Philippines - Private Enterprise Credit Support Project

Report No. PID6731 Project Name Philippines-Private Enterprise Credit(+) . Support Project Region East Asia and Pacific Project ID PHPE57624 Borrower Development Bank of the Philippines (DBP) Implementing Agency Development Bank of the Philippines (DBP) Pre-appraisal Date May 18, 1998 Projected Board Date October 13, 1998 Date of this PID June 29, 1998 Background 1. During the four years before the recent financial crisis of East Asia, the Philippine economy benefited from a decade of structural adjustment that had focused economic policies on trade liberalization and increased domestic competition, privatization, and greater private management and investment in infrastructure. Favorable investor reaction to these changes induced significant increases in private investment and capital inflows contributing to higher growth. Even the impact of financial market turbulence on economic activity was restrained in 1997: real GNP growth slowed to 5.8 percent from 6.9 percent in 1996 but export growth accelerated to 23 percent; and the increase in inflation was modest. Nonetheless, a sharper slowdown is anticipated for 1998 as credit conditions tighten, private investment becomes more restrained, and public expenditures remain constrained by the ongoing effort to contain the deterioration in the consolidated public sector financial position. 2. The financial sector in the Philippines has experienced major reforms in the last decade which have contributed to its overall sound development. However, weaknesses still remain in the regulatory and supervisory environment and these are being addressed by the government. Another area requiring significant attention is the mobilization of long-term resources and the management of banks' assets and liabilities. The Bank Group, ADB, and some bi- lateral agencies have been assisting the Philippines in developing long-term financial instruments through development of securitization/Peso bond market, establishment of a new credit rating agency, drafting of the new Securities Law, and provision of long-term funds to the financial institutions. While the results of these efforts will take time to materialize, the current financial crisis has caused a major setback to medium- and long-term financing. This has impacted fresh investment and the operations of industrial enterprises, and small and medium enterprises (SMEs) in particular. Project Objectives and Description 3. The proposed project will augment long-term resources of DBP and, in turn, of banks with the main objectives of assisting private sector enterprises, particularly small- and medium-sized enterprises. It will, thus, implement the expansion and modernization plans of these enterprises, undertake new projects, and finance permanent working capital requirements. The enterprises would, thus, be able to alleviate their operational and  financial problems arising from the credit crunch and currency crisis and to take advantage of new opportunities created by recent economic developments. 4. The project will assist in further institutional strengthening of DBP which will ultimately enable it to raise all required resources independently (without government guarantee) and hedge foreign currency risks without government assistance. It will require the application of capital adequacy ratios and best financial management practices in DBP. DBP will further analyze its future role and corporate structure and prepare a detailed and time bound action plan for implementation of its institutional strategy. In addition, DBP will strengthen its treasury functions through the use of modern computer hardware and software for information management and analysis. 5. The project will include a credit line for DBP, tentatively set at $148 million, which will be part of its wholesale operations. DBP will onlend the loan proceeds to accredited participating financial institutions (PFIs) who will, in turn, lend to eligible enterprises at market rates. The main focus of the project will be on the industrial sector but viable private sector projects in land transport, power and other utilities, telecommunication, and storage will also be eligible for assistance. Those enterprises which require regulatory and/or other non-financial support/adjustment, will not be financed until such changes have been implemented or made a part of subproject conditionality. Project Finance 6. Under the line of credit component, the cost of project will be the aggregate of cost of individual subprojects which will be estimated by PFIs during their appraisal. The Bank loan will finance normally the foreign cost of subprojects and the remaining cost will be financed through PFIs' lending from own sources and subborrowers' internal funds. A firm cost and financing plan for this main component of the project can not be prepared during project preparation stage though it is tentatively estimated that, on the basis of the previous loan for DBP, the total cost would be $312.5 million of which $148 million would be financed under the proposed Bank loan. 7. The cost involved in DBP's further institution-building will mainly relate to the import of hardware and software for treasury operations, staff training, in-depth financial review, and preparation of a scheme for foreign currency risk management. The total cost of this component is estimated at $2.5 million of which $2 million will be financed through the proposed Bank loan. Project Implementation 8. The project will basically have similar institutional and implementation arrangements as under the last and very successful Industrial Restructuring Project (IRP) of DBP financed by the Bank (Loan No. 3287-PH). DBP will act as the wholesale bank and will onlend to accredited participating financial institutions (PFIs) for lending to sub-borrowers according to an agreed criteria. IRP was utilized by 34 PFIs and the lending was evenly spread over the banks. The proposed loan will also be available to all banks which will meet the accreditation criteria agreed with the Bank. The Wholesale Banking Department of DBP will be responsible for overall project implementation. Coordination with Other Donor Assistance - 2-  9. The Bank Group's strategy for the Philippines aims to improve private business environment and to enhance the country's international competitiveness through, inter alia, strengthening and deepening the financial system. The Bank Group has been coordinating with other multi-lateral and bi- lateral agencies that are assisting the financial and industrial sectors, to achieve the above objective. IFC has provided lines of credit to the Far East Bank & Trust Company. ADB has provided lines of credit and technical assistance for the development of capital market. It is now considering another credit line for DBP for onlending to small infrastructure projects. DBP has also been a recipient of credit lines from OECF, KfW, and JEXIM. Lessons from Previous Bank Operations 10. The Operations Evaluation Department (OED) of the World Bank[Note: Lessons learned from completed and ongoing projects financed by the Bank and other development agencies.] has completed recently its Country Assistance Review (CAR) for the Philippines. It has concluded that the overall impact of the Bank's financial assistance has been highly satisfactory. Domestic financial markets have become considerably stronger, deeper, and more regulated since the crisis of mid-1980s. Along with the Bank, the Government deserves high credit for its strong commitment, decisive action , and exemplary leadership. OED has, however, pointed out that the financial sector in the Philippines still needs further deepening and strengthening. In particular, the regulatory and supervisory regime has to be improved. As regards the Bank's assistance to SMEs, OED has described it "an effective credit allocation program, but a modest job-generating one". OED has recommended that the Bank's future country assistance strategy should, inter alia, include financial intermediary loans. Under the right macroeconomic and institutional environment, as is expected to remain the case in the Philippines, there is a useful role for the Bank in supplementing the supply of private (mostly short and medium-term) credit with long-term funds. 11. The Implementation Completion Report (ICR) on IRP, prepared in July 1995, had noted three main lessons: (a) efforts should be directed to develop the private sector, (b) the Government should have a firm commitment to create conducive policy environment, and (c) development financial institutions (DFIs) should give more attention to environmental protection in their operations. 12. The proposed project is consistent with the recommendations of OED and also takes into account the lessons from IRP. The Bank loan proceeds will be used by private sector only. As OED's report has stated, the Government has an impressive record of creating a conducive policy environment and is fully committed to this objective. PFIs under IRP have complied with the country's legislation and guidelines on pollution control and similar assurances will be obtained under the proposed loan. Benefits 13. The current financial crisis has slowed down the enterprise restructuring and working capital shortages have hindered full capacity utilization. It is affecting the competitiveness of enterprises. Besides, more than 40,000 workers have be laid off during the first four months of 1998 in the formal sector. Unemployment is likely to rise, reversing recent declines, on account of layoffs in the corporate sector and slower job creation following the slowdown of growth. The proposed loan will assist the enterprises to -3 -  restructure and to meet their permanent working capital needs and, thus, to minimize the negative impact of the financial crisis on their operational performance and employment situation. Enterprises will also be able to improve their efficiency and productivity, and, thus, maintain/enhance their global competitiveness. DBP's institutional development will enable to develop into a more market-responsive and sound bank. Finally, the lending under the line of credit will help to restore the confidence of both local and foreign investors and would serve as a catalyst for further long-term domestic and foreign investment. Risks 14. The project has three main risks: First, the Government may back track or slow down on its strategy to develop financial and private sectors and to promote private financing of economic activities. This risk is, however, minimal considering the impressive record of the Government in carrying out reforms and its continued commitment to stronger and deeper reforms in future. Second, the financial crisis in East Asia may worsen with catastrophic effects on the Philippine economy. As a result, the banks may run into serious financial problems and, on the other hand, enterprises defer their plans for further investment. This risk is also not very serious because it is believed that the worst is already over for most of the countries in the region and the Philippine economy should be back to normal within two years. Third, the Government may restrict DBP's autonomy and interfere in its investment decisions. This would be inconsistent with the measures taken during DBP's rehabilitation during 1980s and the Government's non-interference policy followed in subsequent years. It should also be noted that investment decisions on subloans under the proposed credit line will be taken by PFIs and not DBP, though DBP will have the right to reject a subproject if it is not satisfied with it viability and creditworthiness. Program Objective Category 15. The program objective categories are financial and private sector development through the provisioning of long-term funds to private enterprises. Poverty Category 16. The proposed loan is not part of the World Bank's poverty category program. Environmental Aspects 17. In accordance with the Bank's Operational Directive on Environmental Assessment (OD 4.01, Annex. E), the proposed loan is placed in Category "B" involving intermediary lending. PFIs will ensure that all subprojects comply with applicable environment legislation in the Philippines. Generic EIAs developed by the Environment Management Bureau for the subsectors to be assisted under the project would be required for all new investments in those subsectors. In addition, PFIs's capacity to recognize and properly handle the environmental risks will be further developed through (i) the application of a standardized check list for individual subprojects during their appraisal, (ii) annual reporting to the Bank by DBP on its and PFIs' due diligence practices, and (iii) training of DBP and PFIs' staff. - 4 -  Contact Point: Zafar S. Khan, Task Manager The World Bank 1818 H Street, N.W. Washington, D.C. 20433 Telephone: (202) 458-2449 Fax: (202) 522-3454 E-mail: zkhan2@worldbank.org Philippines Contact: World Bank Aloysius Ordu, Sr. Operations Officer Telephone: (63-2) 917-3006 Fax: (63-2) 637-5870 E-mail: Aordu@worldbank.org Public Information Center World Bank 23rd. Floor, The Taipan Place Building Emerald Avenue, Ortigas Center Pasig City Manila, Philippines Telephone: (63-2) 917-3034 Fax: (63-2) 917-3050 E-mail: Ccabalang@worldbank.org Development Bank of the Philippines Ms. Marissa V. Soriano Assistant Vice-President International Resource Mobilization Department Development Bank of the Philippines Makati City Metro Manila, Philippines Telephone: (63-2) 818-9511 Fax: (63-2) 815-1611 Note: This is information on an evolving project. Certain activities and/or components may not be included in the final project. Processed by the InfoShop week ending August 14, 1998. - 5 -  Annex The environmental assessment will be done for individual subprojects by PFIs during project implementation under the supervision and guidance of DBP. DBP had implemented a Training and Technical Assistance grant of SEK10.5 million for strengthening the institutional infrastructure for environmental protection as part of IRP. DBP is quite strong in this area and has closely supervised and guided PFIs during the implementation of IRP. It will play the same role under the proposed project. Each subproject shall comply with applicable laws and regulations of the Philippines governing environmental protection. To achieve this, subproject appraisal requirements by PFIs shall include a pollution control plan approved by the Department of Environmental and Natural Resources. The Bank proposes to make this project as a model for financial intermediary operations for environmental protection purposes. Consequently, PFIs' capacity to recognize and properly handle the environmental risks will be further developed through: (i) review of generic EIA outlines prepared by the Environmental Management Bureau in the Philippines by the Bank, (ii) application of IFC's checklist during subproject appraisal and a format for an annual report by DBP on its and PFIs' due diligence practices to be submitted to the Bank, and (iii) training of DBP and PFIs' staff under a regional program to be offered by IFC in early 1999. -6 -