Colombia - Fifth Small and Medium Scale Enterprise Project

Document of The World Bank FOR OFFICIAL USE ONLY t~~~~-l 3C ,S ZV 3z5 _ ReportN8 P4939-CO MEMORANDUM AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN IN AN AMOUNT EQUIVALENT TO US$80 MILLION TO THE CENTRAL BANK OF COLOMBIA * WITH THE GUARANTEE OF THE REPUBLIC OF COLOMBIA FOR A FIFTH SMALL AND MEDIUM SCALE ENTERPRISE PROJECT FEBRUARY 9, 1989 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be dislosed without World Bank authorization.  CURRENCY EQUIVALENTS (as of July 1, 1988) Currency Unit = Colombian Peso (Col$) USS 1 D ColS 300.0 Col$ 1 . US$ 0.0033 FISCAL YEAR OF THE GOVERNNHTN OF COLOMBIA January 1 - December 31 GLOSSARY OF ABBREVIATIONS BR Central Bank of Colombia CF Private development bank CFP Public SME Development Bank DTF Average 90-day rate for term deposit certifica.tes issued by development and financial banks. FFI Industrial Finance Fund IDB Inter-American Development Bank NGO Non-governmental organization PFI Participating financial intermediary SHE Small and medium scale enterprise SME 4 Fourth Small and Medium Scale Enterprise Project  FOR OFmFCIAL USE ONLY COLOMBIA FIFTH SMALL AND MEDIUM SCALE ENTERPRISE PROJECT .Loan and Proiect Summary Borrower? Banco de la Republica (BR) * Beneficiaries: Small and medium scale enterprises (SMEs) in manufacturing, mining and related ser-ice industries with total assets of less than US$1.0 million equivalent. Amount: US$80 million equivalent. Terms: Seventeen years, including 5 years of grace, at the standard variable interest rate. Relending BR would relend the proceeds of the loan to participating Terms: financial intermediaries (PFIs), pegged to the fully variable average deposit rate of the Colombian banking system (DTF). BR would relend in local currency and would bear the foreign exchange risk since the free market DTF rate has reflected over the long run expectations of currency adjustment and thus contains an implicit foreign exchange risk premium. Relending rates to SMEs would be determined by each PFI according to the maturity, credit risk, operational cost and competition for each loan. Guidelines would establish an allowable maximutm of DTF+4 percentage points in 1989 and DTF+5 percentage points in 1990 for SME loans carrying the minimum 4 year maturity. Haximum interest rates to SMEs and the margins of PFIs would be progressively increased for loans with longer maturities, up to an additional one percentage point for maturities up to 10 years. Financing Plan: US$ Millions Enterprises 54.1 Financial intermediaries 43.7 Industrial Finance Fund 44.1 Other Domestic Sources 13.2 World Bank 80.0 Total 235.1 Rate of Return: SME loan approvals would require at least an l1X financial rate of return Map: IBRD 18370R 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 authorion.  MEOWRNDUM AND RECOCIEKNDATION OF THE PRESIDENT OF THE INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED LOAN TO THE CENTRAL BANK OF COLOMBIA WITH THE GUARANTEE OF TEE REPUBLIC OF COLOMBIA FOR A FIFTH SMALL AND MEDIUM SCALE ENTERPRISE PROJECT 1. The following memorandum and recommendation on a proposed US$80.0 million loan to the Central Bank of Colombia with the guarantee of the Republic of Colombia is submitted for approval. The proposed loan would be repayable over a period of 17 years, including 5 years of grace, at the Bank's standard variable interest rate, and would help finance a Fifth Small and Medium Scale Enterprise Project. 2. Background. The Colombian Government has assigned a high priority to employment creation and income growth among lower income segments of the population, particularly in view of persistent high unemployment rates and socio-political unrest. While the economy sustained overall growth rates of about 5 1 p.a. during 1986-87, the Government is aware that many small and medium scale enterprises (SHEs) do not share in such trends by virtue of a lack of access to institutional credit and technical support systems, and of policies which appear to favor large scale enterprises. 3. Credit to SMEs has declined substantially in the 1980s and is heavily concentrated in the Corporacion Financiera Popular (CFP), a public development bank. In this situation, the Goverment's strategy is to expand the level of SME lending by relying more on private CFs and commercial banks, and by introducing more specific support for microenterprises. It also aims to increase emphasis on raising efficiency and incomes of SMEs, which should help generate increased employment over the medium-term. This would be done inter alia by increasing the provision of technical advisory services to SMEs to resolve enterprise-specific production, management and product marketing problems. While the CFP has developed a strong capacity to reach and support small scale enterprises, little progress has been made in developing it as an autonomous, financially self-sustaining institutional mechanism serving SMEs. Thus, the Government is seeking to * remedy this largely by promoting a more competitive SME lending environment in which CFP must operate. 4. Rationale for Bank Involvement. The Bank's country strategy calls primarily for support to help Colombia to maintain fiscal and monetary discipline, increase export diversification and maintain creditworthiness, and reduce poverty and unemployment. The Bank has supported the generation of employment inter alia under four SME loans, totalling US$92.5 million, through CFP over the past thirteen years. The Bank loan of US$40 million (Ln. 2446-CO) under the Fourth Project (SME4) was fully committed in September 1987 and 95Z disbursed in October 1988. The experience gained in these projects has inspired more attention under the proposed Project to changes in policy and institutional factors, which are equally important constraints to SME development as the lack of available credit.  - 2 - 5. Proiect Obiectives. The objective of the proposed Project would be to increase SME value added and employment creation. This would be done mainly bys (a) making changes in public policies and institutional mechanisms influencing SME access to long-term credit, simultaneously supporting on-going financial sector adjustments by helping to reduce diatortions in resource allocation, adjust the pricing of credit to reflect its cost and associated risk, and upgrade portfolio quality; (b) expanding the number of financial intermediaries making SME loans and the volume of their ovn resources mobilized for this purpose; (c) simplifying loan processing and increasing technical cooperation to SMEs; and td) preparing studies and recommendations during Project implementation on policies influencing capital intensity, business establishment and operations as a basis for a dialogue with the Government on promoting a neutral policy environment for SME development. 6. Proiect Description. The Project would be composed of two components, one for provision of SHE credit (US$234.9 million) and the other for technical cooperation (TC) (US$0.2 million). The credit program would be administered by the Central Bank of Colombia (BR) as the second- tier institution. BR would provide a maximum of autonomy, consistent with prudent supervision of the loan, to first-tier participating financial intermediaries (PFIs). All development banks (CFs) and commercial banks in Colombia could, in principle, become PF1s. To qualify, they would have to meet a set of eligibility criteria under which: (a) all institutions observe the financial and operating requirements of the Superintendency of Banks, which are satisfactory to the Bank for the purposes of the Project; (b) CFs meet the standards of the CF Reform Act of 1987, which embrace the same standards as past B-lnk-financed DFC projects; and (c) CFP meets additional capital, profitability and operating efficiency targets. An initial group of twelve such institutions (including CFP), with nearly 1,300 branch offices, have agreed in principal to implement the credit program. CFP and the Caja Social de Ahorros, another specialized private lender, would act as Managing Institutions to supervise lending to microenterprises through NGOs. 7. The credit program would support SMEs and microenterprises in manufacturing, mining and associated service sector businesses. The program would finance SME loans or equity investments for the purchase of machinery and equipment, spare parts, the construction of industrial building facilities, and permanent working capital needed to increase SME productivity and expand production capacity. It would also finance, for well-defined restructuring plans designed to increase the productivity of existing SMEs, a wider range of eligible expenditures, such as for research and development, marketing, labor retraining and relocation. It would further finance TC to help resolve enterprise-specific problems, including environmental hazards being created by SM.s. 8. The total cost of the project is estimated at US$235.1 million equivalent, with a foreign exchange component of US$80.0 million (34Z). A breakdown of costs and the financing plan are shown in Schedule A. The  - 3 - amounts and methods of procurement and of disbursements, and the disbursement schedule are shown in Schedule B. A timetable of key project processing events and the status of Bank Group operations in Colombia are given in Schedules C and D, respectively. A map and the Staff Appraisal Report, No. 7493-CO dated February 9, 1989, are also attached. 9. Agreed Actions. BR would relend the proceeds of the loan and charge an interest rate equivalent to from DTF-1 to DTF+1 percentage points (DTF is the fully variable 90-day deposit rate for financial intermediaries), depending upon the category of financial intermediary, comitment year and maturity of the SME loan. Maturities of funds relent to PFIs would match those set for SHE clients. The individual SME loan and cumulative financing limits for any one SME would be US$0.5 million. Guidelines establish an allowable maximum interest rate of from DTF+4 to DTF+6 percentage points to SHE cliceCs, again depending upon the above- mentioned factors. Such rates would be 4-6 percentage points above the effective interest rates of the SME 4 Project. Maturities of between 4-10 years with 1-3 years of grace would be established for financing of fixed assets, restructuring plans and technical cooperation; permanent working capital would be financed for up to 5 years with 1 year of grace. The Bank's free limit for ex ante approvals by BR of SME loans would be set at US$400,000, covering an estimated 25? of the Bank's loan amount. The ex ante free limit set by BR would vary according to the experience of the PFI. To maintain supervision quality, a provision would also be made for automatic suspension by BR of a PFI's access to the Project's rediscount facility if performance during a quarter, in terms of recovery of principal and interest due from SME loans, fell below 902. 10. The following other measures were also agreed upon during negotiations: (a) with BR, changes in SME financial policies - (i) an increase in the total asset ceiling for eligible SMEs to US$1.0 million; (ii) elimination of SME interest rate subsidies by 1990 and introduction of flexible pricing by PFIs; (iii) revision of regulations of the Government's directed credit line for SMEs (the FFI) so as to substantially align them with those of the Bank loan; and (iv) provision for a broader definition of eligible expenditures under the credit program for enterprises preparing well-defined restructuring plans; (b) with CFP, (i) attainment of targets of 6.0? of administrative cost as a share of average total assets in 1989 and 5.5? in 1990, and targets of 1.0? of net after-tax profits to total average assets in 1989 and 1.6? in 1990, and (ii) Bank financing limited to 35? of total annual CFP commitments over 1989-90; (c) with all PFIs, draft Participation Agreements with BR specifying inter alia relending terms, appraisal guidelines, documentation requirements, and the need to maintain a sound financial condition and SME lending operations; and (d) with the Government, assurances that capital contributions to CFP are adequate to keep its debt/equity ratio at not more than 7.5:1 at December 31, 1989 and 1990. As special conditions of loan effectiveness, the Government would put into effect the SME financial policy changes, and BR would conclude and duly execute Participation Agreements with at least three PFIs making indicative commitments for SME lending aggregating at least 40? of the loan amount and with one Managing Institution for the microenterprise program. 11. Benefits. The proposed Project would help Colombia to accelerate value added, employment creation and the supply of goods and services of SMEs. Previous Bank-financed projects have clearly demonstrated their  - 4 - ability to have a substantial impact in these areas. Under SME 3 (1834-CO), for example, an ex-post evaluation based on a survey 127 borrowers revealed average incremental growth in sales of 26.5? per year, in employment of 13.31 per year, and in labor productivity of 10.4S per year. The Project would also substantially expand access to scarce long- term investment resources to increase productivity, expand installed capacity, and help to revive existing non-performing loans in the banking system. It would make modes,, adjustments in financial policies influencing SMEs' credit access and help private development and commercial banks to expand their relationships with the SME market. 12. Risks. The main implementation risk associated with the Project lies in the ability of participating commercial banks to adapt their appraisal, supervision and administrative processes to the requirements of SMEs. To mitigate this risk, they, along with other PFIs, would make clear organizational, staff and financial resource commitments to the Project in their Participating Agreements and participate in staff training courses under the aegis of Colombia's Bankers' Association in order to ensure that their systems are well prepared for SME lending. 14. Recommendation. I am satisfied that the proposed loan would comply with the Articles of Agreement of the Bank and recommend that the Executive Directors approve the proposed Loan. Barber B. Conable President February 9, 1989 Attachments  -5- Schedule A COLO0MBIA Fifth Small and 3*8dum Scale Interurise Project Estimated Costs and Financing Pkan Estimated Costs: Local Foreign Total -------US$ millions-------- Credit program 154.9 80.0 234.9 Technical cooperation 0.2 0.2 Total 155.1 80.0 235.1 Financint Plan: Enterprises 54.1 54.1 Financial intermediaries 43.7 43.7 Industrial Finance Fund 44.4 44.1 Other Domestic Sources 13.2 13.2 World Bank - 80.0 total 155.1 80.0 235.1  -6- Schedule B COLOMBIA Fifth Small and Medium Scale Entergrise Project Procurement Nethod and Disbursements Project Element Procurement Method Total Other * Cost A. Civil Works 38.1 38.1 16.3 16.3 B. Machinery and Equipment 128.0 128.0 42.9 42.9 C. Working Capital 53.0 53.0 (9.0) (9.0) D. Other Expenditures Under Restructuring Plans 10.0 10.0 (10.0) (10.0) E. Technical Cooperation Enterprise Specific 6.0 6.0 (1.8) (1.8) TOTAL 235.1 235.1 (80.0) (80.0) Note: Figures in parenthesis are the respective amounts financed by the Bank * Established Commercial Practices consistent with economy and efficiency. Disbursements CateRory Amount Percentage (US$ million) Civil Works 80? (of subloans) Machinery, Equipment and Permanent Working Capital 802 (of subloans) Other Expenditures under Restructuring Plans and Technical Cooperation 80S (of subloans) Estimated IBRD Disbursements IBRD Fiscal Year FY 89 90 91 92 93 94 --------------US$ million--------------------- Annual 0.3 9.7 20.7 27.7 15.8 5.8 Cummulative 0.3 10.0 30.7 58.4 74.2 80.0  -7- Schedule C COLOfMBI Fifth Small and Medium Scale EnterDrise Project Timetable of fty Protect Processing Events (a) Time taken to prepares 16 months (b) Prepared by: Banco de la Replblica, with the assistance of the Colombian Bankers' Association and the World Bank (c) First Bank Missions December 1986 Cd) Appraisal Mission Departure: July 1988 (e) Negotiations: January 1989 (f) Planned Date of Effectiveness: May 1989 (g) List of Relevant PCRs and PPARs: First Small-Scale Industry Project (Ln 1071-CO); PCR of January 5, 1979 PPAR No. 2645 (August 1979); Second Small-Scale Industry Project (Ln 1451-CO); PCR of April 12, 1983; Third Small-Scale Industry Project (Ln 1834-CO); PCR of April 30, 1986.  Schedule 0 STATUS OF BANK OPERATIONS A. STATEMENT OF BANK LOANS AND IDA CREDITS IN COLOMBIA (as of September 30, 1988) (USSillion) Loan Amount (lese Cancellation) Number Year Borrower Purpose Bank IDA Undisbursed 89 fully disbursed loans and one IDA credit 2,536.1 23.5 1/ 1593 1978 Zons Franca Industrial y Industrial * Comercial de Cartagena Export 14.7 0.1 1725 1979 Interconexion Electrice, S.A. Power 72.0 2.1 1857 1980 Banco de la Republica Industrial Cr. 142*0 3.3 1868 1980 Eupresas Publicas de Medellln Power 124.5 9.4 1953 1981 Empresas Publicas de Medellin Pover 85.0 41.6 1996 1981 Instituto Colomblano de fldrologia Irrigation 34.3 1.4 1999 1981 Corporacion Electrica de la Costa Atlantica Power 34.2 6.3 2008 1981 Empress de Energia Electrica de Bogota Power 359.0 10.4 2090 1982 Ferrocarriles Naclonales de Colombia Railways 30.0 0.4 2121 1982 Fonda Vial Nacional Hlghways 149.6 6.9 2174 1982 Republic of Colombia Rural Develop- ment 53.0 28.5 1/ Includes exchange adjustment of US$4.0 million.  Schedule D rag6 -z Of A. STAT1E