Malawi - Financial Sector and Enterprise Development Project

The World Bank FOR OFFICIAL USE ONLY Report No. 19549 IMPLEMENTATION COMPLETIQN REPORT REPUBLIC OF MALAWI FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (Credit 2221-MAI) June 30, 1999 Private Sector Finance Group Africa Region This document has a restricted distribution and may be used by recipients only in the perfornance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit: Malawi Kwarha(MK) US$ 1 = MK 2.65 (Exchange rate of January 1991) US$ I = MK 43.23 (Exchange rate of June 1999) WEIGHTS AND MEASURES Metric system FISCAL YEAR OF BORROWER April I - March 31 ABBREVIATIONS AND ACRONYMS DCA Development Credit Agreement FIAS Foreign Investment Advisory Service ICR Implementation Completion Report IDA International Development Association INDEBANK Investment and Development Bank of Malawi LFC Leasing and Finance Company of Malawi MDC Malawi Development Corporation MIPA Malawi Investment Promotion Agency MOP Memorandum of the President MPTC Malawi Post & Telecommunications Company MSB Malawi Savings Bank NBFI Non-banking Financial Institutions PFI Participating Financial Intermediaries POSB Post Office Savings Bank RBM Reserve Bank of Malawi SDR Special Drawing Rights SME Small and Medium Scale Enterprises ,,#E ,i, i E f iiR iE ............... E iEREE i F iD iSE iTE,fj iER iDiR .................-...............................- ................. ........ .,.,,,.,,.... CuryDirector Baraa ::Kafka, AF ::!! -~~~~~.. .geX m : :::.-T:, t :. ;S :. -:,- ;-: : >....... .. ............ .......... ..............................,..,..:: . ......-- .- .. ...... e m -. "'at i L- t ! tii.tEe - -. S- - ---d f 6bi E - -i :-/ o r t ...... . :i. i :gE.T .2E.iEG)i2.wEz+EiAF1SS - i- T.al uemLad: (av aa,AFTPI TaskTe~m~ Elftha W. il.ia.ms..... AF.T.. ,.,+,,,,~~~~~~~~~~~~~~~~fh I,^, ,S.1 . , g,.... gi .wF-ssl at^u  REPUBLIC OF MALAWI FOR OFFICIAL USE ONLY FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (Credit 2221-MAI) IMPLEMENTATION COMPLETION REPORT TABLE OF CONTENTS Page No. Preface ............................................. i Evaluation Summary ................ ..................... ii PART I -- PROJECT IMPLEMENTATION ASSESSMENT ................ 1 A. Background .........I... I B. Statement/Evaluation of Project Objectives ................... 2 C. Achievement of Project Objectives ....................... 3 D. Implementation Record and Major Factors Affecting the Project. ........ 8 E. Project Sustainability. 9 F. Bank Performance .10 G. Borrower Performance ..10 H. Assessment of Outcome ..10 1. Future Operation ............................11 J. Key Lessons Learned ........................ .....11 PART II -- STATISTICAL TABLES .13 Table 1 : Summary of Assessments .13 Table 2 Related Bank Loans/Credits ..................... 14 Table 3 Project Timetable .15 Table 4 Credit Disbursements: Cumulative Estimated and Actual .15 Table 5 : Key Indicators for Project Implementation and Operation .. . 15 Table 6-A Project Costs .16 Table 6-B Project Financing ........................... 16 Table 6-C: Institutional capacity Building Costs ................. 16 Table7: Economic Analysis ........................ 17 Table 8 : Status of Legal Covenants ....................... 18 Table 9: Bank Resources: Staff Inputs ..................... 29 Table 10: Bank Resources: Staff Missions ................... 29 APPENDICES A. ICR Mission's Aide-Memoire B. Borrower's Contribution to the ICR C. Characteristics of Sub-Loans D. Investment Projections of Projects Assisted by Malawi Investment Promotion Agency (MIPA) 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.  ii REPUBLIC OF MALAWI FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (Credit 2221-MAI) IMPLEMENTATION COMPLETION REPORT EVALUATION SUMMARY Background The Financial Sector and Enterprise Development Project was prepared at a time when Malawi was implementing a comprehensive reform program. The system of rigid and direct controls of the 1980s was being transformed to a more robust, market-oriented economic strategy aimed at poverty alleviation, improved fiscal and monetary management and enhanced structural reforms to, inter alia, strengthen the financial sector and develop the private sector. The Project was the result of extensive preparatory work, which included an Industrial Sector Memorandum, a Financial Sector Review and, in 1990, a FIAS diagnostic review of Malawi's investment climate. Reforms in the financial sector were expected to focus on a market-oriented system of monetary policy management and enhancing competition by allowing new financial institutions to enter the market and by licensing existing institutions to broaden the scope of their activities. Reforms in the industrial sector were expected to focus on: encouraging new investment especially in export- oriented industries; developing the institutional framework for investment promotion; and focusing Government policies on promoting development of Small and Medium Enterprises. Project Objectives The objectives of the project were to support Government efforts to expand exports and improve the policy and institutional framework relevant to private sector investment. These objectives would be achieved by: (a) encouraging the commercial banks and non-bank financial intermediaries to engage in term financing of viable enterprises in the productive sectors, including SMEs and enterprises owned by women; (b) improving the institutional framework for export finance and investment promotion, including support for a proposed investment promotion agency, and an industrial infrastructure and factory shell development program; (c) supporting the strengthening and operational diversification of financial institutions; and (d) improving monetary policy management. The project consisted of three components to achieve these objectives: investment finance component; industrial estates component; and institutional capacity development component. The investment finance component was under-designed with regard to financial management systems and procedures. The industrial estates component was undesigned and some key sub- components under the institutional capacity component were also undesigned or not sufficiently designed.  iii Implementation Experience and Results The investment finance component succeeded in getting financial institutions to undertake term financing to firms in the productive sectors as well as in generating additional investment from the firms and other co-financiers. The Project financed 152 sub-loans to 126 firms, through four financial intermediaries: the Investment and Development Bank of Malawi (INDEBANK), the Malawi Development Corporation (MDC), the Leasing and Finance Company of Malawi (LFC) and the National Bank of Malawi (NBM). Sub-loan amounts ranged from MK 7,900 to MK 20.0 million. INDEBANK sub-loans represented 42 percent of the IDA Investment Credit, followed by LFC with 33 percent and MDC with 24 percent. In terms of sector distribution, the largest share of the total investment and number of sub-loans was in the manufacturing sector, representing 52 percent of the total, with services and transport representing 15 percent each respectively. Achievement of project objectives - especially with regard to the investment finance component - was impacted by three major exogenous factors (political transformation, droughts and economic management) which had a serious impact on achievement of objectives. The political transition changed the country from 30 years of one-party rule to a multiparty democracy; in 1992, there was withdrawal of donor support for non-humanitarian assistance and re-imposition of exchange rate and other controls. This was exacerbated by the most severe drought in thirty years. In 1994, there was deterioration of fiscal discipline during the months leading to the elections as a result of expenditures related to a referendum and elections as well as a firther drought. The Malawi kwacha depreciated by 70 per cent and continued to decline further thereafter while inflation accelerated to 83 per cent in 1995. All of these further undermined the investment climate macroeconomic stabilization process. The uncertainty associated with political change translated into sagging private sector confidence and a "wait-and-see" attitude of private investors. Finally, between mid-1997 and mid-1998 (the end of the project), there was once again deterioration of fiscal discipline, reduction in prices for the major export crop (tobacco) and significant adjustment in the exchange rate. The private sector was, hence, subject to the several economic "shocks" and, at project end, there were significant levels of arrears - measured both as arrears from firms to the PFIs and from the PFIs to the RBM. Hence, while the component was partially successful in achieving its objectives with regard to expanding term financing, the arrears raise concems regarding the sustainability of the results. The macro-economic factors affecting the project were further exacerbated by implementation shortcomings including: (a) the Reserve Bank of Malawi's (RBM) inability to manage and monitor the investment credit; and (b) poor financial management, weak overall project accounting and audit deficiencies resulting in part from the absence of a project implementation unit to coordinate project activities and serve as an interface between IDA and the multiple project counterparts. The industrial sites component expenditures were considerably reduced through re- allocation to other components (from US$7 million to around US$0.5 million) and as a result it is considered as having achieved its objectives in only a negligible manner. The capacity building component is considered to have partially achieved development objectives. Certain activities were completed in a satisfactory manner (e.g. improvement in the institutional framework for investment promotion through the creation of the Malawi Investment Promotion Agency (MIPA) and technical assistance and training for RBM) while in the case of other components, it is  iv difficult to make further judgements regarding the developmental impact in the absence of detailed impact evaluations (e.g. the SME sub-component). The sustainability of the Project is unlikely primarily because the sustainability of the Investment Credit Component - which is the largest component - is rated as unlikely. The sustainability of the underlying investments in 152 projects in the agriculture, manufacturing and, service and commercial sectors is uncertain; the current high levels of arrears on sub-loans raise serious but unanswered questions regarding viability. The arrears from the firms to the PFIs suggests that either the investments are not financially viable at the firm level or if they are viable, there is either a short-term liquidity problem or willful non-payment. At the level of the PFIs, the project sustainability is judged to be unlikely since as funds from the line of credit become depleted through devaluation/inflation and non-repayment, there has been no significant increase of alternative sources of term savings in the economy. As far as the capacity building component is concerned, while support and technical assistance to MIPA and to the banks have been beneficial, for other sub-components, such as the SME Support Fund, it is more difficult to assess their sustainability and developmental impact. Summary of Findings, Future Operations and Key Lessons Learned Project objectives are assessed to have been achieved only partially but the project is rated as unsatisfactory primarily because it is rated as unsustainable. The agenda initiated under the project has continued to be part of the structural adjustment program and the associated First and Second Fiscal Restructuring and Deregulation Projects. The transformation of the financial sector continues with the Government committing itself to more competition and withdrawing itself directly and indirectly from the existing financial institutions. The focus on private sector development activities under FRDP I and II has been threefold: addressing infrastructure constraints, continuing focus on privatization especially of agriculture and related activities; and addressing constricting regulations especially in the area of temporary employment permits. The Government is also in the process of preparing a Private Sector Development Project. The focus of project preparation will be initially on assessing competitiveness of major sectors of the economy and addressing the key constraints based on this analysis. Hence, it is likely that the unfinished agenda under this project (factory shells, industrial estates, export financing) may be addressed by the future operation although at this initial stage of project preparation it is unclear which precise activities would be included. The following are some of the lessons learned from this operation which should help in the preparation of future similar projects: * instability in the macro-economic environment has a substantial impact on financial intermediary lending. Where such instability arises after the commencement of project implementation, there is a self-correcting mechanism built into the line of credit since demand for credit slows down due to higher interest rates and lower demand for products. However, where there is frequent volatility in the macro environment, the Bank needs to work with the Borrower in assessing the impact on the private sector and, if appropriate, finding a mutually agreed method of scaling down or terminating the line of credit; * sustainability of a term lending operation requires that the project design should explicitly address issues of medium-term savings in the domestic economy;  v * project appraisal needs to address design issues at the component level and in the case of multi-component projects, linkages across components. Specific assessments should be undertaken - as are now routinely required - of the Borrower's institutional and implementation capacity. Project covenants - especially with regard to prior review - should be based on this appraisal of Borrower capacity. Further, project administration, financial management and procurement procedures need to be explicitly documented in a Project Inplementation Plan; and * in the case of financial intermediation operations, monitoring indicators should include, in addition to the financial viability of the sub-projects, the viability of the institutions (PFIs and firns).  REPUBLIC OF MALAWI FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (Credit 2221-MAI) IMPLEMENTATION COMPLETION REPORT PART I -- PROJECT IMPLEMENTATION ASSESSMENT A. BACKGROUND 1. The Financial Sector and Enterprise Development Project (the Project) was prepared at a time when Malawi was implementing a comprehensive reform program. The system of rigid and direct controls of the 1980s was being transformed to a more robust, market-oriented economic strategy aimed at poverty alleviation, improved fiscal and monetary management and enhanced structural reforms to, inter alia, strengthen the financial sector and develop the private sector. The Project was the result of extensive preparatory work, which included an Industrial Sector Memorandum, a Financial Sector Review and, in 1990, a FIAS diagnostic review of Malawi' s investment climate. 2. Financial Sector. At the time of project appraisal, commercial banks extended little or no term financing and did not service the Small and Medium Scale Enterprise sector (SME) because of high administrative costs and the perceived high risk associated with SME clients. The insurance companies and the Post Office Savings Bank (POSB), the main mobilizers of term savings, were obliged to invest in Government securities. Finally, the Investment and Development Bank of Malawi (INDEBANK) and the Malawi Development Corporation (MDC) depended almost exclusively on external borrowing to fund their lending activities and the other Non-Banking Financial Institutions (NBFIs), that potentially represented the most innovative part of the financial market, were constrained by the lack of adequate term resources and economic regulations. Reforms in the financial sector were expected to focus on a market-oriented system of monetary policy management and enhancing competition by allowing new financial institutions to enter the market , by licensing existing institutions to broaden the scope of their activities and by enhancing the macro economic conditions to allow savings mobilization and term transformation. 3. Private Sector. At the time of project appraisal, the private sector in Malawi was highly concentrated in output and ownership; constrained by high transportation costs especially resulting from closure of Mozambique trade routes and local transportation monopolies; and considered to have a high efficiency in value added generated and good growth prospects in exportable products. Reforms in the industrial sector were contained in an Investment Policy Statement and were expected to focus on: (a) encouraging new investment by reducing the level and dispersion of protection and simplifying import and export licensing requirements; reducing delays in licensing and company formation; easing foreign exchange administrative procedures; streamlining procedures for access to industrial land; and ensuring timely availability of ready- made factory shells for potential investors; (b) encouraging export-oriented investment in non- traditional export products; (c) developing the institutional framework for investment promotion;  2 and (d) focusing Government policies on promoting development of Small and Medium Enterprises (SMEs). B. STATEMENT/EVALUATION OF PROJECT OBJECTIVES 4. The objectives of the project were to support Government efforts to expand exports and improve the policy and institutional framework relevant to private sector investment. These objectives would be achieved by: (a) encouraging the commercial banks and non-bank financial intermediaries to engage in term financing of viable enterprises in the productive sectors, including SMEs and enterprises owned by women; (b) improving the institutional framework for export finance and investment promotion, including support for a proposed investment promotion agency, and an industrial infrastructure and factory shell development program; (c) supporting the strengthening and operational diversification of financial institutions; and (d) improving monetaly policy management. 5. The Project, which involved $32.0 million equivalent (SDR 22.0 million), consisted of the following three components: (a) an Investment Finance Component ($20.4 m.) to provide term finance to projects in productive sectors promoted by foreign and indigenous private sector entrepreneurs, including SMEs and businesses owned and operated by women; (b) an industrial sites component ($7.0 m.) to provide industrial infrastructure to industrial sites and factory shells to facilitate investment by indigenous enterprises and foreign investors, especially those investing in export-oriented activities; and (c) a multi-faceted institutional capacity development component ($4.6 m.) to support implementation of the reform program in the financial and industrial sectors. Activities supported by this component would include staff training for participating financial intermediaries and SME support institutions; strengthening Reserve Bank of Malawi's (RBM) capacity to manage monetary policy; investment promotion; and supporting and deepening of the financial sector by helping with the diversification and re-orientation of several financial institutions. 6. Project objectives were too ambitious, particularly given the Government's implementation capacity. Furthermore, the project objectives were not well integrated with each other, a critical factor, given the large number of components included in the Project. 7. The Project was prepared during a period of time when there was an extensive discussion ongoing within the Bank on financial sector policies and operations which eventually resulted in a widely disseminated report in 1991 and an Operational Directive (8.30) in 1992. h line with this evolving thinking, the project departed from previous interventions for term financing in Malawi which allocated term financing to separate sectors through specialized financial institutions at different interest rates, terms and conditions. Instead, the Project used the apex approach which resulted in: consolidation of IDA's term lending in Malawi for all productive sectors; and utilization of multiple financial intermediaries. Similarly, there was emphasis on moving towards a market based structure of interest rates by utilizing a reference lending rate which was calculated  3 as an average of all prevailing interest rates on long-term deposits in commercial banks. However, despite these movements towards potential changes in Bank policies, the project design did not deal with a key issue of sustainability i.e. increasing the supply of long-term domestic savings so that the financing gap met during the project period by the line of credit would be reduced by the project end. C. ACHIEVEMENT OF PROJECT OBJECTIVES 8. Context. Achievement of project objectives - especially with regard to the investment finance component - was impacted by three major exogenous factors (political transformation, droughts and economic management) which had a serious impact on achievement of objectives. The political transition changed the country from 30 years of one-party rule to a multiparty democracy; in 1992, there was withdrawal of donor support for non-humanitarian assistance and re-imposition of exchange rate and other controls. This was exacerbated by the most severe drought in thirty years. In 1994, there was deterioration of fiscal discipline during the months leading to the elections as a result of expenditures related to a referendum and elections as well as a further drought. The Malawi kwacha depreciated by 70 per cent and continued to decline thereafter while inflation accelerated to 83 per cent in 1995. All of these also further undermined the investment climate. The uncertainty associated with political change translated into sagging private sector confidence and a "wait-and-see" attitude of private investors. Finally, between mid- 1997 and mid-1998 (the end of the project), there was once again deterioration of fiscal discipline, reduction in prices for the major export crop (tobacco) and significant adjustment in the exchange rate. The effects can be seen through the movements in the exchange rate and the Consumer Price Index: (a) Between project appraisal in 1991 and project completion in 1998, the Malawi Kwacha devalued from 2.65 to 25.7 per US$1. There were several devaluations with the most significant movements in exchange rates occuring in 1992/93 when the kwacha went from 2.65 to 4.5, during 1994 when it went from 5 to up to 15 and between July 1997 to end June 1998 when it went from 15 to 25.7. (b) During the years of project implementation - 1992 through 1998 - the average Consumer Price Index increased over the previous year's average by 13%, 23%, 20%, 83%, 38%, 9% (estimated) and 16% (estimated). 9. The investment finance component succeeded in getting financial institutions to undertake term financing to firms in the productive sectors as well as in generating additional investment from the firns and other co-financiers. These firms were, however, subject to the several economic "shocks" described above and, at project end, there were significant levels of arrears - measured both as arrears from firms to the PFIs and from the PFIs to the RBM. Hence, while the component was partially successful in achieving its objectives with regard to expanding term financing, the arrears raise concerns regarding the sustainability of the results which are discussed in the relevant section (Section E). Given the reduction in funds expended under the industrial sites component as a result of re-allocation to other components, this is considered as having achieved its objectives in only a negligible manner. The capacity building component is considered to have partially achieved development objectives. Certain activities were completed in a satisfactory manner (e.g. improvement in the institutional framework for investment  4 promotion through the creation of the Malawi Investment Promotion Agency (MIPA) and technical assistance and training for RBM) while in the case of other components, it is difficult to make furtherjudgements regarding the developmental impact in the absence of detailed impact evaluations (e.g. the SME sub-component). Project objectives are, hence, assessed to have been achieved only partially. The component-by-component evaluation is provided below. Investment Finance Component 10. The objective of this component was to make IDA funds available to eligible financial intermediaries through an apex arrangement at RBM. The PFIs would on-lend these funds to viable enterprises to finance investment in productive activities through normal term financing mechanisms such as leasing, equity finance and term loans. The sub-projects would range from small to large scale and from private to public, foreign or Malawian or mixed ownership. Initially, no one financial intermediary would have access to more than 20 percent of the total funds under this component, although this ceiling would be reviewed regularly. The PFIs bore the credit risk for the full value of the sub-loan and were thus the ones responsible for assessing the sub- borrowers' creditworthiness. The interest rate charged by RBM to the PFIs was a reference rate, calculated quarterly by RBM, based on a simple average of all prevailing interest rates on long- term deposits in commercial banks. The component was under-designed especially with regard to: the financial management system in the APEX unit which would be utilized in monitoring disbursements made at a sub-loan level; criteria for putting sub-loans into non-accrual status; and impact monitoring at the APEX unit and by PFIs. 11. By project completion, an equivalent of US$ 25.3 million was disbursed through four PFIs: INDEBANK, MDC, the Leasing and Finance Corporation (LFC) and the National Bank of Malawi (NBM). Highlights of the sub-projects financed include: (a) 152 sub-loans were extended to 126 firms ranging in amounts from MK 7,900 to MK 20.0 million; (b) sub-projects financed by LFC represented 70 percent of the totality of firms but only 33 per cent of the IDA credit amount. INDEBANK sub-loans represented 42 percent of the credit amount and MDC - 24 percent (see Graph I and Appendix B). NBM financed only one sub-loan equivalent to about $180,000; (c) in terms of sector distribution, the largest share was in the manufacturing sector (52 percent) with services and transport representing 15 percent each respectively (see Graph 2). (d) Sub-projects financed by MDC and INDEBANK created 4,296 jobs at an average investment cost perjob of US $9,595. 1 LFC could not provide relevant information.  5 Distribution of INDEBANK, MDC and LFC Sub-loans Graph I Graph 2 Sub-loan Distribution by PFI Sub-loan Distribution by Sector 15% 3% Agrihin 15% ~~0 Manufating 33% 0 Services 42% 1Tracing *Tra'mport _ %J MINDEBANK 520h 24% *MDC o LFC 12. The demand for term financing was high and by the Project Mid-Term Review in 1996, an additional $6.0 million had been re-allocated to the Investment Finance Component from the Industrial Sites Component, which was not disbursing. In a subsequent effort to satisfy this demand for financing, it was also agreed to recycle loan recoveries received by the Apex Unit (principal and interest). 13. Impact Assessment at Firm Level. The project monitoring system was very weak and did not continuously track the indicators of the investment finance component which could be used as benchmarks to measure the achievement of the objectives. There was lack of data from all the PFIs which made it difficult to make a quantitative assessment of the current profitability of all the finns. An impact assessment, though not completely adequate, was undertaken during the Mid-Term Review of the project. RBM agreed to carry out a detailed assessment in cooperation with the Ministry of Finance at the end of the project. This was not completed by the time of writing the ICR; the Government's contribution to the ICR provides percentage changes in some indicators but this is not sufficient for a thorough analysis. An additional study - including a survey - being undertaken by IDA and the Government on the impact of the adjustment program on the manufacturing sector is underway at this time and also not completed by the time of the writing of this ICR. 14. For purposes of the ICR, the task team analyzed progress reports provided by INDEBANK for a sample of seventeen fimns. The conclusions are overall mixed. The main financial information available is as to whether the firms had been servicing their debt or not, giving little information about overall perfornance. Once the sub-loan was paid in full, no further (and more recent) financial data was collected. Firms in the sample experienced severe economic and financial difficulties during the mid-1990s since as a result of the devaluation of the Kwacha and the increased inflation - as discussed earlier - there were resulting increases in interest rates. As of June 1998, about half of the seventeen firms in the sample were still facing financial, operational and management difficulties. 15. Impact Assessment at PFI level. During project implementation, record-keeping, accounting and financial reporting on the Investnent Credit (and Industrial Sites) components progressively deteriorated. In May 1998, during the ICR mission, the IDA team was informed that PFIs had significant overdue repayments to the RBM; these had been reported earlier as being  6 up to date in payments. Based on infornation provided by INDEBANK, LFC and MDC, as of mid-1998, arrears represented 30 percent, 44 percent and 87 percent of the IDA sub-loan portfolio, respectively. About 53 percent of all sub-loans, as of June 1998, were in arrears. Infonnation contained in the Government's contribution which shows overdue interest as of April 1999 would appear to confirm that this situation remains. 2 16. The Financial Sector. In terms of increasing sustainability in the term finance segment of the financial sector, the results of this component are unsatisfactory. Overall, the component has not led to any discernible increase in the volume of privately generated and managed term finance in the economy. INDEBANK has been partially successful and has established a separate subsidiary (Indefinance) through which it is mobilizing funds on a commercial basis. MDC has not been able to develop long-term sources of local currency financing and is currently facing serious financial difficulties. Its performance has recently been deteriorating and its prudential standards compromised. While LFC has been able to mobilize deposits, it remains dependent on the IDA Credit facility for local currency term financing. Industrial Sites Component 17. The objective of this component was to provide financing to PFIs for on-lending to eligible developers of industrial sites and to ensure timely availability of infrastructure and factory shells to domestic and foreign investors, especially for export-oriented activities. The objectives of this component were only marginally achieved. This component was added on during project negotiations and was un-designed until the start of implementation. Given that no demand assessment was made during project preparation, the level of funding allocated to this component (US$7.0 million) was determined lO be too high especially given the time frame for implementation. 18. The key issue was access to land and the administrative barriers to acquiring land in developing the industrial estates; this issue still remains unresolved up to this date. Even assuming that this issue could have been satisfactorily resolved, the macro-economic enviromment from 1994 through 1996 would have made financing for this type of activity prohibitively expensive given the medium-term amortization period required for infrastructure projects and the alternative high retums available on Government Treasury Bills. Further, the Project design would have needed to address how the industrial estate would have coordinated satisfactory services to the estate from public utilities which were otherwise ineffective in the delivery of roads, water, sewer, telephone and electrical services. 19. Under the component, two factory shells were financed as was the development of the Maone Park, representing 13% of the amount available. The component was scaled down and the amount reduced from US$ 7.0 m. equivalent to US$0.5 m. Late in project implementation, Government institutions (MIPA and MDC) proposed to channel funding through the Ministry of Lands and Valuation for site upgrading in Lilongwe. IDA did not agree given the short period remaining under the Project. 2 The data is unclear as to the extent of principal also overdue.  7 Institutional Capacity Development Component 20. INDEBANK and MDC. The technical assistance and training provided for strengthening the managerial and institutional capacity of these two financial institutions was assessed to have achieved its objectives. 21. Malawi Savings Bank (MSB). The objective of this component, namely to convert the Post Office Savings Bank (POSB) into an independent, commercially-oriented financial institution and full-service savings bank, was not achieved. The Project financed a consultant to design this component during project implementation; the design is assessed as not having addressed the inherent difficulties in the mobilization of small-sized savings deposits on a cost- effective basis. The implementation of the component was also poor and contributed to the component's failure to achieve its objectives. A law was passed providing for the legal incorporation of the Malawi Savings Bank (MSB) but was not implemented because of lack of reconciliation of funds owed to MSB by Malawi Post and Telecommunications Company (MPTC). Further, agreement was not reached between Govemnment, RBM and MPTC on the proposed separation of deposit-taking operations of MSB from MPTC, including the designation of secured operating premises at select post offices. 22. Support to the RBM in Macro-economic Management. Initial support was provided for RBM staff in macro modeling. Funds were also provided in the drafting of Securities legislation and associated regulations. The sub-component is assessed as having achieved its objectives. 23. Export Credit Guarantee Scheme. This component was not sufficiently appraised although funds were allocated to this component for Technical Assistance, training and support in the establishment of operating policies and procedures of an export credit guarantee scheme. No funding was provided for the guarantee scheme itself. This sub-component was not implemented. 24. SME Support Fund. The objective of this component was to provide training to Small and Medium Scale Enterprises (SME) and to SME support institutions. There were two design deficiencies: first, project appraisal did not focus on whether in the overall sectoral context, technical training was the principal constraint facing SMEs; and second, the fund provided 100% support and the absence of a matching grant element makes it difficult to determine what the priorities should have been across institutions. Taking into account these constraints, implementation seems to have been reasonably successful. Indications are that 4,610 persons, consisting of both trainers and entrepreneurs, were trained in business-related subjects. Site visits and discussions with heads of professional associations and training institutes suggest that the benefits of the training provided have been significant. An evaluation of the achievement of objectives of the SME Fund, including an assessment of the impact of the training on the institutional capacity of organizations supported as well as on ultimate SME beneficiaries was repeatedly requested by IDA from the Borrower. This evaluation was never carried out. In the absence of such an assessment, it is difficult to make further judgements regarding the developmental impact of this component. 25. Support to MIPA. This component helped create MIPA, which is generally regarded as an effective organization. The component has also provided MIPA with extensive financial support in the form of operating costs, training and studies. MIPA's early achievements were limited mostly because of the unstable macro-economic environment and continuing difficulties  8 with the investment regime and with the country's infrastructure. However, it has now become a key player in investment promotion in Malawi and its capacity to provide assistance to investors is demonstrable. In addition to its investment promotion missions, MIPA has been active in assisting enterprises, including SMEs and has established a large database which is accessible to finns. It has also worked with other government agencies and ministries to reduce some of the investment barriers. Preliminary data provided by MIPA, indicate that MIPA has, so far, assisted over sixty enterprises, representing investments equivalent to US$ 198.0 million equivalent, and resulting in the creation of 6,347 jobs. Appendix D provides more details on MIPA's activities. D. IMPLEMENTATION RECORD AND MAJOR FACTORS AFFECTING THE PROJECT 26. As noted earlier, the macro-economic environment was unfavorable throughout the project. Despite the unfavorable environment, early project implementation progressed well, and disbursements were on target, although progress on individual components varied widely. Demand for the investment line of credit was periodically strong despite the unattractive business environment, drought and political uncertainty. However, some components such as the construction of the factory shells and assistance to SMEs experienced serious delays. 27. A mid-term review was carried out in October 1996. The Government prepared an assessment of the impact of the line of credit and of the main sub-projects - which up to that time - were still few in numbers. The information was, however, inadequate in being able to measure global increases in investment, employment and output attributed to the finns which benefited from the IDA line of credit. The Investment Credit Component was assessed as progressing satisfactorily, with full repayment by sub-borrowers to PFIs. Disbursements under the industrial sites component had been limited to two MDC factory shells and support of development at Maone Park with no demand found for this facility under the existing terms and conditions of the financing. Given the lack of progress of the Industrial Sites Component and the need to satisfy the demand for additional sub-projects under the investment component, an agreement was reached between IDA and the Governmentto amend the legal documents to reallocate US$ 5.5 million from the Industrial Sites Component, which was not disbursing, to the Investment Credit Component. Other legal amendments focused on providing greater operational flexibility to the PFIs by raising the threshold under which international competitive bidding for sub-projects would be required; and eliminating review of sub-projects by RBM, leaving the judgment of sub- project merit to the PFIs. 28. Conclusions of the Mid-term Review as they related to the Institutional Capacity Building Component included the following: (a) a recommendation that the management of the SME Fund carry out an evaluation of the achievements of objectives of the Fund, including the net impact of training provided on the institutional capacity of organizations trained and on the ultimate beneficiaries; and (b) that IDA would need to agree with the Government on a Business Plan for the restructuring of Malawi Savings Bank, before approval of further funding under the POSB Component,. The Bank expressed concern over the weak administration and record- keeping under the Project and suggested that the Ministry of Finance put in place corrective measures, to which the Government agreed in writing. These measures included: (a) undertaking a reconciliation of accounts to ensure consistency between the borrower's and IDA's records; (b) delineating clearer lines of responsibility for maintenance of updated commitment and disbursement infonmation for the Institutional Capacity Building Component; and (c) instituting a requirement under the Project that all subsequent approvals of non-objection requests are copied  9 to the relevant parties for them to update their record. The Mid-term Review also concluded that the technical assistance provided to INDEBANK and MDC had achieved its objective. 29. Deficiencies in record keeping and monitoring of project accounts were, early on, limited to the Ministiy of Finance, which was responsible for the institutional capacity component. Monitoring and supervision of the Investment Credit by the Apex Unit did not seem to present a particular problem at the time. As noted earlier, by project completion, however, there was a serious deterioration in the level of record-keeping maintained by the Apex Unit as well. Reporting documentation was out-of-date, incomplete, lacked adequate support documents and, in some cases was inaccurate. Furthermore, PFIs did not monitor regularly arrears, resulting in unhealthy increases as early as 1994. While some counterpart agencies, such as MIPA, kept relatively accurate and up-to-date records, other counterpart agencies did not, with little oversight and reconciliation by the Ministry. Since disbursements in the World Bank are recorded according to disbursement category and not according to sub-component, IDA could only monitor total use of funds and had to rely on the borrower's records for further details. 30. The macro-economic factors affecting the project were fiuther exacerbated by implementation shortcomings including: (a) the Reserve Bank of Malawi's (RBM) inability to manage and monitor the investment credit; and (b) poor financial management, weak overall project accounting and audit deficiencies resulting in part from the absence of a project implementation unit to coordinate project activities and serve as an interface between IDA and the multiple project counterparts. E. PROJECT SUSTAINABILITY 31. The sustainability of the Project is unlikely primarily because the sustainability of the Investment Credit Component - which is the largest component - is rated as unlikely. The sustainability of the underlying investments in 152 projects in the agriculture, manufacturing and, service and commercial sectors is uncertain; the current high levels of arrears on sub-loans raise serious but unanswered questions regarding viability. The arrears from the firms to the PFIs suggests that either the investments are not financially viable at the frm level or if they are viable, there is either a short-term liquidity problem or willful non-payment. At the level of the PFIs, the project sustainability is judged to be unlikely since as funds from the line of credit become depleted through devaluation/inflation and non-repayment, there has been no significant increase of alternative sources of term savings in the economy. As far as the capacity building component is concerned, while support and technical assistance to MIPA and to the banks have been beneficial, for other sub-components, such as the SME Support Fund, it is more difficult to assess their sustainability and developmental impact.  10 F. BANK PERFORMANCE 32. Bank performance during identification, preparation and appraisal was unsatisfactory. Appraisal was deficient as the objectives of the Project were too broad, several components were un-designed or under-designed and the numerous components were not well integrated. Furthennore, no evaluation benchmarks were identified during appraisal and no mechanisms were established to monitor the different project activities. The Bank did not adequately ensure that the Borrower had the capacity to coordinate project activities and the absence of a Project Implementation Unit meant that each counterpart agency was ultimately responsible for record keeping, financial management and procurement. 33. Bank supervision was satisfactory; it overcame design deficiencies and monitored implementation fairly well based on the data made available to it by the RBM Apex Unit and the PFIs. The limitations of the Bank's ability to supervise arose from: a high prior review threshold which limited the amount of information which was required to be sent to the Bank; and a deficient accounting and control system which did not capture sufficient information at the Borrower's level which could be subjected to post review. G. BORROWER PERFORMANCE 34. The Borrower's performance has, overall been unsatisfactory. With the exception of MIPA and the SME Fund sub-components which were managed relatively well, the performance of the other counterparts was unsatisfactory. The performance of RBM and the Apex Unit which was satisfactory initially became deficient during the last year and a half of project implementation not only in the management and monitoring of the Investment Credit Component but also in its compliance with legal covenants and audits (see Table 9 for details on compliance). High staff tumover in the Apex Unit created severe operational difficulties and lack of institutional memory and also contributed to the Unit's unsatisfactory performance. By project completion there was a serious deterioration in the record keeping, accounting and financial reporting of the Investment Credit and Industrial Sites components. H. ASSESSMENT OF OUTCOME 35. The overall outcome of the Project is unsatisfactory especially since sustainability is unlikely. 1. FUTURE OPERATION 36. The agenda initiated under the project has continued to be part of the structural adjustment program and the associated First and Second Fiscal Restructuring and Deregulation Projects (FY96 and FY99 respectively). The transformation of the financial sector continues with the Government committing itself to more competition and withdrawing itself directly and indirectly from the existing financial institutions. The Government has sold part of its shares (and MDC' s shares) in the National Bank of Malawi through a public offering. The Government is also undertaking a review to provide an adequate regulatory framework in the post-privatized financial sector. Finally, the Govermment is in the process of divesting its remaining shares in the  11 National Bank of Malawi and the Commercial Bank of Malawi. It should also be noted that Government shareholdings in some other institutions in the financial sector would be divested as part of the privatization program and that a number of the state owned enterprises in which MDC has made investments are also in the process of privatization. 37. The focus on private sector development activities under FRDP I and II has been threefold: first, addressing infrastructure constraints - the reform of the telecommunications sector, the planned divestiture of the telecommunications entity and the refonn and restructuring of the power sector are a central part of the agenda; second, there has been a continuing focus on privatization especially of agriculture and related activities to provide a focus for new investment in the economy; and finally, there has been continuing work to address constricting regulations especially in the area of temporary employment permits. 38. Finally, the Government is in the process of preparing a Private Sector Development Project. The focus of project preparation will be initially on assessing competitiveness of major sectors of the economy and addressing the key constraints based on this analysis. Hence, it is likely that the unfinished agenda under this project (factory shells, industrial estates, export financing) may be addressed by the future operation although at this initial stage of project preparation it is unclear which precise activities would be included. J. KEY LESSONS LEARNED 39. The following are some of the lessons learned from this operation which should help in the preparation of future similar projects: * instability in the macro-economic environment has a substantial impact on financial intermediary lending. Where such instability arises after the commencement of project implementation, there is a self-correcting mechanism built into the line of credit since demand for credit slows down due to higher interest rates and lower demand for products. However, where there is frequent volatility in the macro enviromment, the Bank needs to work with the Borrower in assessing the impact on the private sector and, if appropriate, finding a mutually agreed method of scaling down or terminating the line of credit; * project appraisal needs to address design issues at the component level and in the case of multi-component projects, linkages across components. Specific assessments should be undertaken - as are now routinely required - of the Borrower's institutional capacity. Project covenants - especially with regard to prior review - should be based on this appraisal of Borrower capacity. Further, project administration, financial management and procurement procedures need to be explicitly documented in a Project Implementation Plan; and * in the case of financial intermediation operations, monitoring indicators should include, in addition to the financial viability of the sub-projects, the viability of the institutions (PFIs and firms).  12 REPUBLIC OF MALAWI FINANCIAL SECTOR AND ENTERPRISE DEVELOPMENT PROJECT (Credit 2221-MAI) IMPLEMENTATION COMPLETION REPORT PART II -- STATISTICAL TABLES Table 1: Summary of Assessments A. Achievement of Objectives Substantial Partial Negligible Not Applicable Macroeconomics policies El O O 0 Sector policies O EZ O O Financial objectives O El 0 El Institutional development O El OO Physical objectives 0 O O 0 Poverty reduction O 0 0 0 Gender concerns 0 0 0 0 Other social objectives O O Cl 0 Environmental objectives 0 0 0 E Public sector management 0 O O El Private sector development 0 OE 0 0 B. Project sustainability Likely Unlikely Uncertain 0 0 0 C. Bank Perfornance Highly Satisfactory Satisfactory Deficient Identification O El E0 Preparation assistance 0 OE 0 Appraisal E E 0 Supervision O 0 EO D. Borrower Performance Highly Satisfactory Satisfactory Deficient Preparation 0 0 0 Implementation El 0 0 Covenant compliance 0 0 E0 Operation E E 0 E. Assessment of Outcome Highly Satisfactory Satisfactory Unsatisfactory Highly Unsatisfactory 0 0 0 0  13 Table 2: Related Bank Loans/Credits Loan/Credit Title Purpos Year of Status Approval Preceding Operations Industrial and Trade Adjustment Credit FY 88 Closed ITPAC * Improve policy environment for the (Credit 1920-MAI) manufacturing sector to increase efficiency of resource use, including imports and expand exports EDDRP Entrepreneurship Development and Drought FY 92 Closed (Cr. 2396-MAI) Recovery Program * improve the environment for entrepreneurial activity; * expand access to financial capital and deepen financial markets; + re-orient the fiscal and labor policy towards human capital development; and * import maize.  14 Table 3 Project Timetable Steps in Project Cycle Date Planned Date actual Initial Executive Project Summary 05/02/90 Appraisal 06/30/90 Negotiations 02/15/91 Board presentation 03/26/91 Signing 06/24/91 Effectiveness 08/29/91 Credit closing 06/30/97 06/30/98 Table 4: Credit Disbursements Cumulative Estimated and Actual * US$ million 1991 1992 1993 1994 1995 1996 1997 1998 1999 Appraisal 1.2 5.1 6.8 6.8 6.2 4.6 1.3 0.0 0.0 estimate Actual 3.3 2.2 4.0 5.4 2.7 3.0 8.7 0.9 0.0 Actua as