Mexico - Manufacturing sector : situation, prospect and policies (Vol. 2 of 2) : Annexes 4 & 5

Report No. 1671-ME tLL Mexico Manufacturing Sector: Situation, Prospects and Policies (In Two Volumes) 7-) Volume II: Annex IV: Small and Medium Scale Industry - Annex V: Capital Goods May 1, 1977 Latin America and Caribbean Region FOR OFFICIAL USE ONLY Document of the World Bank This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  Currency Unit: Peso (Mex$) Prior to September 1, 1976: US$1.00 Mex$ 12.50 Mex$ 1.00 = US$0.08 Mex$ 1 million = US$80,000 On September 1, 1976 the fixed parity of the peso was abandoned. During 1977 the value of the peso has fluctuated in the range of 20-23 pesos per US dollar. As of August 31, 1977 the values were: US$1.00 = Mex$ 22.87 Mex$ 1.00 us$o.o4 Mex$ 1 million = US$43,733 Fiscal Year: January 1 through December 31.  FOR OFFICAL USE ONLY ANNEX IV SMALL AND MEDIUM SCALE INDUSTRY Industrial Development and Finance Division Latin America Projects Department This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.   SMALL AND MEDIUM SCALE INDUSTRY Table of Contents Page No. I. Participation of Small and Medium Scale Industry in the Industrial Sector ...... .................. ........... 1 II. Financing of Small and Medium Scale Industry .......... 9 Fondo de Garantia y Fomento a la Industria Mediana y Pequena (FOGAIN) ...... .............................. 10 Fondo Nacional de Fomento Industrial (FOMIN) ......... . 12 Fideicomiso de Conjuntos, Parques y Ciudades Industriales (FIDEIN) ............................... 14 Fondo Nacional de Estudios de Preinversion (FONEP) .... 15 Fondo para el Fomento de Exportaciones de Productos Manufacturados (FOMEX) .............................. 15 III. Technical Assistance .................. ................ 16 IV. The Overall System ...... ............................ .. 18 This report was prepared by Messrs. D.A. Cook, J. Levitsky, T.L. Hutcheson and K. Challa, based on the findings of an Industrial Sector Mission led by Mr. A. Nowicki (LC1) in October/November, 1976.   I. PARTICIPATION OF SMALL AND MEDIUM SCALE INDUSTRY IN THE INDUSTRIAL SECTOR 1.01 The most common definition of Small and Medium Scale Industry (SMI) in Mexico is that used by Fondo de Garantia y Fomento a la Industria Mediana y Pequena (FOGAIN), a specialized trust fund administered by Nacional Financiera (NAFINSA), which discounts loans to SMI extended through the banking system. FOGAIN classifies SMI as manufacturing enterprises having equity capital between Mex$ 25,000 and Mex$ 25 million (US$2,000 and US$2 million prior to the recent peso devaluation 1/). Based on this definition SMI comprised the bulk of Mexican manufacturing industry in 1970, accounting for 65% of enterprises, 73% of gross production and 83% of employment in the sector. Enterprises with less than Mex$ 25,000 in equity capital are classified as "artisan" type industries and are supported through separate institutional arrangements. In total these very small enterprises account for only 1% of manufacturing output and 5% of employment. 2! (See Tables 1 and 2). 1.02 During the decade 1960-1970 SMI (as defined by FOGAIN) increased in importance within the manufacturing sector through the creation of new enterprises and the expansion of existing enterprises. Its share of manufac- turing output increased from 68.2% to 73.4% and of employment in manufacturing from 77% to 83.2%. This dynamic growth seems to have occurred in two phases. Between 1960 and 1965 growth came primarily from the establishment of new, relatively small enterprises. The total number of SMI enterprises increased from 56,652 to 76,680 but the average number of employees per firm droped from 12.2 to 9.5. Total employment in SMI firms increased by only 5% in this period. From 1965 to 1970 the number of firms remained almost constant with 1/ FOGAIN changed the upper limit to Mex$ 30 million in 1975 and is at present examining the desirability of further modifying these limits to take account the effects of the recent peso devaluation. 2/ Note that FOGAIN's analysis of SMI is based only on enterprises engaged in manufacturing rather than all industrial enterprises. However, since manufacturing enterprises make up the overwhelming majority of all industry (see Table 1), the percentage figures quoted in this paragraph would hold even if all industrial enterprises were included. Note also that all figures in this section are based on analysis of the 1970 Industrial Census. There are significant differences between this Census and the overall Population Census, with the latter showing considerably higher employment in manufacturing. The differences are partly the result of poor coverage of the small enterprises in the industrial census, many of which are not registered with the appropriate authori- ties. In addition, there are differences in the definition of manufacturing, with the population census probably including a variety of commercial activities such as tailoring, banking, etc., in manu- facturing.  -2- ANALYSIS OF THE 1970 INDUSTRIAL CENSUS DATA Table 1: Summary of Number of Industrial Enterprises and Employment (1970) Average No. Number of Total of Employees Establishments 1/ Employment per Establishment Manufacturing Industry 2/ 118,983 1,521,661 13 Petroleum & Basic Chemicals 3/ 28 56,987 2,035 Other Extractive Industries 980 60,586 62 1/ For the purposes of the Census subsidiaries of an industrial group operating at different locations are classed as different establishments. 2/ Including repair and service of machines and metal working industries. 3/ Exeluding enterprises engaged primarily in the distribution of these products. 1/ Table 2: Classification of Manufacturing Enterprises Based on Equity Capital (1970) (Amounts in millions of pesos) Large Industry SMI Artisan Industry Quantity % Quantity Quantity % No. of Enterprises 523 0.44 76,753 64.64 41,464 34.92 Invested Capital 43,430 29.64 102,312 69.83 766 0.52 Gross Production 52,088 25.60 149,260 73.36 2,105 1.03 Value Added 18,772 23.68 59,810 75.45 685 0.86 Fixed Assets 37,846 37.32 62,933 62.06 629 0.62 Total Employment 170,770 11.23 1,298,256 83.21 84,549 5.56 1/ Including enterprises engaged in repair and service of machines and metal working industries.  - 3 - growth coming mainly from the expansion of existing enterprises in response to increased capital investment. The number of employees per firm increased from 9.5 to 17.8 and average capital invested per firm grew from US$50,000 equivalent to US$107,000 equivalent. During the 1965-1970 period total employment in SII enterprises increased by almost 90%, but the capital intensity of SMI firms did not increase significantly, capital invested per employee growing from US$5,200 to US$6,000 equivalent. 1/ Unfortunately, statistics are not yet available from the 1975 census to perform a similar analysis for 1970-1975, but preliminary results suggest that SMI grew less rapidly during this period. 1.03 While FOGAIN's definition of SMI is not significantly out of line with the definitions used in several other countries, it covers too large a proportion of Mexican industry and too broad a range of enterprise sizes and types to allow a detailed analysis of the characteristics and needs of enterprises of different sizes. 1.04 NAFINSA has recently performed some interesting analyses of the 1970 industrial census data using the different SMI definition. Enterprises with up to 25 employees but excluding "artisan" type enterprises (as defined above) were classified as small, and those with 26 to 250 employees as medium sized enterprises. Combined they would account for about 45% of gross output and 55% of employment in manufacturing. The Bank mission replicated and extended NAFINSA's analysis with the help of the Department of Statistics of the Secretaria de Programacion y Presupuesto (Ministry of Programming and Budgeting). Tables 3 through 5 summarize the results of these analyses. They reveal several interesting differences among enterprises depending on their size, type of activity and goegraphic location. These are briefly noted below, with emphasis on the differences between small and medium sized enterprises: - Over 90% of the enterprises comprising the SMI range have 25 or less employees. On average the small enterprises have only 4 or 5 employees. Medium sized enterprises are generally very much bigger, having 75 workers per firm on average. - Medium sized enterprises, although they represent less than 10% of SMI firms, contribute nearly 80% of value added and output by SMI firms and provide about 60% of employment. - Fixed Assets per employee are much higher in medium sized firms (US$5,406) than in small firms (US$1,782). 1/ Some of the above differences between the period 1960 to 1965 and 1965 to 1970 may-be more apparent than real since there were differences in the sampling.  - 4 - Whereas value added per worker is generally higher in medium sized firms, value added per unit of capital invested is higher in small firms. If a 10% cost of capital is assumed, then value added per unit of capital costs plus labor costs is slightly higher (by about 10% on average) for medium sized firms than for small firms. Value added as a percentage of gross output is somewhat higher for small enterprises (40.6%) than for medium sized firms (37.6%). While the majority of industrial enterprises belonging to all three size categories are located in the provincial area identified as Zone 3 1/, the relative concentration of large enterprises is much higher in the area covered by and surrounding the three largest cities (Zone 1) than in the smaller cities and the provincial area. Almost three-quarters of the manufacturers in the provincial area are small. Small enterprises are to be found operating in almost all industrial subsectors, and in some subsectors such as food products, garment making, wood products and leather goods, much of the output comes from relatively small firms. An overwhelming majority (93%) of the small enterprises are organized as sole proprietorships with unlimited liability for the owner. In contrast, 83% of the medium sized and 94% of the large enterprises are publicly incorporated companies; the majority of the remaining medium and large size enter- prises are organized as partnerships with limited liability to the owners. l/ To guide the Mexican regional development program, the Government cate- gorized all parts of Mexico into one of three "zones" depending on the degree of urbanization: Zone 1 includes the Federal District (including Mexico City), the metropolitan areas of Guadalajara and Monterrey and some municipalities immediately surrounding them. Zone 2 includes 10 smaller urban centers, namely the municipalities of Tlaquepaque, Zapopan, Lerma, Toluca, Cuernavaca, Jiutepec, Cuautilancingo, Puebla, San Pedro Cholula and Quaretaro. Zone 3 includes all other parts of Mexico.  ANALYSIS OF THE 1970 INDUSTRIAL CENSUS DATA 11 1/ Table 3: Analysis of Industrial Enterprises According to Size (1970) Large Medium Small Artisan (250 employees) (26-250 employees) (up to 25 (Equity less employees) than Mex$25,000) Number of Establishments 1,065 7,820 69,614 41,464 Equity Capital Invested 87,263 48,620 11,122 766 (million pesos) Gross Fixed Assets 62,329 31,713 6,226 628 (million pesos) Gross Production 113,435 78,320 18,531 2,105 (million pesos) Value Added 44,700 29,463 7,533 685 (million pesos) Total Employment 630,444 586,635 279,619 84,549 Gross Fixed Assets/Employee 7,914 5,406 1,782 595 (US$ equivalent) Equity Capital Invested/ 11,072 6,624 3,200 725 Employee (US$ equivalent) Value Added as Percentage 39.4% 37.6% 40.6% 32.5% of Gross Production Value Added per unit of 51.2% 60.6% 67.7% 89.4% capital invested Value Added per year per 5,680 4,000 2,160 640 employee (US$ equivalent) Number of employees per 592 75 4 2 Establishment Total Annual Remuneration 31,000 24,000 15,000 3,000 per Employee (pesos) _/ Excluding Petroleum and Basic Chemicals Industries.  -6 - ANALYSIS OF THE 1970 INDUSTRIAL CENSUS DATA Table 4: Geographical Distribution of Industrial Enterprises According to Size (1970) 1/ & 2/ Large Medium Small Total Number of Number of Number of Number of Enterprises % Enterprises % Enterprises % Enterprises x Zone 1 366 34.3 3182 40.1 27,168 24.5 30,716 25.6 Zone 2 69 6.5 352 4.5 2,258 2.0 2,679 2.2 Zone 3 630 59.1 4286 54.9 81,652 73.5 86,568 72.1 Total 1,065 100.0 7,820 100.0 111,078 100.0 119,963 100.0 1/ Excluding enterprises engaged in petroleum and basic chemicals industries. 2/ Enterprises with 25 employees or less are classified as "small", those with 26 to 250 as "medium", and those with more than 250 employees as "large".  ANALYSIS OF THE 1970 INDUSTRIAL CENSUS DATA Table 5; Principal Characteristics of M. nfacturing Eteis in Mexico Accor_ina toSize end TyPe 6f Activity (1970) & 2/ Number of Establishmaents Eselosment Wages and Salaries Total Capital Invested (Thousand 8$) Sma-ll Medioo Lerge rotaf Smal Pfedi Lg Ttiu Lrg Totl Small Mediuss Large Total Total Mnufactoriog lodootry 110,419 7,331 1,161 118,983 364,168 586,635 630,444 1,581,247 3,465,576 11,216,001 17,661,441 32,343,028 11,899,974 57,263,432 87,262,556 156,415,962 Foci 53.349 1,039 169 54,557 136,879 72,445 91,151 300,475 955,687 1,271,884 1.886,815 4,114,386 3,374,974 10,751,952 13,502,531 27,629,457 Bovorseen 1,797 226 74 2,097 6,215 22,337 39,299 67,851 61,141 451,372 1,139,464 1,651,977 477,122 3,988,624 6,848,799 11,315,145 Tobacco 32 16 55 63 246 1,277 9,165 10,688 6,319 13,856 241,646 265,621 110,089 179,429 1 752,107 1,941,625 Tabtilco 2,469 976 145 3,592 15,467 72,154 66,944 154,565 174,035 1,287,205 1,644,364 3,105,604 1,151,226 7,232.707 9,308,297 17,692,230 Cor.ent flaking 12,749 904 55 13,708 40,833 59,574 24,172 124,379 377,434 852,526 511,022 1,740,982 1,018,892 3,006,250 1.472,104 5.497,246 Wood 6 Cork Prod-cts 3,392 156 41 3,589 9,493 13,664 18,854 42,011 77,732 180,325 248d034 506,091 201,926 775,864 1,337.965 2,315,755 Waod FPruftore 3,560 247 12 3,819 12,899 16,258 4,469 33,676 122,333 268,913 78,733 469,979 248,453 928,314 296,246 1,473.013 Paper Products 396 186 33 617 3,397 16,520 17,646 37,563 49,539 417,799 632,349 1,099,678 281,596 2,433,492 5,833,664 8,546,754 PFinting 4,258 348 26 4,632 19,555 23,639 13,678 56,872 280,446 616,797 45D,614 1,347,857 1,044,010 2,519,470 1,526,157 5,089,637 Leather Goods 1,213 102 3 1,318 4,943 6,216 810 11,969 48,404 126,610 20,877 195,891 171,375 558,749 182,301 912,425 Rubber Goodi 3,326 104 10 3,440 8,206 7,115 6,888 22,209 83,941 186,546 362,267 632,754 247,550 731,351 1,475,060 2,453,961 Chbalcalo 2,095 801 132 3,028 15,251 63,416 60,156 138,823 299,066 1,728,246 2,227,845 4,255,157 1,924,973 10,827,665 15,895,227 28,647,865 Petro-CbeeoIcals 55 32 4 91 304 2,231 1,964 4,499 5,735 61,066 59,336 126,137 39,969 552,276 888,539 1,480,794 Non-Metallic Minerals 7,845 348 73 8,266 28,258 24,099 38,962 91,319 198,984 505,772 1.200,399 1,905,155 624,358 3,831,418 8,387,315 12,843,091 Steel and Iros 123 149 62 334 1,154 13,041 55,7837 69,979 18,156 339,309 2,078,657 2,435,637 111,377 2,978,399 17,468,156 20,558,332 Metal Mechanics 8,154 663 87 8,904 29,504 46,780 45,239 121,523 323,159 996,218 1,171,101 2,490,478 1,065,850 4,096,149 5,902,021 11.064,020 Me-hainOcds Machinery 1,969 302 41 2,312 9,530 20,202 15,481 45,213 136,257 496,250 442,384 1,074,891 666.683 2,650,135 2,697,118 5,902,934 Eleotricel Machinery 589 374 99 1,062 4,807 33,632 50,091 58,533 80,740 780,828 1,320,271 2,181,839 399,592 3,171,767 5,706,632 9,277,991 Transport Eqoipseot 578 198 57 833 4,091 11,009 49,073 70,173 58,100 370,489 1,752,673 2,181,262 237,160 2,000,775 10,399,789 12,637, 724 Various Masufactoring 2,542 156 23 2,721 10,389 11,121 6,684 28,194 108,367 260,200 193,075 561,643 402,012 1,004,628 996,957 2.4035597 Vale Aiied (Thoueani 1$H) Gro.s Producton (Tousand t f CaPital Ieted Pl Laor Cot S,,,all Madion Large Total Smal Msdloo Large Total Smal Medium _ Large_ Total Manufaeturing Industry 8,219,026 29,463.577 44,700,038 82,382,641 20,637,673 78,331,702 113,435,133 212,404,445 4,654,573 16,942,344 26,387,697 47,984,624 Food 2,281,734 4,620,123 4,432 ,54 11 234,161 7,305,143 17,766.511 13, 799, 781 30,871,435 1,293,156 2,347.027 3,347,027 6,877,253 Beyerages 215,794 1,578,341 3,071, 98 4,865,933 521.526 4,101,939 7,191,200 11,814,665 108,915 850,234 1.824,345 2,783.494 Tobacco 8,359 48,303 1,791,736 1,848,398 13,632 180,403 2,833,104 3,027,139 7,328 35,599 416,856 459,783 Teatilse 488,226 2,642,950 3,135,308 6,266,484 1,380,785 6,587,008 7,392,721 15,368,514 289,159 2,010,567 2.575,193 4,874,919 Caroent Making 836,118 1,653,166 946,801 3,441,085 1,869,711 4,051,734 2,267,946 8,189,391 479,323 1.153,150 658,230 2,290,703 Wood & Cork Products 156,834 394,594 493,833 1,045,26t 354,354 866,594 1,167,769 2,388,717 97,925 257,909 381,830 737,665 Wood Furottur- 253,044 533,327 153,423 939,794 513,892 1,200,060 260,423 2,074,375 147,179 361,744 108,358 617,281 Paper Products 1l($844 997,579 1,524,002 2,633,425 279,449 2,908,446 4,202,066 7,3589,960 77,699 565,425 1,215,717 1,858,841 Prioting 600.313 1,1372927 895,300 2,633,540 1,277,462 2,285,723 1,867,819 5,431,004 364,847 868,744 603,229 1,856,620 Leether Goods 100,197 275.630 58.427 434,254 253,389 743,539 101,347 1.178.275 65,542 182,485 39,107 287.134 Rubber Goidn 177,257 451,889 1,163,635 1,792,781 348,339 912,950 2,346,461 3,608,250 108,696 259,681 509,773 878,150 Chbeicale 899,759 4,442,740 5,854,589 11,197,088 2,361,015 11,320,835 14,232,505 27,914,355 491,564 2,811.015 3,817,367 7,119,946 Psaco-Cheunolale 21,127 287,695 191,622 500,444 61,120 770,321 449,317 1,280,758 9,732 116,293 148,195 274,ZIS Non-Metallic Minerals 444,162 1,076,119 2,639,733 4,180,014 879,349 2,366,849 5,400,013 8,646,211 261,421 888,917 2,039,132 3,189,467 Steel and Iron 75,521 842,705 6,100,759 7,018,985 224,697 2,750,485 21,104,916 24,080,098 29,295 624,321 35824,958 4,478,604 Metal Mechanics 687,807 2,100.106 2,525,631 5,313,544 1,442,466 4,527,266 5,754,244 11,723,976 429,743 1,405.839 1,761,302 3,596,884 MechanIcal Machinery 360.534 1,052,695 1,019,004 2,432,233 650,738 2,204,434 2,223,104 5,078,276 191,845 761,264 712,095 1,665,204 Electrirol Machinery 181,492 1,687,548 3,140,981 5,009,048 446,048 3,939.624 6,813,027 11,198,699 120,700 1,097,806 1,890,936 3,109,442 Transport Eqoip..ent 123,441 847,244 4,269,086 5,239,771 269.019 1,896,345 13,181,748 15,347,113 81,816 570,565 2,795,049 3,445,030 Various Mnufacturiog 256,841 486,975 369,651 1,113,440 520,353 1,033,760 678,132 2,232,445 148,570 360,662 292,772 802,004 1 u 55sed on Nacintai Financiers's a*sly se of 1870 lodoatral Cansos. The lieting of subsectors is not exhaustive of all aonufoolurlng neOto. 2 11 snteptltsea sitb 25 employeeg or less sr. defined as "small", those '4th 26 to 250 employees as and those vith more than 250 eamployees as "large".  - Average remuneration 1/ per employee varies widely (by a factor of 3) among subsectors ranging from about Mex$ 12,000 per year in enterprises producing wood and food products to Mex$ 35,000 per year for those engaged in basic metal industries. In comparison, variations in annual remune- ration depending on size are smaller: average remuneration is about Mex$ 15,000 per year in small industry compared to Mex$ 24,000 in medium sized enterprises and Mex$ 31,000 in large enterprises. Remunerations in the artisan enter- prises, however, are very low, averaging only about Mex$ 3,000 per year. 1.05 Based on FOGAIN's 1974 study of the enterprises they have financed, SMI firms appear reasonably profitable, earning about 10% on sales and 18% on equity capital. Nevertheless, in common with similar sized enterprises in other countries, SMI in Mexico and particularly the small enterprises tend to have deficiencies in areas such as accounting, production, financial management and marketing which stem from the small size and lack of special- ization of their management team (typically the owner and his family for small firms). The growth prospects of the small firms have been limited not only by these deficiencies but also by the greater difficulties they have in securing adequate financing from normal commercial sources, relative to medium sized and larger firms. 1.06 In view of the predominance of SMI enterprises within Mexican manufacturing, and their labor intensity and regional dispersion relative to larger firms, industrial growth will not only be more rapid but also will provide more jobs and can be more decentralized if SMI are strengthened. Furthermore, SMI enterprise provide the seed bed for the development of entrepreneurial talent and for upgrading the skills of the labor force, and by their linkages with large industry and agriculture and their heavy involvement in the production of mass consumption goods they contributed to other important economic and social development goals. However, if SMI is to make its full potential contribution, some strengthening of financial and non-financial support to SMI will be required. 1/ Wages or salaries plus other monetary benefits.  -9- ,l SIALL AND MEDIUII SCALE INDUSTRY 2.01 Mexico's well developing banking system, comprising public, private and mixed ownership institutions has been the primary source of outside financing for industry as a whole including SMI. Commercial banks and investment banks (financieras) make industrial loans and investments primarily from their own resources, but they also have access to discounting facilities with public sector trust funds, of which FOGAIN is the most important in the case of SMI. During the late 1960s and early 1970s the banking system developed rapidly with the real volume of outstanding credit increasing and lengthening in its term. Mexico's open financial system allowed a free flow of capital into and out of the country, and the long period of stability of the peso exchange rate encouraged US deposits in Mexican banks and foreign borrowings by Mexican firms. Foreign exchange liabilities of Mexican firms grew to roughly one half of their peso liabilities. Generally, credit was readily obtainable by firms that were judged to be reasonable credit risks by virtue of their size and reputation or the collateral they could offer. It was mainly the smaller firms that had difficulties in securing credit. Financial intermediaries made comparatively little use of the trust funds since they could earn higher margins on resources raised through bonds and deposits. 2.02 Since 1973, accelerating inflation and tighter monetary control have slowed down the growth of the financial system and reduced credit availability. By 1974 access to credit had become a serious problem for SMI with about 30% of firms having to supplement credits obtained from normal banking channels by borrowings from money lenders and other unofficial sources, and less than half of SMI firms able to secure most of all of their credit requirements. The recent major peso devaluation have accentuated this trend. Not only are companies' needs for working capital financing much greater, but there has been a substantial decline in the volume of resources mobilized by the banking system. In addition, large companies with heavy foreign exchange liabilities have switched to domestic borrowing. In these circumstances demands for peso financing are substantially in excess of the amounts the banking system can presently supply. Initial indications suggest that indus- trial credit is likely to remain in very short supply for at least the next 2-3 years. 2.03 Financing of SMI by the banking system is supplemented by three public sector trust funds all of which are administered by Nacional Financiera (NAFINSA). These are FOGAIN (Fondo de Garantia y Fomento a la Industria Mediana y Pequena), FOMIN (Fondo Nacional de Fomento Industrial), and FIDEIN (Fideicomiso de Conjuntos, Parques y Ciudades Industriales). Other trust funds, which are designed to serve industry as a whole provide some support to SMI for specific purposes. These are Fondo Nacional de Estudios de Preinversion (FONEP) administered by Nacional Financiera to finance preinvest- ment studies and technical assistance activities, and Fondo para el Fomento de las Exportaciones de los Productos Manufacturados (FOMEX) administered by Banco de Mexico to support exporting industries. The activities of these trust funds are briefly described below.  - 10 - Fondo de Garantia y Fomento a la Industria Mediana y Peguena (FOGAIN) 2.04 FOGAIN is a government trust fund administered by Nacional Financiera for developing and financing small and medium scale industry (SMI) in Mexico. It is the oldest and best known of Mexico's SMI institutions, and has been operating since 1954. It can rediscount up to 100% of credits granted to SMI enterprises by financial intermediaries--mainly commercial banks and financieras but including also credit unions established by groups of smaller enterprises. Traditionally, enterprises with equity capital between Mex$ 25,000 and Mex$ 25 million have been eligible for FOGAIN discounts, but recently the upper limit has been raised to Mex$ 30 million and the lower limit has been increased to Mex$ 300,000 for enterprises located in Zone 1, i.e. Mexico City, Monterrey and Guadalajara. 2.05 FOGAIN discounts loans for working capital (up to Mex$ 3.5 million), fixed assets (up to Mex$ 4.5 million) or for debt restructuring (Up to Mex$ 7 million). Normally, the financial intermediary bears the full credit risk. FOGAIN can guarantee a proportion of the credit, but it has seldom used this facility in practice. Interest rates on loans discountd by FOGAIN are relatively low, ranging from 10% in Zone 3 to 12% in Zone 1, including a margin of 3 percentage points for the intermediary. When lending from their internal resources banks charge effective interest rates (including commissions) in the range 15-25%. 2.06 During 1975 FOGAIN authorized discounting of 2,274 credits amounting to about Mex$ 1.18 billion, of which 56% was for working capital and a further 40% for fixed assets. These credits were granted to 2007 SMI enterprises, of which enterprises with equity capital of less than Mex$ 1 million received 43% of total credit, and those with equity capital of Mex$ 1 to 3.5 million a further 36%. More than half of the assisted enterprises had 20 or less employees; 60% were located in Zone 3. 2.07 During the period 1961-1971 FOGAIN's operations remained static at the level of about 750 loans per year. From 1972 on, operations began to in- crease fairly rapidly as FOGAIN became more promotional and coinciding with the period of tight liquidity in 1974, FOGAIN made 2,900 loans. Lending remained at this high level in 1975 and the first half of 1976, but following the September 1976 devaluation FOGAIN has been experiencing a further upsurge in demand. 2.08 FOGAIN's portfolio of outstanding loans is financed mainly out of equity subscriptions by the Government, loans from Banco de Mexico (resources provided from legal reserves of banking system) and a series of loans from the Inter-American Development Bank (IDB). The table below shows the develop- ment of these resources since 1971.  - 11 - Accumulated Resources Utilized by FOGAIN as at End of Period (millions of pesos) June 1971 1972 1973 1974 1975 1976 Equity subscriptions 189.7 289.7 339.7 359.7 409.7 409.7 Reinvested Profits 69.9 82.3 88.9 85.0 80.7 81.7 IDB Loans 189.3 188.6 283.1 308.4 314.7 327.1 Banco de Mexico Loans - - 200.0 500.0 700.0 800.0 Other Loans 4.5 3.8 12.8 38.5 18.7 19.6 Total Resources 453.4 564.3 924.5 1,291y7 1,523.9 1,638.1 2.09 From the above table it can be seen that equity has declined as a proportion of total resources from 57% in 1971 to 29% in 1976, whereas Banco de Mexico loans have increased rapidly and now represent almost 50% of total resources. FOGAIN has to pay 8% for Banco de.Mexico funds and on average about the same interest rate, plus commitment fees, for IDB funds. Since it earns an average of a little less than 8% from intermediaries, its profits have been declining. During 1974 and 1975 FOGAIN registered losses of about 4 million pesos. Following the recent devaluation, losses in 1976 and 1977 are anticipated unless relending rates are substantially increased. 2.10 FOGAIN is the best known and most widely used SMI financing institu- tion. Its volume of lending is substantial, amounting to almost US$100 million equivalent in 1975. It has many years of experience in working with SMI enter- prises and by operating through the full banking system has achieved a broad national coverage of regions and subsectors. In recent years FOGAIN has established regional representatives in the provincial offices of NAFINSA, who are promoting the fund with banks and industrialists and assisting some clients to prepare loan applications. 2.11 However, FOGAIN's position as a second tier institution also has some disadvantages. It must depend on commercial banks and financieras to present credit applications and does not generally have a close relationship with potential or existing clients. This has led to some bias in its operations towards the larger SMI enterprises and has limited FOGAIN's role in technical assistance. 2.12 In its 22 years of operation until mid-1976, FOGAIN has discounted credits to approximately 10,700 enterprises, which represents only 14% of the total number of SMI enterprises eligible to receive its assistance. Of the assisted enterprises about 6,400 were small (25 or less employees) and 4,300 were medium sized. Comparison of these figures with the analysis of the 1970 Census indicates that FOGAIN has financed almost 60% of eligible medium sized enterprises but only 9% of eligible small enterprises. This bias towards medium sized enterprises is not intentional on FOGAIN's part, but arises because the intermediaries, who normally carry the credit risks, have several reasons to prefer medium-sized rather than small clients under the prevailing conditions for FOGAIN discounts:  - 12 - (a) transaction costs are relatively much higher for small loans to small clients, but lending margins are fixed at 3% regard- less of loan size; (b) it is usually easier to obtain adequate security and collateral from medium sized enterprises and FOGAIN's guarantee facility is not sufficiently attractive to encourage banks to make loans to firms with inadequate collateral; (c) many of the smaller firms have inadequate accounting systems, which makes it both costly and difficult for them to provide the basic information needed to obtain a FOGAIN discount. Furthermore, some firms are reluctant to deal with a public sector institution because of fear that information supplied may adversely affect their future tax liabilities. 2.13 Being a second tier institution, FOGAIN is not well placed to identify and provide directly the technical assistance needs of its clients. Although FOGAIN has recently established a Technical Assistance Department, the department is small (3 professionals) and is also involved in promotional activities. So far its main achievements have been to produce some short courses, illustrated by visual aids to explain the operations of FOGAIN to banks and potential clients and to introduce basic accounting principles to their small clients that may need help in preparing loan requests. FOGAIN is-considering proposals for additional short courses covering accounting and other aspects of management that could be given to groups of client firms. More active involvement by FOGAIN in this area has been handicapped by the concentration of its staff in Mexico City and by the fact that its in- come has been barely sufficient to cover its normal operating costs. Fondo Nacional de Fomento Industrial (FOMIN) 2.14 FOMIN is another trust fund established by the Government and administered by Nacional Financiera to support SMI. It is a comparatively new institution which started operations in 1972. Its role is to assist in the establishment of new enterprises or the expansion of existing enterprises by investing up to one third of the total equity capital required. Its investment is intended to be temporary. Once the assisted company achieves a satisfactory financial position FOMIN's equity participation will be offered for sale to other shareholders, employees or outside investors. Although there are no formal restrictions on the size or type of enterprise that can be supported by FOMIN it is expected to invest mainly in SMI enterprises. Typically, the type of company requesting assistance from FOMIN is (i) a new enterprise whose sponsors have been unable to raise sufficient equity capital, or (ii) an existing enterprise undertaking a major expansion that cannot be financed entirely from borrowed funds, or (iii) an existing enterprise that has been experiencing financial difficulties and requires a fresh injection of equity capital to provide a basis for recovery.  - 13 - 2.15 By the end of May 1976, FOMIN had approved investments totalling Mex$ 364 million in 142 enterprises, 74 of which were new enterprises, and 80 were located in Zone 3. About one quarter of these enterprises intended to export part of their production. Taking enterprises with a total equity capital of up to Mex$ 2 million (after FOMIN's investment) as small, and those with equity capital between Mex$ 2 million and Mex$ 25 million as medium, 36 of the approved investments would be in small enterprises, 99 would be in medium sized enterprises and 7 in large enterprises. On average, the equity capital of assisted enterprises would amount to Mex$ 8.5 million after FOMIN's investment. 2.16 Generally there is a significant time lag between the approval and completion of an investment, primarily associated with legal processing. As of May 31, 1976 FOMIN's total portfolio of completed and still held investments amounted to Mex$ 180 million distributed among 70 companies. Of these 26 were operating profitably, 23 were making losses and the remaining 21 were either in the installation stage, or had stopped or not yet started operations because of technical, financial or legal problems. To date FOMIN has sold part of its shareholding in 13 companies, of which 10 sales resulted in small profits, one was at cost and 2 resulted in substantial losses. Overall these sales resulted in a minor net loss of Mex$ 12,000. FOMIN's resources have all be derived in the form of equity contributions by the Government. Although these resources are effectively cost free, FOMIN has not yet achieved sufficient return on its equity investments to cover its operating costs. 2.17 During its first 4 years of operation, FOMIN has adopted a high risk profile in its investment decisions. Not only are a high proportion of its investments in new enterprises, mostly in the less developed regions, but it has also assisted a number of existing enterprises that were already in severe financial difficulties. Although the quality of its portfolio has gradually been improving, it appears likely to suffer some substantial losses on its present investments. On the other hand, its opportunities to offset these losses through dividend income and capital gains are limited by its policy of selling its shareholding once a company is operating normally and profitably and the generally thin market for minority equity holdings in SMI enterprises. Furthermore, because of the substantial manpower costs involved in selecting, evaluating, processing, supervising and ultimately selling its investments, FOMIN's operating costs per investment are inevitably quite high. Consequently, under present arrangements it is difficult for FOMIN to use a;-> significant proportion of borrowed funds to finance its operations, and t-us -Its expansion prospects are limited by the availability of Government c