Burundi - Small Enterprise APEX Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7025-BU STAFF APPRAISAL REPORT BURUNDI SMALL ENTERPRISE APEX PROJECT February ^5, 1988 Industry and Energy Operations Division South-Central and Indian Ocean Department Africa Region This document has a restricted disbudion and may be used by recipients only in the performance of their officil duties. Its contents may not otherwise be disclosed witout World Bank authoraion.  CURRENCY EQUIVALENTS Currency Unit = Burundi Franc (FBU) US$1.00 . FBu 125 (June 1987) US$1.00 - FBu 114 (Annual Average 1986) US$1.00 ' FBu 105 (June 1985) GLOSSARY OF ABBREVIATIONS AGCD - Administration Generale de la Cooperation au Developpement BANCOBU - Banque Commerciale du Burundi BBA - Banque Belgo-Africaine BCB - Banque de Cridit de Bujumbura BNDE - Banque Nationale de Developpement Economique BRB - Banque de la Ripublique du Burundi CADEBU - Caisse d'Epargne de Burundi CAMOFI - Caisse de Mobilisation et de Financement CCCE - Caisse Centrale de Coopiration Economique CCI - Chambre de Commerce et de l'Industrie du Burundi CCP - Office des Cheques Postaux CCPF - Centre de Perfectionnement et de Formation CFTB - Centre de Formation Technique Bancaire du Burundi COOPEC - Cooperatives d'Epargne et de Credit CPI - Chambre de Promotion Industriel DEG - Deutsche Entwicklungsgesellschaft EIB - European Investment Bank FNG - Fonds National de Guarantie SBF - Societe Burundaise de Financement SIP - Societe Immobiliere Publique SOCABU - Societe d'Assurances du Burundi Societi Holding - Sociite Holding Arabe Libyen Burundais UNDP - United Nations Development Program UNIDO - United Nations Industrial Development Organization USAID - United States Agency for International Development GOVERNMENT OF BURUNDI FISCAL YEAR January 1 - December 31  FOR OFFICIAL US ONLY BURUNDI STAFF APPRAISAL REPORT SMALL ENTERPRISE APEX CREDIT CONTENTS Pane No. Credit and Project Summary .................. .... PART I - THE SECTORAL ENVIRONMENT .... .......... ......... ...... . 1 A. The Economic Setting ...**....*****..**.............. . ............ 1 B. The Small Scale Enterprise Sector ............... .......... 2 Importance and Characteristics ......................... 2 Formal SSE ...................... * 3 Informal SSE ... o***........................... .... 3 Artisan Sector ........ #.0 .... ,*06 . .~... 5 Government SSE Policies ......**.*0* ............*.... 5 Import Licensing ....... 0000* ........... *..*..... 6 Price Decontrol ............................... 6 Production Incentives .# ........... . .. . . .. . . . .. . . . . . 6 Tariff Reform .................6..................... 6 Investment Code ........ ....... .............0 ........... 7 The National Guarantee Fund ............ .......... 7 Promotion and Training Institutions ....... ............. 7 Ministry of Commerce and Industry (MCI) .............. 8 Industrial Promotion Center (CPI) ...... .............. 8 Chamber of Commerce and Industry of Burundi (CCI). *.. 8 Government Staff College (CPF) ............. .......... 9 C. The Financial Sector ......... ..... ....... ...........* .. ...... 9 Institutional Structure . ...... ......... . ,....... 9 The Central Bank (BRB) .................... O.. 10 The Commercial Banks ..........*.... *....*.. ,........ 11 The Development Banks ... ........... ............... 13 The Savings and Credit Cooperatives (COOPECs) ........ . 15 Iuterest Rates and Resource Mobilization ............... 15 Credit Policy .............. .. *...*..... .*.**... 17 Term Lending and SSEs: Need for the Proposed Credit.... 19 This report is based on the findings of an appraisal mission to Burundi in June-July 1987. The mission was composed of Messrs. Christian Schmidt and Andres Jaime of AF3IE and of Messrs. Jacob Levitsky and Roman Semkow, Consultants. This document has a restricted distribution and may be used by recipients only in the performance of their offlchl duties Its contents may not otherwise be disclsed without World fank authorintion.  - ii - Pate Nc. PART II - BANK GROUP SECTOR LENDING STRATEGY ........... ........ 20 PART III - THE PROJECT ..... ...........*....**.** .***......... 21 Project Objectives and Justification .. ................. 21 Lessons Learned from Previous SME Assistance Efforts ...2: Project Description .................... 22 Credit Component .. ............... .. . .. .. ..... . 22 Institutional Arrangements ............ ..........t 22 Eligible Intermediaries ............................. 23 Eligible Beneficiaries and Subprojects ....... ......... 24 Terms and Conditions of Financing .0..................... 25 Subloan Processing and Administration ............... 26 Assistance and Training Component ...................... 27 Design and Special Features .....aa................. 27 Entrepreneurship Development Program ................ 27 General SSE Assistance Training for Banks ........... 28 Estimated Cost of the Component's Various Programs ... 29 Terms and Conditions ........ ................ . 29 Project Management Unit ....... . ........ ...... .. ... . 30 Small Enterprise Bureau ..................... . 31 Project Cost and Financing ............................. 32 Project Implementation ...... ........ .................. . 32 Project Management .................................. 32 Procurement and Disbursement ........................ 32 Special Account ..................................... 34 Auditing and Reporting ... .... .............. ..... . 34 Project Benefits and Risks ............................. 34 Benefits .............................34 Risks .. .................................. 35 PART IV - AGREEMENTS AND UNDERSTANDINGS TO BE REACHED .......... 35 ANNEXES: I - Draft Participating Agreement .......................... 37 II - Appraisal Format ....................................... 45 III - Simplified Appraisal Format ...... ............ ....... .. . 50 IV - Supervision Format ............. **000...... .......................... 55  -iii - Page No. ANNEXESt (continued) V - Draft Agreements ........ .. ............................ 57 (a) Project Management Unit (Management Agreement) ..... 57 (b) Small Enterprise Bureau (Cooperation Agreement) .... 60 VI - Draft Terms of Reference for (a) SSE Technical Assistance ........................... 63 (b) Bank Seminars .......... .. .......................... 66 VII - Companies and Employment in the formal SSE Sector in 1986 .......... ................................... 68 VIII - Stratification of a formal SSE Sector sample by Employment ..................e********.****..* ...... 69 IX - Expenditure Pattern of Households and Demand Projection for Selected Consumer Goods ..... ........ ... 70 X - Central Bank Organization chart, 1987..... ............. 71 XI - List and Characteristics of Financial Institutions ..... 72 XII - Interest Rate Structure as of May 1, 1987 .............. 73 XIII - Distribution of Credit to the Economy by Term Structure. 75 XIV - Summary Balance Sheets of Commercial Banks ............. 76 XV - Summary Balance Sheets of BNDE & SBF ................... 77 XVI - Distribution of Bank Deposits by Category of Depositors. 79 XVII - Distribution of Bank Deposits by Sector and Term ....... 80 XVIII - Synopsis on Savings and Credit Cooperatives (COOPECs) ... 81 XVIX - Schedule of Disbursements .............................. 83  BURUNDI SMALL ENTERPRISE APEX PROJECT CREDIT AND PROJECT SUMMARY Borrowers Republic of Burundi Beneficiaries: Banque de la Republique du Burundi (BRB), participating financial intermediaries, Chamber of Commerce and Industry, and small enterprises. Amount: SDR 5.7 million, equivalent to US$8 million. Terms: Standard IDA terms. Relendinft Terms: The Borrower would pass on US$7.2 million equivalent to BRB at 7.0 percent p.a. minus an administrative fee, of 0.5 percent (to cover the operating cost of a Project Unit within BRB) for 30 years, including a grace period of 10 years. BRB would onlend the funds to qualified participating financial intermediaries at 7.0 percent (or at the treasury bond rate to be established following the introduction of a treasury bonds auction), with a flexible amortization schedule reflecting the aggregate maturity of subloans extended by intermediaries. The onlending rates would be revised annually. Interest rates charged by participating intermediaries to beneficiary SSEs would be, initially, 11 percent for subloans of up to seven years and 12 percent for subloans beyond seven years. Following the introduction of a market-oriented rediscount rate, interest rates would be variable and market-determined. The foreign exchange risk would be borne by the Government. The Borrower would use the remaining US$0.8 million to (i) provide training and technical assistance to participating intermediaries and beneficiary SSEs and, (ii) establish an SSE promotion unit in the Chamber of Commerce and Industry. Benefits: In the past, Burundi has not had a practical and effective approach towards SSE development. With the mandate recently given to the Chamber of Commerce and Industry to take the lead in SSE promotion, the proposed project would help nurture this development, which is expected to generate new job opportunities at a relatively low capital cost. It is expected that the credit component would help create 2,500 new jobs at an average cost of US$4,000 per job. The impact of the project is expected to be appropriately dispersed both geographically and among various groups with benefits reaching subborrowers in the secondary cities and microenterprises.  -ii- Risks: Being the first apex operation in Burundi, the project lnvolves institutional arrangements that are new to the Central Bank and to the participating intermediaries. Initial dalsy in subloan processing may occur as BRB will need to familiarize itself with the system and as participating intermediaries develop further their appraisal and supervision capacity. This risk would be considerably reduced by the swift implementation of the technical assistance component and by close IDA supervision during the initial project execution phase. Estimated Costs Local Foreign Total -----------US$ million---------- Investments 3.0 7.0 10.0 Technical Assistance and Training 0.4 0.6 1.0 SSE Bureau 0.1 0.1 0.2 3.5 7.7 11.2 Financing Plan: SSE Subborrowers 1.5 - 1.5 Participating Financial Intermediaries 1.5 - 1.5 Government 0.2 - 0.2 IDA 0.3 7.7 8.0 3.5 7.7 11.2 Estimated Disbursements: IDA FY 1989 1990 1991 1992 1993 1994 Annual 0.7 1.1 1.8 2.4 1.6 0.4 Cuwulative 0.7 1.8 3.6 6.0 7.6 8.0 Economic Rate of Returns NA. Maps No. 20663.  BURUNDI STAFF APPRAISAL REPORT SMALL ENTERPRISE APEX PROJECT I. THE SECTORAL ENVIRONMENT A. The Economic Setting 1.01 Burundi is a small, densely populated and land-locked country with over 4.5 million inhabitants and an estimated GNP per capita of US$250 in 1986. The population is overwhelmingly rural (93 percent) and derives its livelihood from subsistence agriculture and coffee cultivation. Despite the predominance of the rural economy (60 percent of GDP), Burundi has a relatively developed services sector and a small but active manufacturing sector which the Government is eager to promote as agricultural development is constrained by land availability and increasing demographic pressures. 1.02 Following a period of growth due to the coffee boom in the mid- 70s, Burundi's economy started encountering serious financial and economic difficulties in 1981. Terms of trade deteriorated and oil prices surged. A rapid increase in domestic demand and expansionary fiscal and monetary policies led to a deterioratiotn in the balance of payments and large budget deficits. Between 1978 and 1983, the current account deficit increased from 5 percent of GDP to 12 percent, and the budget deficit from 6 percent to 11 percent. Inflation, which was running at a high rate of 15 percent p.a. led to a rapid appreciation of the Burundi franc in the absence of corrective adjustments. To control the increasing deficit in the balance of payments, administrative controls were imposed on imports and on foreign exchange. In addition, price controls were imposed for imported and domestic goods. These control measures led to distorted prices, high rents accruing to monopolist importers, lack of Interest in productive sector investments and to a general slowdown of economic activity. 1.03 Towards the end of 1983, the Government launched a program of initial adjustment measures. These included the depreciation of the Burundi franc by 30 percent versus the US dollar, an increase of producer prices of main export crops (ranging from 6 to 50 percent) and the raising of some taxes. In addition, public wages were frozen, and an effort was made to control both capital and recurrent public expenditures. But while Government revenues initially increased significantly due to higher coffee revenues, continued import restrictions on intermediate goods hampered the output of the modern sector. Furthermore, a prolonged drought in 1984 led to a reduction in agricultural value added of about 6 percent, and thus to a 1 percent decline in real GDP.  -2- 1.04 Starting in 1985 the economic situation recovered somewhat. GDP growth reached 4.2 percent due to a substantial recovery in agricultural value added (a result of higher world coffee prices), and expansion of existing manufacturing units. The balance of payments improved as well. With IMF and IDA assistance, preparation for the first Structural Adjustment Program --currently being implemented--began in May 1985 with the objective of restoring financial equilibrium in the short-term and initiating a medium- term restructuring of the economy. 1.05 Main short term adjustment measures included: the adoption of a realistic and flexible exchange rate policy, the correction of the appreciation of the real effective exchange rate which had occurred during the previous years, progressive liberalization of exchange controls and prudent financial policies compatible with the objective of (i) reducing the budget deficit, (ii) maintaining a sustainable balance of payments position, (iii) containing inflation to about 5-6 percent, and (iv) increasing credit to the private sector. 1.06 The medium term adjustment program included the rationalization of the incentive syst,m through further decontrol and liberalization of the economy, and the improvement of the efficiency in resource allocation through major changes in trade and industrial policies. The Government has also taken important steps to strengthen public expenditure management and to rehabilitate the public enterprise sector. 1.07 The above measures have already produced important changes in the economic environment. Faced with increased competition, firms are now looking for cheaper sources of imports (notably in the regional and non- traditional markets) and export markets are being explored. Manufactured exports increased by 60 percent in nominal value in 1986 (80 percent of which in the form of processed coffee), and export contracts for beer, glass, soap, tobacco and textiles have increased substantially. Moreover, the depreciation of the FBu (23 percent in terms of SDR, between July and December 1986), offset the impact that import liberalization might otherwise have had on increased demand for imports. The policy environment for industry has, as a result, improved substantially. The second tranche of IDA's first structural adjustment credit was released on April 21, 1987. Another SAC carrying the adjustment process further is currently being prepared, and SAF discussions are being finalized. B. The Small-Scale Enterprise Sector Importance and Characteristics 1.08 Small-scale enterprises (SSEs) in Burundi are a non-homogeneous and relatively small group, varying significantly in complexity and sophistication as well as by size and activity. SSEs with the same number of employees or comparable sales volume often differ in management style, organization and ability to maintain records, depending on the nature of their activity or the background and capacity of the owner-manager. Partly because of this diversity, and partly because of the absence of a clear official definition of small--and in the Burundian context also medium-- enterprises, reliable data on Burundi's SSEs are scarce. In the absence of  - 3 - comprehensive statistics, the characterization below draws on several scurces, Including the National Studies and Statistics Service, various Ministries (Commerce and Industry, Labor, Justice), and the Chamber of Commerce and Industry, all of which focus on different aspects of SSE activity, such as employment, taxes, licensing, permits, etc. 1.09 The SSE sector is marked by very limited donor support. Except for past UNIDO assistance to the iniustrial promotion center (para. 1.31) and two SSE credit lines to one of the development banks, most donor assistance has concentrated so far on selected artisan activities in the provinces. 1.10 Officially, all SSE establishFrants belong to one of four categories, namely the formal and informal industrial sector and the modern and traditional artisan sector. The formal industrial sector includes, besides registered SSE establishments, the 7 larger manufacturing companies in Burundi, among which are the beer and bottle factories. Activities in all four categories are geared towards meeting domestic demand for basic goods. As in other countries of comparable stage of industrial development, food processing (excluding coffee and tea) dominates manufacturing the sector. Other activities are linked to shelter (basically construction materials), clothing, (weaving, spinning, etc.), furniture making, wire drawing and gem cutting. Overall, all four SSE sector categories contribute one third to the total manufacturing sector which, in this predominantly agricultural country, accounts for about 10 percent of GDP and which grew at an average annual rate of 4 percent in real terms between 1978 and 1986. 1.11 The formal SSE sector comprises all officially registered firms in Burundi except for the 7 large manufacturing firms mentioned above and employs about 20,000 people. Its activities are monitored by the National Studies and Statistics Service, which has a roster of 557 registered companies. Of these, 69 percent are in the commercial and services sector and 20 percent in manufacturing. The majority (60 percent) are concentrated in the metropolitan region of Bujumbura. While relatively few companies employ a large labor force, 66 percent employ less than 50 persons each in the agro-industry, mining and manufacturing subsector. In the remaining sectors, the majority of companies employ less than 25 persons each. 1.12 Capital investments of the formal SSE sector are concentrated in the manufacturing sector. The average investment for the sector is US$40,000 per enterprise. Basic financial ratios of the sector indicate that long-term credit has so far not played a significant role in the fixed capital formation of formal manufacturing enterprises. Over half of the assets are self-financed by company owners. As a result, debt servicing represents only 3 percent of total operating expenses for the sector. At the same time, 25 percent of companies carry no debt at all. 1.13 The informal SSE sector, defined as all non-registered SSE activities in Bujumbura and the larger provincial towns, especially in Ngozi and Gitega consists of an estimated total of 950 companies employing less than 25 persons each. The best available estimates indicate that about 65 percent of these companies are active in the commercial and  - 4 - services sector. Most of them exist and manage to operate outside the official legal framework, hence reliable information on their activities is scarce. Compared to the country's predominant agricultural sector, informal inoustrial establishments do not require assets such as land, nor do they require large amounts of capital. The labor force generally is made up primarily of the owners plus a few family mt bers and apprentices. A special 1987 Bank survey of the informal sector in Bujumbura, which represents the most developed market, reveals that activities are concentrated mainly in retail trade, construction, manufacturing, electrical and mechanical repair and transport. Trade constitutes 66 percent of the total output of the sector, while manufacturing activities constitute less than 20 percent, and construction less than 3 percent. In the latter two subsectors, it is the formal sector which dominates. Other informal SSE activities include pottery, carpentry, tailoring, and basket making. Metal fabrication is also a significant, more rural manufacturing activity, but it is concentrated in the provinces of Ruyigi and Bubanza. 1.14 Most SSEs in Burundi's formal and informal sector are owned, managed and operated by nationals, unlike the few large companies which often have foreign interest and management. Less than 2 percent of the staff of all SSEs are foreign. Available data also suggest that SSEs are more labor intensive and less dependent on imported inputs than larger enterprises. 1.15 Between 1973 and 1986, the net increase in the number of registered SSEs amounted to 421, which resulted from 4,142 start-ups and 3,721 closures. While the number of start-ups indicates that there is no lack of entrepreneurial spirit in Burundi, the emount of closures demonstrates simultaneously that the SSE sector faces problems as well as it tends to base new activities on inadequate feasibility studies, overrates the market potential and underestimates operating costs. 1.16 SSEs in Burundi encounter a number of constraints, brought to the attenition of the appraisal mission in all main provinces: (i) The access to bank credit, both for fixed assets and working capital is still difi-lcult with banks being concerned more about collateral quality than financial viability of the project; (ii) SSEs are characterized by their lack of well established management structure and orzanization, and by rudimentary accounting s:stems. Basic practices such as quality, production and inventory controls are virtually unknown. The resulting excess costs are integrated in the product cost structure and passed on to the consumer disregarding price and demand elasticity; (iii) Market limitations represent a lesser, but still relevant problem. The expenditure pattern of rural households which represent 92 percent of total households indicates that purchases are limited to basic consumer needs: food, clothing, housing, medicine and household goods of first necessity. As a result, SSEs face a local market the growth of which is restricted by the modest purchasing power of its predominantly rural population; (iv) Being landlocked, another difficulty for economic operators in Burundi is the access to appropriate technoloay and imported raw materials. Transit of goods is unreliable and very costly. Only large companies can afford adequate inventories to safeguard against stock outs. In addition, imports of second-hand equipment are currently prohibited, resulting in low capacity utilization and high investment costs per job. It is expected,  however, that under SAC II, this restriction will be lifted; (v) Finally, local distribution channels are In disarray and suffer from collusive practices. Since Burundi's independence In 1962, over 190 commercial trading centers have ceased operation. SSEs unable to develop costly private distribution channels encounter serious marketing problems in commercializing and selling their products. 1.17 Successful SSEs in Burundi have been built up by individual initiative and have developed by reinvestment ok surpluses. In the past several years, few new SSEs have been established. This can be attributed mainly to the economic slow down until 1985 (para. 1.02). Since SSEs have generally found it difficult to obtain professional assistance in the past to prepare bankable feasibility reports and in getting banks interested in their project proposals, few of them had access to funds other than the equity investments of the owner or his imediate or extended family, although some SSEs have in rare cases operated on suppliers' credits. Those that have had access to bank credit have been mainly financed by BNDE and, more recently, by SBF for machinery and equipment imports. The appraisal mission strvey (para. 1.16) showed that new SSEs are being established again and this will result in increasec credit demands. Improved assistance and increased regional coverage to meet financing needs will substantiate this additional credit demand. 1.18 The Artisan Sector. The modern as well as the traditional artisan sectors are made up of a large number of establishments, most of which are unregistered and do not keep any records of their activities. Despite these shortcomings, the artisan sector is an important generator of employment. Traditional artisan activities are carried out by approximately 100,000 farmers, predominantly in the rural areas. These activities, which range from basket weaving to brick making represent a part-time occupation providing additional Income. Skills are transmitted from one generation to the next. More 'modern' artisan activity implies, by local definition, that the craftsmen, received either formal training at a specialized institution or church mission or underwent apprenticeship training, or both. Whereas the traditional craftsman operates as an individual in his spare time, modern craftsmen exercise their profession on a full-time basis and usually have employees assisting them. Approximately 40,000 craftsmen conduct activities in metropolitan Bujumbura and in smaller townships. According to a 1987 study of the artisan sector by a foreign consulting company, modern artisans are increasingly in competition with each other due to the often homogeneous products and have to survive on very small profit margins. 1.19 Burundi's artisan sector received considerable donor assistance from both official bilateral and NGO sources. This assistance is mostly granted in the form of expert advice and is scattered among various, in some instances quite distant provinces. Government Policies affecting SSEs 1.20 Although the Government of the Third Republic, formed in September of 1987, has reemphasized the importance of SSE development, there are no regulations for SSEs separate from those for large enterprises. However, after a period of emphasizing large public sector projects as an instrument  - 6 - for industrial growth, the Government now recognizes that further industrial development appropriate to the country's scale and needs should largely involve privately owned small- and medium-scale enterprises. In the past, the growth of the sector was partly hindered by policies such as price controls and import restrictions, but also by cultural values which gave higher social status to administrative and military positions compared to trade and industrial activities. This environment has changed. Starting in 1984, numerous public appeals have been made by highly placed Government officials for national talents to concentrate on economic productive activities, start their own busir.ess and rely on their own capacity to be economically successful. 1.21 The new macroeconomic environment, together with the need to promote the participation of Burundian entrepreneurs in the country's investment and growth process, has thus accorded a high priority to private sector enterprises and to improving the policy and institutional framework for their development. In the process, the Government has implemented major changes in trade and industrial policies. While they do not affect SSEs exclasively, they do have the same results for them as for other economic agents. The main steps towards deregulation of the economy were in the areas of import licensing, price determination, production incentives and tariff reform. 1.22 Import Licensing: At present, most import licenses are granted automatically, except for a limited number of luxury goods, and for 3 groups of locally manufactured goods, subject to temporary quantitative restrictions. Previous regulations which had led to monopolization of the trader profession have been abolished. 1.23 Price Decontrol: Most price controls have been removed, after they had been fixed for most manufactured goods at the producer, wholesale and retail levels until 1985/86. This policy was applied to producer prices through a fixed 20 percent profit margin (cost plus) oa production cost. For some strategic products (salt, cement, sugar), prices can still be subject to a ceiling (for no longer than four months), to offset possible speculation caused by acute shortages or temporary import difficulties. The new pricing policy applies to public enterprises as well. 1.24 Production Incentives: The above measures were complemented by a set of incentives designed to stimulate -nvestment and production in the productive sectors. The Investment Code was revised (para. 1.26) to provide automatic incentives to all investors (Burundian and foreign) who meet specific criteria related to utilization of labor and adequate rates of return. Other incentives include elimination of all export taxes on manufactured goods and the reactivation of the draw-back system. 1.25 Tariff Reforms With a view to reducing high rates of effective protection the Governaent restructured Import tariffs and provided a basic rate of protection for the production of intermediate goods based on domestic resources. To this end, the number of duty rates was reduced from 57 to 5, a minimum duty of 20 percent was established on all imports and the maxim-m duty was reduced to 100 percent, applied essentially to luxury goods. Non-luxury goods are now taxed in the 20-50 percent range, to be  narrowed to 20-40 percent in 1989. For a few cases in which higher rates might be imposed to protect infant industries, the Government has introduced formal procedures to grant selected enterprises a temporary relief in form of an import surcharge (with a maximum rate of 30 percent) levied for a maximum period of three years. This import surcharge rate would be gradually reduced during the three-year period. 1.26 A new Investment Code was promulgated in March 1987. The new Code, which was revised under the Structural Adjustment Credit, provides automatic incentives to all investors (Burundian and foreign) who meet specified criteria, namely having an economic rate of return of at least 10 percent for the project and an investment cost per job of less than US$20,000. This increases the access of SSEs to the Code as provisions contained in the previous Code encouraged investments only if they reached a minimum size, i.e., FBu 15 million (US$125,000) for new projects and FBu 10 million (US$85,000) for extensions. Other changes in the new code include (i) lifting the protection against competing imports and no longer prohibiting the establishment of new enterprises even if they compete with existing a~--4vities; (ii) eliminating the exeAption of import duties on equipment and industrial imports; and (iii) reducing the review process (including final approval or rejection) to a maximum of three months. The Code's benefits now consist essentially of a profit tax exemption for a fixed period of five years and seven years for industries located outside Bujumbura. 1.27 The National Guarantee Fund. In July 1987, a decree was approved setting up the Fonds National de Guarantie (FNG)-- a National Guarantee Fund--the purpose of which is to provide additional guarantees to the banks for a substantial part of the loans to SSE when the latter cannot furnish sufficient collateral. The appraisal mission advised the Government in the form and procedures of the FNG. It is envisaged that the guarantee scheme, if operated efficiently, will help remove one of the major obstacles to increase lending by the commercial banks to SSEs, namely the lack of adequate collateral of such borrowers. 1.28 The FNG would guarantee up to 70 percent of a loan for a 1 percent annual fee on the guaranteed portion to a maximum of FBu 10 millions for fixed assets loans. The FNG would also guarantee 60 percent of working capital loans up to a maximum of Flu 5 million for each borrower. Eligibility for guarantees would be limited to enterprises with fixed assets not greater than FBu 30 million (US$240,000 equivalent). Promotion and Training Institutions 1.29 The principal institutions charged with promoting the development i of Burundi's SSE sector are the Ministry of Commerce & Industry (MCI), the National Development Bank (BNDE), the Industrial Promotion Center (CPI), and more recently, the Chamber of Commerce and Industry (CCI). With the exception of 3 foreign experts (not specifically focussed on SSE issues) in BNDE, there is no other donor assistance for SSEs. The main training institution is the Government Staff College (CPF). Even though a major objective of the technical assistance component of this project is to help the Chamber of Commerce and Industry meet its new promotion role, the other institutions might also render useful services to potential SSEs.  - 8 - 1.30 The Ministry of Commerce and Industry (MCI) has a General Directorate with two departments for industry and artisanal sector. Both departments report being understaffed. At this point, the MCI does not have any units directly concerned with policy formulation and preparation of legislation to promote the SSE sector. 1.31 The Industrial Promotion Center (Centre de Promotion Industrielle, CPI) was created in 1981 to help promote and develop Burundian industry through provision of assistance to industrial enterprises. CPI is a parastatal agency under direct control of the Ministry of Commerce and Industry. The 1986 operating budget was FBu 56.6 million (US$450,000 equivalent), provided by Government resources and foreign donor grants. Main activities have included the preparation of project feasibility studies and, since 1985, the provision of technical assistance to firms in technological choice, management, and training. In the past, CPI's role has been limited by frequent changes in management as well as by difficulties in gaining acceptance by the private sector. Furthermore, the local staff of 22 have inadequate backgrounds and some are working only part-time. Under the new Government, CPI is redefining its role to become a study unit and shift all assistance functions to the Chamber of Commerce and Industry. 1.32 The Chamber of Commerce and Industry (CCI) represented in the past a relatively small segment of the commercial and industrial community, mainly the larger enterprises based in Bujumbura. Starting in 1987, the Government has given the mandate to the CCI to expand its activities and play a more aggressive role in representing the business community throughou.t the country. This initiative came about by realizing that a private organization was more suited to effectively reach the private sector and channel the assistance needs. As a consequence, CCI's structure has been modified significantly and its budget increased considerably. Under the project, CCI is to play a leading role in implementing the technical assistance program. Following a membership drive after its mandate was increased, CCI currently has over 2,000 associate members, and the number is still increasing. The General Secretary is a dynamic and knowledgeable executive and former Dean of the Faculty of Economics and Administration at the University of Burundi. 1.33 CC!'s budget is entirely financed from membership dues which range from FBu 2,000 to FBu 100,000 p.a., depending on the size and equity strength of ths member company. In parallel to its membership drive, CCI is expanding its services, and it has already established 4 representations outside Bujumbura to better attend members' needs in the provinces. Recently two Directors have been recruited. One has responsibility for domestic affairs covering information, communication training, assistance and coordination with the regional chapters of the chamber. The other director oversees international affairs, including import/export, relations with regional trade zones such as CEPGL, PTA, foreign chambers of commerce, etc. 1.34 The 1987/1988 program of the CCI focuses on the launching of training programs both in the capital city and throughout the most important provinces. This shows that the Chamber does not perceive itself only as a lobbying group but that it responds to the needs of its members,  -9- who concluded that governmental agencies did not generate the practical, private sector oriented programs required. Despite its relatively fresh start in Burundi's business promotion, the CCI, through its enthusiastic staff, has shown its willingness to assume a leading role in assisting enterprises. Therefore, CCI was chosen as the best suited institution in the country to take charge of the project's TA program. 1.35 The Government Staff College. The Government Staff College (Centre de Perfectionnement et de Formation en cours d'emploi, CPF) is a parastatal agency primarily sponsored by UNDP. It started operations in 1979, has a total of 40 local staff, and 3 foreign experts. Revenue sources comprise mostly Government subsidies and foreign donor grants. The center focuses its overall attention on civil servants even though private sector participants are allowed to participate in the courses. The center organizes management seminars and workshops, conducts research on management and training issues, publishes its own monographs and studies and maintains an audio-visual library. However, the few workshops and seminars oriented towards the private sector tend to concentrate on scientific management suitable for big corporations only. C. The Financial Sector Institutional Structure 1.36 The financial sector in Burundi consists of: (i) the Central Bank (BRB); (ii) three commercial banks: Banque de Credit de Bujumbura (BCB), Banque Commerciale de Burundi (BANCOBU) and Banque Belgo-Africaine Burundi (BBAB); (iii) three other deposit-taking institutions: Caisse d'Epargne du Burundi (CADEBU), Caisse Centrale de Mobilisation et de Financement (CAMOFI) and Comptes Courants Postaux (CCP); (iv) two other lending institutions: Holding Arabe Libyen Burundais (HALB) and Fonds de Promotion Economique (FPE); and (v) two development banks: Banque Nationale de Developpement Economique (BNDE), a mixed institution with 40 percent Government participation, and Societe Burundaise de Financement (SBF), controlled (54 percent) by the Government but with sizeable (31 percent) local private shareholding. 1.37 The Government, directly or through two fully Government owned financial institutions (BRB and FPE) holds a controlling interest in all financial institutions but the commercial banks. With other public sector enterprises, Government holds close to 50 percent of the capital of the commercial banks but needs the Burundian private shareholders to marshal a majority. Foreign shareholding is limited to the commercial banks (49 percent in two banks and soon a similar or lower proportion in the third) and to BNDE. The Burundi private sector holds shares only in the commercial banks and in SBF. 1.38 In addition to these institutions there is an array of savings cooperatives (COOPECs) started with French assistance in 1984 which are not yet accredited by the Central Bank (para 1.60). There are also quasi- financial institutions which comprise: the Institut National de la Securite Sociale (INSS), a Government agency which collects contributions from employers and employees, and manages the national pension plan; the Societa d'Assurance du Burundi (SOCABU), a mixed sector insurance company which  - 10 - used to have a monopoly in the insurance business in the country but has now a competitor (UCAR), recently established with foreign participation; the Office des Cultures Industrielles du Burundi (OCIBU) which collects, processes and partly finances the coffee crop; and the Coffee Equalization Fund. The relative importance of the various institutions in terms of their lending to the economy is shown in the table below and in Annex XI. Total credit outstanding by the financial institutions at the end of 1986 amounted to FBu 16.1 billion (US$129 million). DISTRIBUTION OF CREDITS TO THE ECONOMY (Annual averages An percent) 1981 1982 1983 1984 1985 Central Bank 7.6 4.4 3.2 2.5 2.2 Commercial Banks 65.1 62.0 53.3 50.1 53.0 Development Banks 12.5 16.5 25.2 27.8 26.7 CAMOFI 6.6 8.9 9.7 10.5 10.3 CADEBU 6.4 6.6 7.2 8.0 7.0 Other 1.8 1.6 1.4 1.1 0.8 TOTAL 100.0 100.0 100.0 100.0 100.0 Source: BRB 1.39 There is a certain measure of competition within Burundi's financial system. The commercial banks compete among each other and with BRB, CADEBU, CAMOFI and CCP for public sector deposits, and with CADEBU and CCP for private sector deposits. On the credit side, development institutions participate in short-term credit, namely coffee financing, while commercial banks are required to allocate a portion of their resources to term credit. 1.40 The financial institutions participating in the project (the Central Bank, and the commercial and development banks), as well as the COOPECs, are described in more detail in the paragraphs below. 1.41 The Central Bank (BRB) regulates financial institutions in Burundi and defines and administers national monetary and credit policies. The latter function is performed by BRB's three-person Executive Committee (the Governor, Vice-Governor and the Administrator) and approved, when not actually directed by the Minister of Finance. Between October 1986 and October 1987, BRB was without a Governor and the Executive Committee was virtually inactive. This weakened the Central Bank and led to the Minister of Finance increasingly assuming the task of formulating monetary and credit policies. As Burundi's central financial institution, BRB issues the currency, manages the foreign exchange reserves, and acts as the Government banker and the lender of last resort to the financial system. It also accepts deposits from and grants credit to a number of public sector enterprises, and manages a Credit Bve..au (Centrale des Risques) which collects from the financial institutions monthly information on the  - 11 - amount and nature of loans outstanding to any given borrower and advises each financial institution of the total loans extended to each of their customers. 1.42 The Central Bank's regulation of financial institutions mainly focuses on three aspects: (i) interest rate regulation - BRB currently still fixes the minimum deposit and maximum lending rates, thus predetermining the financial spread available to financial institutions; (ii) prior approval for bank credit exceeding a certain amount (currently FBu 10 million or US$80,000); and (iii) classification of credits as wrediscountablen or "non-rediscountable" and the related operating ratios that banks have to maintain. BRB does not establish reserve requirements and commercial banks are financially regulated mainly through the operating ratios. 1.43 BRB's past supervision of the management and operation of financial institutions has been weak, especially as regards inspection. BRB relies exclusively on information and data provided monthly by the financial institution, and undertakes no thorough inspection of the banks other than occasional brief on-the-spot checks. Despite the past lax control, banking institutions are generally well managed and financially sound. They have their own provisions policies and adequate appraisal and disbursement procedures. 1.44 BRB has a total staff of 418, including its Bujumbura headquarters and one branch each in the 2 largest provinces. The fact that in the past year BRB has been without a Governor accounts in part for its managerial weakness. With the recent appointment of a new Governor, this situation is expected to change. BRB's organization structure appears in Annex IX. 1.45 The three commercial banks were until 1985 fully foreign-owned. In 1985 the foreign parent companies of the two larger banks sold 51 percent of their shares to Burundian interests, mainly to the Government and public sector enterprises. The transfer to local shareholders of up to 80 percent of the capital of the third bank (BBAB) is currently being negotiated. The former parent companies have retained the management of BCB and BANCOBU until the end of 1987 under a management contract agreed upon at the time of the sale of their shares. The authorities have recently made known their intention to extend the management contracts. Furthermore, the Minister of Labour has agreed to reconfirm, prior to negotiations of the project, the employment status of non-Burundian staff in the banks (and all other private firms). The three banks are still closely linked to their European shareholders and their policies, procedures, and management practices reflect those of the parent companies. BCB and BANCOBU are the dominant institutions, with 43 percent and 37 percent respectively of the total loan portfolio of commercial banks. They have a branch network in the country (six branches for BANCOBU, five branches for BCB) which would allow the project to reach SME clients outside of Bujumbura more directly. The third bank is only active in the capital and has a more limited range of services. 1.46 The commercial banks extend mainly short-term credit with a large proportion of loans financing export and import operations. Other short- term credits are extended through overdrafts. Banks do not engage in more  - 12 - sophisticated types of operations such as leasing. Coffee financing constitutes another central part of the lending business. Until recently commercial banks were the only institutions engaged in this very profitable and virtually risk free activity, but lately, with the help of the authorities, other financial institutions have become involved in coffee financing (development banks and OCIBU). 1.47 Following Central Bank instructions to commercial banks (para. 1.71) to hold at least eight percent of their outstanding portfolio in the medium- term (2-7 years) and long-term (over 7 years), the banks are becoming familiar with term credit but so far, in the abse':e of a functioning guarantee fund (para. 1.27), term loans are gtanted mostly to well-known clients. The capacity of commercial banks to appraise loans is generally adequate. Credit analysis, although emphasizing the personality of the borrower, also covers such aspects as evaluation of market potential, sales forecast, projected cash flow, pro-forma financial statements, quality of the management, and includes direct visits to the company. The appraisal capabilities of commercial banks' staff will be further strengthened under the TA component of the project. (para. 3.29 iii). 1.48 Procurement and disbursement procedures vary from bank to bank, but appear generally satisfactory. For large, well-known clients, disbursement is made directly to the beneficiary. For smaller or less well-known clients and for foreign goods, funds are directly disbursed to the supplier or contractor, and other disbursement and procurement conditions are more thoroughly checked. Under the proposed project, participating institutions would be required to receive quotations from three suppliers and to disburse directly to the supplier, except for small payments of less than US$5,000. 1.49 Practically all bank lending is backed by some form of collateral (mortgages, floating charges on stocks or other assets, personal guarantees, overseas guarantees, etc.) even though the enforceability of some of these guarantees is legally difficult and time-consuming. The collateral requirement is a particularly important problem for SSEs and limits their access to institutional credit. (para. 1.27 on Guarantee Fund and para. 1.75 on Code Fonciere). 1.50 All commercial banks seem to have a fairly sound portfolio condition and the impact of the non-performing loans is manageable. The exact situation, however, is difficult to assess because of differences in the policies followed by individual banks, as the Central Bank provides no guidance on the treatment of doubtful and contentious loans. Commercial banks generally apply the standard provisions policies of their parent companies. 1.51 Banks are reasonably leveraged, with an average debt-equity ratio as of December 1986 of 9.8:1 and a range varying between 8.5:1 and 18.6:1 (Annex XIV). Banking profits are moderate. Net profJts represented about 12 percent of the capital funds in 1986 but were inflated in one bank by an exceptional profit of FBu 94 million. The net profits on assets represented slightly over 1 percent of the average total assets in 1986 and 1.5 percent of the average loan portfolio but fell to 0.3 percent and 0.5 percent respectively if non-recurrent profits are excluded.  - 13 - 1.52 The Development Banks. Burundi has two development banks, BNDE and SBF. The Banque Nationale de Developpement Economique (BNDE), Burundi's first and principal development finance institution, was established in 1967 as a limited liability company with a share capital of FBu 60 million (US$ 0.7 million), subscribed 75 percent by Government and public institutions and 25 percent by Burundi's three local commercial banks. BNDE's objectives at its inception were to provide term loan and equity funds to agricultural, industrial and tourism enterprises and to finance housing. The institution received strong support from the international community (the French Caisse Centrale de Cooperation Economique - CCCE - provided the general management of the bank until 1970) and its equity base was expanded four times between 1969 and 1983 to allow international development assistance organizations (DEG, CCCE, EIB, etc.) to participate in its shareholding. BNDE's FBu 740 million (US$5.9 million) capital at the end of 1986 is subscribed 40 percent by the Government and BRB, 46 percent by the EIB, CCCE, DEG and AGCD and 14 percent by the commercial banks and other local public sector institutions, thus rendering majority ownership to the Government. Although BNDE has earned reasonable profits (FBu 50.6 million in 1986 but much less in the previous years), it has preferred to build up its reserves and equity base rather than pay dividends. 1.53 The strong international support has allowed BNDE to establish itself as an important institution for development financing in Burundi. In addition to a DFC-type credit (Cr. 731-BU for US$3.4 million) which IDA provided to BNDE in 1977, significant institutional and financial support came from KfW, CCCE, EIB and the African Development Bank. Over the years, BNDE*s project appraisal and supervision capacity was gradually strengthened and adequate procedures and policies were instituted. The number of staff was kept at appropriate levels (as of December 31, 1986 BNDE employed 49 people, 22 of whom were professionals) and staff quality Improved with the assistance of foreign donors and IDA, who funded experts for the positions of Chief Financial Officer, Economist/Financial Analyst and Engineer, and provided training. A Burundi national successfully assumed the General Manager position in 1979, but the institution will continue to need the support of some three expatriate assistants until their counterparts become fully capable of replacing them. 1.54 No Project Performance Audit Report (PPAR) has been issued on the IDA credit to BNDE. A Project Completion'Report (PCR) of January 1987, however, noted that the two main objectives of the IDA credit - to provide financing on appropriate terms to well conceived and viable industrial projects and to strengthen BNDE's project appraisal capabilities and internal organization - were only partly met at the time. The PCR pointed out that despite intense political pressure and weaknesses in the legal system, BNDE did succeed in improving its internal organization and procedures and in maintaining a relatively sound portfolio. Since its establisbment, BNDE has financed over 4,400 loan operations for about FBu 3.9 billion (US$40 million) and five equity participations for FBu 56.5 million. BNDE's operations have always been sectorally diverse and cover agriculture, manufacturing, mining, handicraft and housing. About two- thirds of all loans were to enterprises in the capital Bujumbura with the remainder distributed throughout the provinces. About 82 percent of all BNDE loans were medium/long term and went to private (36 percent), public  - 14 - (38 percent) or mixed-sector projects. Over the past 3 years, BNDE's lending (excluding coffee financing) increased from FBu 480.0 million in 1984 to FBu 826.0 million (US$7.0 million equivalent) in 1986. 1.55 As of December 31, 1986, BNDE had an outstanding portfolio of FBu 3.0 billion (US$25 million equivalent) two thirds of which in medium- and long-term and counted with US$14 million in foreign exchange resources for new approvals. About 85 percent of these resources are for specific operations or have special conditions regarding procurement or type of projects. This limits BNDE's financing flexibility, especially as far as origin and used equipment are concerned. BNDE's foreign exchange resources come mainly from the European Investment Bank. the Caisse Centrale and the African Development Bank. The Government has also from time to time allocated funds to BNDE for specific purposes. 1.56 Since the somewhat unsatisfactory experience with BNDE during implementation of IDA's Cr. 731-BU (para. 3.03), which was closed in 1983, the institution has significantly improved its internal procedures with respect to loan administration and project supervision. BNDE seems to be the only financial institution which strictly applies clearly defined policies with regard to non-performing loans. Loans are classified as overdue as soon as a repayment installment has been missed, an action that tmmediately triggers a review of the borrower's situation and may lead to classification of the loan as doubtful. Doubtful loans become automatically contentious once the file is sent to BNDE's lawyers. As of December 31, 1986, BNDE's doubtful and contentious loans were 9.7 percent of the portfolio and are classified below. BNDE balance sheet is presented in Annex XVa. BNDE: Doubtful and contentious loans by sector at the end of 1986 (BuF million and in percentage of total loans to each sector) Doubtful Contentious Total Housing 0.7 (0.1) 7.4 (0.8) 8.1 (0.9) Trade and artisanat 9.9 (3.4) 45.6 (15.8) 55.5 (19.2) Industry 114.0 (18.8) 10.9 (1.8) 124.9 (20.6) Tourism 11.2 (6.0) 12.7 (6.8) 23.9 (12.7) Agriculture 18.6 (4.7) 12.7 (3.2) 31.3 (7.9) Small equipment 11.7 (4.9) - - 11.7 (4.9) Total 166.1 (6.3) 89.3 (3.4) 255.4 (9.7) Source: BNDE BNDE is expected to be one of the largest users of the proceeds of the proposed project. 1.57 Burundi's other development finance institution, the Socite' Burundaise de Financement (SBF), started operations in 1982, and is the  - 15 - country's only financial institution with a sizeable local private shareholding (34 percent'. The rest of its shares are held by the state (16 percent), the state-owned Fund for Economic Promotion FPE (40 percent), and SOCABU (10 percent). SBF provides medium- and long-term loans for housing, commercial and transport equipment and to a lesser extent agriculture, mainly coffee financing. Total medium- and long-term loans at the end of December 1986 amounted to FBu 754 million (US$6 million) and together with coffee financing made up 87 percent of the institution's total credit. Over the past 3 years, SBF's lending (excluding coffee financing) increase from FBu 234.0 million in 1984 to FBu 1.1 billion (US$9.0 million equivalent) in 1986. All of SBF's term resources are local and come mainly from the FPE and the Institut National de Securite Sociale (INSS) (FBu 223.8 and 100 million respectively). SBF balance sheet is shown in Annex XVb. 1.58 Although SBF is young it has a small but competent staff of 21, including 10 professionals, and has established itself as a quality institution with appropriate policies and procedures. Its previous Managing Director was a former Central Bank Governor and he was replaced in October 1987 by the former Minister of Plan. The nine-member Board of Directors approves all loans exceeding FBu 50 million, a Board subcommittee (the Conseil de Direction) is authorized to approve loans of between FBu 10 to 50 million while the Mrnagement Committee, comprising the Managing Director and two delegate-administrators, has approval authority for loans below FBu 10 million. SBF has three departments - administration, finance and projects - which are well suited to its size and functions. 1.59 The SavinRs and Credit Cooperatives (COOPECs). The most recent addition to the range of financial institutions have been the COOPECs (Cooperatives d'Epargne et de Credit) established with French assistance in 1984. By May 1987 the COOPECs comprised a network of 31 cooperatives in the central rural areas of the country with over 33,000 members, deposits of almost BuF 70 million (US$500,000 approximately) and outstanding credits of about BuF 16 million (US$128,000). The COOPECs are growing at a fast rate and their operations may be expected to double in volume by mid-1988. 1.60 The COOPECs represent an important development in being the first financial institutions to operate within these rural areas but are not yet accredited by the BRB. Their lending volume is small and mostly for consumption loans. Thus, they have no need at present for additional financial resources nor for technical assistance which they receive from the French Credit Mutuel. (See Annex XVIII for further details). Interest Rates and Resource Mobilization 1.61 Interest rates are regulated by BRB, which determines the maximum rates (including commissions) the commercial banks and other financial institutions can charge on their loans and, since 1981, the minimum interest rates they must pay on deposits, thus setting a ceiling on the gross spread of deposit taking financial institutions. In October 1981 the maximum interest rates on deposits were changed to minimum rates and the rate level raised by 2 to 3.25 percent while lending and rediscounting rates were also increased significantly. In August 1986 the general level of interefst rates was raised again and financial institutions were also required to pay a 3 percent interest on demand deposit balances in excess >f FBu 100,000  - 16 - (US$800). The August 1986 change also simplified and unified the structure. The number of posted rates went down from 94 to 57 and special deposit and lending rates for non-bank financial institutions were abolished, all financial institutions being subjected to the same interest rate structure. On May 1, 1987 the scale was further simplified and some of tite anomalies in the previous scale removed. The scale presently in force still has 37 posted rates, but unified agriculture and industry lending rates and treats all financial institutions alike. Interest rates for non-rediscountable loans range now between 10 and 16 percent, while rates on rediscountable loans range between 6 and 13 percent (10-12 percent for term loans), with the corresponding discount rates set between 5.0 and 9.5 percent (7.5-9.5 for term discount). 1.62 Real interest rates were negative from 1981 to 1984 and turned significantly positive since then. The increase in 1986 seems to have been a delayed reaction to the surge in the inflation rate in 1984 which had by then reached 14 percent but declined since. Infiation is currently about 5 percent. Such a delayed reaction might have occurred again in May 1987 when the rates were lowered at a time when preliminary indications pointed to an increase in the inflation rate. The latest change kept real interest rates on deposits marginally positive. 1.63 Despite encouraging improvements, the new interest rate scale still provides insufficient margin for certain types of operations especially in the medium term field. Similarly the spread between term lending and rediscounting rates may be too narrow. Margins are more comfortable for non rediscountable credits but the liquid assets ratio (para. 1.72) and the medium-term credit requirement (para. 1.71) severely limit the freedom of the banks in that area. To make the financial sector efficient, the Central Bank is currently considering, and should be encouraged, to let the financial institutions and market forces determine freely their deposit and lending rates. As a minimum, rates on non-rediscountable credit and on demand deposits should be deregulated and other rates linked to a central rediscount or reference rate. Once the auction market for treasury bills is established (para. 1.65) the resulting rate in this market should be used as the reference rate. 1.64 Interest rates on Government securities held by financial and quasi-financial institutions are determined by agreement between the Ministry of Finance and the purchaser. These securities have been issued to a few selected institutions at different negotiated interest rates which seem to bear no relation with the matur