan

3.13 Baluchistan is the least developed province and accounts for only 1Zof the total number of SSI units in the country. The development constraintsof the province are numerous and would take large amounts of human and physi-cal capital to resolve over the long term. However, even within the currentsituation, there are SSI project opportunities whicn can be exploited throughan effective promotional program which would bring together the immediateelements needed for project development, i.e., the right entrepreneur for theright project and financing under the SSI lending scheme. With thishypothesis, an integrated promotional scheme was launched under SSI I toidentify immediate project possibilities, in the context of existing con-straints, identify prospective sponsors, and assist in project developmentand implementation. The Government of Baluchistan employed IACP to undertakethis program since the DSI was not adequately staffed for this purpose.Under this program, IACP has identified 50 project possibilities and ispreparing 10 project feasibility studies. It also has identified 35 poten-tial entrepreneurs and investors to match with these projects. Since thisprogram appears to have a good chance of success in generating projects, theGovernment of Baluchistan wants to continue with it for the remaining 40project opportunities identified and sustain the promotional effort by build-ing capability for this function within the DSI itself. During the fieldstudies conducted by IACP, six DSI officers were attached with various IACP

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teams for training. They would form the core of a unit in DSI which willcarry on the promotional program on a permanent basis.

3.14 Under the same program, a study of the existing marketing system inthe province would be conducted. A serious constraint to successful projectimplementation in Baluchistan is effective marketing of processed or manufac-tured products, which is highlighted by the province's relative isolation asa result of a poor infrastructural base. This isolation, in turn, probablyleads to trading patterns (within and outside the province) which may be morecomplex than if markets were more accessible. Consequently, increased costsare incurred, greater margins are applied to cover risks, and additionalstorage and transport facilities are required. All these factors, theireffects, and related costs need to be analyzed, particularly for those sec-tors in which opportunities already have been identified, with a view toguide actions by the Provincial Government to promote SSI and generalindustrialization. Aside from defining marketing problems, this study alsowould identify opportunities for private marketing and service organizationsto help overcome logistical barriers.

3.15 Proposed Assistance and Estimated Cost. The cost of these componentsfor Baluchistan is estimated to be US$0.61 million for three years. Localstaff and administration costs of about US$0.23 million would be met by DSI.IDA would finance the cost of office equipment of US$0.06 million, consult-ancy services of US$0.25 million, staff training of US$0.02 million for theinvestment promotion scheme and US$0.05 million of consultancy services forthe marketing study, totaling US$0.38 million.

Project Identification and Development for NWFP

3.16 The North West Frontier Province is the second least developed ofthe four provinces of Pakistan. It accounts for only 7% of the total numberof SSI units in the country. The province, however, has adequate infrastruc-ture and local resources to be able to attract more investments in the SSIsector. However, based on past patterns, there might be a need to attractentrepreneurs and skilled workers from the Punjab to accelerate exploitationof project opportunities. The Province's Small Industry Development Boardhas requested IDA assistance in setting up a unit similar to the one for DSI,which will undertake sectoral opportunity studies, identify potentialprojects in different areas of the province, prepare project profiles,promote investments and attract entrepreneurs in and out of the province toinvest in these projects. Since SIDB is stronger than DSI, it is felt thatthe capability for project development and promotion could be built withinSIDI from the outset to enable it to continue with these activities beyondthe proposed three-year project period. Already there is a core group inSIDB which could be expanded to undertake this function.

3.17 Proposed Assistance and Expected Cost. The total component cost isestimated to be US$0.27 million for three years. Local staff and administra-tion costs would be approximately US$0.12 million. It was understood thatSIDB had already an approved budget equivalent to the amount required for thefirst year. IDA would finance the equipment cost estimated at US$0.04 mil-lion and foreign and local consultants at US$0.11 million, totaling US$0.15million.

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Management Trainiag Program for SSI

3.18 Discussions with entrepreneurs, agencies concerned with SSI develop-ment, as well as knowledgeable individuals in industry and the academicfield, indicate the need for management training for SSIs. Some ad hoctraining does exist on specific technical skills, such as those undertaken bythe SICs, but there is no organized effort in providing managerial training.There are successful models in Asian countries of institutions providingmanagement training where various short-term training courses and seminars instandard packages are regularly conducted on a fee-paying basis. Typically,SSI operators are people who have not had any formal training in management.Short packaged courses on production planning and control, marketing manage-ment, accounting, etc., conducted in a format and at a level suitable forSSIs have been found to assist in improving managerial performance of SSIs,resulting in some gains in productivity.

3.19 Alternatives have been explored in locating such an institutionwithin an existing federal or provincial agency, or an existing trainingorganization or university. The most feasible alternative appears to be thesetting up of a new but small institute, with modest core staffing, anddrawing on part-time expertise and resources from various sectors (SICs,banks, entrepreneurs, and academics) and effectively linked with SICs whichare directly in contact with the potential clientele and could provide thedelivery network. The institute would be attached to the Federal Ministry ofIndustries. It will be governed by a board consisting of representativesfrom the Federal Ministry of Industries, the SICs, the PBC, IDBP and theacademic and business sectors. A training council will be organized at theoperating level, which will determine the types of training programs offeredin various locations. The courses offered, possibly from a few days to a fewweeks, will be "mobile" and conducted in areas (nation-wide) where SSIs areconcentrated. The SIC. could provide the training venues. A core staffconsisting of a head and five training specialists, with the appropriatesupport staff, will be based in Lahore in the Punjab province whereapproximately 55X of small industries are situated. They will be primarilyinvolved in course design, identifying suitable resource persons, developmentof training materials, and course scheduling. Recruitment of the traininginstitute's director and at least one training speciaist would have to becompleted before funds for this component would be disbursed. This wasagreed on at negotiations.

3.20 Proposed Assistance and Estimated Costs. The expected operatingcosts for a core staff and administrative expenses amount to approximatelyUS$0.40 million for three years; the cost of part-time resource persens areexpected to be covered by fees initially charged; the cost of a trainingadvisor for 24 months would be US$0.24 million; training and office equip-ment, US$0.08 million; a study tour to similar institutions abroad by its keystaff, US$0.02 million; totaling US$0.74 million. IDA would finance thetotal cost of operations for the first three years. To ensure the continuityof the institute beyond the Project, an endowment fund of about Rs 10 millionis proposed to be contributed by the Provincial Governments, the FederalMinistry of Industries, the five commercial banks and IDBP. Earnings from

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this fund would support the institute beyond the three-year period. Disbur-sement of 50Z of the endowment fund of Rs 10 million would have to be com-pleted before funds for this component would be disbursed. This was con-firmed at negotiations.

Subproject Preparation Fund

3.21 While che participating commd.-rcial banks will continue to have soleresponsibility for receiving subloan applications, subproject appraisal andcredit checking, experience under SSI I shows that some prospectivesub-borrowers, especially newer and smaller entrepreneurs, have difficulty inpreparing their project proposals in a form required by the banks forappraisal purposes. For new projects, there were problems in market researchand analysis and preparation of financial projections. For existingprojects, a major problem area sas reconstructing operating performance frominadequate records. To assist subborrowers in these respects, a subprojectpreparation fund was established under SSI I by which the Small IndustriesCorporations could be funded to undertake this function. To date, more thaa600 subborrowers have been assisted by this fund. Funding for subprojectpreparation will be continued under SSI II.

3.22 Institutional Arrangements and Cost. The procedures and schedule offees established under SSI I will remain. On request by a subborrower or abanker, an SIC would undertake project preparation. An SIC would be paid outof the fund only upon completion of the subproject study and its acceptanceby a bank. At that time, the SIC can claim 10 of the fee. The other 90% ofthe fee is paid only upon approval of the subproject and the subloan by thebank. The subproject preparation fund would continue to be administered byIDBP's Small Industries Refinance Department. Application for IDA withdrawalwill be made by IDBP with the SIC concerned as the designated payee. TheSICs will receive these funds at IDA terms. An amount of US$0.2 million orabout 0.5% of the subloan component will be allocated for this purpose.

Subcontracting Study

3.23 In response to the desire of the Government, as reflected in theSixth Plan, to develop subcontracting between large and small industries, IDAwould finance a study on subcontracting in the engineering sector, with PBCas implementing agency. The study would analyze existing incentives whichmicigate against subcontracting by public enterprise to domestic SSI sup-pliers; propose an incentive system to promote subcontracting; identifyprocesses and components which could be easily subcontracted in the shortterm; recommend measures to strengthen capabilities of large industries toprovide technical assistance to small industries; and survey the top 100 SSIengineering firms to assess their capabilities for subcontracting. The studyis expected to cost US$0.05 million.

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IV. THE CREDIT

A. Terms and Conditions

4.01 Leuding Component. The proposed IDA Credit of US$50 million equiv-alent (SDK 47 million) would be made to the Government of Pakistan on stand-ard terms. Under the proposed Credit, the subloan component of US$48 millionequivalent would be onlent to the Industrial Development Bank of Pakistan bymeans of a subsidiary loan agreement between GOP and IDBP. Signing of thesubsidiary loan agreement by GOP and IDBP would be a condition of Crediteffectiveness. IDBP, in turn, would onlend this amount to the five commer-cial banks through participation agreements betweea IDBP and the banks.Signing of participation agreements by at least two banks and approval andissue by these participatiag banks of a circular governing operating policiesand procedures, eligibility criteria, and sublending terms and conditions>would be conditions of effectiveness of the Credit (para 6.03). Drafts ofthe subsidiary loan agreement, the participation agreements and the proposedcircular of the participating banks were discussed and agreed to duringnegotiations.

4.02 Technical Assistance Components. The US$1.06 million of technicalassistance for the SICs would be passed on to the respective SICs at IDAterms. The US$740,000 for the management training program component and theUS$50,000 for the subcontracting study would be disbursed to the proposedtraining institute and the PBC, respectively, as a grant from GOP, since bothare federal agencies. As in SSI I, the US$150,000 for training for thecommercial banks will be onlent to the commercial banks at 6.5% p.a. withoutthe 1.5% IDBP fee. Approval by relevant authorities of the PC 1 documents 1/for each of the SIC components would have to be completed before disburse-ments against the respective components can be made. For the proposed train-ing institute, approval by a relevant authority of its charter would berequired before funds for it may be disbursed. These were confirmed atnegotiations.

4.03 Relending Terms. For the subloans, the final lending rate would be11% (para. 3.09). As in SSI I, to provide sufficient incentive to the com-mercial banks to lend to smaller subprojects and to compensate for higheradministrative costs and risks of SSI lending, the commercial banks wouldreceive an interest spread of 5.25X for free-limit subloans and 4% for sub-loans above the free-limit. IDBP, as the refinance agent, would receive thesame fee of 1.5% to cover administrative costs and the financial cost ofbridge-financing. The overall interest spread structure is shown below:

1/ Approval of the Planning Commission Form No. 1 (PC 1) is the basis forbudget allocation in Pakistan.

-23-

Free-limit Above Free-limitSubloans Subloans

z X

1. Lending Rate to Subborrower 11.00 11.002. Spread to Commercial Banks 5.25 4.003. Spread to IDBP 1.50 1.504. GOP Spread 3.50 4.755. IDA Rate 0.75 0.75

Commitment charges would be waived by GOP since the Credit involves manysubprojects and five participating institutions. However, commercial bankscould charge commitment fees to their subborrowers accordiag to their normalpractice.

4.04 Repayment Terms. Since the maximum allowable maturity of subloans is10 years (para. 3.09) the commercial banks would repay IDBP on a fixed amor-tization schedule nf 12 years inclusive of a grace period of five years;banks would be allowed to use recycled funds arising from shorter subloanmaturities only for lending to SSIs which meet the eligibility criteria.IDBP's amortization schedule to GOP would coincide with the banks' repaymentschedule to IDBP since IDBP's liabilities under the Credit would be contin-gent on repayment bv the commercial banks.

4.05 Exchange Risk. As in other recent IDA/IBRD credits/loans, GOP wouldcarry the exchange risk. However, subborrowers would not be required to paythe exchange risk fee. Experience under SSI I shows that only a small por-tion of subloan amounts was used as foreign currency subloans for directimports while most of the subloan amounts were used for local purchases ofdomestic or foreign goods (para. 2.09).

B. Administrative Procedures

4.06 Refinance Arrangements and Revolving Fund. All subloans which areapproved by the commercial banks and subsequently authorized by IDA areeligible for refinance for up to 70% of subloan amounts (para. 3.09). Acommercial bank can claim refinance against subloan disbursements from IDBPon a periodic (e.g. monthly) basis by furnishing IDBP a certification thatdisbursements have been made and required procurement procedures have beenfollowed. Each bank would keep, in a case-by-case file, documents evidencingdisbursements and procurement of goods. These files will be opened toinspection by IDA and IDBP review missions. Under the first Credit, IDBP hada credit line of Rs 10 million from the State Bank of Pakistan which servedas a revolving fund from which refinance was made to the participating Banks.The SBP credit line will be increased to Rs 50 million to accommodateexpected refinancing needs under the proposed Project. IDA will advance US$2million from the proposed credit to augment this fund once the Credit isdeclared effective. IDBP will refinance the participating banks using thesefunds. After refinance, it will, in turn, seek reimbursement from IDA on aperiodic basis, proceeds from which will be used to replenish the revolvingfund. Increase in the SBP line of credit from Rs 10 million to Rs 50 millionwas discussed and confirmed at negotiations.

-24-

4.07 Procurement. Goods and services costing US$20,000 equivalent or moreper item or US$50,000 equivalent or more per contract shall be procuredthrough international shopping (limited international tendering) on the basisof at least three competitive quotations; for contracts of goods and serviceswith single items costing less than US$20,000 or combined items costing lessthan US$50,000 equivalent, the participating bank would ensure and certifythat these are reasonably priced and are suitable to the requirements ofsubprojects. Under existing procedures, the banks require their clients toobtain three competitive quotations for fixed investment loans. For sub-loans, under the proposed Project, the banks would be required to maintainrecords of the method of procurement, summarizing offers and awards persubproject. IDBP would periodically review these records which are kept incommercial bank branches. Based on IDBP reports on these reviews, IDA super-vision missions would examine some records on a sampling basis.

4.08 Disbursements. In view of the large number of subprojects and thesmall size of subloans, the normal DFC procedure of disbursing against expen-ditures of individual subprojects would be inappropriate. Thus, all disbur-sements for foreign or local expenditures made by the commercial banks willbe financed equally at 70% of subloan amounts. Disbursements would berefinanced against certified statement of expenditures for which appropriatedocumentation would be retained by the commercial banks and made availablefor IDBP/IDA supervision missions. IDA's reimbursement would be limited toexpenditures made by a subborrower not more than 180 days prior to IDA'sreceipt of IDBP's request for reimbursement, except for those expendituresallowed to be retroactively financed (para. 4.11). For the technical assis-tance components, IDA would disburse 1OOX of expenditures for consultants andtraining; for CIF cost of imported equipment and supplies; and for theex-factory cost of local equipment and supplies. For imported equipment andsupplies which are purchased locally, IDA would disburse only 75%, giving a25Z average allowance for taxes and duties. For the training institute, IDAfunds will meet 100% of all expenditures for the first three years of opera-tion, up to a maximum of US$740,000. Withdrawal applications will be sub-mitted to IDA by the implementing agency concerned. Disbursement of thetraining funds for the commercial banks would be for 100% of foreign costsand will be channeled through IDBP. The Credit is expected to be committedin three years and disbursed in six years from Board date (Annex 9). This isshorter than the regional subsector disbursement profile of ten years and theBank-wide subsector profile of eight years. However, these projections arebased on experience under SSI I which, after only three years, is already 60%disbursed. 1/

4.09 Reporting, Accounts and Audits. The participating banks would submitsemi-annual progress reports on commitments, disbursements, collections andarrears under the project to IDBP. IDBP will consolidate the report fortransmittal to IDA. In addition, the banks would maintain proper accountsfor subloans including supporting disbursement and procurement documents,which would be audited annually, according to current practice. After fulldisbursement of a subloan, a participating bank will prepare a subproject

1/ It is 80% disbursed at the participating commercial bank level (para1.02).

-25-

completion report, comparing actual vs. projected costs and benefits of thesubproject. IDBP would consolidate these reports and include them in itssemi-annual report to IDA.

4.10 The technical assistance implementing agencies would prepare andsubmit semi-annual progress reports direct to IDA. Accounts specific to thecomponents would be maintained separately and would be audited annuallyaccording to curreat practice. Audit reports should be submitted to IDA nolater than six months after the close of the fiscal year.

4.11 Retroactive Financing. Despite full commitment of Credit 1113-PAK,it was agreed with the commercial banks, IDBP and PBC that subloan sanction-ing should continue in order not to disrupt the momentum generated under thefirst Project. Accordingly, the commercial banks continued processing sub-loans, subject to availability of funds, and by February 29, 1984, had sanc-tioned 277 subloans amounting to US$14.5 million. To ensure that investmentsin these subprojects are realized, it is recommended that retroactive financ-ing be allowed to meet 70Z of the disbursements related to these subloans.These disbursements are expected to amount to about US$7 million at theexpected signing date. It was agreed at negotiations that retroactivefinancing will be allowed up to a maximum of US$5,000,000 equivalent or 10%of the Credit.

V. BENEFITS AND RISKS

Benefits

5.01 The SSI sector has been an important segment of the Pakistan economyand is expected to continue to play a major role in the development effortunder the Sixth Five-Year Plan. The proposed Project would dovetail withGOP's strategy for the sector of making investment and working capital creditmore readily available to small industries, and of providing them complemen-tary support through effective technical services. The IDA credit would filla significant portion of the resource gap for SSI lending, especially forfixed investments, complementing the short-term resources of the commercialbanks available for 'orking capital lending. Application of project-basedlending methodology by the commercial banks is expected to improve projectselection to ensure not only financial, but also economic viability, ofsubprojects. It is anticipated that about 1450 subprojects would befinanced, resulting in an investment of about US$115 million. Differentialspreads according to the size of the subloan would continue to induce thebanks to give increased attention to smaller subborrowers. As in SSI I, itis expected that about 85% of the subloan amounts would be for lo-ans of belowRs 1.5 million. Direct employment generated is projected to be about 35,000full time jobs, with fixed cost per job averaging about US$3,500. With thegreater participation of the commercial banks in financing individual sub-projects (para. 3.09), domestic resources mobilized for SSI lending would beincreased and gradual reduction of IDA participation would be signalled inadvance.

5.02 The proposed project continues to hava strong institution buildingaspects. The lending component of the Project szould have important effectsin strengthening tne credit delivery system for SSIs through the commercialbanks network of branches. Capability for project appraisal and supervision

-26-

will continue to be improved not only at bank headquarters, but in 45 circleoffices and 400 branches. The technical assistance components will build oathe existing structure of the SICs enhancing their comparative institutionalstrengths and increasing their interaction with, and relevance to, theprivate sector. Overall, the complementary but distinct roles of SSI lendingby the commercial banks and technical assistance by the SICs would be moreclearly delineated and operationally effected under the Project.

5.03 Increased attention given to the less developed areas of Baluchistanand NWFP through more intensive project promotion activities would assist inachieving GOP's objective of more balanced development without resorting todistorting measures of allocation or subsidization. The technology informa-tion and extension services components are expected to have a significantimpact in modernizing SSI technology and improving productivity. Managementpractices in small industrial enterprises are to be upgraded through themanagement training program for SSIs.

Risks

5.04 As is generally the case for industry, the SSI sector may see itsperformance affected by present infrastructural deficiencies, which candiscourage investment, affect production, or reduce marketing efficiency.The still limited capabilities of the SICs in terms of adequately qualifiedstaff and logistical support may also make it difficult to extend projectbenefits as widely and deeply as desired. The Project itself, through train-ing and consultancy services, will continue to build the SIC's to become moreeffective channels for promotion and extension services.

5.05 Inasmuch as the small industry sector is exclusively a privateactivity, investment in the sector and the performance of individualenterprises is subject to effects from overall economic aad political condi-tions. Should these suffer important changes or adverse developments, thesector will naturally be affected, although to a lesser extent than largeindustries which require greater investments and have greater visibility.

VI. RECOMMENDATIONS

6.01 During negotiations, GOP's agreement was obtained on the following:

(i) onlending terms and conditions, margins, eligibility criteriaand refinance arrangements (paras. 3.08-3.09 and 4.06);

(ii) budgetary allocations by GOP, the SICs and the banks as counterpartfunds for the techaical assistance components of the Project(para. 3.12);

(iii) increase in the SBP credit line to Rs 50 million for IDBP'srevolving fund (para. 4.06);

(iv) procedures for procurement, disbursement, reporting, accountingand auditing (parns. 4.07-4.10);

-27-

(v) amount and procedures for retroactive financing (para. 4.11);

(vi) staffing patterns and training programs for participating banksand the SIRD (paras. 3.06-3.07);

(vii) an annual review and appropriate adjustment of onlending rates(para. 2.09);

(viii) terms of reference for consultants to be employed for thetechnical assistance components;

Cix) staffing patterns of the SICs for their respective componeuts;

(x) timetable for disbursement of 50% of the Rs 10 million endowmentfund for the training institute (para. 3.20);

(xi) timetable for the recruitment of the training institute's directorand at least one training specialist (para. 3.19);

(xii) timetable for the approval by relevant authority of the traininginstitute's charter (para. 4.02); and

(xiii) an implementation timetable for the technical assistance components(Annex 8).

6.02 During negotiotions, drafts of the following documents were discussedand agreed on:

(i) subsidiary loan agreement betwveen GOP and IDBP;

(ii) parcicipation agreements between IDBP and the participatingcommercial banks;

Ciii) circular containing operating policies and procedures of theparticipating banks.

6.03 It is recommended that the following conditions be met prior toCredit effectiveness:

(i) signing of the subsidiary loan agreement between GOP and IDBP,satisfactory to IDA (para. 4.01);

(ii) signing of participation agreements between IDBP and at leasttwo participating banks (para 4.01); and

(iii) approval by the respective boards of these banks and issue of acircular containing operating policies and procedures under theProject, satisfactory to !DA (para. 4.01).

6.04 The proposed Project constitutes a suitable basis for an IDA Creditof US$50 million equivalent (SDR 47 million) with standard terms, underconditions outlined in Chapter IV.

-28-

ANNEX 1Page 1

PAKISTAN

SECOND SHALL INDUSTRIES PROJECT

Profile of Subprojects Financed Under Credit 1113-PAK

Credit Utilization

1. The US$26 million subloan component of Credit 1113-PAK was fullycommitted to 646 subprojects by the five commercial banks by September 30,1983, more than one year ahead of schedule. As of February 29, 1984, disbur-sements by the commercial banks to subprojects had reached US$26.3 million,of which 80% or US$21.0 million are eligible for refinancing by IDA. Actualdisbursements by IDA as of the same date was US$10.3 million, reflecting adisbursement lag of about US$11 million.

2. Despite full commitment of Credit 1113-PAK, the commercial bankscontinue to sanction subloans under the same terms and conditions as thoseof Credit 1113-PAK and in anticipation of the proposed second credit. Thiswas done in order to lend momentum to the proposed second credit. As ofFebruary 29, 1984, the five banks had committed another US$14.5 million to277 subprojects of which 70% or US$10.2 would be eligible for refinancingunder the proposed credit. Moreover, another US$8.1 million of subloans arebeing processed and US$11.5 million are in the pipeline. Compared to thefirst project, which took six months to take-off, the proposed second projectwill have a strong start-up.

Subproject Profile

3. Subloan Characteristics. The average subloan size has beenUS$48,000; free-limit subloans averaged US$43,000 while above free-limitsubloans, US$172,000. The ratio between free-limit and above free-limitcases was 96:4 in number and 85:15 in amount compared to the IDA requirementof 50:50 in amount, indicating that a large percentage of subloans were forsmaller enterprises. Subloans had an average maturity of 7 years and 3months. On average, subloans were applied to factory building construction(20%), machinery and equipment (65%) and permanent working capital (15%).Only 10% of subloan amounts were used in foreign exchange for direct importsby subborrowers; most subloans financed local goods as well as imported butlocally available goods. Including these indirect foreign costs, the foreignexchange application of subloans is estimated to be about 30%. The averageequity contribution of 67% by sponsors was much higher than expected at

-29-

ANNEX 1Page 2

appraisal (40%) and the minimum equity requirement of 30% indicating greaterdomestic resource mobilization than expected and stronger capital structuringof subprojects by the commercial banks. Overall, the financing pattern wasas follows: sponsor's equity of 67%, commerciaL bank financing of 7% and IDAfinaacing of 26%. The subloan component of US$26 million has resulted intotal investments of Rs 1.3 billion or US$93 million.

4. Subproject Characteristics. The first Credit has financed 453 newsubprojects and the BMRE (balancing, modernization, replacement and expan-

* sion) of 193 existing units. Subsector distribution was as expected atappraisal. About 35% of subprojects sanctioned belong to the five subsectorsidentified at appraisal as growth areas: light engineering, textiles andgarments, surgical instruments, sports goods and leather products. Another40% are in agro-processing activities, such as ice and cold storage, oilextraction, cotton ginning, rice/flour milling and fruit/vegetableprocessing.

-30- ANNEX 1

Page 3

Table I

Subsectoral Distribution-of Subprojects Under Credit 1113-PAK

Subsectors No. Amount(RB million)

1. Textiles and GarmentsWeaving 46 27.57Finishing 4 5.28Specialized Textiles 29 17.23Garments 14 13.05

2. Surgical Instruments 18 12.203. Leather and Leather Goods 9 7.184. Sports Goods 5 3.745. Light Engineering

Workshop 37 22.07Rerolling 23 17.06Wires and Cables 8 4.51Agri Implements 19 10.41Electrical Goods 10 5.21Others 7 6.80

6. Furniture and Wood Products 24 13.177. Oil Extraction 48 30.238. Cotton Ginning 46 33.629. Ice and Cold Storage 76 39.5410. Marble Processing 6 4.3911. Printing and Packing 28 22.9512. Fruits and Vegetables and Other Agro. Business 31 21.3813. Rice/Flour Milling 33 15.4114. Hotel 10 8.7315. Poultry Farm and Feeds 27 15.7616. Miscellaneous 88 64.87

646 420.36

5. About 90% of the subloans approved are for projects located in thePunjab (60%) and Sind (30%) provinces, with NWFP receiving only 7Z andBaluchistan 3% of IDA subloans. This distribution was somewhat more lopsidedthan as expected at appraisal, but is reflective of population distributionand past lending pattern of the commercial banks. More intensive promotionalwork in the less-developed areas is included under the proposed SSI II toincrease their share of SSI investments. About 38% of subprojects have fixedcosts (excluding land and buildings) of Rs 500,000-999,000; 32% are in therange of Rs 100,000-499,000. Average subproject size is about Rs 736,000,much lower than the size ceiling of the Rs 3,000,000 of fixed assets (exclud-ing land and building).

-31-

ANNEX 1Page 4

Table 2

Size Distribution of Subprojects under Credit 1113-PAK

(Rs in million)1. FIXED ASSETS EXCLUDING LAND AND BUILDINGS NO. AMOUNT

a- Less than Rs 100,000 37 2,156b- Rs 100,000 to, Rs 499,000 209 62,400c- Rs 500,000 to Rs 999,000 246 171,536d- Rs 1000,000 to Rs 1999,000 126 168,272e- Rs 2000,000 and above 28 71,382

Total 646 475,746

2. TOTAL ASSETS

a- Less than Rs 500,000 56 18,614b- Rs 500,000 to Rs 999,000 94 82,518c- Rs 1000,000 to Rs 1999,000 295 480,007d- Rs 2000,000 to Rs 2999,000 105 251,376e- Rs 3000,000 and above 96 428,397

Total 646 1,260,912

6. Economic Impact. The 646 subprojects sanctioned under the firstproject are expected to generate about 22,500 new jobs at a total cost perjob of about US$4,000; fixed cost per job is about US$3,250. The subprojectsfinanced under this Credit are almost totally dependent on local rawmaterials (97%). Exports constitute a significant portion of subprojects inspecific export-oriented subsectors such as surgical instruments, sportsgoods and garments but overall constitute less than 5% of total output. The646 subprojects are expected to produce sales of Rs 3.7 billion and valueadded of about Rs 843 million. Capital/output ratio is 0.4 compared to theSSI sector average of between 0.6 to 0.8.

7. Credit Institutions' Participation. Among the participating banks,National Bank of Pakistan was the most active with 178 subloans sanctioned,followed by United Bank Limited with 163 and Habib Bank Limited with 147;Muslim Commercial Bank had 103 while Allied Bank Limited was last with 55.This reflects the relative sizes of the commercial banks, i.e. three bigbanks and two smaller ones, and was as expected at appraisal.

8. Performance. Based on a sample of subprojects visited, lendingdecisions being made under the credit appear sound. The quality of sponsorselection is high, with a good balance between existing and new clients,traditional (usually from the trade sector) and new (usually professionalsand former Pakistani expatriates) entrepreneurs. Subproject appraisal isgenerally good, but appraisal report presentation could be improved.Moreover, there is a tendency to under-estimate working capital requirementsand over-invest in buildings.

-32-ANNEX 2

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Profile of Commercial Banks(1982)

(Rs million)

ABL EBL KCB NBP UBL TOTAL

Total Assets 8,160 63,880 19,455 41,466 38,651 171,612

Deposits 5,604 40,840 12,735 30,838 27,101 117,118

Total Advances 4,560 25,074 9,305 14,921 18,538 72,398

Industrial Loans 1,556 5,367 2,031 7,850 1,396 18,200

All SSI Loans(net increase) 118 596 165 257 331 1,467

SSI I Loans (X) 9 23 17 26 25 100

Capital and Reserves 178 1,279 387 839 791 3,474

Net Profit 5 273 44 99 29 450

Branches 698 1,845 1,341 1,381 1,670 6,935

Branches Designatedfor IDA Leading 40 80 41 200 42 403

Proposed Circle SIDS 8 12 8 7 10 45

-33-

ANNEX 3

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Comparative Capital Intensity, Capital Productivityand Labor Productivity of SSIs 1/

Capital Capital LaborIntensity Productivity Productivity

K1L (Y/K) (Y/L)(US$) (US$)

Pakistan (1976) 1,762 1.2 2,185

Philippines (1975) 3,746 0.78 2,933

Thailand (1976) 5,480 0.48 2,652

Malaysia (1973) 3,197 1.01 3,246

Singapore (1978) 13,413 0.73 9,790

Sources: Pakistan : Census of Manufacturing, 1975/76.Philippines: National Census of Statistics Office, unpublished

version of 1975 census results.Thailand : Tambunlertchai, Lochaweachit, 1980.Malaysia : Department of Statistics (Malaysia), Census of

Manufacturing Industries, Peninsular Malaysia, 1973.Singapore : Department of Statistics (Singapore), Report on the

Census of Industrial Production 1918, unpublishedversion.

1/ The figures were computed in local currency and converted into USdollar equivalents at official exchange rates of respective data year.Respective index is computed as below.

Capital Intensity : K/LCapital Productivity : Y/KLabor Productivity : Y/L

Where: K stands for value amount of fixed assetsY stands for amount of value addedL stands for number of employees

-34-

ANNEX 4

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Organizational Profile of SICs as of December 1983

PUNJAB SIND NWPP ALUCKISTAN

1. Date Established 1965 1972 1972 19722. No. of Staff (officers) 2006 (961) 681 (168) 564 (45) 161 (85)3. Operating Budget (FY83) Rs 28 m Rs 21m aRs 8m Rs 14 m4. Total Assets Rs 279 m Rs 40 m Rs 69 a Rs 6 a5. Major Activities

(a) Industrial Estates (acres) 15 (1035) 6 (307) 7 1(b) Service Centers 8 5 5 1(c) Carpet Centers 84 48 16 36(d) Handicraft Centers 9 1 6 55Ce) Handicraft Retail Outlets 5 6 - 1(f) Projects Prepared under

SSI I (value) 569 102 32(Rs 340 a) (Rs 111.4 a)

(g) Skills Training Centers(trainees) 25 (3700) 88 (1315) - _

(h) Textile Centers - - 8 -6. Name of Operating Units a) Administration a) Planning a) Estates a) Planning 6

b) Planning and b) Credit and b) Appraisal DevelopmentCoordination Advisory c) Planning b) Procurements

c) Finance and c) Handicrafts d) Cottage c) MarketingAccounts d) Export and Industries d) Projects

d) Handicrafts Commerce e) Marketing e) Smalle) Service Centers e) Project and f) Afghan Industriesf) Works End-Use Refugees Estatesg) Industrial f) Finance and g) Works f) Accounts

Promotion Accounts & Auditsand Advisory g) Purchase andServices Licensing

h) Surveyi) Secretariat

7. No. of Zonal Offices 7 2 5 0

Source: Mission's questionnaire for SICs, Oct. 1983.

-35-

ANNEX 5

PAKISTAN

SECOND SMALL INDUSTRL.S PROJECT

SubLoan Pipeline of Commerci2l Banks for SSI II(as Lf February 29, 1984)

(Rs million)

ABL BBL MCB NBP UBL TOTALNo. Rs. No. Rs. No. Rs. No. Rs. No. Rs. No. Rs.

Subloans Already Approved 23 17.6 108 65.1 19 21.9 55 36.1 72 54.3 277 195

Subloans BeingProcessed atHeadquarters 8 7.1 32 31.8 18 20.8 25 20.2 22 29.1 105 109

Estimate of SubloansBeing Processedat Branches 20 15.0 60 35.0 25 25.0 60 40.0 55 40.0 220 155

Total 51 39.7 200 131.9 62 67.7 140 96.3 149 123.4 602 459A= = ==- _ = = = == = _

-36-

ANNEX 6

PAKISTAN

SECOND SNAIL INDUSTRIES PROJECT

Estimated Proiect Costs and Financing Plan(US$ million)

IDA IDA GOPI Com. PrivateComponent Foreisn Local SIC Bank Sector Total

A. Lending Component 30.00 18.00 - 21.00 47.00 116.00B. Training for Commercial Banks 0.15 - - 0.15 - 0.30C. Baluchistan DSI

Capital Cost 0.03 0.03 - - - 0.06Consultancy 0.16 0.14 - - - 0.30Training 0.02 - - - 0.02Administrative Cost - - 0.23 - _ 0.23Sub-total 0.21 0.17 0.23 - - 0.61

D. NWFP SIDBCapital Cost 0.02 0.02 - - - 0.04Consultancy 0.03 0.08 - - - 0.11Administrative Cost - - 0.12 - 0.12

Sub-total 0.05 0.10 0.12 - - 0.27

E. Management Trainins ProgramCapital Cost 0.05 0.03 0.39 0.39 - 0.86Consultancy 0.24 - - - - 0.24Training 0.02 - - - - 0.02Administrative Cost - 0.40 - - - 0.40

Sub-total 0.31 0.43 0.39 0.39 - 1.52

F. Subproiect PreparationConsultancy - 0.20 - - - 0.20

G. Subcontracting StudyConsultancy 0.05 - - - - 0.05

R. Contingencies 0.15 0.18 - - - 0.33

TOTAL 30.92 19.08 0.74 21.54 47.00 119.28.= ee ,S,

-37-

ANNEX 7Page 1

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Small Industries Refinance Department of IDBP

Strategy Statement, Policies and Procedures,Work Program and Organization

1. The objective of the Statement is to outline the Small IndustriesRefinance Department's (SIRD) strategy for its operations during FY85 andFY86 as a refinance agency under IDA's Small Industries Projects.

Priorities. Consistent with overall priorities and policie. spelledout in the Government of Pakistan Sixth Five Year Plan (FY84-FY88) SIRD wouldscrive towards the development of the small industries sector by providingfinancial assistance to small industrial units through the participatingbanks. The following types of projects would be encouraged:

(a) enterprises engaged in light engineering activities, productionof engineering material for other manufacturing industries,industrial machinery for domestic use and exports, and thosecatering to the aeeds of large industrial enterprises bymanufacturing for them spares and consumable stores.

(b) enterprises using agricultural inputs and/or supplying inputsfor agriculture.

(c) enterprises which are export-oriented or import substituting andthose manufacturing high value added goods for domestic/exportmarkets.

(d) enterprises based on agricultural and industrial waste, localraw material, locally produced machi.aery and equipment.

(e) enterprises in the small industrial sector which contributeto geographical dispersal of IDA Credit assistance and to thedevelopment of less-developed regions of the country.

(f) enterprises which are labour-intensive and contribute inthe reduction of unemployment at a comparatively lowercapital cost.

-38- ANNEX 7Page 2

2. Portfolio Diversification and Sectoral Priorities. SIRD wouldstrive for a wider dispersal of the IDA Credit, particularly in theless-developed regions of the country. For this purpose, SIRD would adoptthe following guidelines:

(a) the SLID, in collaboration with the participating banks, wouldmake efforts to direct financiag towards promising subsectorssuch as leather products i.e. leather garments, shoes, etc.;food items, preservation of fruit, fruit juices, light engi-neering units, textile made-ups, ready-made garments, hosieryand knitted material, towels, ecc. for export as well asdomestic markets, agro-based industries, marble products,agricultural equipment and parts thereof, woodworking andfurniture and automotive parts.

(b) To enable participating banks to diversify their areas ofassistaace under the IDA Credit by subsectors, SIRD would providethem with the requisite information based on the subsectorstudies carried out and surveys coaducted by the Planning andPre-investment Studies and Promotion Departments of IDBP fromtime to time.

(c) On the basis of IDBP's long experience in the field of termfinancing, SIAD would extend assistance to participating banksin improving their appraisal standards.

(e) SIRD would extend assistance to particating banks in organizingtheir end-use and supervision functions in respect of subprojectsavailing long term finance under SSI-I and the proposed SSI-IICredits of IDA.

(f) SILW would take measures to avoid/forestal excessive financing ina particular subsector where saturation point has been reachedand further financing may create idle/extra capacity.

(g) SIRD would keep watch on the utilization of IDA Credit withreference to allocations made in the policy statements ofparticipating banks, for the underdeveloped regions of thecountry and, if required, suggest ways and means to achievetargets fixed by the banks.

(h) SIlD would monitor more closely the performance of each of theparticipating banks with regard to its operations under the IDACredits and provide assistance, where needed, in improving itsperformance.

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ANNEX 7Page 3

3. Operating Policies and Procedures

(a) Subloan Review. For subloans above the free limit (Rs 1.5million), SIRD would review the appraisal reports submittedby the commercial banks in order to determine whether thesubprojects are economically justified, financially viableand technically sound, and whether they meet the eligibilitycriteria. SIRD would summarize the project proposal and wouldforward its review and the commercial bank's appraisal report toIDA for approval of the subloan. Communication would be sent tothe banks through SIRD. For free limit subloans, SIRD wouldreview subprojects only in respect of the eligibility criteria.

(b) Disbursement and Collection. SIRD would submit to IDAwithdrawal applications containing siummary information on itsdisbursements to comnercial banks for IDA's authorization andreimbursement. For -ree limit subloans, the commercial bankswould submit subprojecets individually or in batches. SIRD wouldbriefly review these to see whether the projects meet theeligibility criteria and, if so, reimburse the banks up to 70% oftheir eligible disbursements. SIRD would also collect principaland interest from the commercial banks based on their respectiveamortization schedules and accordingly repay GOP.

Cc) Subloan Monitoring. SIRD would monitor the subloans financedby the banks through semi-annual reports submitted by theparticipating banks. These reports would provide tabulatedinformation on a subproject basis regarding the types and sizesof subprojects approved, names of companies financed, location,subsector group, subloan amount and breakdown of fixed investmentand permanent working capital, rate of disbursement, collectionperformance and arrears position. IDBP would consolidate thisinformation and prepare for IDA semi-annual progress reports onthe overall utilization of the credit, broken down for eachbank. SIRD would inspect supporting procurement and disbursementdocuments to ensure proper utilization of the Credit proceeds.The participating banks would submit regularly to SIRD supervisionand subproject completion reports which SIRD would consolidate andinclude in its semi- annua' reports to IDA.

(d) Subsector Support. SIRD would continue to administer and providedesign support to the subsector studies fund under SSI I, whichwould be used to finance studies of promising SSI subsectors, andto develop project profiles and models intended to assist theparticipating banks in project appraisal. The subsector studywould estimate credit and investment requirements in order toprovide feedback to commercial banks ia developing their SSIpipelines. Based on its own subsector analyses, SIRD wouldidentify subsector potential and constraints and feed these

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ANNEX 7Page 4

information to the participating banks for the formulation ofappropriate action programs.

(e) Training. SIRD would organize training for officers ofparticipating banks in SSI project appraisal and supervisionmethodology. The training would be conducted locally with theassistance of local training institutions. In the case of seniorofficers, the training would take the form of overseas on-the-jobtraining with leading commercial banks and training institutes.

4. Work Program. SIRD's work program for FY85 and FY86 is given below:

(a) Sanctions/Approvals. Keeping in view the first credit experienceand the subproject pipelines of the participating banks, thesanctions/approvals in the next two years are estimated as under:

FY85 360 Rs 416 millionFY86 361 Rs 417 million

It has been assumed that 80Z of the approved cases will be freelimit cases involving an average subloan amount of Rs 1 million and20% above free limit cases involving an average subloan amount ofRs 3 million. In 1985-86, excess approvals up to 20% of the amountof the second credit will also be made to cover for possiblecancellations or withdrawals.

(b) Disbursement of Refinance. Based on the above estimates ofapproval, the following amounts of refinance are expected to bedisbursed to the participating banks:

1984-85 Rs 314 million1985-86 Rs 218 million

(c) Collections. During FY85, repayments by the commercial banks areexpected to total Rs 37.3 million. In FY86 a similar repaymentfigure is expected. The system for collection will be reviewedto handle these and future volume of operations.

(d) Training

(i) Overseas Training. (1) Under the second credit, processing ofloan applications is proposed to be decentralized to circleoffices of the participating banks. Participating banks' SSIDofficers at head office and these circle offices are proposedto be sent to Manila for a four-week training course onproject appraisal and supervision methodology and for atwo-week on-the-job training with leading DFIs dealing in SSIfinancing. Twenty-five officers from the five banks have

-41-ANNEX 7Page 5

already been selected by PBC for this purpose. Asia BusinessConsultants, Manila, have already been requested to submittheir proposal in this regard. The training course isexpected to be held sometime in July - August 1984. (2)Three to four IDBP officers are also proposed to be sent foran on-the-job training with leading DFIs in SSI financing inManila or South Korea sometime in July - August 1984.

(ii) Local Training. Training in project appraisal and supervisionmethodology for participating banks' officers posted at SSIDsof circle offices will also be arranged in 1984-85 with theInstitute of Business Administration in Karachi or Lahoreand/or the Development Banking Institute ot the NationalDevelopment Finance Corporation. The training program for1985-86 will be developed later in response to requirements.

(e) Subsector Studies. Proposals for carrying out the followingsubsector studies have already been invited from a number ofinternational and national consultants: cooking and other householdequipment, agro-based industries, marble products, agriculturalequipment and parts thereof, automotive parts and accessories,furniture and wood products. Proposals have also been invited fora reappraisal of the following subsector: surgical instruments,cutlery products, sports goods. IDBP has already receivedproposals from some consultants and the remaining proposals areexpected to be received by the end of March 1984. Selection ofproposals and consultants with the approval of the participatingbanks and IDA is expected to be finalized by the end of May 1984and the contract will be awarded to the selected consultant withthe approval of the World Bank. It is estimated that reappraisalof the three subsectors named above and three subsectors studiesout of the six mentioned above will be made in 1984-85, while theremaining three subsector studies will be conducted in 1985-86.

(f) Project Profiles. Based on the above subsector studies, projectprofiles shall also be prepared and distributed to the participat-ing banks for information and guidance of their SSIDs at HeadOffice and Circle Offices.

(g) Follow-up. The progress of utilization of the credit and theestablishment and operations of the subprojects shall also bereviewed and analyzed in accordance with the operating policiesand procedures (para 3), and in consultation with the World Bankperiodically.

(h) Promotion of the Second Credit. Meetings with chambers of commerceand industry and trade bodies will be organized in 1984-85 at allimportant cities to explain the salient features of the Credit andchanges made in the eligibility criteria and appraisal procedures.

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(i) Review of Proposals relatins to Common Subsectors. IDBP willreview proposals received from the participating banks relating toimportant SSI subsectors and provide feedback to the banks on thestatus of these subsectors and on ways of improving appraisalstandards.

(j) Surveys of SSI Units in the Country. IDBP will carry out analyticalsurveys of small industrial units set up in the country with IDACredit assistance or otherwise to find out the sectoral develop-maet problems and prospects of SSI uaits in the country. On thebasis of findings of these surveys, IDBP would provide necessaryguidance to the banks.

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PAKISTANSMALL INDUSTRY REFINANCE DEPARTMENT

Organizaton Chart

Dopuly ManagrecorI

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SubpOeC Rsioew toxex & Res &h& i Montoring Dtursement Tranig

i 2 P1eWsIPioesx 2 Ainds

2 Rofrssoral Poa orioals 2 P¢ofncolna'

Exthr' under SS I

- -Prpoosd under SI fl

jofl '0WB has Ithee deputy managing d~oCts who reot diectly to thle mwiag4ngSctr

World Bonrk-26210

L

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ANNEX 8Page 1

PAXISTAN

SECOND SMALL INDUSTRIES PROJECT

Implementacion Timecable for the Technical Assistance Components

A. Management Training Program for SSI

Target DatesCritical Activities Start Completion

1. Disbursement of 502 ofendowment fund July 1, 1984 September 30, 1984

2. Constitution of the Board andformulation and approval of charter July 1, 1984 July 31, 1984

3. Identification and hiring ofdirector and one training specialist July 1, 1984 December 31, 1984

4. Identification and hiring oftwo-year consultant July 1, 1984 December 31, 1984

5. Constitution of Training Council January 1, 1985 January 31, 1985

6. Identification and partial hiring offour other training specialists October 1, 1984 March 31, 1985

B. Investment Promotion and Project Development for Baluchistan

Tarset DatesCritical Activities Start Completion

1. Identification and hiring oflong-term (three-year) consultant July 1, 1984 December 314 1984

2. Identification and hiring of key localprofessional staff i.e. overall head,head of investment promotion, head ofresearch and head of planning July 1, 1984 December 31, 1984

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ANNEX 8Page 2

3. Identification and partial hiring ofsubsector consultants January 1, 1985 June 30, 1985

4. Identification and hiring of otherlocal professional staff January 1, 1985 June 30, 1985

C. Projecc Identification and Development for NWFP

Target DatesCritical Activities Start Completion

1. Identification and hiring oflong-term (three-year) consultant July 1, 1984 December 31, 1984

2. Identification and hiring of key localprofessional staff i.e. overall head,head of investment promotion and headof research July 1, 1984 December 31, 1984

3. Identification and partial hiring ofsabsector consultants January 1, 1985 June 30, 1985

4.. Identification and hiring of otherlocal professional scaff January 1, 1985 June 30, 1985

D. Subcontracting StudyTarget Dates

Critical Artivities Start Completion

1. Identification of consultants July 1, 1984 December 31, 1984

2. Survey of 100 SSI engineering firms October 1, 1984 March 31, 1985

3. Survey of large engineering firms October 1, 1984 March 31, 1985

4. Survey report April 1, 1985 April 30, 1985

5. Draft final report to PSC for comments May 1, 1985 .May 31, 1985

6. Submission of final report to IDA June 1, 1985 June 30, 1985for comments

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ANNEX 9

PAKIST-N

SECOND SHALL INDUSTRIES PROJECT

Estimated Schedule of Disbursements 1/CUsS OOOs)

IDA Fiscal Year Semi-Annually Cumulative

1985 July - Dec 0.10 0.10Jan - Jun 2.50 2.60

1986 July - Dec 6.00 8.60Jan - Jun 6.00 14.60

1987 July - Dec 7.00 21.60Jan - Jun 7.00 28.60

1988 July - Dec 7.00 35.60Jan - Jun 7.00 42.60

1989 July - Dec 3.00 45.60Jan - June 2.00 47.60

1990 July - Dec 2.40 50.00

1/ Assuming Board presentation in June 1984.

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ANNEX 10

PAKISTAN

SECOND SMALL INDUSTRIES PROJECT

Documents Available in Project File

1. Brief Assessment of Small-Scale Industries Program under the Sixth Planof Pakistan, by L. Chico (Consultant), December 1983.

2. Proposal for the Establishment of a Small Industries Promotion Unit inBaluchistan, by L. Chico (Consultant), December 1983.

3. Proposal for the Establishment of a Project Development Unit in theSIDB of NWFP, by L. Chico (Consultant), December 1983.

4. Proposal for the Establishment of a Center for Technical Informationand Extension Services in SSIC, by L. Chico (Consultant), December 1983.

5. Proposal for Setting-up of a Pakistan Institution of Entrepreneurship,by L. Chico (Consultant), December 1983.

6. Questionnaire on SSI Financing by five commercial banks.