Peru - Small-scale Enterprise Project

Document of The World Bank FOR OFFICIAL USE ONLY Report No. 9238 PROJECT COMPLETION REPORT PERU SMALL SCALE ENTERPRISE PROJECT (LOAN 2064-PE) DECEMBER 28, 1990 Trade, Finance and Industry Division Country Department IV Latin America and the Caribbean Regional Office This document has a restricted distribi.tion 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 - Inti (I/.)* Average Market Rates for Period End of 1981 US$1 0.42 Intis End of 1982 US$1 3 0.70 Intis End of 1983 US$1 1.63 Intis End of 1984 US$1 3.47 Intis End of 1985 US$1 10.98 Intis End of 1986 US$1 13.95 Intis End of 1987 US$1 = 16.70 Intis End of 1988 US$1 = 128.83 Intis ABBREVIATIONS AND ACRONYMS BCR - Banco Central de Reserva del Peru (Central Bank) BIP - Banco Industria del Peru (Industrial Bank of Peru) COFIDE - Co-poracion Financiera de Desarrollo (Development Finance Cornoration) CONADE - Corporacion Nacional de Desarrollo DFC - Development Finance Company FOPINAR - Fondo de Fomento para la Pequena Industria y la Artesania ICSA - Inversiones COFIDE S.A. IDB - Inter-American Development Bank PCR - Project Completion Report PROPEM - Programa de Apoyo Multisectorial a la Pequena Empresa (Multisectoral Development Program for SSEs) SME - Small and Medium Scale Enterprises SSE - Small Scale Enterprise TRB - Tasa de Redescuento Bancario (Central Bank Rediscount Rate) GOVERNMENT OF PERU FISCAL YEAR January 1 - December 31 *Note: The new Government that took office in 1985 changed the currency unit from the Sol (S/.) to the Inti (I/.). One Inti is equivalent to 1,000 Soles.  FOR OFFICIAL USS ONLY THE WORLD BANK waShington. OC 20433 US A OnKi ni O.eCgW-Ce,v Opg'vatt, IvahitniEi December 28, 1990 MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT SUBJECT: Project Completion Report on Peru Small Scale Enterprise Project (Loan 2064-PE) Attached, for information, is a copy of a report entitled "Project Completion Report on Peru - Small Scale Enterprise Project (Loan 2064-PE)" prepared by the Latin America and the Caribbean Regional Office. No audit of this project has been made by the Operations Evaluation Department at this time. Attachment This document has a restncted distnbution and may be used by maCpienlts oniy in the pefformanc of thetir officil dutwL Its contents maUy not otherwtse be discilsod nthoxut WoM Bankt autbhotioz  FOR OFFICIAL USE ONLY PROJECT COMPLETION REPORT PERU SMALL SCALE ENTERPRISE PROJECT ,LOAN 2064-PE) TABLE OF CONTENTS Page No. PREFACE ............... .......^...................................i EVALUATION SUMMARY .iii PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE .1 A. Project Identity .1 B. Background .1 C. Project Objectives and Description. 3 D. Project Design and Organization. 5 E. Project Implementation. 6 F. Project Results. 7 G. Project Sustainability. 8 H. Bank Performance. 8 I. Borrower Performance. 9 J. Project Relationship ........................... 10 K. Project Documentation and Data ....................... 10 PART III. STATISTICAL INFORMATION .11 1. Related Bank Loans .11 2. Project Timetable .12 3. Loan Disbursements ...... ................. 13 4. Status of Covenants .14 5. Use of Bank Resources .21 ANNEXES 1. COFIDE: Subproject Distribution and Profile .23 2. COFIDE: Subproject Employment Generation .26 3. COFIDE: Use of Loan Funds Through Financial Intermediaries 29 4. COFIDE: Interest Rates Charged by Financial Intermediaries and Commercial Rates ..31 5. COFIDE: Comparative Balance Sheets, 1981-1988 .32 6. COFIDE: Income Statements, 1981-1988 .33 7. COFIDE: Financial Ratios, 1981-1988 .34 This document ha- a restricted distribution and may he used by recipients onlk in the performance ol their official duties It% contents ma_ not otherwise he disclosed without World Bank authoril7ation  PROJECT COMPLETION REPORT PERU SMALL SCALE ENTERPRISE PROJECT (LOAN 2064-PE) PREFACE This is the Project Complet' . Report (PCR) for the Small Scale Enterprise (SSE) Project in Peru, fot which Loan 2064-PE, in the amount of US$26.0 million equivalent was approved on December 8, 1981. Under the project, the Borrower, Banco Central de Reserva del Peru (BCR), used Corporacion Financiera de Desarrollo, S.A. (COFIDE) as an apex unit to channel the SSE funds to multiple retail financial institutions. Implemen- tation took place during a period of severe economic recession, increasing unemployment, and accelerated inflation. The loan, therefore, disbursed slower than expected, even though fixed onlending rates became negative as inflation occelerated. The loan was closed on December 31, 1987, two years behind schedule. A total of US$752,000 was cancelled. This PCR was prepared by the Trade, Finance and Industry Division, Country Department IV of the Latin America and Caribbean Regional Office. The Bank suspended disbursements to Peru on May 5, 1987, based on Peru's accrued non-payment of obligations. Preparation of this PCR was delayed mainly because, following the suspension of disbursements, resources for work on Peru were limited. Preparation of Part II was requested from the Borrower. But, given the time elapsed since closing of the loan and the fact that many of the Borrower's staff involved in managing the project have retired or moved to new assignments, Part II was not completed. Preparation of this PCR has not involved a mission to Peru. It is based, inter alia, on the Staff Appraisal Report, the Loan and Guarantee Agreements, supervision reports, correspondence between the Bank and the Borrower, a survey of SSEs carried outr by the Bank in December 1986, and internal Bank memoranda. This PCR was read by the Operations Evaluation Department. The draft PCR was sent to the Borrower for comments, but none were received.  - iii - PROJECT COMPLETION REPORT PERU SMALL SCALE ENTERPRISE PROJECT (LOAN 2064-PE) EVALUATION SUMMARY Obiectives 1. While the US$26 million loan to the Banco Central de Reserva del Peru (BCR), to be executed by Corporacion Financiera de Desarrollo, S.A. (COFIDE), was designed as a credit line with objectives to provide term czedit for small scale enterprises (SSEs) and to finance technical assistance, the creation of a more competitive environment for SSE term lending through improvements in interest rate policy and broader financial intermediary participation was also envisaged. More specifically, objectives were to: (i) generate new employment opportunities; (ii) contribute to decentralization of economic activity by providing more term credit to areas outside Lima: (iii) involve the commercial banks in providing term credit for small scale industrial investment; (iv) support the Government and BCR's efforts to eliminate subsidized interest rates and standardize financial terms and conditions for SSE lending; and (v) provide technical assistance resources to COFIDE to support its overall institutional development and to upgrade the SSE lending capabilities of financial intermediaries. The loan assigne' US$25.25 million to the credit component and US$750,000 for technical assistance. Implementation and Results 2. The loan was approved on December 8, 1981, and declared effective on August 17, 1982. The loan's pr..ncipal objectives as a credit line were achieved, i.e., sound projects to SSEs were financed by Bank funds through multiple retail financial institutions. However, the actual implementation took longer than expected. The final commitment date was postponed three times by one year at a time and the closing date was extended twice. Both economic and institutional factors affected the pace of loan commitments and disbursements: (i) COFIDE's financial crisis at the start-up of the project diverted the attention of its senior management from the establishment within COFIDE of the Small Scale Enterprise unit (Programa de Apoyo Multisectorial a la Pequena Empresa - PROPEM) which was to administer the loan resources. PROPEM was not fully staffed and prepared to operate until almost seven months after effectiveness. T-e first disbursements were made in the last quarter of FY83, one year later than anticipated. During loan implementation, the lack of training of PROPEM's staff and inadequate policies and operating procedures contributed to operational delays; and (ii) the deep economic recession of 1982-84 and the reduction in the spread to the intermediaries after the BCR introduced a new interest rate structure in 1985, affected demand by SSEs for credit to expand capacity or inventories. The loan was closed on December 31, 1987, two years later than initially estimated. 3. COFIDE used US$25.25 million in loan funds to finance 1,978 subprojects. The project did favor small scale enterprises as had been intended: 48* of the subloans by number were below US$10,000; 34Z were in the size range of US$10,000-US$40,000; and 18? were more than US$40,oor -d less than US$200,000.  - iv - Thirty percent of the subloans consisted of new investments; 702 were expansion and modenmizati-.n. Given the small: size of the maximum subloan under the project (US$200,000) detailed Bank review of subptojects took place ex-post on a sample basis during supervision missions. To enhance quality control, the Bank carried out a survey of 117 sample SSEs, in June 1986. when the loan was 872 disbursed. Results of the survey were that the loan implementation was generally successful: (i) the project generated 10,562 new SSE jobs at a cost of about US$6,000 per job; (ii) nineteen commercial banks and ten development finance companies channeled the resources to SSEs, thus resulting in increased competition between financial insti.utions and better service to SSEs. The participating regional banks and the large network of regional branch offices of commercial banks allowed 542 of the term resources to be channeled to areas outside Lima; and (iii) arrears or the PROPEM loans were orly 3Z. 4. The lonn was less successful in implementing the broad-based objective of seeking a more competitive environment for SSE term lending. The Bank required improvements in interest rate policy as a condition of loan effectiveness. Thus, initially, the resources were channeled by the financial intermediaries at the maximum commercial interest rate on subloans made by such entities. During the second year of loan implementation the onlending rates fell below the commercial rates and the prevailing rates for similar term loans, such as the Inter-American Development Bank's (IDB) SSE credit line to the Banco Industrial del Peru (BIP). COFIDE a.d the Banco Central de Reserva (BCR) violated the financial loan covenants by: (i) not meeting to exchange views on the adequacy of the interest rates to be charled on the subloans, as a function of the rediscount banking rate and the maximum regulated commercial interest rate; and (ii) not informing the financial intermediaries that the loan required an adjustment of their onlending rates to the maximum regulated commercial interest rates. The Bank had to monitor continuously interest rate performance and broach the subject with COFIDE and the BCR. When the onlending rates became negative and grounds for suspension became clear, while Bank miu ions called this event to the attention of BCR authorities, the Bank was faced with the difficulty of using suspension - the Bank's remedy for violation of loan covenants - as the ultimate weapon. The project design did not provide other tools to ensure long-term improvements in interest rate policy. 5. Performance of the technical assistance component was satisfactory. Of the technical assistance resources of US$750,000, a total of US$545,000 were used to serve the project's aim oi providing quality services to an expanding SSE client base by strengthening the organization and staffiLng capabilities of COFIDE and of the financial intermediaries. Findings and Lessons Learned 6. The design of this first Bank SSE operation in Peru was based on the underlying premise that apex credit delivery systems that involve multiple retail financial institutions are better suited than credit lines channeled through single financial institutions to intermediate a large number of small loans and, through the network of intermediaries, to provide good customer service to its borrowers. In the Bank's recent review* of the performance of 70 Small and Medium Scale (SME) projects in 36 countries, spanning a fifzeen year period, the approach to the provision of credit of the Peruvian SSE loan is highlighted as a success. The report also concludes that, comparing actual outcomes to projected outcomes, this SSE loan achieved all of its objectives, i.e., subloans were small, the number of jobs created at low costs surpassed expectations, and the subloan repayment rate was high. 1/ Worlu Bank Lending for Small and Medium Enterprises: Fifteen Years of Experience, PPR, 1989.  - v 7. COFIDE had been a model devetcpment finance company (DFC) in the 1970s in Latin America. The Bank had already completed a First Industrial Credit Project (Loan 1358-PE) and had initiated a Second Industrial Credit Project (Loan 1968-PE) through COFIDE. However, in hindsight, the strategic choice of COFIDE as the apex unit backfired. The optimal roles and responsibilities of apex units depend mostly on the experience and competence of the retail banks in lending to SSEs, and on their ability to establish their credentials as SSE lenders in the financial markets. Where banks are inexperienced or of dubious competence, the more successful apex units in the Bank's experience have taken active roles in promoting the program, training loan officers in participating retail banks, and ensuring that the system functions efficiently. In this case, COFIDE's fulfillment of its apex unit role was mixed--although a wide financial intermediation was indeed accomplished- under the loan, COFIDE failed to provide PROPEM with autonomv to carry out its role as an independent project entity which would not only channel the loan's resources through a network of intermediaries but also take a lead role in strengthening the staffing capabilities of financial and technical assistance institutions to provide quality services to an expanding SSE client base. Today, PROPEK has disappeared. and the BIP continues to be the main SSE lender. 8. Early in loan implementation (July 1983), the Bank found that COPIDE's senior management was fully engaged in attempting to handle COFIDE's overwhelming financial problems and could find little time to focus on the problems of the SSE operation. These had two aspects - operating and institutional. Getting PROPEM to operate efficiently and transforming the project unit from a discount facility to an efficient lending and assistance fund was a constant theme throughout the Bank's supervision. The Bank addressed the staffing and procedural problems affecting the internal efficiency of the PROPEM unit by recommending that PROPEK's Chief be trained in FOPINAR. one of the Bank's model SSE development funds within the Corporacion Financiera Nacional, in Ecuador. On the institutional issues, the Bank sought to: (i) establish PROPEK as a project entity with a separate budget, financial goals and responsibilities; (ii) broaden PROPEM's technical assistance role to develop programs to assist SSE project participants; and (iii) develop loan supervision systems and improved training programs for participating financial intermediaries. 9. There are lessons to be learned from COFIDE's poor implementation performance: (i) operating priorities and management of the project unit cannot be divorced from the financial strength of the institution, i.e., the Bank failed to see that, as in the case in Ecuador and Mexico, an SSE fund's development role flourishes when housed in financially sound institutions which want to carve a niche in the market; and (ii) the success of loan implementation depends on the willingness of the Borrower to carry out the Bank's objectives, but these, in turn, have to take into consideration the benefits and risks to the Borrower. For example, COFIDE incurred a two-year delay in providing external training to PROPEM's chief executive. It was clear that COFIDE's financial problems were overwhelming and could not focus its attention on PROPEM, but also, the project design did not help the Borrower to achieve the Bank's objectives. The technical assistance funds were denominated in the Bank's currencies of disbursements, wheteas the credit component resources were in soles. In a period of rapid devaluation of the sol, neither the BCR nor COFIDE were reluctant to enter into a liability which would imply a foreign exchange risk.  - vi - Proiect Sustainabilitv 10. SSE lending reverted to the BIP and wider participation of financial institutions in SSE lending ended with the project. The expected benefits of the project are therefore not being realized.  PROJECT COMPLETION REPORT PERU SMALL SCALE ENTERPRISE PROJECT (LOAN 2064-PE) PART I. PROJECT REVIEW FROM THE BANK'S PERSPECTIVE A. Project Identity 1. Name Small Scale Enterprise Project Loan Number 2064 - PE RVP Unit Latin America and the Caribbean Region Country Peru Sector Finance and Industry B. Backgroundl 2. During the 1970s, the Peruvian economy went through a period of rapid growth fueled by expansionary fiscal and credit policies (1968 to 1976), a serious financial and balance of payments crisis followed by a recessionary period (1977 to 1979), and the incipient stages of an ec' .mic recovery (starting in late 1979). The cyclical nature of the economic activity during the 1970s is reflected in the growth of GDP, which averaged 4.3Z p.a. during the 1968-76 period, dropping to minus 0.32 p.a. in 1977-78, and recovering to 3.42 p.a. in 1979-80. With slow economic growth and a rapidly growing population (2.72 p.a.), the country's per capita income virtually stagnated during the late 1970s and was US$930 in 1980 as compared to US$910 in 1970 (at constant 1980 prices). The economic crisis of the late 1970s and the high population growth rate had worsened a traditionally serious unemployment problem. At the time of appraisal, it was estimated that 11Z of the non-agricultural labor force was unemployed. 3. The behaviour of industrial output and investment followed the swings of economic act3vity: after a decrease in industrial output and investment during 1977 and 1978, industrial production recovered slightly (4.1Z) in 1979 and grew more strongly (5.92) in 1980. This recovery, however, had not changed a situation of very low levels of industrial employment. While manufacturing contributed an estimated 27% of the country's GDP in 1980, total employment in the formal manufacturing sector amounted to only 5-6Z of total employment. Adding an estimated equal number of jobs in the informal sector, the total contribution to employment remained in the 10-12Z range. 1/ Based on PERU: Policies to Stop Hyperinflation and Initiate Economic Recovery. A World Bank Country Study, April 1989.  4. Prior to 1978, Peru followed the import substitution approach to industrial development providing high tariff protection--supplemented by import restrictions for a large number of products--generous fiscal incentives (up to 85% of tax exemptions), and credit on relatively favorable conditions. This policy framework stimulated the developmenr of import substitution industries with low domestic value added, low productivity, and low capacity utilization. Although export incentives in the form of negotiable export tax credit certificates (CERTEX) were introduced on a small scale in 1970, industrial development was inward-oriented and manufactured PAports were relatively minor, amounting to roughly one pcrcent of industrial ouw)ut. 5. A major reorientation of industrial policies took place in connection with the 1978 Economic Recovery Program, which was supported by a Bank Program Loan. The complex system of non-tariff protection (import licensing, prohibitions, state monopolies, and, in particular, the National Register of Manufactures (RNM), which consisted of a list of industries maintained in the Ministry of Industry--imports competing with goods produced by industries on the list were banned) was dismantled and replaced by a new tariff system which became effective in December 1979. In addition, more vigorous export promotion efforts were undertaken along with a more flexible exchange rate policy. These policy changes, together with falling domestic demand in the late 1970s, resulted in an important reorientation of industrial development, with the value of manufactured exports increasing from about 1.6Z of industrial output in 1976 to almost 8% of industrial output in 1980. Textiles and fish products accounted for most of this increase. 6. General elections in 1979 brougnat back a ci"vlian Government whose official economic tenet jas free markets and free prices. Small scale industry was expected to participate vigorously in Peru's economic and industrial growth. Preliminary indications at the time of appraisal were that small scale industry had benefitted from the new import liberalization process. SSEs were able to purchase many imported raw materials and intermediate goods at iower prices than those that persisted when local manufacturing was practically the only source of supply. The recovery was, however, short lived: the new Government embarked on bulky infrastructural investments that complicated macroeconomic management, more so in the face of declining terms of trade, internationpl recession, and an increasingly overvalued exchange rate. These problems culminated with the drying up of external voluntary lending, particularly after the onset of the Mexican debt crisis in 1982. GDP plummeted by 12Z in 1983 and inflation doubled to more than 100%. In response, the Government reversed the import liberalization process. 7. In 1984, upon the impossibility of reaching an agreement on foreign debt rescheduling and fresh financing with creditors, the Government engaged in a policy of undeclared a-rears. In 1984-85, steps were taken to stabilize the economy by means of active exchange rate depreciation, frequent adjustment to prices and some reduction of public expenditure. These measures failed to stabilize inflationary pressures and economic growth slowed down. The new administration that took office in mid-1985, followed a completely different economic strategy oriented to quick economic recovery by bolstering consumption demand and using existing idle capacity. Consumption demand was fueled by increasing real wages, tax cuts, and freezing state enterprises' prices and tariffs. The use of idle capacity was promoted by closing the domestic market to competing imports and establishing multiple exchange rates and interest rate subsidies. The initial response of the economy was an unparalleled output and  - 3 - employment expansion in 1986 and 1987. This growth was achieved at the .xpense of growing financial and external imbalances. In 1987, when disbursemelits of all loans to Peru were suspended because of non-payment to the Bank, inflation had picked up to 115% per year. In July 1987, the new Government attempted to nationalize the commercial banks, finance firms, and insurance companies on the grounds of democratizing credit allocation and breaking the links between financial groups and credit institutions. Beginning in 1988, Peru entered in a hyperinflationary process whose consequences have beent (i) progressive reduction of economic activity (accumulated reduction of 30% of GDP); (ii) increasing financial disintermediation (saver's financial assets dropped from 20% to 52 of GDP); and (iii) virtual collapse of public sector revenues. C. Project Objectives and Descrip"ion 8. While this project was designed as a credit line which would provide term credit for small scale enterprises and finance technical assistance, the creation of a more competitive environment for SSE term lending through improvements in interest rate policy and broader financial intermediary participation was also envisaged. The newness, small size, lack of political and social clout of many small entrepreneurs, and the perception of higher risks in SSE lending by many bankers oftelL have precluded credit access by small firms. Thus, the line of credit was to establish a second-tier apex system to channel the resources through multiple retail financia'l institutions (typically a mix of commercial banks and development finance companies) to SSEs. More specifically, objectives were to: (i) generate new employnment opportunities; (ii) contribute to decentralization of economic activity by providing mort term credit to areas outside Lima; (iii) involve the commercial banks in providing term credit for small scale indust,ial investment; (iv) support the Government and BCR's efforts to eliminate subsidized interest rates and standardize financial terms and conditions for SSE lending; and (v) provide technical assistance resources to COFIDE to support its overall institutional development and to upgrade the SSE lending capabilities of financial intermediaries. To achieve these ends, the loan consisted of a US$26.0 million equivalent line of credit to BCR, to be executed by COFIDE, to finance the foreign exchange component of an estimated 1,500 subprojecCs, and a technical assistance program (US$750,000 of loan funds) to upgrade the capabilities of the staff of COFIDE and of financial intermediaries. 9. Credit Component. Eligible enterprises included firms other than an agricultural or livestock enterprise, with annual sales of up to US-$750,000 equivalent, and fixed assets, excluding land, of up to US$300,000 equivalent. The broad definition included firms, legally defined in Peru as SSEs, engaged in industrial, tourist services and commercial activities, as well as agroindustry, fishing, forestry, construction, and mining operations. Loan resources would finance investments in fixed assets, related working capital, and permanent working capital for utilization of installed idle capacity. The maximum investment eligible for financing under the project would be US$200,000; the maximum subloan would be US$180,000, including US$100,000 of Bank funds. It was expected that the average subloan size would be about US$25,000. Given the small size and large number of subprojects that was expected under the project, based in great measure on the BIP's own lending practices to SSEs, COFIDE set up an automatic discount mechanism, with simplified appraisal criteria and processing procedures: free limits were developed by type of intermediary (for the BIP US$100,000 based on its extensive experience and capabilities in SSE lending; US$70,000 for other development, commercial and regional banks, and  development finance companies; US$40,000 for credit cooperatives and other intermediaries. COFIDE was expected to review from 5-10% of the subprojects. Detailed Bank review of subprojects was to take place ex-post on a sample basis during supervision missions. COFIDE would refinance 90% of the loans made by intermediaries for fixed assets and permanent working capital. For this loan disbursement category, Bank participation would be limited to a maximum of 50X of the investment. In principle, all financial intermediaries legally established in Peru and in good standing with the BCR which would meet the eligibility conditions - regarding sound financial practices and project appraisal capabilities - set forth in COFIDE's policies for financial intermediation, would be eligible to participate in the operation. 10. The Bank loan was made to BCR for 15 years, including four years of grace, at a fixed interest rate of 11.62 p.a. The BCR would onlend to COFIDE the equivalent in soles of the US$25.25 million of the Bank loan intended for SSE financing and an additional amount equivalent in soles to US$10 million from its own resources, for 15 years, including four years of grace, at the prevailing Central Bank discount rate (Tasa de Redescuento Bancario - TRB). In ordeL to maintain the real value of the Bank funds to be onlent by BCR in soles, the BCR would semi-annually adjust the amount of its commitment to COFIDE, expressed in soles, to be financed out of such Bank funds. This adjustment would be equivalent to any difference that developed due to variations in the exchange rate during the previous six months in the amount of soles equivalent to the Bank loan not yet repaid. In effect, this scheme would be a form of indexing that would assure that the soles value of the disbursed and outstanding resources of the proposed Bank loan remain equivalent to the foreign currencies being held by the BCR throughout the life of the loan. 11. A cumbersome matrix was set up for COFIDE's onlending rates and spreads. COFIDE was to refinance or discount loans made by eligible inte-mediaries for the same periods as the loans received by SSEs, and at a rate equivalent to the TRB plus 2% for loans up to US$10,000 equivalent, TRB plus 3Z for loans between US$10,000 and US$40,000, and TRB plus 4Z for loans above US$40,000, all payable monthly. This was to provide COFIDE with a nominal spread of about 3% on average (an effective spread of about 4.4z). The differential rates to intermediaries would allow intermediaries a higher spread on the smaller loans which would be more costly to evaluate and process, and to COFIDE a higher spread on larger loans which would be above COFIDE's free limits to intermediaries and would thus require further appraisal by COFIDE. The higher spread on smaller loans was also expected to provide intermediaries with an incentive for lending to the smaller enterprises among SSEs. 12. Eligible intermediaries would onlend Bank and BCR resources to SSEs for periods rangirg between two and ten years, including a grace period of up to three years for fixed assets and associated working capital investment; and for periods of one and a half to five years, including a grace period of up to two years for permanent working capital investments. Interest rates would be up to the prevailing maximum rate allowed for term lending. These rates would be positive in real terms, and would allow intermediaries a nominal spread in the range of 8-10%, to allow the intermediary a profit after covering estimated processing and risk costs of some 7Z to 8% depending on loan size. The loan would provide the only long-term resource available in local currency for the industrial sector with attractive spreads for intermediaries. 13. Technical Assistance. At the request of COFIDE, a US$750,000 technical assistance component was added to the loan to finance the foreign exchange costs  - 5 - of a US$900,000 program which would essentially consist of three elements: (i) training of the staff of COFIDE and financial intermediaries on project appraisal and lending techniques, including a comprehensive training program for loan officers of financial intermediaries dealing with SSEs; (ii) a young executive development program within COFIDE, including training with international banks, both in Peru and overseas, and scholarships for post- graduate studies abroad; and (iii) training of middle level executives of the Financial Resources Division in foreign resource mobilization and cofinancing. In July 1980, COFIDE was assigned the role of major wholesaler of term resources, both local and foreign. COFIDE also became the financial agent for medium- and long-term foreign borrowings of public enterprises. Thus, COFIDE believed that the technical assistance program would strengthen its institutional development and allow COFIDE to play a more important and effective role in fostering broader financial intermediation. The loan resources for technical assistance were to be onlent by the BCR to COFIDE in the same currencies and on the same terms and conditions as the Bank loan. Because of the adjustment scheme envisaged in the credit component and the difference in currency, terms, and conditions between the credit and the technical assistance components, agreement was reached on the BCR keeping separate accounts (a total of four) for the loan and on a yearly audit of such accounts. D. Project Design and Organization 14. The design of this first Bank SSE operation in Peru was based on the underlying premise that, as measured by smaller subloan sizes, higher job creation rates with lower costs, and higher subloan repayment rates, apex credit delivery systems that invelve multiple retail financial institutior.s are far more effective than credit lines channeled through single financial institutions. For many years, the BIP was practically the only financial institution channeling term resources to SSEs (funded mostly by the Inter- American Development Bank (IDB), and through a special program targeted to the rural SSEs, supported by USAID resources). In the late 1970s, the BIP had suffered from an inadequate organization, over-staffing, and deficiencies in its resource mobilization side, owing mostly to low cost resources being made readily available by the Government for financing SSEs at subsidized interest rates. On the lending side. however, and particularly lending to SSEs, the BIP had developed a high degree of operational and institutional competence. The only major weaknesses in the lending side were cumbersome loan appraisals, where a much higher degree of thoroughness and quality was required by the BIP than the smaller loans would merit, and lengthy and time consuming procedures. Because the term resources of the loan were to be made available to other financial intermediaries cn equal terms and conditions, it was expected that the BIP would be motivated to improve the efficiency of its lending operations, particularly in the loan application processing. 15. The new Government that took office ir, mid-1980 had adopted a strategy for COFIDE that was intended to change fundamentally its role in the new decade: COFIDE would divest itself of its frozen investments in industries nationalized through 1979 and concentrate on development banking functions. This reorientation of COFIDE's activities had been an issue raised by the Bank throughout the life of the First Industrial Credit Project (Loan 1358-PE) and during loan preparation of the Second Industrial Credit Project (Loan 1968-PE), a loan which was to complement the SSE project. COFIDE would expand its lending operations to the private sector and increase its coverage of that sector by channeling increasing amounts of term capital, particularly foreign resources, through financial intermediaries. To this end, COFIDE's Board of Directors  introduced organizational changes in September 1980 which included the creation of a new Financial Intermediaries Division, partly staffed with personnel experienced in dealing with intermediaries as a result of the transfer to COFIDE in the same year, of four specialized funds operated by the BCR. In light of the institutional reorganization, the Bank chose COFIDE as the executing agency for the project. For the management of the project, a special unit (PROPEM) was created in the Financial Intermediation Division. 16. In hindsight, the selection of COFIDE as the apex unit had its shortcomings. The optimal roles and responsibilities of apex units depend mostly on the experience and competence of the retail banks in lending to SSEs, and on their ability to establish its credentials as ar SSE lender in the financial markets. Where banks are inexperienced or of dubious competence, the more successful apex units in the Bank's experience have taken active roles in promoting the program, training loan officers in participating retail banks, and ensuring that the system functions efficiently. In this case, COFIDE's fulfillmer.t of its apex unit role was mixed--although a wide financial intermediation was indeed accomplished under the loan, COFIDE failed to take a lead role in strengthening the staffing capabilities of financial and technical assistance institutions to provide quality services to an expanding SSE client baae. With no autonomy from COFIDE to design credit programs that meet the needs of retail banks and SSE clients, and although PROPEM's staff was eventually trained in Ecuador by FOPINAR, one of the Bank's model SSE apex units, the transformation from viewing its role as a discount facility to an SSE development credit facility never achieved its full potential. Today, PROPEM has disappeared, and the BIP continues to be the main SSE lender. If the Bank's objectives were really aimed at "assisting COFIDE in financing such productive facilities and resources in Peru as will contribute to the economic and social development of the country", and taking into account the newness of COFIDE's role as a wholesale financier for the sector, there may have been more benefits in establishing the apex system instead at the BIP, with long experience in SSE lending. E. Project Implementation 17. The loan was approved on December 8, 1981, and declared effective on August 17, 1982, with no significant delays (two months). To comply with its broad-based objectives of eliminating subsidized 4.nterest rates and standardizing financial terms and conditions for SSE lending, as a condition of loan effectiveness the Bank required the BCR to issue the necessary resolution to exempt commercial and regional banks from provisions of the banking law, prohibiting them to engage in term lending operations, and to authorize them to approve loans of up to ten years. The BCR also authorized commercial banks, regional banks, and savings associations which would participate in the SSE project, as well as an IDB Project No. 377, to charge maximum commercial interest rates for long-term lending. 18. The actual implementation took much longer than expected. The commitment end date was postponed three times from December 31, 1984 to March 31, 1985, to June 30, 1986, and finally to June 30, 1987. The closing date was extended twice between December 31, 1985 and December 31, 1987. An amount of US$752,000 was cancelled from the loan account in February 1987. When disbursements to Peru were suspended in May 1987, for non-payment of its cbligations, the loan was fully disbursed. 19. Both economic and institutional factors affected the pace of loan commitments and disbursements: (i) COFIDE's financial crisis at the start-up of  -7- the project diverted the attention of its senior management from the establishment of the Small Scale Industry t'nit (PROPEM) which would administer the loan resources. Thus, PROPEM was not fully staffed and prepared to operate until almost seven months after effectiveness. The first disbursements were made in the last quarter of FY83, one year later than anticipated. During loan implementation, the lack of training of PROPEM's staff and inefficient operating policies and procedures contributed to operational delays. These delays, which averaged 4 to 5 months, resulted, in turn, in reduced foreign exchange receipts by the BCR as the sal value of subloans relative to the dollar declined by 40? between the time of FOPINAR disbursement and Bank disbursement; and (ii) the deep economic recession of 1982-84 affected demand by SSEs for credit to expand capacity or inventories. The loan was closed on December 31, 1987, two years later than initially estimated. F. Project Results 20. The loan's principal objectives as a credit line were achievedt (i) the project generated 10,562 new SSE jobs at a cost of about US$6,000 per job; (4i) participating regional banks and the large network of regional branch offices of commercial banks allowed 542 of the term resources to be channeled to areas outside Lima. thus contributing to further decentralization of economic activity; (iii) nineteen commercial banks and ten development finance companies channeled the resources to SSEs, thus resulting in increased competition between financial institutions and better service to SSEs. Of these, the BIP accounted for 652 of operations and 342 of total resources used; and (iv) arrears on the PROPEH loans were only 3Z. Statistics on subloans are shown in Annexes 1-3. COFIDE used US$25.3 million in loan funds to finance 1,978 subprojects. The project did favor small scale enterprises as had been intended: 48Z of the subloans were below US$10,000; 34Z were in the size range of USSlO,O00-US$40.000; and 182 were more than US$40,000. Thirty percent of the subloans consisted of new investments; 702 were expansion and modernization. The subsectoral distribution showed that about 502 of the resources went to four subsectors--textiles, food processing, services and commerce, and metalmechanics. Given the small size of the maximum subloan under the project (US$180,000) detailed Bank review of subprojects took place ex-post on a sample basis during supervision missions. To enhance quality control, the Bank carried out a survey of 117 sample SSEs, in 1986, when the loan was 852 disbursed. Results of the survey were that the loan implementation was generally successful. Some questions regarding economic and social gains were, however, raised by the financing of service and commercial companies. 21. The loan was less successful in implementing the broad-based objective of seeking improvements in interest rate policy. Because improvements in interest rate policy were a condition of loan effectiveness, initially the resources were channeled by the financial intermediaries at the current allowable commercial interest rate on subloans made by such entities. During the second year of loan implementation, the onlending rates fell below the commercial rates and the prevailing rates for similar term loans, such as the Inter-American Development Bank's (IDB) SSE credit line to the Banco Industrial del Peru (BIP). The Bank had to monitor continuously interest rate performance and broach the subject with BCR, with limited success. Although progress was achieved in reducing subsidies, the design of the project did not provide the necessary tools for achieving long-term interest rate policy improvements. 22. Performance of the technical assistance component was satisfactory. Of the technical assistance resources of US$750,000, a total of $545,000 were used to serve the project's aim of providing quality services to an expanding.SSE  client base by strengthening the organization and staffing capabilities of COFIDE and of the financial intermediaries. The technical assistance resources were used to finance scholarships abroad and to carry out training courses in Finance and Development in Peru. Although the resources were used, there were, however, some disappointing aspects: (i) whereas the credit component resources were denominated in soles, the technical assistance funds were denominated in the Bank's currencies of disbursements. In a period of rapid devaluation of the sol, the BCR and COFIDE were reluctant to enter a liability; (ii) poor implementation by COFIDE, which failed to provide PROPEM with the autonomy to coordinate the technical assistance activities, and incurred a two-year delay in providing external training for PROPEM's chief executive; and (iii) inadequate project preparation on the Bank's part. G. Proiect Sustainability 23. By the time the loan was closed, at the end of 1987, the Bank had suspended disbursements to Peru and COFIDE's capability to mobilize foreign or local resources had long since dried up. On the other hand, other sources of financing of private sector activities in Peru also disappeared, as a result of growing financial repressions that culminated with the nationalization of commercial banks in mid-1987. SSE lending reverted to the BIP and wider participation of financial institutions ended with the project. The expected benefits of the project are therefore not being sustained. H. Bank Performance Z4. During preparation and appraisal, Bank staff worked closely with COFIDE on the preparation of a set of policies and a comprehensive operations manual to govern SSE lending ("Proyecto de Creacion de un Programa de Credito ultisectorial para la Pequena Empresa"). Under the Loan 1968-PE, Bank staff worked closely with COFIDE on a policy statement for financial intermediation that would guide COFIDE's lending through other financial intermediaries. The Bank also worked closely with the BCR on interest rate policy improvements. The Bank was overly optimistic about the sustainability of measures the BCR took as a condition of effectiveness of the SSE loan. 25. The Bank made a considerable supervision effort with this loan: twelve supervision missions between 1982 and 1987 using a total of 30 staff weeks. During project implementation, the maj, problems affecting this loan were: (i) COFIDE's financial crisis at the start of the project diverted the attention of its senior management from the establishment of PROPEM, which would administer the loan resources; (ii) during loan implementation PROPEM did not fully achieve its potential; (iii) deep economic recession of 1982-84 and the reduction in the spread to the financial intermediaries after the BCR introduced a new interest rate structure in 1985, affected demand by SSEs for credit to expand capacity or inventories. The Bank sought to address these problems through intensive supervision activity. 26. COFIDE's financial situation was analyzed in etail under the Loan 1968-PE supervision activity. During the start-up phase of this loan, Bank supervision missions paid considerable attention to PROPEM's organization, logistic support, and reviewed in detail procedures for sub'.oan approval and discounted operations. Initially, the unit was indeed organized to perform routine discount functions and project review. Early in loan implementation (July 1983), the Bank found that COFIDE's senior management was fully engaged in attempting to handle COFIDE's overwhelming financial problems and could find little time to focus on the problems of the SSE operations. These were two in  nature: operating issues, which could be dealt with in the short term, and major institutional policy issues, which would require executive attention. The Bank addressed the staffing and procedural problems affecting the internal efficiency of the PROPEM unit by recommending that PROPEII's chief executive travel to Ecuador to observe and participate in the operations of FOPINAR (one of the Bank's model SSE development funds within the Corporacion Financiera Nacional) and thus broaden his understanding of the detailed policies, procedures, budget, supervision methods, and technical assistance operations, which underlie successful SSE development organizations. The training was very effective and, finally, two and a half years after effectiveness, the administration of the project began to show signs of improvement and disbursements accelerated. 27. On the institutional issues, the Bank seeked to: (i) establish PROPEM as a more independent project entity with a budget, financial goals and responsibilities; (ii) broaden PROPEM's technical assistance role to develop programs to assist SSE project participants; and (iii) develop loan supervision systems and improved training programs for participating financial intermediaries. The transformation of PROPEM from a discount facility to an efficient lending and assistance fund was a constant theme throughout supervision. Although the unit did reach a satisfactory first stage of institutional development, its potential never materialized. The Bank failed to see that, as is the case in Ecuador and Mexico, an SSE fund's development role can only really be achieved whem housed in financially sound institutions. Also a lesson learned is that technical assistance coordination requires institution building which takes time to develop. The Bank was unrealistic in its expectations for a newly established unit within a weak institution. 28. The Bank recognized that there was little to be done in the short-term to deal with the low demand which resulted from the 1982-84 recession. On the other hand, the Bank detected early that under the new interest rate structure introduced by the BCR in 1985 the spreads of the financial intermediaries would be reduced from 11-13Z to 2-3%. Also, the effective rate on PROPEM subloans was marginally higher than the average rate on short-term commercial credit. The Bank intervened quickly and resolved the matter. I. Borrower Performance 29. Institutional Performance. COFIDE's operations have been dominated by its mandate to coordinate and guarantee the financing of state enterprises. Since the mid-1970s, COFIDE had been a holding company for a number of nationalized basic industries. By 1980, a large proportion of COFIDE's resources were frozen in these equity holdings. This loan was implemented as a complement to Loan 1968-PE, which supported the separation of COFIDE's investment portfolio from its lending operations. Corporacion Nacional de Desarrollo (CONADE) was created in 1981, as a holding company for COFIDE S.A. and Inversiones COFIDE S.A. (ICSA). The first to continue lending operations and the latter to hold the investment portfolio, including the basic industries. The transfer of equity holdings to ICSA was on the basis of a loan of about US$ 100 million from COFIDE to ICSA that would be repayed from the sale of these firms to the private sector. However, the Government's ambiguous position with respect to privatization made ICSA unable to sell any of its companies and to service its debt to COFIDE. The expected reorientation of COFIDE's operations towards the private sector did not materialize either. 30. Financial Performance. Up to 1982, COFIDE maintained a relatively sound financial position. It had been able to mobilize abundant external  - 10 - resources, its portfolio was not yet showing large arrears problems, and it had been able to maintain the real value of its capital through periodic revaluations of its equity investments. By 1983 COFIDE's financial situation had become critical as a result of its excessive lending to and guarantees undertaken on behalf of financially strapped public sector enterprises. Moreover, COFIDE's loss of access to the tax free revenue bond market substantially reduced its long term local currency resource base. Slower loan recuperations and lower interest income from its industrial loan portfolio further exacerbated its financial problems. COFIDE's financial crieis is covered in detail in the PCR for Loan 1968-PE, 31. Compliance with Covenants in the Legal Agreements. COFIDE did not comply with Section 3.03 of the Loan Agreement which established that the BCR establish four project accounts, one of which had maintenance of value obligations. Because of Peru's deteriorating economic situation and the BCR's restrictive monetary and budgetary program, the Bank did not enforce the maintenance of value obligation under the covenant and granted a waiver to the BCR. COFIDE violated two interest rate covenants: (i) Section 3.05 of the Loan Agreement which established that the financial intermediaries should be allowed to charge the maximum commercial rate on subloans. COFIDE and the BCR, after Bank letter advice, complied with delays; (ii) Section 3.07 of the Loan Agreement which established that COFIDE and the BCR meet to exchange views on the adequacy of the interest rates to be charged on subloans as a function of the rediscount banking rate and the commercial rate. J. Project Relationship 32. The project period covered eight years between preparation and cancellation in 1987. During this period, Bank's project officers, COFIDE's management, PROPEM's staff, and Government teams changed. In addition, country related problems led to suspension of disbursements of all loans to Peru. These circumstances affected continuity in project supervision. K. Project Documentation and Data 33. During the life of the loan, COFIDE produced a large number of documents concerning its lending program, sources and uses of funds, and resources applied. The quality of COFIDE's financial reports and external audits remained low, despite the Bank's efforts under Loan 1968-PE as well as under this loan to press COFIDE to improve its financial record keeping and accounting systems. A recurrent problem has been the discrepancies between COFIDE's annual financial reports and the reports presented by the auditors. Only since 1984 do audit reports present analysis of arrears in the total portfolio. Audit reports give very superficial treatment to Bank loans. The required annual audit of the four project accounts maintained by the BCR were not submitted.  - 11 - PART III: STATISTICAL INFORMATION 1. Related Bank Loans Year of Loan Title Purpose Appr val Status Comments Industrial To support the 1976 Closed The final closing Credit Project financing through was 6/30/83, Loan 1358-PE COFIDE of two years later than manufacturing and intially tourism projects contemplated. US$2.9 million of the loan was cancelled. Second Industrial To support the 1981 Closed The final closing Credit Project financing of was 12/31/87, Loan 1968-PE manufacturing and two and a half years tourism projects later than initially through financial contemplated. intermediaries US$20.3 million of having access to the loan was Bank funds which cancelled. COFIDE would channel. Also to support modification of the public sector financial system.  - 12 - 2. Proiect Timetable Date Date Date Item Planned Revised Actual Identification 12/80 12/80 (Executive Project Summary) Preparation 3/81 3/81 Appraisal Mission 5/81 5/81 Post Appraisal 8/81 Loan Negotiations 10/14/81 10/26181 10/26/81 Board Approval 12/81 12/08/81 Loan Signature 6/82 6/16/82 Loan Effectiveness 8/82 8/17/82 Loan Commitment End Date 12/31/84 3/31/85 12/31/85 6/30/86 6/30/87 6/30/87 Loan Closing 12/31/85 12/31/86 12/31/87 Cancellation Date - - 2/23/87 Comments: The Bank suspended disbursements to Peru on May 5, 1987 based on Peru's accrued non-payment of obligations to the Bank.  - 13 - 3. Loan Disbursements Cumulative Estimated and Actual Disbursements (US '