Philippines - Third Rural Finance Project

Report No. PID6763 Project Name Philippines-Third Rural Finance (@+) Region East Asia & Pacific Sector Rural Development & Natural Resources Project ID PHPE57598 Borrower Land Bank of the Philippines (LBP) Implementing Agency (1) Land Bank of the Philippines 313 Sen. Gil Puyat Ave. Makati City, Metro Manila Philippines Tel: 632-814-0154 Fax: 632-817-4619 (2) People's Credit & Finance Corporation (PCFC) 4/f Hanston Bldg. Emerald Ave. Ortigas Center, Pasig City Metro Manila Philippines Tel: 632-633-3456 Fax: 632-633-3439 Date PID Prepared December 1, 1998 Appraisal July 1, 1998 Board Date December 3, 1998 Background Country and Sector Background 1. The Philippine economy has recovered and has been on the growth path in the last 4 years. However, the recent East Asian financial crisis has impacted negatively on Philippine economic growth and the stability of the banking sector. Real GNP growth is estimated to have decelerated from 6.9w in 1996 to 5.8w in 1997, with a projection of a further decline to 3t in 1998. Several Philippine banks are over exposed to the property sector and to unhedged foreign currency loans to domestic borrowers. The financial crisis brought a deep depreciation of the peso against the US dollar. Thus, there is concern about the quality of banking assets and unhedged dollar denominated loans. The net results of the financial crisis were (a) an improvement in the trade account in 1997; (b) a softening of the fiscal position as revenue collection slowed down; (c) a deep credit squeeze in the corporate and banking sectors which drastically cut private consumption and investment; (d) weakening of the banking sector's balance sheet and operations; and (e) an overall decline in economic growth. Following a reduction in economic growth to about 3t in 1998, a recovery to 5t is projected to take place in the year 2000. Recovery will depend primarily on (a) the adoption of sound economic policies by the new Philippine government (to be installed after the national election in May 1998); (b) the recovery of growth in the corporate and banking sectors that have been  battered both by the credit squeeze and the currency depreciation; and (c) the immediate return of investor confidence in the regional markets. The country would need substantial financial support from both the Bank and the IMF to recover and resume a sustained growth path in the near term. While the financial crisis will weed out or hasten the demise of weak firms, including possibly banks, it is not certain that the weeding out process will be confined to such firms. The banks in their desire to protect their balance sheets from exposure to failing firms, especially those with unhedged dollar denominated loans, might not care or exert effort to distinguish between good and bad firms. A general credit squeeze is much easier to implement than a discriminating credit policy. Staying liquid while exploiting high yielding TBills, or taking a position in the foreign exchange market is a survival strategy that several banks have adopted, leading to a degree of failure in the credit market. Indeed, there are strong evidence that the financial crisis has hit good borrowers, especially the small and medium scale enterprises, who have suddenly been faced with escalating and volatile interest rate costs, and credit rationing by banks, particularly, a reduction of the availability of working capital loans. Clearly, a reduction in credit availability may cause many viable (economically and technically) business and production entities to go out of business, mainly because of financial distress, causing a great loss to the economy, increasing unemployment and poverty, particularly in the rural areas. Clear evidence of strong demand for medium and long term credit for rural investment has been shown by the fact that funds under CLF I and II which were set up to meet this demand at market rates have been drawn down substantially ahead of target. There continues to be an absence of medium and long term Peso denominated financial instruments within the banking system, and given the financial crisis, this is unlikely to change in the near future. This is a market failure; without such resources, either banks have to finance investments using short term resources, leading to maturity mismatches in the banking sector, or else investors are exposed to the financial risk of not having their short term loans rolled over. There is a considerable unsatisfied demand for micro-enterprise loans in the rural sector. The micro-enterprise clients demand loans ranging from P 25,000 (US$625) to P 100,000 (US$2,500) for working capital and small capital investments. Commercial banks do not cater to micro-enterprise clients despite the latter's proven profitability. The Micro-Finance Institutions (MFIs), i.e., Rural Banks (RBs), Cooperative Rural Banks (CRBs), credit NGOs and credit cooperatives serve this market niche. The typical moneylender provides small consumption and very short-term production credit while traders provide larger short-term production loans. Some RBs and CRBs can now obtain lines of credit for micro-enterprise loans from PCFC, a newly formed government owned corporation wholesaling loans to micro-finance institutions The credit NGOs rely on donations/grants, limited volume of commercial loans from the Bankers' Association of the Philippines (BAP) Credit and Guaranty Corporation and lately, on PCFC's wholesale funds to provide retail loans to micro-enterprise clients. Overall, however, RBs, CRBs, and NGOs reported a severe shortage of available financial resources to meet the current demand. The government has recognized the role of micro-enterprise loans in poverty alleviation and PCFC has been tasked to be the lead agency for micro-finance. So far, it has accredited as retail conduits 86 MFIs of which 46 are either rural banks or cooperative rural banks. 2. Objectives Building on the achievements of the Second Rural Finance Project (Loans -2 -  3938, 3939, and 3940-PH), the proposed project would: (a) provide financial support, through the establishment of the Countryside Loan Fund (CLF III), to the rural economy to overcome the difficulties created by the regional financial crisis, and the devaluation of the Peso; (b) providing additional medium and long term financial resources for viable investments in the rural areas; (c) assist the government in its efforts to alleviate rural poverty through the provision of financial and institutional support to the country's micro-finance system; and (d) strengthen LBP as the main financial institution serving the rural areas and PCFC as the wholesale micro-finance operation in the country. 3. Description It is estimated that the necessary financial resources to carry out the above stated project objectives over a period of five years would be in the order of US$216 million. The project would include the following four components: (a) Countryside Loan Fund III (CLF III) about US$207 million; (b) Micro-finance Loan Fund (MLF) about US$6.7 million; (c) Strengthening LBP's institutional capability (only training US$20 million); and (d) Strengthening PCFC (training US$0.3 million) 4. Financing Following is a tentative financial plan for the project: At least US$42 million equivalent (15t of total sub-projects costs) would be provided by the investors as their equity participation. At least US$22 million equivalent (109) would be provided by the Participating Financial Institutions (PFIs), and US$150 million (no more than 759) would be provided by IBRD. The institutional strengthening component would be carried out and financed by the Land Bank of the Philippines (LBP, about US$2 million), and PCFC for its own training program about US$0.3 million. 5. Implementation The project would be implemented over a period of five years. LBP would be responsible for overall project implementation while PCFC will be responsible for the implementation of the micro-finance component (its credit program and its institutional development plan). The Program Lending Group of LBP would handle day to day implementation of the credit component (CLF) and the Corporate Planning unit within LBP would be responsible for the implementation of LBP's institutional strengthening component. 6. Sustainability Sustainability of this project is based on the benefits to its participants. The project would benefit the sub-borrowers/investors by providing term financing which is currently very limited in the countryside and would contribute to the profitability of the PFIs and LBP. The credit component whether under the CLF III or the micro-finance is a demand driven operation. This would ensure that all participants would have interest to sustain this operation. 7. Lessons learned from past operations in the country/sector The board lessons that emerge from the review of the previous agricultural and rural credit projects are: (i) directed credit by crop or type of investment, at subsidized interest rates, did not sustain economic growth, improve credit delivery mechanism in the rural areas, or increase - 3 -  access of rural borrowers to formal credit facilities: (ii) heavy arrears and poor financial conditions of the apex financial institution or the selected PFIs severely constrained sub-projects' sustainability; (iii) private financial resource mobilization is extremely important for institutional sustainability; (iv) strong financial institutions along with qualified and experienced management and staff at headquarters, branches and field offices, are crucial to project success. When interest rates either fell significantly below or move well above prevailing market rates, serious implementation problem emerged: above market-rates resulted in slow disbursement, while below-market rates led to concentration of credit to relatively wealthier and large clients. These lessons would be incorporated in the design of the proposed project. 8. Poverty Category The project would contribute directly and indirectly to poverty alleviation. Indirectly, through the CLF III which would provide term financing for viable investments in the rural areas. Thus providing more employment opportunities and increase the economic activities in these areas. The micro-finance component would directly contribute to poverty reduction through the financing of viable economic activities of the rural poor. 9. Environmental Aspects Environmental assessment category B. The main issue is how to address environmental impact from a large number of sub-projects whose size and character are unknown at this stage. LBP has already established (under the 2nd Rural Finance Project) an Environmental Unit (EU) that is operating well. The EU would be responsible for ensuring that sub-borrowers comply with the Philippine environmental law and regulations. The training program under the institutional strengthening component would enhance LBP's capacity to ensure that sub-loans are adequately screened for environmental impact, EAs are carried out according to Bank guidelines if required. No indigenous peoples plan or resettlement plan will possibly take place. 10. Contact Point The InfoShop The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone No. (202)458 5454 Fax No. (202) 522 1500 The World Bank 23rd Floor, The Taipan Place Building Emerald Avenue, Ortigas Center Pasig City Manila, Philippines Telephone: (63-2) 637 5855-64 Fax: (63 2) 917 3050 Task Team Leader: Arie Chupak, EASRD Tel: (202) 458-1889 Fax: (202) 477 2733 Note: This is information on an evolving project. Certain activities and/or - 4 -  components may not be included in the final project. Processed by the InfoShop week ending December 4, 1998. 11. This information is based on an evolving project. Certain components and details are subject to change and may not be necessarily included in the final report. - 5 -  Annex Adequate arrangements and procedures would be maintained to ensure that sub-projects with adverse environmental impact will not be financed under the project. LBP will specify that sub-borrowers for CLF III funded projects would comply with all laws and regulations of the Philippines related to environmental protection, consistent with environmental guidelines of the Bank. LBP would be in charge of supervising compliance. To reduce the risk that sub-projects with undesirable environmental or social impacts would be financed by CLF, the following measures would be taken. The existing procedures and guidelines agreed under SRFP among LBP, the Department of Environment and Natural Resources (DENR), and the Environmental Management Bureau (EMB) would prevail and be applied under the proposed project. All sub-projects would comply with the Presidential Decree 1586 and its related regulations, which describes the Philippine environmental legal requirements for new investments. For the following generic sub-projects: poultry and piggery, agro-processing, land clearing, and fish and pond development, and any other sub-project as the Bank may require, an Environmental Impact Statement (EIS), as required by the above Presidential Decree and in line with the guidelines established under SRFP, would be prepared. The Environmental Unit (EU) of LBP would provide LBP, PFIs, and related sub-projects with environmental technical assistance and coordination services. To enable performance evaluation in respect to environment, the EU will conduct, on a spot check basis, environmental audits of the projects endorsed. These should be done in the presence and assistance, to the extent possible, of the PFIs. The higher of 10% of the approved sub-projects which require environmental clearance, or 50 sub-projects would be audited and the level of compliance is expected to be no less than 80%. 1/ Various official government and Bank documents provide a good discussion of the recent Philippine experience. 2/ PCFC was incorporated and registered with the Securities and Exchange Commission in 1996 and supervise by LBP. 3/ The BAP Credit and Guaranty Corporation has a lending rate for the credit NGOs based on the 91 day Treasury bill rate plus 1%-. During this period of financial crisis, the lending rate has been increased to the 91 day Treasury bill rate plus 4%. - 6-