Philippines - Second Small and Medium Industries Development Project

Document of The World Bank FOR OFFICIAL USE ONLY FILE COPY Report No. 2417-PH PHILIPPINES STAFF APPRAISAL REPORT ON THE SECOND SMALL AND MEDIUM INDUSTRIES DEVELOPMENT PROJECT May 18, 1979 Projects Department East Asia and Pacific Regional Office This document has a restricted distribution and may be used by recipients only in the performnance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS US$1.0 = P 7.40 P 1.00 US$0.135 P 1 million US$135,135 P 1 billion US$135 million ABBREVIATIONS ADB - Asian Development Bank ASM - Annual Survey of Manufacturers BOI - Board of Investment CB - Central Bank of the Philippines CEO - Chief Executive Officer (of IGLF) COE - Census of Establishments CPA32 - Counterpart Project Agreement 32 CSMI - Commission on Small and Medium Industries DBP - Development Bank of the Philippines DCP - Design Center of the Philippines DLC - Department of Loans and Credit (of CB) ECA - Economic Cooperation Administration (of the US) ESCAP - Economic and Social Commission for Asia and the Pacific ERR - Economic Rate of Return FCDU - Foreign Currency Deposit Units FRR - Financial Rate of Return IGLF - Industrial Guarantee and Loan Fund MASICAP - Medium and Small Industries Coordinated Action Program MOF - Ministry of Finance MOI - Ministry of Industry MOT - Ministry of Trade NACIDA - National Cottage Industries Development Authority NBFI - Non-Bank Financial Intermediaries NCSO - National Census and Statistical Office NEDA' - National Economic and Development Authority OBU - Offshore Banking Units OIA - Office of the Internal Audit (of CB) PDB - Private Development Banks PDCP - Private Development Corporation of the Philippines PISO - Philippine Investments Systems Organization PNB - Philippine National Bank RC - Review Committee (of IGLF) SBAC - Small Business Advisory Centers SMI - Small and Medium Industries SSEs - Small-Scale Enterprises STD - Special Time Deposits ,UNIDO - United Nations Industrial Development Organization UPISSI - University of the Philippines Institute for Small-Scale Industries USAID - United States Agency for International Development  FOR OFFICIAL USE ONLY - ii - FISCAL YEARS July 1-June 30 (up to June 30, 1975) July 1-December 31, 1975 (interim) January 1-December 31 (from January 1, 1976) 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.  PHILIPPINES SECOND SMALL AND MEDIUM INDUSTRIES DEVELOPMENT PROJECT STAFF APPRAISAL REPORT TABLE OF CONTENTS Page No. BAS-IC DATA 1. THE INDUSTRIAL SECTOR . . . . . . . . . . . . . . . . . . . . . 1 Recent Developments . . . . . . . . . . . . . . . . . . . . . 1 Structure of Manufactirl.ag Industry . . . . . . . . . . . . . 2 Industrial InvestmeaL . . . . . . . . . . . . . . . . . . . . 4 Industrial Sector Issues and Policies . . . . . . . . . . . . 4 Prospects . . . . . . . . . . . . . . . . . . . . . . . . . . 7 2. THE SMALL AND M4EDIIP4 INDUSTRIES (SMI) SECTOR . . . . . . . . . 8 The Role of SMI in the Manufacturing Sector . . . . . . . . . 8 Institutional Framework for Assistance to SMI . . . . . . . . 10 Prospects for SMI . . . . . . . . . . . . . . . . . . . . . . 14 3. THE FINANCIAL, Sc'OR . . . . . . . . . . . . . . . . . . . . . 15 _.. ... .. ... Overview . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Profile of Financial Institutions . . . . . . . . . . . . . . 15 Financial Markets ........ ... ... .... ... . 17 Recent Developments . . . . . . . . . . . . . . . . . . . . . 18 Financial Sector Issues . . . . . . . . . . . . . . . . . . . 20 4. THE INDUSTRIAL. GUARANTEE AND LOAN FUND . . . . . . . . . . . . 22 A. Institutional Aspects . . . . . . . . . . . . . . . . . . . 22 Charter and Objectives ....... .. ... .. .. . 22 Ownership and Adminstrative Arrangements . . . . . . . . 22 Organization and Staffing . . . . . . . . . . . . . . . . 23 Procedures and Standards . . . . . . . . . . . . . . . . 25 Operating Policies . . . . . . . . . . . . . . . . . . . 26 The Accreditation Scheme ...... .. .. .. .. . . 27 This report was prepared by Mr. Khalid Siraj, Mrs. F. Khambatta and Ms. K. Brosnan following their visit to the Philippines in November-Decemnbe^ 1973.  -2- Page No. B. Operations .. . . . . . . . ... . . . . . . . . . . . 29 Volume of Operations ... . . . . ..... . . . . . . 29 Characteristics of Operations . . . . . . . . . . . . . . 31 C. Proposed Policy Changes ... . . . . ..... . . . . . . 33 Financing of Medium-Scale Industries The New Guarantee Scheme ..34 Interest Rates ..34 D. Impact of the Bank's Assistance to IGLF . . . . . . . . . . 35 Features of Subprojects Financed under Bank Loan No. 1120-PHI. 35 Economic Impact of Projects Approved Under Bank Loan No. 1120-PH ..36 E. Financial Position and Performance . . . . . . . . . . . . 37 Financial Position ..37 Financial Results ... . . . . . ...... . . . . . . 38 Audit .... . . . . . . . ...... . . . . . . . . . 38 Quality of Porfolio ... . . . . ..... . . . . . . . 39 F. Prospects .... . . . . . . . . . . . . . . . . . . . . . 40 IGLF's Business Prospects and Projections . . . . . . . . 40 Operational Priorities ..40 Resource Requirements ..41 Financial Projections . . . . . . . . . . . . . . . . . . 41 5. THE MEDIUM AND SMALL INDUSTRIES COORDINATED ACTION PROGRAM (MASICAP) .43 Origin and Aims of the Program . . . . . . . . . . . . . . . 43 Organization .43 Method of Operation .44 Operational Record .44 Performance of MASICAP Projects . . . . . . . . . . . . . . . 45 Strengths and Weaknesses of the Program . . . . . . . . . . . 45 Proposed Changes ... . . . . . . . . . . . . . . . . . . . 45 6. CONCLUSIONS AND RECOMMENDATIONS ... . . . . . . . . . . . . . 47 Objectives and Justification of the Loan . . . . . . . . . . 47 Features of the Loan .48 Agreements and Understandings Reached at Negotiations .50 Recommendation . . . . . . . . . . . . . . . 51  -3- LIST OF ANNEXES 1. Members of the Review Committee (RC) as of December 1, 1978 2. Proposed New IGLF Policies 3. List of Accredited Institutions as of December 1, 1978 4. Supporting Tables and Charts T-1 Regional Distribution of Branches of Accredited Financial Institutions as of November 30, 1078 T-2 Summary of Operations, July 1, 1974 - December 31, 1978 T-3 Details of Operations, July 1975 - December 31, 1978 T-4 Characteristics of STD Approvals by Sector, July 1, 1974 - December 31, 1978 T-5 Characteristics of STD Approvals by Regions, July 1, 1974 - December 31, 1978 T-6 Characteristics of STD Approvals by Size, Purpose and Maturity, January 1, 1976 - December 31, 1978 T-7 Features of Subprojects Financed under IBRD Loan No. 1120-PH by Industry T-8 Features of Subprojects Financed under IBRD Loan No. 1120-PH by Size of Loan and Size of Borrower's Assets T-9 Features of Subprojects Financed under IBRD Loan No. 1120-PH by Geographical Distribution T-10 Economic and Financial Rates of Return on IGLF Projects Financed by PDCP and PISO T-11 Summarized Balance Sheets as of December 31, 1974-78 T-12 Summarized Income Statements, CY74-78. T-13 Analysis of IGLF Portfolio T-14 Analysis of Arrears on IGLF Portfolio as of December 31, 1978 T-15 Trend of Arrears Between Participating Institutions and End-Users of IGLF T-16 Projected Operations T-17 Resource Position as of December 31, 1978 T-18 Projected Balance Sheets, December 31, 1979-82 T-19 Projected Cash Flow, CY79-82 T-20 Projected Income Statements, CY79-82 T-21 Status of M4ASICAP Projects, 1973 to September 30, 1978 T-22 Summary of MASICAP Projects, 1973 to September 30, 1978 T-23 Disbursement Schedule for the Proposed IBRD Loan C-1 Organization Chart of the IGLF Unit, November 30, 1978 C-2 Proposed Organization of the IGLF Unit C-3 Proposed Organization of MASICAP 5. Selected Data and Documents Available in the Project File  PHILIPPINES INDUSTRIAL GUARANTEE AND LOAN FUND Basic Data 1. Year of Establishment: 1952 2. Ownership: 100% owned by Government 3. Status of IBRD Loan (as of April 30, 1979): Rate of Out- Project Loan No. Date signed interest Amount /a Disbursed /a standing /a ----------- US$ million --------- SMI 1120-PH 6/5/75 8.5% 12.0 12.0 12.0 4. Operations (P'000) Loans July-Dec 1975 CY76 CY77 CY78 Approvals 19,035 29,220 20,332 46,989 Disbursements 24,295 26,868 21,702 43,779 5. Interest Rates and Charges: a. Interest rate (current): Ultimate sub-borrower: 12%; intermediary financial institution: 7%. b. Interest rate (proposed): Ultimate sub-borrower: 14.7% - 15% /b; intermediary finan- cial institution: 6.7% on small industry loan and 9% on medium industry loan. c. Guarantee fee: 2% of the amount guaranteed 6. Financial Position (P'000) 1974 1975 1976 1977 1978 Total assets 56,010 103,521 122,866 141,817 162,437 Long-term portfolio 42,080 79,121 87,051 89,817 113,961 Total liabilities 25,783 42,225 58,499 69,176 87,027 Long-term liabilities 23,649 40,100 55,097 62,984 80,592 Current ratio 11.1:1 19.2:1 14.7:1 11.3:1 12.3 Debt/equity ratio 0.8 0.7:1 0.9:1 0.9:1 1.1:1 Reserves & provisions as % of portfolio 2.4 1.3 1.1 1.8 2.2 7. Financial Perfomance (P'000) Gross income 2,162 2,850 6,983 7,670 10,114 Interest income 2,150 2,664 6,251 7,247 9,596 Financial expenses 1,951 1.006 2,803 4,922 6,028 Net income/(loss) (180) 996 3,071 1,793 2,769 Ratios As % of avg total assets: Gross income 3.9 3.6 6.2 5.8 6.6 Financial expenses 3.5 1.3 2.5 3.7 4.0 Gross margin 0.4 2.3 3.7 2.1 2.6 Admin. & promotional expenses 0.7 1.1 1.0 0.7 0.9 Net income (-0.3) 1.2 2.7 1.4 1.7 /a IGLF component only. Total loan amount was $30 million, of which $28.3 million is disbursed and outstanding. lb Including service charge at 1.5% on small industry loans and 1% on medium industry loans.  PHILIPPINES THE SECOND SMALL AND MEDIUM INDUSTRY DEVELOPMENT PROJECT STAFF APPRAISAL REPORT 1. THE INDUSTRIAL SECTOR Recent Developments 1.01 Industrialization has been a prime objective of Philippine economic development since independence. The industrial sector /1 grew rapidly in the fifties as the Government's import substitution policy, an overvalued exchange rate and low interest rates led to a significant replacement of imports by domestic production. This was followed by a period of slower growth through the 1960s. The economy picked up temporarily in 1972 and 1973 but this improvement was short-lived, and growth rates fell sharply as a consequence of the 1974 recession; the growth rate of gross value added at constant prices in the manufacturing sector dropped from 13.9% in 1973 to 3.5% in 1975 rising again to 5.7% in 1976 and 7.5% in 1977. 1.02 The industrial sector contributed 34.7% of GDP in 1977 (see Table below) of which 71% was from manufacturing. The manufacturing sector also accounted for about 30% of fixed investment and 10.4% of total employment. PERCENT DISTRIBUTION OF GDP BY SECTORAL ORIGIN, CURRENT PRICES 1970 1973 1977 Agriculture, fishery & forestry 27.8 29.3 28.1 Industry Mining and quarrying 2.8 3.4 1.6 Manufacturing 22.5 24.7 24.7 Construction 3.6 3.8 7.5 Electricity, gas and water 0.7 0.8 0.9 Total industry 29.6 32.7 34.7 Services 42.6 38.0 37.2 GDP at market prices 100.0 100.0 100.0 Source: National Accounts Staff, NEDA. /1 The industrial sector includes mining, manufacturing, constructution and utilities.  - 2 - The mining sector was stagnant over the period 1973-77, and comprised only 1.6% of GDP in 1977 mainly because of the low world market price of copper. Owing to an increase in the production of nickel and copper and a higher price of chromite, the mining sector experienced a growth rate of 20% in 1977 (constant 1972 prices). The construction sector grew rapidly between 1974-76 mainly because of the growth of relatively construction-intensive public investment, but the growth leveled off in 1977 and 1978. Structure of Manufacturing Industry 1.03 Sectoral Composition. The sectoral composition of manufacturing since 1970 is shown below: SECTORAL COMPOSITION OF MANUFACTURING (Value added in P million at constant 1972 prices) 1970 1973 1976 1977 Value Value Value Value added % added % added % added x Consumer Goods 6,379 53.9 7,669 50.3 9,184 52.6 9,619 51.2 Food 3,552 30.0 3,871 25.4 4,558 26.1 4,814 25.6 Beverage and tobacco 1,393 11.8 2,049 13.4 2,415 13.8 2,587 13.8 Textiles, apparel and leather 1,172 9.9 1,410 9.3 1,756 10.1 1,794 9.5 Printing and publishing 262 2.2 339 2.2 455 2.6 424 2.3 Intermediate Goods 4,159 35.2 6,174 40.4 6,557 37.5 7,325 39.0 Paper and paper products 341 2.9 420 2.8 538 3.1 547 2.9 Wood and cork products 497 4.2 627 4.1 558 3.2 714 3.8 Chemicals and rubber products 1,096 9.3 2,232 14.6 2,694 15.4 3,157 16.8 Petroleum 858 7.3 1,358 8.9 1,134 6.5 1,069 5.7 Nonmetallic mineral products 394 3.2 597 3.9 613 3.5 626 3.3 Basic metals and metal products 872 7.3 940 6.1 1,020 5.8 1,212 6.5 Durable and Capital Goods 1,029 8.7 1,143 7.6 1,443 8.2 1,567 8.3 Machinery 532 4.5 582 3.9 589 3.3 644 3.4 Transport equipment 497 4.2 561 3.7 854 4.9 923 4.9 Miscellaneous 256 2.2 266 1.7 297 1.7 282 1.5 Total 11,823 100.0 15,252 100.0 17,501 100.0 18,793 100.0  Although manufacturing value added grew by an average annual rate of 6.8% over the period 1970-1976 the relative sectoral share did not change signi- ficantly. During the first half of the period intermediate goods slightly increaser! their share of total value added at the expense of consumer goods, but this trend was reversed and in 19'77 consumer goods accounted for 51.2% of total gross value added. The rmajor growth industries were chemicals and rubber products (16.3%), beverages and tobacco (9.2%), and transport equipment (9.3%), 1.04 Export Performance, Manufactured exports grew slowly until the late 1960s. The 1970 devaluation followed by the floating of the peso, together with the introduction of import duty rebates and the system of bonded warehouses for exporters, contributed to an increase in the growth of manufactured exports in the early 1970s. The most dynamic aspect of this export growth has been the rapid surge in exports of nontraditional manufac- tures, especially garments, handicrafts and electronic products, which have risen from US$226 million in 1973 to $545 raillion in 1976 and $717 million in 1977, an annual average growth of 33% during 1973-77./1 The export value of minerals, particularly copper, increased significantly in the late 1960s and early 1970s but slumnped in 1975. Increased production of copper and a higher price for chromite raised the value of mineral exports from $362 million in 1975 to US$520 million in 1977. 1.05 Ownership Size and Value Added. The industrial sector is predom- inantly privately owned and generally concentrated in large capital-intensive units. In 1975 organized manufacturing units with over 200 employees repre- sented only 2.9% of the total number of registered enterprises but accounted for over 66% of total manufacturing employment and 72% of valued added. 1.06 Employment Performance. Until the mid-1970s the industrialization process did relatively little in terms of employment creation. Between 1960 and 1971, employment in manufacturing grew at an annual rate of about 2.5%, fell to zero percent between 1971 and 1973 but rose again to 8% for the period 1974-1976. In 1977, some 1.6 million workers were employed in the manufacturing sector. This included an estimated 1 million employed in the unorganized sector in small household and craft operations. In 1977, 50% of the employed labor force was in agriculture, 18.5% in services, 12.6% in commerce and 10.4% in manufacturing. Industry is expected to provide a much larger proportion of jobs in the future, particularly through increased exports and the development of cottage and small-scale industry./2 /1 For a detailed discussion of nontraditional exports see IBRD Report No. 1765-PH, The Philippines Country Economic Memorandum, October 26, 1977, Annex A. /2 Philippine small and medium industries sector is reviewed in paras. 2.01 to 2.15.  -4 Industrial Investment 1.07 Capital expenditure in the manufacturing sc,-rtor in 1975 increased by 27% reflecting decisions to expand cacpaclty tal-e-cx in 1 -7