Nepal - Cottage and Small Industries Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 7710 PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (CREDIT 1191-NEP) APRIL 14, 1989 Industry and Energy Division Country Departmfnt I Asia Region 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.  CURRENCY EQUIVALENTS Currency Unit - Nepalese Rupees (Rs) Appraisal Year Average: US$1.00 - Rs 13.2 Intervening Years Averages US$1.00 - Rs 18.0 Completion Year Averages US$1.00 - Rs 21.9 ABBREVIATIONS AND ACRONYMS ADB/N - Agricultural Development Bank of Nepal CIC - Credit Information Cell CIDB - Cottage Industry Development Board CIHE - Cottage Industry Handicrafts Emporium (the Emporium) CGS - Credit Guarantee Scheme CSI - Cottage and Small Industries CTA - Chief Technical Advisor DCVI - Department of Cottage and Village Industries ESC - Export Services Center ISC - Industrial Services Center NBL - Nepal Bank Limited NIDC - Nepal Industrial Development Corporation MNTC - Nepal Metal Trading Company NRB - Nepal Rastra Bank NWTC - Nepal Wool Trading Company OED - Operations Evaluation Department PCC - Project Coordination Committee PCIs - Participating Credit Institutions PCR - Project Completion Report PCU - Project Coordination Unit PDC - Product Development Center PMU - Project Management Unit RBB - Rastriya Banijya Bank TPC - Trade Promotion Center UNDP - United Nations Development Programme FISCAL YEAR July 16 - July 15  FoR oMCIL USE ONLY THE WORLD BANK Washington, D.C 20433 U.S A. Ok*e d ovw .hw4i" Ops#atmns EvakiU*Nin April 14, 1989 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Nepal - Cottage and Small Industries Project (Cr.; 1191-NEP) Attached, for information, is a copy of a report entitled 'Project Completion Report on Nepal - Cottage and Small Industries Project (Credit 1l9l-NEP)" prepared by the Asia Regional Ofs.Lce. Full evaluation of this project has not been made by the Operations Evaluation Department. Attachment 1This document has a restricted distribution and may be used by fetipients only in the performane Of their offcial duties. Its contents rnay not otherwise bc dischOsed without World lBankt authofization.  FOR OlFFLIAL USE ONLY PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (Credit 1191-NEP) TABLE OF CONTENTS Pags No. PREFACE ......* ...................... i BASIC DATA SHEET ............................................... --*** . *- t EVALUATION SUMMARY .s.o.. . .--. .o.. .................. ....... ..... *.... * vii I. INTRODUCTION ................................ .......... 1 Sectoral Setting .................... 004 ... 1 3ector Issues and Problems ..... ................... ... 2 Sector Goals ........... ...... . 2 IDA Assistance Strategy and Involvement in the Industrial Sector ................... ............... . 3 1. OBJECTIVES AND IDA EXPECTATIONS ............. ............. 4 Project Origins ...................................... 4 Project Objectives ....... .................... ........ 4 Project Description ...... .............................. 5 III. PROJECT IMPLEMENTATION AND IMPACT ........................ 7 A. Subprojects .......................................... 7 General ............................................ 7 B. Institutional Aspects ....... ..... 9 Nepal Rastra Bank/CSI Fund ......................... 9 The Participating Credit Institutions (PCIs) ....... 11 Portfolio Management ..... .......................... .12 Credit Guarantee Scheme ............................ 13 C. Technical and Marketing Services ............. ......... 15 Export Development ....... .......................... 16 Extension and Training . ............................ 18 Raw Material Supply ................................ 19 Monitoring and Coordination ..... ................... 21 IV. THE ROLE OF IDA .................. . 22 V. CONCLUSIONS AND LESSONS LEARNED ..................... ..... 23 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.  TABLE OF CONTENTS (cont'd) Page No. ANNEXES 1. Subsectoral Distribution of Subloans ..... .................... 25 2. District-wise Distribution of Subloans ............... . 26 3. Analysis of Subloans by Size ................................. 27 4. Growth Trends in Key CSI Exports ..... ........................ 28 5. CSI Fund Financial Performance ...... ......................... 29 6. Organization Chart: Nepal Rastra Bank/CSI Project Office .... 30 7. Organization Chart: Nepal Rastra Bank ............. . .......... 31 8. Credit Performance of PCIs .................................. 32 9. Nepal Bank Ltd. tNBL): Branch Distribution of Subloans ...... 33 10. Rastriya Banijya Bank tRBB): Branch Distribution of Subloans ................................................... 34 11. Agricultural Development Bank (ADB/N): Branch Distribution of Subloans ................ .. ................. 35 12. Borrower's Comments on the Project Completion Report ......... 37 13. UNDP's Comments on the Project Completion Report ..... **....... 41  - i - PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (Credit 1191-NEP) PREFACE This Project Completion Report (PCR) reviews the achievements of the Cottage and Small Industries Project (IDA Cr. 1191-NEP and UNDP NEP/80/016) implemented in Nepal from FY82-FY87. The PCR was prepared by staff of the Industry and Energy Division, Country Department I, Asia Region, based on information collected during a December 1987 mission and from proiect files (including a draft PCR provided by the project's Chief Technical Advisor). This project has not been audited by the Operations Evaluation Department. The draft report was sent to the Borrower and UNDP for comments. These comments have been taken into account in finalizing the report and are reproduced as Annexes 12 and 13.  - iii - PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (Credit 1191-NEP) BASIC DATA SHEET LON POSmON (Amount. In UNS MilIIon) As ot Jan Ja. 109ao Osltnal Disbursed Cancelled Roald Outetandin. Credit Amount 6.50 6.91 0.0 0.0 7.47 Conponnt.: Credit Componeit 4.50 4.a0 TA Component 2.00 1.01 UNDP Cotinancing for Technical Assistance 2.02 CUiJ3LT!VE ESTIMTAED AND ACTUAL DiS3URSEUENTS FfT2 FYft FY84 FY0S FY6 FY67 Appraisal Estimteo (USS U) 0.41 2.19 6.71 6.50 06.0 6.50 Actual (US U) - 0.2L 1.49 3.97 5.0? 6.91 Actual as X of Appraisal (3) - 11.42 26.09 61.08 76.00 90.92 PROCT DATES Orilinal Revised,Aotual Board Approval - 11/24/61 Credit Agreement - 08/09/62 Effecti0ve 06/06/62 07/09/62 Terminal Dote for S4bprojct SubmissIon 12/81/84 12/81/6 Loan Closing 12/81/46 12/81/06  - iv - STAFF INPUTS (staff weeks) FYT7 FY79 FY60 FY31 FY62 FY83 FY84 FY65 PYSO FY%7 Total Peappraisl 0.1 1.0 39.4 5.7 - - - - - - 46.2 Appraisal - - 10.6 49.5 6.0 - - - - - 65.0 Negotiations - - - 0.1 7.6 - - - - - 7.7 Supervision _ _ 14.6 18.4 31.1 26.7 10.0 8.1 102.7 Total 0.1 1.0 CO O c.a 27.3 16.4 31.1 25.7 10.0 8.l 221.9 MISSION DATA No. of No. of Date Of Month/Year Weeks Persons Reoort Identification 01/78 1.0 1 01/78 Preparation 06/79 1.0 1 na. Preparation 11/79 1.0 1 n .. Preappralsal 02/80 3.0 2 04/60 Preapprali l 08/80 2.0 1 na. Appraisal 06/80 4.0 4 10/80 Supervision I 09/61 2.0 1 11/61 Supervision II 04/82 2.0 1 04/62 Supervision III 01/83 1.2 2 n.e. Supervision IV 04/83 5.0 2 04/63 Supervision V 06/83 1.0 1 05/68 Supervision VI 06/68 1.0 1 08/84 Supervision VII 08/83 1.0 2 10/8J Supervision VIII 07/84 1.0 1 08/84 Supervision IX 10/84 1.0 1 10/84 Supervision X 01/85 4.0 8 01/65 Supervision XI 05/86 8.4 8 05/85 Supervision XII 06/86 1.0 1 07/86 Supervision XIII 11/86 1.0 1 11/6S Completion 11/87 3.0 a 09/66  l ~~~~~~~~~~~- v - OTHER PROJECT DATA Borrowr: Kingdom of Nepal Impl_menting Agencloe: Credit Component Nepal Rostra Bank TA Component Cottage Indutry Development Board Cottage Industry Handlcraft. Emporium Industrial ServIee Centor Trad Promotion Center Follow-on ProJect: Second Cottage and Small Industries Project (Credit 1696-W) Amount USS10 million equivalent Board Approval 05/18/86 Credit Agreement Date 09/26/8S Effect venes 07/31/67 Planning Closing .ste 06/80/94  - vii - PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (Credit 1191-NEP) EVALUATION SUMMARY i. Nepal's industrial sector is small and unO?rdeveloped, with limited prospects for import substitution and export of most modern industrial products. Output consists primarily of consumer goods, construction materials and simple assembly items. Private investment is concentrated in cottage and small industries; outside Kathmandu Vallay, industrial production occurs almost exclusively in cottage industries, which service the rural subsistence economy by providing textiles, food, forest-based and simple metal products. Industrial development is constrained by Nepal's limited natural resource base, small domestic demand, lack of a skilled workforce, landlocked position, and inadequate transport systems. Because of the con- straints, Nepal must adopt a highly selective approach to industrial develop- ment (para. 1.01). ii. CSI development has been a priority of the Government's industrial development program because it can yield substantial employment and foreign exchange benefits at relatively low cost. CSIs generate over one-third of Nepal's industrial CDP, providing full- or part-time employment to about 1.2 million people in about 400,000 enterpriseo. Exports represent a growing percentage of cottage industry outputs (para. 1.02). iii. The project was designed to help achieve the Government's objectives of increasing incomes and generating employment and foreign exchange through expanded production and export of CSI products by: (a) building programs and capacities of key commercial, public and banking institutions to provide effective services to viable CSIs; (b) implementing innovative, product- specific extension services in the Bagmati and Gandaki zones, which could be replicated in other areas; and (c) providing improved, simplified incentives to encourage efficient production and expanded sales of CSI products. A major objective was to tap marketing knowhow and organizing skills of private exporters and other-commercial agents to provide training and commercial services to cottage industries. About 60X of the project funding was expected to go to CSI development in Kathmandu Valley with about 40X to rural production concentrations in rural Bagmati and Gandaki (para. 2.03). iv. The first CSI project's performance was generally good. The project achieved its lending component objectives satisfactorily with most of its quantitative targets having been either achieved or surpassed. Some activities in the complex technical assistance component fell somewhat short of their objectives. In general, the project helped in upgrading the Govern- ment's capability to provide technical and financial assistance to CSI entrepreneurs and operations; introducing project-based term credit to CSIs; developing NRB into an apex institution geared to administering such lending; inducing three participating banks to promote, appraise and supervise CSI subprojects; providing innovative technical assistance inputs to sub-borrowers; and, all in all, set a solid framework for successive projects (para. 5.01).  - viii - v. Some useful lessons were gained in implementing the first CSI project which should be reflected in the implementation of the second CSI project and preparation of any new CSI activity. Effective appraisal procedures, inten- sive supervision and the enforcement of credit discipline in the repayment of subloans and the institutionalization of a credit guarantee scheme are impor- tant elements in project-based lending. An important lesson in the export development component was that more time than anticipated was needed to resolve the material supply, product design and marketing problems limiting export expansion. With the initial success achieved by CIDB In its programs, it will be important to adopt a more selective approach by providing substan- tial training to trainers to enable them to help upgrade the skills of exist- ing artisans. CIDB should ensure that the upgrading of skills leads to concrete market outlets based on local demand for consumer goods and export demand for manufactured products, such as wool carpets, garments and silver jewelry, in which Nepal has already demonstrated it could increase its com- petitiveness (para. 5.02).  Nz--$ PROJECT COMPLETION REPORT NEPAL COTTAGE AND SMALL INDUSTRIES PROJECT (Credit 1191-NEP) I. INTRODUCTION Sectoral Setting 1.01 Nepal's industrial sector is small and undeveloped, with limited prospects for import substitution and export of most modern industrial products. Output consists of consumer goods (footwear, textiles, processed foods), construction materials and simple assembly items. Within th.e formal sector, large-scale manufacturing is concentrated mainly in public enterprises in or near Kathmandu Valley. Private investment is concentrated in small and cottage industries; outside Kathmandu Valley, industrial produc- tion occurs almost exclusively in cottage industries, 1/ which service the rural subsistence economy. Industrial development is constrained by Nepal's limited natural rescurce base (other than water resources for hydroelec- tricity), extremely small domestic demand, lack of a skilled technical and managerial workforce, and its geographical position, which isolates it from appropriate sources and markets. The long, porous border with India makes it difficult for Nepal to protect "infant industries" from competition with goods from India's more developed industrial sector; similarly, India's relatively developed industrial base limits India as a potential market for Nepal's industrial exports. Nepal's landlocked position, the inefficient overland transport system through India or Bangladesh, and the undeveloped air cargo system add a substantial transport cost to imports and exports. In view of the above problems, Nepal must adopt a highly selective approach to industrial development. Promotion of cottage and small industries (CSIs) is a key part of this approach as it can yield substantial employment and for- eign exchange benefits at relatively low cost. 1.02 As a result, CSI development has been a priority of the Government's industrial development program. In particular, CSI contributions to develop- ment have been increased rural employment and incomes and expanded non-traditional exports. Cottage industries generate over one-third of Nepal's industrial GDP, providing full- or part-time employment to about 1.2 1/ Under the Industrial Enterprise Act, (October 1982) the definition of cottage industries for purposes of fiscal incentives and technical services includes those with fixed investment, including land and buildings, of up to Rs 500,000 in rural areas and Rs 800,000 in urban areas. Small-scale industries are defined as those with fixed invest- ment not exceeding Rs 2 million.  -2- million people in about 400,000 enterprises. Most are household units, with fixed assets below Rs 1,000 and annual output ranging from Rs 300 to Rs 16,800 per worker. Over 90% of output is in woollen, handloom, food, forest-based and metal products. Outside Kathmandu Valley, cottage industry skills and incomes are coricentrated among poor hill families. 1.03 Exports represent a growing percentage of cottage industry output. Total exports to overseas countries grew by over 200 percent from 1981/82 to 1986/87 (from Rs 462 to Rs 1,528 million, respectively), with carpets, gar- mencs and handicrafts rising from 24 to 75 percent of total exports to over- seas countries. Market studies carried out under t.e first CSI project indicated the potential for doubling exports to the United States and Europe in some product categories (particularly in wool carpets). Sector Issues and Problems 1.04 Major obstacles to industrial development are Nepal's small domestic market, landlocked position, and limited skills and resource base. Industries catering to local markets face low disposable incomes and serious competition with Indian consumer goods industries, which benefit from economies of scale. In most hill areas, purchasing power, already below subsistence levels, has been declining continuously since '982/83 due to stagnant or declining agricultural production, increasing population density and the lack of unexploited arable land. In manufactured exports, Nepal's landlocked position results in high transport costs, a sizeable burden on export prices of low value items. Cottage industry production in the hills is constrained by seasonal demands from agriculture and limited commercial orientation of the artisans. Traditional techniques limit productivity. Most craftspeople are not entrepreneurs; their tradition, scale, and knowledge limit growth beyond the household level and necessitate services by market agents for distribution of inputs and finished products. 1.05 Institutional constraints also are serious. Public programs to assist cottage industries have been weak. Private agents and exporters, who already play a major role in input supply, quality control and marketing in the Kathmandu Valley, have not found enough incentives to extend networks into hill areas, in spite of their difficulties meeting volume orders. Exporters face bureaucratic delays in licensing and shipping and are exempt neither from duty nor sales vax on imports needed for cottage industries. Pre-export financing and wolting capital credit are inadequate. Sector Goals 1.06 In the Sixth Five-Year Plan (1980-1985), the Government gave priority to increasing rural employment and incomes through CSI development. The Government also recognized the need for special institutional arrangements to service this sector. The Plan emphasized decontrol of cottage industries and improved incentives to the private sector. Also, the Government's industrial  -3- policy favored strengthening the banks and existing public and private agents rather than establishing new institutions to cover all aspects of cottage industry development. These strategies have been fully endorsed by IDA. 1.07 The Seventh Five-Year Plan (1985-1990) also calls for increased support for the development of cottage and small industries to supplement rural incomes and employment and to expand non-traditional exports. IDA Assistance Strategy and Involvement in the Industrial Sector 1.08 While the legislative framework of industrial policies has had limited impact on promoting private large- and medium-scale industrial investments and exports, it has had a positive impact on cottage and small industries, which exhibit considerable potential for developing Nepal's relative comparative advantage in producing low-volume/high-value cottage industry goods--carpets, among such goods, have become Nepal's second large3t export. IDA assistance strategy in the sector has been designed to achieve three objectives: (a) to provide advice in formulating, modifying and implementing industrial policies for more effective support to prospective private entrepreneurs; (b) to complement financial resources provided by IDA under two credits (i.e., Cr.705-NEP and Cr.15;5-NEP, both for medium- and large-scale private industrial investment); and (c) to continue to provide financial resources and technical assistance to enhance further the contribu- tion of cottage and small industries to the country's industrial activity. The broader goal is to develop the industrial sector so as to provide much needed alternate sources of employment to Nepal's traditional agricultural base, while effectively generating foreign exchange through increased exports and effective import substitution. 1.09 IDA's involvement in industrial development in Nepal falls into two categories: (a) support to cottage and small industries through the first CSI project, and (b) financing of medium and large agro-based, light engineering and service industries, utilizing the Nepal Industrial Develop- ment Corporation (NIDC) as a financial intermediary. In November 1984, an Industrial Development Project (Cr. 1535-NEP) was approved, consisting of a line of credit to assist development of the leather subsector and support private industrial investment. The International Finance Corporation has three operations in Nepal: a US$3.1 million expansion of the Soaltee Oberoi Hotel (FY85); a DM 14.5 million loan to Nepal Orind Magnesite Company to mine and produce deadburnt magnesite for export 'FY82); and a DM 7.8 million loan to the Nepal Metal Company to mine and concentrate zinc and lead for export.  -4- II. OBJECTIVES AND IDA EXPECTATIONS Project Origins 2.01 When the Government requested assistance from IDA to prepare a cot- tage and small industry project, IDA provided fuids from the Technical Assis- tance Credit (Cr. 659-NEP). The project identification report of January 1978 included terms of reference for indepth study and project preparation in five product groups including: carpets; cotton handloom products; metal utensils and curios; wood, bamboo and reed products; and certain agro-itidustries. These were selected by the Government and IDA, based upon their importance, market prospects and problems which could be addressed within a project. 2.02 The study, sponsored by the Department of Cottage and Village Industries (DCVI) and conducted by the Industrial Services Center (ISC) with outside specialists, consisted of two phases. Phase I was a survey of cot- tage industries in the six districts of Gandaki Zone and three districts of Bagmati Zone. The survey identified panchayat (local administrative council) concentrations of cottage units in each product group, determined charac- teristics of existing units, and described public and private services. The Interim Report, summarizing Phase I, was reviewed by DCVI, IDA and a steering committee with representatives of the involved ministries, departments, credit institutions and the private sector. Phase II included detailed analysis of the key product groups and proposals on institutional arrange- ments, subsector components and costs. Eight subsector and institutional specialists from Asia were employed for about 35 staffmonths to work with ISC on Phase II. Phase II also involved export potential studies for Nepalese woollen, cotton and handicraft products in the US and selected countries in Europe. Project Objectives 2.03 Based on the above preparation studies, the project was designed to help achieve the Government's objectives of increasing incomes and generating employment and foreign exchange through expanded production and export of CSI products by: (a) building programs and capabilities of key commercial, public and banking institutions to provide effective services to viable CSIs; (b) implementing innovative, product-specific extension services in Bagmati and Gandaki Zones which could be replicated in other areas; and (c) providing improved, simplified incentives to encourage efficient production and expanded sales of CSI products. A major objective was to tap marketing knowhow aud organizing skills of private exporters and other commercial agents to provide training and commercial services to cottage industries. About 60X of the project funding was expected to go to cottage industry  -5- development in Kathmandu Valley, with about 402 to rural production con- centrations in rural Candaki and Bagmati. Over 70% of training and commer- cial services was expected to cater to development of selected woollen and handloom products; and smaller amounts devoted to metal crafts in Kathmandu Valley and to forestry-based industries concentrated in rural Gandaki. Project Description 2.04 The main components of the project were: (a) Financing subloans to cottage and small industries and related com- mercial concerns; plus improving credit and operating systems of Nepal Rastra lank (NRB) and the participating credit institutions (PCIs); (b) Expanding and improving CSI export promotion programs in the Trade Promotion Center (TPC); and establishing an export promotion office (Products of Nepal) in New York; (c) Strengthening extension programs and services of the public service agencies--Cottage Industries Development Board (CIDB), and the Cot- tage Industry Handicraft Emporium (the Empori:m); and (d) Establishing a monitoring and evaluation system and preparing for subsequent plojects. 2.05 Under the lending component, two lecal commerical banks, Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB), and the Agricultural Develop- ment Bank of Nepal (ADB/N) were responsible for term lending to CSIs, related market agents, and input supply companies. These lending activities wese encouraged and strengthened by: (a) supplying US$4.5 million equivalent to help fi'l the gap between term lending requirements of CSIs and related commercial agents in the project area and limited credit resources available for this sector (limitatinns resulting from tighter credit controls and resources directed primarily at commercial activities); (b) establishing a CSI Refinance Unit within NRB to do subproject appraisal review and provide partial refinance of eligible subloans made by the PCIs; and (c) encouraging the PCIs to increase lending to viable CSIs and related commercial concerns through attractive spreads, effective guarantees, and trained CSI officers at headquarters and in key branches. 2.06 Under the technical and marketing services component, private and public services to CSIs in key product groups were to be improved by: (a) supporting TPC in providing assistance to exporters with market contacts, product development, and strengthening of the supply base. Production specialists, sales and exposure trips, performance contracts, and two foreign promotional offices were to be financed; (b) reactivating the CIDB to assume responsibility for public development services to CSIs, with product specific  -6- extension services in Kathmrandu Valley, an improved Handicraft Design and Promotion Centre, and integrated services to selected cottage industry clusters in areas of Gandaki Zone which were not covered by private commer- cial agents; (c) strengthening the Emporium's handloom operations by provid- ing an advisor and seed capital for procurement and distribution of cotton yarn, handloom accessories, and textiles in the project area; (d) providing advisory services to the Nepal Rastra Bank's CSI Refinance Unit and training for CSI staff of NRB and the PCIs; and (e) funding ISC staff and consultancy for monitoring, evaluation and preparation of subsequent projects.  -7- III. PROJECT IMPLEMENTATION AND IMPACT A. Subprojects General 3.01 Although the credit disbursed generally more siowly than expected, the credit component was committed and disbursed relatively quickly. IDA's first CSI project is considered a landmark in project-based financing in the country, which partly explains its attraction to potential sub-borrowers and the relatively rapid commitment of the credit component. The CSI project introduced active promotion, project appraisal and supervision of term loans to CSIs, input supply companies and market agents. The credit component's popularity reflected the existence of a substantial demand for CSI term financing and the relative attractiveness to sub-borrowers of having to finance only 20% of their investments. 3.02 Enterprises eligible for subloans under the project were: manufac- turing and marksting concerns engaged directly in the production of cottage industry products; and CSIs with fixed investment, after the subloan, of up to Rs 800,000 (US$60,600). Only CSIs with fixed costs per job not exceeding Rs 12,000 (US$900) after the subloan were eligible for credit. Also eligible were investment enterprises owned by private individuals, partnerships, incorporated bodies, or cooperatives. The maximum subloan size was Rs 800,000, including fixed investment and permanent working capital financ- ing. Subloans helped finance foreign and local costs of fixed assets and permanent working capital in either new or expansion subprojects. The credit was not allocated among the participating banks. Exporters organizations engaged by the Trade Promotion Centre as performance contractors in Candaki Zone were eligible for loans, provided the credit institutions, standards of viability were met. Refinance to projects of market agents for production facilities located in Kathmandu Valley were limited to no more than 30% of the total refinance granted under the project. In most cases, banks provided no more than 80% of the subproject cost, leaving 20% financed by sponsors for existing artisans with established markets. 3.03 The SAR estimated that the project would support about 2,600 subloans and would create roughly 40,000 jobs. The CSI project, in fact, supported 3,369 subloans with total investment costs in excess of US$12 million and more than 40,000 jobs created. Approximately 40% of lending has been to export-oriented industries, such as woollen aiid metal products, which helped to generate needed foreign exchange and consolidate Nepal's presence in foreign markets in such sectors as carpets and garments. The rest was for import-substituting activities, including handloom and agro-based enterprises. Preparation and implementation of the project increased the Government's awareness and understanding of CSI development problems, which  -8- further resulted in more effective and integrated assistance to CSIs. An important contribution of the project was the positive impact it had in stimulating the mobilization of additional resources for CSI financing, with the NRB and the three PCIs providing, by mid-July 1987, Rs 81.6 million (US$3.7 million); comprised of Rs 32.6 million (NBL), Rs 31.5 million (RBB), and Rs 17.5 (ADBIN). 3.04 Sectoral Distribution. Annex 1 details subsectoral distribution of subloans. The distribution by subsector of the 3,369 subprojects financed by CSI subloans was woollen carpets and garments, 301 (compared to SAR estimates of about 402); cotton products, 23Z (SAR,22Z); metal products, 7? (SAR, 4Z); forest-based products, 112 (SAR, 14Z);; agro-based products, 13? (SAR, 8?); and others, 16? (SAR, 2?). The average subloan per worker was Rs 6,120 (US$282), with woollen products appearing to be the most labor-intensive at only Rs 4,013 (US$185) per worker while metal and agro-based products were on the higher end at Rs 9,425 (US$434) and Rs 10,693 (US$493) per worker, respectively. 3.05 Geographical Distribution. The wide branch networks of the three PCIs participating in the project have been effective in achieving a geographical dispersion in the nine districts covered by the first CSI project. There were 25 PCI branches in the 3 districts in the Bagmati Zone and 31 PCI branches in the 6 districts in the rural Gandaki Zone. The dis- trict-wise distribution of subloans is given in Annex 2. Out of 3,369 sub- projects financed, 64.5? were in the Bagmati Zone with Kathmandu district accounting for 36.4Z of the subprojects and 49.2? of the financing (including 3 input supply companies which obtained Rs 9.5 million or 7.8Z of the amount of financing in Kathmandu district). Some 35.52 of the subprojects were in the Gandaki Zone which tended to be smaller subloanp, accounting for 25.6Z of the financing. 3.06 Size of Subloans. The analysis of subloans by size is given in Annex 3, and summarized in the table below: Subloan Size (Rs) Subprojects Financing (Z) (Z) Less than 40.000 53 14 40,000 - 100,000 30 29 100,000 - 800,000 17 57 The relevance of these figures for PCI branches' arrears and the recovery rates is discussed below. 3.07 Economic Impact. Excluding the cost of the sponsors' contribution to project costs, which would normally be at least 20?, the 3,369 subprojects financed under the Credit generated about 40,000 jobs at a cost per job of about US$300. Approximately 75? of the subloans were for new enterprises, contributing to the build-up of the country's entrepreneurial base. As  -9- expected at the time of appraisal, almost two-thirds of the subprojects are located in the Kathmandu Valley (Bagmati Zone), helping to relieve the employment problem in this area. The project also contributed significantly to the development of small industry in rural Gandaki, which accounted for 36Z of the subprojects and about 8,800 jobs generated. Approximately 452 of lending was to export-oriented industries, such as wool and metal products; the remainder was for import-substituting activities, including handloom and agro-based enterprises. In 1981/82, exports to overseas countries totalled Rs 604 million, with carpets, garments and handicrafts representing about 24! of the total. Over the project period tocal exports grew to Rs 1,528 mil- lion, with these three product categories representing about 752 of the total (Annex 4). B. Institutional Aspects Nepal Rastra Bank/CSI Fund 3.08 NRB, the central bank, recognized that to develop sound CSI lending operations in the PCIs, specialized trained staff, attractive spreads, effec- tive guarantees, and adequate refinance were needed. A CSI Refinance Fund, with its own policies, procedures, staff, and financial resources, was estab- lished in NRB to channel IDA funds. Staff of the CSI Fund reviewed sub- project appraisal reports (para. 3.10) and refinanced CSI subloans submitted by PCIs; monitored appraisal, supervision and collection standards; collected repayments of refinanced amounts; and reported quarterly to the CSI Coor- dinating Committee and IDA. Prior to credit effectiveness, NRB made an ini- tial contribution of Rs 5.0 million to the CSI Fund to cover initial operat- ing costs as well as the time lag between NRB's refinancing and reimbursement from IDA. Four additional contributions were made by NRB, bringing its total contribution as of mid-July 1987 to Rs 35.0 million (US$1.6 million). The CSI Fund financial performance exceeded all appraisal projections. Disburse- ments over the project period were expected to be about Rs 54 million, while actually totalling more than Rs 130 million (Annex 5). Repayments also surpassed projected levels (an estimated Rs 39 million to an actual Rs 44 million). A cash balance of about Rs 0.6 million was projected while Rs 4 million was achieved. The purpose of the refinancing fund was to facilitate disbursements, while administrative costs were expected to be covered by short-term financial returns on transiting funds. 3.09 Organization and Staffing. Annex 6 shows the organization chart and staffing of the NRB/CSI Project Office. The CSI Project Office that administered the Fund was set up within the Department Finance Department of the Nepal Rastra Bank. (A detailed organization chart of NRB is given in Annex 7.) It has its offices in leased premises (with two houses) near the NRB headquarters and is headed by a manager. The project manager is assisted  -10- by three deputy managers--one handling the Planning and Credit Guarantee Section and Account Section, with two officers and six support staff; one handling the Appraisal Section, Refinance Section, and Administrative Sec- tion, with three officers and twelve support staff; and one handling the Monitoring Section and NIDC Section, with three officers and three support staff. Field officers have been set up in Dang, Pokhara and Bharatpur with a total of five officers and eleven support staff. The total staffing of the CSI project officers involves 17 officers and 30 support staff, which is considered to be adequate to cover the fund's activities. All officers have received intensive training in CSI lending and refinance operations and have qualifications and experience acceptable to IDA. 3.10 Policies and Procedures. Prior to credit effectiveness, a statement of policies and operating procedures satisfactory to IDA was adopted by NRB. The statement outlined procedures for review of subprojects, monitoring of PCI activities and methods and conditions of refinance. For subloans of over Rs 20,000 (US$1,000), subsequently increased to Rs 40,000 (US$2,000) and Rs 100,000 (US$5,000) for the second CSI project, the Fund reviewed appraisals prepared by the PCIs prior to granting refinance; for smaller subloans, refinance was granted on the basis of the PCIs' appraisal showing the sub- project to be eligible, economically viable and having appropriate lending terms. However, a 20% random sample of these smaller subloans was subjected to a more detailed post-approval review of technical, financing and marketing aspects. 3.11 To ensure expeditious review of subloan applications of about Rs 40,000, the fund aimed to complete its procedures within three weeks of receiving the applications. In practice, this review averaged between one to three months, due mainly to difficulties in interviewing the sponsor. In a few instances, approval of refinancing took up to six months. The main reason cited was to give time for sponsors to initiate subproject activities. About 5% of subprojects sanctioned by PCIs were not refinanced. Although PCIs had sufficient funds to handle these subloans rejected for refinancing, the subprojects were not entitled to the automatic guarantee under the CSI Credit Guarantee Scheme. The review procedures were designed to ensure that about 30% by number and 86% by amount of subloans received preapproval review by the CSI Fund, with the actual result being *'out 47Z by number and about 86Z by amount. The CSI Fund monitored the PC1s' supervision standards through field visits to subprojects. PCIs submitted quarterly reports to the fund for review, aggregation and submission to the CSI Coordinating Committee and IDA. There was no detailed analysis of arrears and the status of these subprojects--information which becomes critical as the second CSI project progresses, and should be done as part of supervision of the second project. This is particularly important since the project completion review pointed to deficiencies in collecting and processing subprojects data by the fund.  -11- 3.12 Onlending Terms. The participating banks initially charged CSI sub-borrowers a standard annual interest rate of 11%. Although the Govern- ment only agreed in May 1986 to modify the interest rate structure, IDA's CSI project rate was increased to 15% in June 1985. The banks initially main- tained spreads of 4X for subloans above Rs 20,000 and 6% for subloans of up to Rs 20,000. With the increase in interest rates, the spreads increased to 7% for subloans above Rs 40,000 (increased from Rs 20,000 -- see para. 3.10) and 8Z for subloans up to Rs 40,000. The CSI Fund received 2% to cover administrative costs, and 1% as a premium (of guaranteed amour-ts outstanding) for the credit guarantee scheme. COMPARISON OF PROJECTED AND ACTUAL LENDING RATES AND SPREADS Size of Subloans <20,000 >20,000 <40 000 >40 000 (SAR Projections) Actuali Final Onlending Rate 11 11 15 15 Minimum Spread to PCIs 5 4 8 7 Minimum Spread to CSI Fund 2 2 2 2 Credit Guarantee Premium 1 1 1 1 Minimum Onlending Rate to NRB to HMG 3 4 4 5 The initial rate for the second CSI project subloans is expected to be 15%, with an inflation rate as of mid-April 1987 estimated at 8.7%. The CSI Fund receives 1.75% for subloans above Rs 40,000 and 0.75% for subloans up to Rs 40,000, and 3% as the premium (of guaranteed amounts outstanding) for the credit guarantee scheme. The Participating Credit Institutions (PCIs) 3.13 Two domestic commercial banks--Nepal Bank Limited (NBL) and Rastriya Banijya Bank (RBB)--and the gricultural Development Bank (ADB/N) made sub- loans to eligible CSIs, market agents and raw material supply companies in the project area. To be eligible for refinance, each PCI complied with minimum staffing and training requirements and adopted suitable standards and procedures for approving subloans. Annex 8 shows the relative credit perfor- mance of PCIs. ADB/N had a slightly greater number of subprojects sanctioned and handled more of the smaller loans, especially in rural Gandaki in view of its greater network of branches. Its recovery rate percentage also was slightly better than the two commercial banks. NBL and RBB had generally similar performance results.  -12- 3.14 The CSI project was a pioneering one in project-based term lending in Nepal, and institution building in relation to CSI lending by the PCIs has been a major project objective. Through substantial, systematic efforts, the PCIs have established a satisfactory organizational framework for processing CSI subloans. Yet, considerable progress remains to be done in improving appraisal standards, procedures, and supervision and collection, as explained below. The three PCIs strengthened their CSI lending capabilities by estab- lishing CSI units at head and zonal offices and assigned trained staff at branch offices as envisaged in the Staff Appraisal Report (No. 3172-NEP of October 29, 1981). A total of 25 PCI branches in the Bagmati Zone and 31 PCI branches in the Candaki Zone participated in the project. As of July 15, 1987, about 208 PCI officers and 117 non-officer level staff had been trained in project appraisal and supervision techniques, for a total of 325 trained staff. Additional training would be necessary for more staff when the second CSI project expands into 18 additional districts. Refresher courses or workshops would also be useful for those previously trained after taking experience gained in the project into consideration. 3.15 As required by the NRB/CSI Project Office, the PCIs make quarterly reports which focus on the main aspects of CSI lending operations, such as subsectoral distribution, breakdowns by districts and branches, size categories, and collection and arrears of subloans. Yet, as indicated ear- lier, collecting and processing the data by the NRB/CSI Project Office as well as within the PCIs is not up to date and there is a significant time lapse between the actual transaction and the reporting. There is a need to improve the data flows and it is necessary to focus greater attention on project monitoring and supervision particularly in improving the rather discouraging collection performance (para. 3.16). Setting up a micro-computerized Credit Information Cell (CIC) at the CSI Project Office would improve monitoring and supervision and also reduce processing time of refinance approval and disbursements. Corollary to this, up-to-date credit information, especially of defaulters, should also be available at the Credit Informaticn Cell. Credit information clearance was required by sub-borrowers from some 20-25 PCI branches. This was either undertaken by the PCIs through letters, which take considerable time or, to expedite the process, is solicited by sub-borrowers themselves. It would be much more effective and a significant shortening of the process if the CIC could provide the necessary clearance. In some instances, the circulation to all PCI branches of the names of defaulters was effective in actually prompting repayment. Portfolio Management 3.16 As of mid-July 1987, the collections of principal and interest on the CSI portfolios were at 66% of receivables. Total amount of arrears repre- sented 19% of the outstanding CSI loans portfolio. All three PCIs were within the overall recovery rate qualification criteria of 60X--NBL (64Z), RBB (66Z), and ADB/N (69%). However, 29 of the 56 PCI branches were below the 70% recovery rate qualification criteria set for branches. Annexes 9 to  -13- 11 show the branch distribution of subloans for each PCI and the recovery rates of respective branches. For several PCI branches, the collection performance was below standard mainly due to the larger sub-borrowers (over Rs 100,000). Repayment by these larger sub-borrowers would bring most of these branches within the qualification criteria. 3.17 Site visits by the PCR mission to 12 of the larger subprojects which were in arrears indicated that most of them were operating profitably and should have been able to service their loans. Except for a potentially profitable engineering industry subproject still in the stage of developing its market, which was of high potential, all subprojects were producing at full capacity and several of them had expanded their capacities and were plowing back pro