DEocument of The World Bank FOR OFFICIAL USE ONLY Rqot No. 7712-lAG STAFF APPRAISAL REPORT MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT FEBRUARY 16, 1990 Africa Regioi South Central and Indian Ocean Department Industry and Energy Operations Divisior. Tbis document has a restricted distribution and may be used by recipients only In the performance of their offcial duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS Currency Unit - Malagasy Francs (PMG) US$1.00 P MG 1,580 (March 1989) WEIGHT AND MEASURES Metric System FISCAL YEAR January 1 - December 31 ABBREVIATIONS AO - Money Market Bidding APB - Professional Bankers' Association APEM - Malagasy Enterprise Promotion Association AU - SME Assistance Unit BFV - Bank for Commerce BMOI - Malagasy Bank of the Indian Ocean BNI - Bank for Industry BP - Project Bureau BTM - Bank for Agriculture CB - Central Bank of Madagascar CBD - Central Banking Department of the IMF CCCE - Caisse Centrale de Cooperation Economique CCI - Chamber of Commerce & Industry CFC - Training Center for Managers CIDA - Canadian Intetnational Development Agency CNAPS - Social Security Fund CNFPB - National Banking Training Center FED - European Development Fund FIVMPAMA - Association of Malagasy Entrepreneurs FNI - National Investment Fund FNUP - Commodity Price Stabilization Fund GEM - Malagasy Entrepreneur Grouping GDP - Gross Domestic Product ILO - International Labour Organization ,.OCAE - National Institute for Commercial Science and Accounting IRF - Investment Rediscount Fund ISAc - Industrial Sector Adjustment Credit ITPAC - Industry and Trade Policy Adjustment Credit JCEM - Association of Young Entrepreneurs MEP - Ministry of Economy and Plan MFB - Ministry of Finance and Budget OGL - Open General License System PAS - French Structural Adjustment Credit PB - Project Bureau at the Central Bank PE - Public Enterprise PFI - Participating Financial Intermediaries PSAC - Public Sector Adjustment Credit SERDI - Industrial Development Studies Agency SDR - Special Drawing Rights SME - Small and Medium Enterprise UNDP - United Nations Development Program UNIDO - United Nations Industrial Development Organization FOR OFICIL USE OM.Y MADAGASCAR STAFF APPRAISAL REPORT FNANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT Table of Contents Page No. Credit and Project Summary . . . . . . . . . . . . . . . . . . i-ii Introduction . . . . .... ...... ... ...... .... ....... .... ....... 1 PART I. THE SECTORAL ENVIRONMENT . . . . . . . . . . . . . . 1 A. Economic Setting .. . . . . . . . . . . . . . 1 Background ..1 Structural Adjustment Policies . . . . . . . . . . . . . 2 Recent Developments . . . . . . . . . . . . . . . . . . 4 B4 The Fnrri4al: Retor - e . ..... ......... . 4 Structure. 4 Performance of the Banking Sector . . . . . . . . . . . 7 Liquidity and Profitability . . . . . . . . . . . . . 7 Portfolio Restructuring . . . . . . . . . . . . . . . 8 Lack of Competition . . . . . . . . . . . . . . . . 9 Monetary Policy .10 Interest Rates, Resource Mobilization, and Efficiency in the Banking System . . . . . . . . . . 14 C. Private Enterprise Sector . . . . . . . . . 15 Past Performance and Policy . . . . . . . . . . . . . 15 Industry ... . . . . ..... 15 Agriculture . . . . . . . . . . . . . . . . . . . . . . 16 Services ... ... 17 Constraints and Development Potential . . . . . . . . 17 Small and Medium Enterprises . . . . . . . . 18 Government SME Policies . . . . . . . . . . . . . . . 19 Technical Assistance to SMEs . . . . . . . . . . . . . . 19 This report is based on the findings of an appraisal mission to Madagascar in January 1989. The mission was composed of Messrs. Christian Schmidt and Andres Jaime of AF3IE, of Philippe Callier of EDIFI and of Messrs. Heinz Bertsch and Roland Tenconi, Consultants. This document has a rtricted 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. PARTU . W _GROUP LE ING STRATEGY . . . . . . . . . . . . 21 PART III. THE PROJECT . . . . . . . . . . . . . . . . . . . . 22 Project Objectives and Justification . . . . . . . . . . . 22 Lessons Learned from Previous Projects . . . . . . . . . . 22 Project Description . ................. . 23 Sector Policy Measures and Conditions . . . . . . . . . 23 APEX Credit Component . . . . . . . . . . . . . . . . . . 25 Size of the Component . . . .. . . . . . ... . .. . 25 Institutional Arrangements . . . . . . . . . . . . . . . 25 Eligible Intermediaries . . . ............ ... 26 Eligible Beneficiaries and Subprojects . . . . . . . . . 26 Terms and Conditions of Financing . . . . . . . . . . . 27 Subloan Processing and Administration . . . . . . . . . 29 Assistance and Training Component . . . . . . . .*. . . . 30 Design and Special Features . . . .... * . . . . . 30 Financial Sector TA Program . .... ..... ... . 30 Technical Assistance to the Mining Sector . . . . . . . 31 Private Sector Framework ... . . . . .............. . 31 Development of Small and Medium Enterprises . . . . . . 32 Summary of Estimated Cost ... ................. 35 Terms and Conditions .... . . I . ... 35 Project Bureau . . . . . . . . . . . . . . . . . 35 SME Assistance Unit . . . . . . . . . . . . . . . . . . . 36 Project Cost and Financing . . . . . . . . . . . . 37 Project Implementation .... . . . . ................ . 38 ProjectManagement ................. 38 Procurement and Disbursement ... . . . ............. . 38 Special Account .... . . . . . . . . . . . . . . 39 Auditing and Reporting ........ .... 39 Project Benefits and Risks ................ 40 Benefits . . . . . . . . . . . . . . . . . . . . . 40 Risks . . . . . . . . . . . . . . . . . . . . . . . . 40 PART IV - AGREEMENTS AND UNDERSTANDINGS REACHED . . . . . . . 40 ANNEXES I. Distribution of Credit by Sector . . . . . . . . . 43 II. Distribution of Credit by Term and Type of Borrower . 44 III. Summary Balance Sheet of BFV . . . . . . . . . . . . . 45 IV. Summary Balance Sheet of BNI . . . . . . . . . . . . . 46 V. Sumnary Balance Sheet of BTM . . K ......... 47 VI. Central Bank Organization Chart ... . . . . . . . . . 48 VII. Schedule of Disbursements . . . . . . . . . . . . . . . 49 VIII. Selected Documents Available in the Project File . . 50 MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT CREDIT AND PROJECT SUMMARY Borrower: Democratic Republic of Madagascar. Beneficiaries: Central Bank of Madagascar (CB), participating financial intermediaries, the Small and Medi'm Enterprise (SHE) Assistance Unit at the Ministry o' Economy and Plan, Chamber of Conmerce and Industry, Association of Young Entrepreneurs, local training institutions and consulting firms. Amount: SDR 36.4 million (US$48.0 million). Termst Standard IDA, 40 years. Relending Terms: Mi) The borrower would onlend US$45.0 million equivalent in local currency to CB at CB's regular reference rate (currently 12.0 percent p.a.) minus an administrative fee of 0.5 percent (to cover the operating cost of the Project Bureau within CB) for 30 years, including a grace period of 10 years. CB would onlend the funds to qualified participating financial intermediaries at its regular reference rate with a flexible amortization schedule reflecting the aggregate maturity of subloans extended by intermediaries. The onlending and final lending rates would be flexible and adjusted periodically. The spread which participating intermediaries could charge to beneficiary enterprises would initially be limited to a maximum of 7 percentage points. Prior to release of the Credit's second portion, this cap would be removed. The Government will assume the foreign exchange risk. With real interest rates in local currency roughly equivalent to real interest rates in internatlonal markets, and as the exchange rate and interest rate policies are broadly based on a market-clearance approach, domestic interest rates would adequately reflect the expectations of devaluation. The project would include provisions to ensure the continued adequacy over time of the onlending arrangements, i.e., that they continue to reflect the economic cost of capital, including the implicit foreign exchange risk. (ii) The Us$3.0 million equivalent in local currency allocated for Technical Assistance would be made available to implementing agencies by Government on a grant basis. - ii - Benefits: Expected benefits are to help maintain the momentum of the reform process in the financial sector, especiallv now that the first new private comercial bank has just started operations. The Credit would furthermore act as a cacalyst, paving the way for more active private sector initiatives not only in the financial sector, but likewise in the industrial and other productive sectors, through helping support proposed reforms in the Chamber of Commerce and Industry and involving the private sector in the technical assistance component. Broader access to credit by the private sector is expected through the APEX line of credit component, which would encourage real sector supply response in the form of investment and reconstitution of permanent working capital. Risks: idagascar is undergoing substantial changes in its banking sector not only through portfolio restructuring of existing banks but also through allowing private capital to re-enter the sector for the first time since 1972. While the project aims at reinforcing and carrying forward these reforms, there remains a risk that the political will to continue with this process might falter, especially in implementing expected privatization efforts of financial institutions and within the enterprise sector in general. The Government's commitment to reform and achievements during the last five years suggest that the risk is not excessive. Estimated Project Costs: Local Foreign Total 2 ------------USS million----------- Investments 18.5 44.0 62.5 94.3 Technical Assistance and Tra'ning 1.6 1.9 3.5 5.3 SME Assistance Unit 0.2 0.1 0.3 0.5 TOTAL 20.3 46.0 66.3 100.0 Financing Plan: Subborrowers 18.1 - 18.1 27.3 SME Assistance Unit 0.2 - 0.2 0.3 Proposed IDA Credit 2.0 46.0 48.0 72.4 TOTAL 20.3 46.0 66.3 100.0 Estimated IDA Disbursements: IDA Fiscal Year 1990 1991 1992 1993 1994 1995 1996 1997 -------------------------(USS million)--------------------- Annual 0.5 3.5 7.5 8.5 8.3 9.4 6.0 4.3 Cumulative 0.5 4.0 11.5 20.0 28.3 37.7 43.7 48.0 Rate of Return: n/a Map: n/a MADAGASCAR STAFF APPRAISAL REPORT FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) PROJECT Introduction 1.01 Since the early 1980s the Government of Madagascar has demonstrated its commitment to the adjustment process through the implementation of important and difficult measures which were supported by several IDA adjustment operations and by successive IMF stand-by arrangements. The most recent adjustment operation, the Public Sector Adjustment Credit (PSAC), approved in June 1988, made substantial progress on banking sector issues and initiated a process of policy reforns, both to be supported and carried further by the proposed Credit. 1.02 Overall, the operation would blend into the ongoing Government policy reform program launched in 1983. It is intended to consolidate the financial sector policies supported by earlier credits, and to capitalize on the major restructuring efforts already made in the financial sector through additional supply-oriented measures in a number of important policy areas. Its main components would be: a US$45.0 million APEX credit line for financing viable majority private investment projects in all productive sectors, the provision of a US$3.0 million technical assistance and training component and, finally, a set of accompanying policy reforms concernxing the financial and private enterprise sectors. PART I - THE SECTORAL ENVIRONMENT A. Economic Setting 1.03 Background. With a population of 11.6 million growing at 32 per year and a per capita income of US$200 in 1987, Madagascar remains one of the poorest countries in the world. Its economic record is mixed, characterized by stagnation from 1972 to 1980, sharp deterioration between 1980 and 1982, and financial stabilization with limited economic growth since 1983. Preliminary estimates for 1989 suggest that economic growth has picked up, reaching over 4X. Agriculture continues to be the mainstay of the economy, employing four-fifths of the population, creating about 42Z of GDP and generating over 802 of export earnings. 1 '4 The poor economic performance of the 1970s stemmed largely from in&ppropriate economic policies, which emphasized a much increased role for the public sector, with industrialization as the central objective, agri- culture in a supporting role, nationalization of foreign-owned enterprises, extensive consumer subsidies, and controls over private economic activity. Nevertheless, until 1978, the Government also pursued cautious financial policies that kept the fiscal deficit low, held the balance of payments in approximate equilibrium and resulted in a debt service ratio of only 4Z. 1.05 Between 1978 and 1980, the Government embarked on a policy of massive public investment. It was poorly coordinated, concentrated on economically unviable prujacts, and was financed mainly with external borrowing on commercial terms. This policy, combined with declining terms of trade and stagnant domestic revenues produced a fiscal deficit of 142 of gross domestic product (GDP) in 1980, an annual inflation rate of 302, and a large increase in the external debt burden that has severely constrained economic growth. 1.06 In mid-1980, the Government ini.Ated measures aimed at financial stabilization, and from 1982 ons-,rds it reinforced them, with IMF assistance. From 1981 to 1986, policy adjustment centered largely on demand management. During this period, the fiscal deficit was reduced substantially (from 14Z to 4.5Z of GDP in 1988), mainly by lessening expenditures. 1.07 Largely as a result of these developments, the annual expansion of domestic credit fell sharply, and annual inflation dropped from about 30Z in 1981-82 to about 132 in 1983-86. On the external side, the current account deficit was cut almost in half from its level of about US$425 million in 1981. With exports stagnating and scheduled external interest payments almost doubling, the brunt of the adjustment feil on imports, which dropped by more than half in real terms since 1982. Real GDP, which had contracted by 10? between 1980 and 1982, started growing again in 1983, and reached an estimated growth rate of 32 in 1938 and over 42 in 1989. Structural Adjustment Policies 1.08 After several years of progress in stabilizing the economy, the Government turned its attention to restructuring the economy through supply-oriented measures after 1985. Initially, it pursued a cautious reform strategy addressing structural distortions sector by sector, based on their importance, beginning with industry, moving on to agriculture and the trade and exchange rate regimes and then, with support from the Bank's PSAC, approved by the Executive Directors in June 1988, on to a broader agenda that includes public sector and partial banking sector reform. 1.09 Concerning industry, the Government, in 1985, eliminated most ex-factory price controls and reduced the controls on profit margins. It also improved the quality of public investment in manufacturing, eliminated the export taxes on manufactured products, and ovex-hauled the investment code. IDA supported this effort with an Industrial Sector -3 Adjustment Credit (ISAC) in FY86. In 1987, the Government-owned banking sector tightened credit to loss-making public enterprises, a step that led some unviable units to close. In parallel, the Government undertook a series of studies to determine the viability of public enterprises and of the financial sector. 1.10 The sectoral policy improvements in industry could not result in a lasting supply response as long as the external trade and exchange regime continued to be dominated by quantitative restrictions and an overvalued exchange rate. Thus, in 1987, the Government moved to establish a trade and foreign exchange allocation regime broadly based on market forces. The measures included: (i) a large devaluation totaling 462 in foreign currency terms (Hay-June 1!87); (ii) replacement of the quantitative import restrictions, which were being used for protective purposes, with a simplified tariff structure (January 1988); and (iii) implementation of a market-determined allocation system for foreign exchange for imports, through the open general license (OGL) system (July 1988). IDA supported these reforms with the Industry and Trade Policy Adjustment Credit (ITPAC) in FY87. More recently, and in carrying the above sector specific changes further, IDA approved the PSAC in FY88, which centered on: (i) reforming the budgetary process to raise the efficiency of allocation and utilization of Government resources; (ii) streamlining the parastatal sector to concentrate public resources on activities that are economically viable and that belong in the public domain; (iii) reforming the commercial banking system, including its opening to private capital to improve competitiveness and efficiencyt and (iv) removing of administrative obstaclas to the expansion and diversification of exports, including elimination of the state monopolies over traditional export crops. 1.11 These st:uctural reforms are complex and it will take two to three years to implement them effectively. During this period, GDP growth is expected to continue improving gradually and surpassing pzpr2tąsl6it growth. To implement the program successfully requires changes in the administration's core instruments for macroeconomic management, including the spin-off of state-owned enterprises to the private sector, and changes in the financial sector, including credit for investment. Recognizing these needs, the Government has decided to improve the availability of term financing through the banking system (which is in the process of partially being privatized) and through accompanying policy changes in the financial sector. The proposed Credit would support the implementation of these objectives. -4- Recent Developments 1.12 Economic developments in 1987 and early 1988 were disappointing, mainly because of exogenous factors and in spite of the considerable policy improvements, mentioned above. Despite good performance of non-traditional exports, exports as a whole fell by about 15? in SDR terms in 1988, largely because of unfavorable developments in world prices for coffee, the country's major export ccnuodity. Imports also declined for the sixth consecutive year, reaching leqs than half the 1981 level in real terms. Because of these external developments, fiscal revenues were lower than foreseen in the stand-by arrangement with the IMF. However, prudent monetary management led to inflation lower than forecast, even with the major devaluation of May-June 1987. and the expenditure program remained broadly on track. 1.13 The year 1988 was a period of transition, during which many of the policy prerequisites for sustained growth were put into place. They produced a limited initial supply response, mostly in the second half of the year. The principal reasons for the still limited response were, in addition to infrastructural bottlenecks and a general climate of uncertainty, a further decline in the terms of trade, continued adminis- trative restrictions, some controls over exports, and a banking sector still faced with portfolio problems which resulted in limited credit allocation. The credit problems had derived largely from the poor financial condition of the public enterprises (PEs). However, and notably -during the second half of 1988 and continuing in 1989, exports began to increase and so did capacity utilization of new and smaller firms. In parallel, the severe decline in imports during the first half of 1988 was more than reserved in the second half. Because of the shift toward *better-buy" imports fostered by the removal of quotas and by the OGL introduction, 1988 marks the first year of the decade during which real imports, of both producer and consumer goods, did not decline. The sum of these signs permitted arriving at a convergence of views among the Government, the IMF and IDA on a medium-term scenario entailing 4.5Z projected real annual growth through 1992. B. The Financial Sector Structure 1.14 The Malagasy financial sector consists of the Central Bank, three state commercial banks plus a recently constituted private commercial bank, a postal savings and checking system, two state insurance companies and a national investment fund. There is also a Social Security Fund (CNAPS) and a Commodity Price Stabilization Fund (FNUP). In general, the sector is marked by its predominantly public ownership and limited variety of institutions, services and markets. The commercial banks enjoy a quasi- monopoly in the collection of savings and the provision of credit. Securities markets are non-existent and the issue of non-marketable Treasury bills to the general public has had only limited success. 1.15 The Central Bank (CB) was established in 1973 following Madagascar's decision to withdraw from the franc zone. The CE took over the management of Madagascar's foreign assets as well as the formulation and implementition of monetary and credit policies. In addition, the CB determines ceilings on credit extended by the commercial banks, authorizes loans in excess of specified amounts and allocates rediscount quotas. Finally, the CB is also responsible for supervising commercial banks and for determining various maximum or minimum ratios between their assets and liabilities. The CB has a staff of 56 high-level professionals, including its Antananarivo headquarters, the Toamasina branch and a representation office in Paris. It is organized into eight departments which report to the Director General and the Deputy Director General. The CB's organi- zation structure appears in Annex VI. 1.16 During the early 1980s, the CB's bank supervision performance was lagging. The last inspection of a bank took place in 1983. It was only in 1985 that the CB, with the help of an outside auditor, set up criteria to be used in classifying bank borrowers according to the degree of risk. However, the CB did not define clear rules for the treatment of consortium credits, write-offs and accrual of interest due on doubtful loans. In the light of growing difficulties in the financial system, the CB has recently been taking a more active role in supervising the commercial banks. In June 1987, it obtained the services of a foreign expert that conducted a diagnostic of the CB's supervision function and proposed measures to correct the weaknesses. After the enactment of the new Banking Law in May 1988, which defined new supervisory functions for the CB, it prepared, in consultation with IDA, a prcgram to strengthen the supervision of banks. The proposed project would .clude a technical assistance component to support the implementation of the above-mentioned program (para. 3.33). Given the urgent need of this technical assistance, it has been launched before the project effectiveness, through a PPF financing of US$250,000 approved on February 17, 1989. 1.17 In 1975, the then existing four private commercial banks (largely foreign-owned or affiliated to foreign financial institutions) were nationalized. In 1977, the banks, together with the then State Development Bank, were reorganized into three fully Government-owned commercial banks, each of which was ir- principle responsible for a specific sector of the economy: BNI for inCustry, BMD- for agriculture and BFV for commerce. In practice, the specialization was never enforced rigidly and has been somewhat limited by difficulties in determining the exact boundaries of each sector, differences in the geographical distribution of branches (BTH has branches in a number of localities where the other banks are not represented) and the pooling of resources through consortium credits. Loans by BDM and BFV to their specialized sectors (i.e., agriculture and commerce) represent only about one-third of their total portfolio. ENI directs a major portion of its resources (802) towards industry, mining, construction and transport but nevertheless accounts for only 50Z of the total loans to the industrial secto.. All three banks have important branch networks. BTM, due to its focus on the rural sector, has - 6 - the largest one, with a total of 64 offices and 1,656 staff. BFV's network includes 26 offices and has a staff of 1,350. BNI, which tends more towards corporate lending, has 23 offices and a staff of 1,191. 1.18 Until recently, the three state banks were governed by a Joint Management Board. As departing members were never replaced, membership in the Board declined from 12 to 2--the Minister of Finance (ex-officio chairman) and the Executive Director (OAdministrateur D6l1gue") of the banks. In practice, the Board rarely met and the Executive Director alone approved loans exceeding the specified ceilings. In November 1986, a new and separate board was appointed *o.r each bank, consisting of the Minister of Finance as Chairman and representatives of the Government and the public and private sectors. In each board, the private sector is represented by 2 members out of 12. This particular reform has had a very limited impact on the independence of the banks and the competition among them so far. In addition, an abnormal situation still exists as high-level managers of the Central Bank (including the Director of Inspection) are members of the board of the three banks. This practice could undermine the ability of the CB to exercise its supervislon role with independence and objectivity and is therefore to be changed under the project. 1.19 Both BNI and BTM have channeled IDA lines of credit to Malagasy enterprises. BNI was the beneficiary of Cr. 977-MAG approved by IDA in January 1980 for US$5.0 million. It also received a US$5.0 million industrial line of credit under IDA Cr. 1541-MAG, approved in December 1984. BTM has also participated as financial intermediary in two IDA projects, namely through Cr. 1064-MAG in FY81 and Cr. 1804-HAG approved in April 1987. The balance sheets of BFV, BNI and BTM are shown in Annexes III to V. 1.20 The enactment of the new Banking Law in May 1988 opened the banking system to the possible entrance of new institutions from the private sector and to participation in the capital of the existing institutions by private local or foreign investors. Formerly, the State was the only economic agent allowed to be the owner of banks. 1.21 The first actual effect of this opening of the banking sector has been the recent establishment of a fourth bank, a new private bank (75Z foreign, 25Z local private sector ownership), which started operations in mid-1989. This bank, called Banque Malgache de l'Ocean Indien (BMOI) is initially operating only in the capital, and has a staff of approximately 60 employees, of which 6 expatriates. Its capital of PMG 2 billion limits the maximum amount of its liabilities (mainly deposits) to FMG 25 billion (about US$16 million). 1/ This compares with liabilities of PMG 132 to 203 billion for the three existing banks. 1/ This maximum amount arises from the 12.5:1 limit on the debt/equity ratio set by the banking law. -7- 1.22 The Professional Bankers' Association (APB) represents the interests of the banking sector and advises the Minister of Finance, to whom it reports. The APB began operations in June 1985. Its first major task has been to begin work, on behalf of both Government and the banks, on a case-by-case review of the banks' portfolios of non-performing parastatal enterprises. The Postal Checking System and the Postal Savings System provide windows in post offices which make checking and passbook savings accounts accessible to depositors in most parts of the country. The Postal Savings system was officially transformed into a savings bank (Caisse d'Epargne) in 1985, but until the and of 1988 no actual change had taken place, and the System continued to operate as the traditional postal savings institution. The impact of the two systems on the financial sector is very limited. The two insurance companies are also controlled by the State, which is their major shareholder. Their portfolio consists mainly of time deposits, Treasury bills, equity, bonds issued by banks, loans to the Government and loans to policyholders. No special housing financing institution fulfills the need for this type of credit ir. Madagascar. 1.23 The National Investment Fund (FNI) was originally intended to utilize, for productive investments, the long-term resources of state- controlled institutional investors, such as the Social Security Fund (CNAPS), the Commodity Price Stabilization Fund (FNUP) and the two State insurance companies. The sole shareholder of the FRI is the Government. The statutes of the FNI restrict its beneficiaries to publicly controlled and socialist cooperatives units of production which are required to relinquish their decision-making authority to the FNI in order to qualify for use of its resources. In the early 19808, the FMI participated in 20 projects which included some of the more ill-advised industrial and agro-industrial public sector projects. Since then, FNI has not made new commitments. At the end of 1986, FNI's assets amounted to FMG 10 billion. Performance of the Banking Sector a) Liquidity and Profitability 1.24 As of September 30, 1988, short-term loans of the banking system, representing 82? of the total portfolio, amounted to FKG 496 billion (see Annex II). This apparent high liquidity position is misleading because the short-term nature of many loans .L questionable. Rollovers are frequent and a laige portion of short-term credits are extended in the form of overdrafts, which makes it difficult to identify non-performing loans. At least one-third of the short-term loans went to enterprises whose turnover was a fraction of the amount of their short-term debts to the banks. It is difficult to see how those enterprises will be able to generate adequate cash flows to reimburse their short-term debts. 1.25 In 1987, bank profits before provisions represented 35? of capital and reserves. These results, however, were inflated by the underestimation of the volume of non-performing loans and the accrual cf some interest due on doubtful and contentious loans. In recent years, banks have needed extremely high operating profits in order to generate sufficient cash flow to constitute portfolio provisions. Since the system -8- has an oligopolistic structure, these profits have been obtained by imposing very high interest spreads (para. 1.33). The current opening of the system to new institutions and shareholders, and the resulting increase in competition should reduce these rents and, therefore, the banks will have to restructure themselves in order to lower their administrative expenses and reduce their need for additional provisions. b) Portfolio Restructuring 1.26 All three state banks have been in a difficult situation for several years as a significant portion of their loan portfolio was non-performing, or in practice frozen through successive rollovers of short-term loans. The portfolio problems of some banks were serious enough to have made them virtually insolvent. 1.27 By the mid-1980s, loan losses sometimes exceeded substantially the value of equity, so that liabilities far exceeded the realizable value of assets. At the end of 1987, the aggregate loan portfolio of the three banks amounted to FMG 526 billion and included, according to the auditors, FMG 221 billion or 42Z of doubtful loans in C (probable risk) and D (certain risk) categories. The situation however varied from bank to bank as loans classified in C and D represented between roughly 30? and 60? of the total portfolio depending on the bank. In addition, off-balance sheet engagements increased significantly the risk exposure of the Malagasy banks as contingent liabilities on behalf of clients amounted to 1MG 238 billion at the end of 1987. Of this, 242 were off-balance sheet engagements in favor of clients classified as C and D, adding some FMG 57 billion to the losses to be provisioned by banks. Considering this latter factor, IDA estimated that, by end 1988, required additional provisions ranged from FMG 89 billion to FMG 149 billion, depending on the value assigned to Government guarantees and the probability of contingent liabilities becoming actual ones. This compares with a consolidated equity for the three banks at the same date of PMG 84 billion. 1.28 The above situation has been addressed recently. Following agreements reached under ITPAC and PSAC, the Central Bank mandated the first round of write-offs in April 1988 for a total of FMG 82 billion, which reduced the existing provisions against bad loans to FMG 57 billion. Another set of agreements was reached in February 1989 about a second round of provisioning and write-offs for two of the three banks (BFV and BTM). The subsequent portfolio restructuring, implemented in April 1989, resulted in provisioning and writing-off another PMG 48 billion (US$30 million equivalent). To achieve this write-off, French CCCE-PAS counterpart funds were used to cover part of the financing. The second round of write-offs for BNI will be undertaken in connection with the overall institutional restructuring of this bank (para. 1.34), which is expected to take place before the end of 1990. The remaining counterpart funds from the CCCE-PAS (approximately FMG 10 billion) would be used to finance the restructuring of BNI. -9- c) Lack of Competition 1.29 Besides the problems associated with the quality of the portfolios of the state banks, the most important problem hindering the effective mobilization and allocation of financial resources by the financial sector to promote growth is the lack of competition. This lack of competition is due to the ownership and management structure of the banking system, to the institutional framework in which monetary policy is conducted and to the scarcity of relevant information available to che public. 1.30 The ownership and management structure of the banking system hinders competition within the financial sector firstly because the commercial banks enjoy a quasi-monopoly in the collection of savings and the provision of credit and do not face any significant competition from non-bank financial intermediaries or markets, and secondly, because the three banks of significant size are all owned by the State. Although since November 1986 each bank has its own separate management board, as noted earlier, each board is headed by the Minister of Finance and the representation of the private sector on the 12 member boards is limited to two members. The remaining board membeIs are civil servants (including Central Bank staff) which tend to make the three institutions act more as a consortium than as competitors. 1.31 In addition, until the enactment of the new Banking Law in May 1988, the private sector, local or foreign, was barred from participating in the capital of the Malagasy banks. The new Banking Law opened the banking system to the possible entrance of new institutions from the private sector and to the participation of private investors, foreign or local, to the capital of existing banks. 1.32 The new institutional framework is expected to foster effective competition within the banking sector by allowing free entry in the industry. Potential banks, however, must receive the agreement of the Minister of Finance. Among the criteria to be met to receive the agreement of the authorities is the "capacity of the enterprise to contribute to the Government's goals in the field of economic development'. A restrictive interpretation of this criterion could be an obstacle to free entry in the sector in response to profit opportunities. Weakening of competition among banks could also result fxom another inconsistent provision of the new Banking Law (art. 51) which requires that a bank cannot lend to any client more than 50 percent of the client's total indebtedness. 1.33 In addition to these legal and institutional constraints, it is clear that the small number of banks, the pre-allocation of credit ceilings by banks, and the absence of effective alternatives to the banking system for the collection of savings and the provision of credit is likely to encourage the formation of e cartel. Such a cartml exists in practice and price competition does not exist presently among the Malagasy banks: Although most interest rates are now officially deregulated, all banks adhere to the interest rate schedule established by the Professional Bankers' Association (APB). - 10 - 1.34 Although the new fourth bank is of a significantly smaller size than the existing public banks, it constie tes the first actual step to making the banking system more competitive. Subsequent steps would include the establishment of additional new banks and the partial privatization of the state-owned banks. In accordance with agreements under PSAC, BNI would go through an overall corporate restructuring and at least 51Z of its ownership would be private, and at least 252 of the ownership of BFV and/or BTM would also be privatized. Monetary Policy 1.35 Since its introduction in 1982, the main instrument used to control the monetary aggregates in Madagascar is the overall credit ceiling. The CB sets quarterly an overall ceiling on net domestic credit and a subceiling on credit to Government. The global ceiling on bank credit to non-Government is tbe" derived as a residual. The CB then apportions a fraction of this global ceiling between the banks, with the remaining portion being allocated for the CB's own direct lending. This apportioning of the commercial banks global ceiling into individual credit ceilings is carried out by the CB based on banks' sources and uses of funds over the preceding three-year period and their projections for the forth- coming year. Consequently, this method of distribution of individual credit ceilings is tantamount to preserving banks' relative positions in the banking sector and thus contributes to limit competition among banks. 1.36 In order to increase the effectiveness of monetary policy, the Government and the Central Bank are launching a process of reform of their policy framework, with the main thrust of replacing direct quantitative control mechanisms by a more flexible system of monetary control based on the use of market-oriented indirect instruments. As part of this process, which would be supported by the proposed IDA Credit, the present system of competition-limiting individual credit ceilings would be dismantled in two steps. First, the current system would be replaced by a competition- oriented method of distribution of individual ceilings,2/ and later, once the indirect monetary control mechanisms are in place and have been tested, individual credit ceilings by banks would be eliminated altogether. 1.37 The main instrument used to influence the local interest rates is the discount rates of the Central Bank. The regular rate, known as the basic rate, is currently 122. In addition, a preferential rate exists, aimed at promoting exports and agricultural output, presently set at 9X. An instruction of the Central Bank, issued every time there is an adjustment of the discount rates, prescribes that the banks are allowed to determine freely their lending rates "taking into account the rates of the Central Bank" and that they will apply the new rates to all outstanding credits. Thus a change in the discount rate affects directly all lending rates, which are typically established by adding a margin to the 2/ The apportioning would be based on banks' actual performance in deposit mobilization. - 11 - appropriate discount rate. Under the priposed project, the general reference rate would switch from the administratively-determined discount rate to a market-determined rate based on banks' bidding for liquidity. 1.38 The system of required reserves was established in March 1987. It is currently an instrument of selective credit policy rather than an instrument of monetary policy as indicated by the fact that credits eligible for preferential rates (i.e., credits to exporters and to agri- cultural enterprises), which amount to about 302 of the total outstandinag credits of the banks, are deducted from the base used to compute the reserve requirements. 1.39 Since July 1988, the required reserves are computed as 62 of the average amount of credits outstanding during the previous quarter, after deducting credits eligible for the preferential interest rate, plus 202 of the daily average of the bank's deposits with the Central Bank during the previous quarter. The combination of a ratio of 6S on outstanding credits and a ratio of 202 on reserves implies that credits are subjected to an effective reserve requirement ratio of 7.5X. 1.40 From a banking system liquidity management point of view, the existing system of reserve requirements suffers from three design weaknesses. First, the use of the system as a selective credit instrument reduces the effectiveness of the reserve requirements in managing the overall liquidity because of the different treatment of regular credits and credits at preferential rates, in spite of the fact that these two types of credits have the same effect on the m netary aggregates. Second, the important lag between banking transactions subject to reserve requirements taking place and the time the obligation to hold the reserves becomes effective introduces some inertia which complicates the management of the system. This effect is reinforced by the fact that required reserves held in one quarter themselves generate an obligation to hold reserves during the next quarter. As a result, credits made at a given time can influence the reserve requirements during several consecutive quarters. third, the obligation to hold reserves on deposits with the Central Bank introduces an additional distortion because it implies that the reserve requirements will depend not only on the amount of credit outstanding and the overall amount of liquidity within the banking system, but also on the distribution of this liquidity among the banks when they use the money market organized by the Central Bank. 1.41 The money market is composed of two segments. On the informal interbank market ("face to face market"), which emerged in March 1987, transactions are made directly between banks, at a mutually agreed rate, for maturities of up to ten days. On the money market managed by the Central Bank, which exists since 1975, the CB absorbs the excess liquidity of banks by accepting interest-yielding deposits for terms of up to 30 days and provides needed liquidity through repurchase agreements of two to five days (longer maturities are available but not used in practice). The rates on this market are established by the CB with reference to the discount rate and are presently, depending on the maturity, 8S to 92 for deposits and 142 to 14.25S for the financing facility. The money market of the - 12 - Central Bank plays an important role. Because Treasury bills are not presently negotiable on a secondary market, open market operations as a tool to absorb excess liquidity are not an option. The acceptance of interest yielding deposits by the Central Bank is in this context a substitute for the sale of Treasury bills on the open market. Never- theless, the two instruments are not identical as the rates on the Central Bank money market are administratively controlled. 1.42 The only rates freely determined on the money market are the rates on the face to face interbank market. Arbitrage opportunities between the two segments of the market (the face to face market and the Central Bank market) imply however that these rates will fluctuate only within the limits determined by the Central Bank market. The nominal spread between the highest rate on deposits and the borrowing rates on this market is currently very large (5 points and 5.25 points, depending on the maturities). The effective spread is even larger (6.8 points and 7.05 points) because the effective yield on deposits, taking into account the reserve requirements to which deposits with the Central Bank are subjected, is 7.22 (i.e., 92 / 1.25). 31 The effective yield on shorter term deposits is still lower (6.4S, i.e., 82 / 1.25). 1.43 The advantage of a large spread on the Central Bank money market is that it allows greater flexibility of the rates on the face to face interbank market. However, the floor on this market implied by the effective yields of 6.42 and 7.22 on deposits on the Central Bank money market corresponds to a negative real rate of interest when exTected inflation is on the order of 82 to 10. 1.44 Since 1987, individuals, private and public enterprises and the Central Bank and, since September 1988, the banks themselves, can subscribe to Treasury bills issued through an adjudication process. These bills are not currently negotiable, although no legal prescription prohibits the issuing of negotiable notes. To date, only six-month and twelve-month bills have been issued. 1.45 The total amount of such Treasury bills adjudicated in 1988 amounted to FMG 9.7 billion (US$6.5 million). The current limit of adjudication is FMG 1.5 billion per month. During 1988, the Central Bank absorbed 40S of the twelve-month bills, but the six-month bills have been subscribed mainly by the public (582) and by the banks (302), with the Central Bank only absorbing the remaining 122. Ever since the banks have been authorized to participate in the adjudication, the Central Bank has not had to purchase any six-month bills and the adjudication limits have frequently been exceeded. 3/ The 1.25 factor arises from the reserve requirement of 202 on deposits at the Central Bank. - 13 - 1.46 The yield on these bills has often reached up to 22.8Z for the six-month bills subscribed by the non-bank public, but fluctuated between 15.5Z and 19.1Z for the twelve-month bills. These yields appear to be high, particularly when considering the low adjudication limits, the liquidity of the banks and the very low yields available on investments on the Central Bank money market. They can be explained by the novelty of the instrument and, therefore, the uncertainty concerning the functioning of the market (the minutes of the adjudication meetings are not published, in spite of the existence of relevant regulations prescribing such publica- tion); and also by the lack of liquidity of the instrument, which is not negotiable. 1.47 The relatively modest stock of Treasury bills outstanding and the current adjudication limits suggest that these Treasury bills should not presently be considered as a significant tool for monetary policy. However, if the volume issued were increased and if the bills were made negotiable, the market for Treasury bills could make an important contribution to the development of the financial sector, because: - Open market operations would become possible, enabling the Central Bank to influence the banks' liquidity and the interest rates on the money market through an indirect, market-based mechanism; - a flexible instrument to manage their secondary liquidity would become available to the banks; and - a step forward would have been taken to stimulate the development of money and capital markets in a way which could effectively provide competition to the banking sector in the field of mobilizing financial savings. 1.48 A final instrument of monetary policy available to the Central Bank is the requirement for a prior authorization for all bank credits which would bring the level of indebtedness of any borrower to the banking system beyond the threshold (if not already reached) of FMG 1.0 billion (US$633,000). This requirement has the perverse consequence of diluting the full responsibility of banks in the matter of credit decisions (which are in any case subject to the existing prudential rules), in addition to slowing the processing of loan applications. It does not appear to offer advantages outweighing these costs. As a first step to correct this distortion, the CB has already increased the threshold of its prior authorization prerogative from FMG 100 million to FMG 1.0 billion. Subsequently, and as a condition of effectiveness of the proposed Credit, the CB wotld raise the threshold to FMG 5 billion (US$3.2 million). Finally, and as a condition of disbursement of the second portion of the proposed Credit, the CB would abolish the prior authorization requirement. - 14 - Interest Rates, Resource Mobilization, and Efficiency in the Bankin8 System 1.49 From 1974 to 1985 interest rates were mostly controlled by the Central Bank, and remained virtually unchanged. In April 1985, the interest rate structure was simplified and liberal.zed in accordance with IMF recommendations. Since then the Central Bank only sets its two rediscount rates (normal and preferential), and the minimum rate f r deposits from individuals of 6 to 12 months. Theae rates have been adjusted several times since 1985, the current levels being 122 for the normal rediscount, 9Z for the preferential rediscount (which applies to credits granted to export-oriented activities and agricultural activities for food self- sufficiency), and 14Z for the minimum rate for the above mentioned deposits. 1.50 The structure of interest rates which has evolved from this system presents an anomaly which is likely to undermine the efficiency of resource allocation through the banking system: Because the cost of certain types of medium and long-term credits eligible for preferential rates is now lower than the above mentioned mandatory minimum interest rate on certain term deposits, an arbitrage opportunity exists which could be diverting credit from productive uses. This anomaly, caused by the low preferential discount rate, would be eliminated through the new structure of CB refinancing rates proposed under the project (para. 3.07). 1.51 In 1987, the average remuneration of bank deposits was 7.62 with sight deposits yielding about 2? p.a. and time deposits about 18?. In 1988, the yield on time deposits with a minimum maturity of six months ranged from 11.5? for enterprises to 15? for individuals, compared to an inflation rate of about 132 in 1988. The yield on time deposits is therefore marginally positive in real terms except for shorter maturity deposits, particularly for deposits below 3 months. These yields compare with a market-determined yield of about 172 on Treasury bills with maturities of 6 months to one year. Overall, the remuneration of bank deposits appears to be adequate with some limited scope for improved resource mobilization through the introduction of household savings schemes. 1.52 To the extent efficiency in banks can be measured in terws of gross spreads, the banking system of Madagascar can be considered inefficient. Gross bank spreads expressed as a percentage of average total assets are large, reaching 8.2Z in 1987. This spread reflected average gross earnings of 13.52 of assets compared to financial expenses of 5.32. As indicated above, interest payments to depositors reached 7.6? of average total deposits in 1987. Similarly, interest income was 16.32 of average loans. It could therefore be argued that the spread between interest earnings from the average borrower and interest payments to the average depositor was 8.72, a high level that reflects in part the oligopolistic structure of the market. 1.53 In practice, it is difficult to define the 6average* borrower of Malagasy banks. There are really two classes of borrowers. Those in categories C and D which are generally unable to service their loans, - 15 - and those in categories A (problem free) and B (slight problems) which effectively account for all interest earnings recorded in the books of the banks. Therefore, banks earn little or zero on C and D loans while the average yield on A and B loans was about 192 in 1987. On this basis, the interest differential between the yield on performing loans and the average remuneration of depositors was about 11.4Z. 1.54 The large operating margin of Malagasy banks is necessary for them to cover their relatively large administrative expenses (3.1Z of assets) and loan loss provisions for C and D credits (4.4Z of assets). The administrative expenses of banks are due to an excessive number of employees relative to the volume of operations. The restructuring of the banks should involve a significant reduction in the number of staff in parallel wJ2h improvements in average remunerations. Cost savings are therefore likely to be limited. A more significant reduction in bank margins would result from a lower level of annual provisions made possible by portfolio restructuring including write- offs of non performing C and D credits. 1.55 Provided the necessary write-offs are completed as agreed, it would be possible for the banks to remain profitable and to achieve a progretsive reduction in bank margins and, consequently, a reduction in lending rates from about 19Z at present to less than 13Z. This would leave unchanged the current level of deposit rates. C. Private Enterprise Sector 1.56 Past Performance and Policy. Since 1985, Madagascar's macroeconomic and industrial policy that affects the private sector has been completely re-oriented in an attempt to reverse the previous system of planned economic management adopted in the late 1970s. Recognizing its own limitations in its ability to efficiently allocate resources, the Government has sought to increase its reliance on the market system to promote the private sector. This shift in policies has profoundly altered the economic environment and incentive structure in which the Malagasy private sector operates. Therefore, the sector is today at crossroads, as it faces the challenge of restructuring in order to survive in the new free market system. Industry 1.57 Industrial production was weak in the early 1970s, with little or no growth. It picked up by 1974, so that the implementation of the inward- looking strategy coincided with an optimistic environment in the industrial sector. The next burst in industrial activity peaked in 1979 with the introduction of the ambitious public investment program. This all-out investment program primarily fueled import demand, but also had an effect on domestic demand in a subordinate fashion. Although the industrial sector maintained its production for a few years after the beginning of the inward-looking period, the downturn was obvious by 1980, and unmitigated until 1982, by which time industrial production had dropped by 25? from its 1979 peak. In this later period, the effects of the import-substituting - 16 - policies had been cexpounded by the effects of the restrictive stabili- zation measures taken to sustain that import-substituting policy. Among the sub-sectors hardest hit were food and beverages, chemicals and construction materials. 1.58 Today, there are 360 manufacturing enterprises in Madagascar (excluding artisanal enterprises), more than half of which are located in Antananarivo. They employ about 100,000 people or 2.65 of the economically active population. As c result of the nationaLization mentioned above a large part of industry came under Government control by the late 1970s. The State holds shares in over 100 enterprises and controls the majority in over 155. Virtually all large industrial enterprises are Government-owned. Those in which the Government holds a majority account for an estimated 652 of sectoral output and a similar share of employment. It should be noted, however, that substantial ownership changes are to occur under PSAC in the form of divestiture. 1.59 The industrial sector i.s dominated by the activities of two sub-sectors: food processing, textiles, and garmentlknitwear. They account for about 751 of employment, output and value added. The food processing industries are dominated by the activities of sugar production, fish canning and the brewery, with sugar production alone accounting for about 502 of the value of output in this sub-sector. The two major state-owned sugar companies (SIRAMA, SNCBE) were rehabilitated in 1985 together with a French partnership (Sucrerie de Bourbon). The textile industry is also dominated by two large enterprises (COTONA, SOTEMA) in which the Government is principal shareholder, but which are managed by foreign private companies with IFC's involvement. They recently underwent extensive rehabilitation and extension and employ about 7,000 persons which represents 50t of total sub-sector employment. However, adjustment problems loom large, particularly for SOTEMA, in view of the increased competition from abroad and the company might be left with no other option but closure. In addition to textiles and food processing other--somewhat less important--subsectors comprise household chemicals, construction materials, petroleum refining and some intermediate goods such as metal and paper products. Agriculture 1.60 Employing four-fifths of the population and accounting for more than 802 of export earnings, agriculture is the most important contributor to the national economy. Due to its unique ecological diversity, most tropical and temperate climate crops can be foiud in Madagascar. Less than 5? of the land area is cultivated, of which more than half is under rice, which accounts for 302 of agricultural production value. Recent deregu- lation of rice markets have helped increase production since the mid-1980s. 1.61 In value terms, the beef cattle herd provides the second most important product (16? of agricultural GDP). Industrial crops, notably sugar and cotton, contribute about 7?. A small group of export crops (coffee, cloves, vanilla, and pepper) accounts for about 15? of production value, but some 75? of export earnings, and coffee alone for about 50?. - 17 - A combination of low producer prices, over-taxation by Government, a monopolistic parastatal marketing system, and a serious decline in quality caused a reduction of production with imports on the increase, mostly in the form of food aid. However, recent liberalization of markets has encouraged a revival of production, particularly of coconut palm and of artisanally processed groundnuts. Specific supply responses are also noticeable for coffee and green pepper, where for the first time in a decade land use has increased and formerly abandoned agro processing units have been revitalized, respectively. Services 1.62 With the general services sector still being at an infsnt stage, considerable potential emerges in tourism for which Madagascar's unique environment, culture and coastlines constitute strong assets. The tourist entry of 30,000 in 1988 has the potential to increase tenfold during the next decade provided the proper framework for private investment is adopted. 1.63 Constraints and Development Potential. Obstacles to private enterprise efficiency were caused in the past by major constraints such as an overly regulated business and investment climate w'ich was coupled with the previously mentioned severe economic crisis, poor Government policy coordination and the unavailability of foreign exchange. In addition, obsolete equipment, lack of spare parts and difficult access to financial resources hampered the efficiency of the private sector. 1.64 Recent macro, sectoral and financial studies, supported by analyses at the enterprise level suggest that there is significant develop- ment potential of enterprises in the productive sectors in a more liberal and deregulated policy environment. Companies are already adjusting and responding to the changed environment. Government's stabilization and growth policies including deregulatory measures, removal of price controls, and provision of incentives in the framework of the Investment Code have already started to change and improve the previously poor investment climate, and an initial supply response is taking place. However, to realize fully the projected supply response in terms of increased output, exports and employment, it would be necessary to improve and/or expand production capacities through investment in machinery replacement and modern expansion equipment. The proposed project would provide needed term financing for these investment activities in all productive sectors in support of the Government's growth policies. At the same time, the project would contribute to accompanying adjustments in financial sector policies in the form of further deregulation. 1.65 Concerning reform measures for the private sector, a thorough reorganization of the Chamber of Commerce and Industry (CCI) is needed to reestablish it as a truly representative body of the private sector. A consensus approach by the various private sector groups has been prepared in the forv. of draft revised statutes. The issuance by Government of new statutes, reinvigorating the CCI and allowing it to become a private sector * 18 - representative entity, is envisaged under the project. Assistance in the restructuring and strengthening of CCI would be provided by the proposed Credit. 1.66 To further support the private sector development potential, a new and improved Investment Code and a law on the establishment of industrial free zones were promulgated in late 1989. The new Investment Code envisages the creation of a one-ztop Investment Promotion Center. This initiative would be supported by the technical assistance component of the project. Finally, to improve public access to general economic information, needed for analysis and decision-making of private sector investors, the Central Bank is to start again the publication of a monthly statistical bulletin. 1.67 Small and Medium Enterprises. A special development potential of SMEs has been detected by virtually all relevant parties involved, including the Government, major donors and various local interest groups. Recognizing this potential and the fact that SMEs could play a major part in the economic recovery, also for social reasons, existing SME entre- preneurial talent is to receive special attention under the project through several of the technical assistance subcomponents. 1.68 Madagascar's SME sector (defined as companies with a varying range of asset size depending on the definition of each technical Ministry but not exceeding the equivalent of US$500,000) is still relatively little developed with about 300 SMEs operating in the manufacturing sector, some 250 small contractors in the construction industry and about 180 SMEs in tourism including hotels, car rental, tour operators and travel agencies. SME activities in other (sub-) sectors such as mining, cransport, garages and trade are less documented but equally important, especially in the informal sector. SMEs cover a wide variety of activities in the industrial manufacturing field including food industry, textile, leather, carpentry, furniture, household chemicals, metal working, glass making and construction materials, bakeries and printing shops. Craftsmanship is widespread, but so far has rarely led to transformation into small or even medium-scale enterprises. Tb' number of SHEs in manufacturing industry (and most likely in the economy as a whole) declined over the last decade primarily because of adverse economic conditions, leading to increased closures of existing SMEs and only few creations or extensions of existing ones. Partial industrial survey data showed that about 25Z of SMEs were established before Independence (1960) and the average life of industrial SMEs in 1987 was more than 20 years. 1.69 A lack of financial and support services combiv.'d with weak institutions and the Government's cferemphasis on large public enterprises in its investment, credit, foreign exchange allocation and other economic policies resulted in an unsatisfactory performance of the small and medium- sized private enterprises. Limited information indicates that production techniques are generally outdated, and SME operators frequently lack technical, managerial and financial know-how. About two-thirds of the SMEs operate at significantly reduced levels of installed capacity. Survey data - 19 - also suggests a low level of integration (horizontal as well as vertical) between SMEs, little production of intermediate goods and virtually no subcontracting between large firms and SMEs. 1.70 Government SME Policies. During the past two to three years, the Government began to change its SME strategy in the wake of the liberalization, restructuring, and economic adjustment measures. A new Investment Code was promulgated with a special SME regime and the Govern- ment started to establish SME promotion and information services in all technical ministries as well as in the three public banks. In addition, a promotion unit was created in the then Ministry of Finance and Economy to provide coordination in the Government's information activities aimed at potential SHE promoters. With the ministerial restructuring that occurred in recent months, the Economy function of that Ministry was transferred to the newly created Ministry of Economy and Plan (HEP). Consequently, the SME coordination unit has recently been reestablished at the MEP. The Government is now more aware of the need to initiate supporting actions to major sectoral and macroeconomic restructuring efforts underway and, more specifically, of the socio-economic development potential of SMEs, in particular for employment creation. Technical Assistance to SHEs 1.71 Technical competence to assist SMEs is largely available locally e.g. through managerial and technical training institutions including the National Institute for Commercial Science and Accounting (INSCAE), the Professionals' Training Center (CFC), University Departments, as well as through the banks and approximately 50 local consulting firms, some of which have built up considerable sector-specific know-how. However, existing SMEs and potential SME promoters make only sporadic use of the available expertise, basically because of the cost. The private sector and to a lesser extent the Government are aware that these local resources merit to be activated and focused more closely on SME promotion. 1.72 Assistance to SMEs is being provided by a number of limited programs subsidized by donor agencies. Program objectives so far have been modest relative to needs. UNIDO, through a public consulting firm, the Soci6te d'Etudes et de Realisation pour le Developpement Industriel (SERDI) is extending technical assistance services annually to 12-15 SHEs in the industrial sector in the Antananarivo area. ILO is successfully concluding a pilot project in entrepreneurship development that started end-1987 by selecting 30 among 250 would-be SME promoters and helped them to develop their own feasibility studies; four of these projects have already reached the implementation stage and 15 others, all in or around the capital, stand a good chance of obtaining finance and subsequently of being launched by end-1989. ILO, backed up by UNDP, plans to capitalize on the experience by extending the program initially to four regional centers by the end of 1989 to create 100 new viable SMEs within three years (1989-1992) with a total technical assistance cost of about US$700,000. - 20 - 1.73 The main domestic initiative is APEs "Association pour la Promotion de l'Entreprise Malgache), a 1987 activity started by the country's key employers' organization GEM (Groupement des Entreprises de Madagascar) which rallied 30 industrialists, consulting firms, banks and insurance company to provide back-up advice, seed capital and credit guarantees to young entrepreneurs; six SMEs have received assistance by APEM in 1988 absorbing about US$20,000 in cofinancing or in guarantees; funds from outside donors in the order of US$200,000 encourage APEM to provide assistance to an increased number of new SMEs. 1.74 Training in accounting and in management techniques is partly provided by the Institut National des Sciences Comptables et de l'Administration de l'Entreprise (INSCAE), created in 1981 based on the Bank's initiative, and since backed by France (Mission d'Aide et de Cooperation) as well as by Canada (Canadian International Developm.nt Agency - CIDA). INSCAE enjoys a good reputation and its graduates seem to meet eager demand from enterprises, including from SHEs, throughout the country. (Output: p.a. up to 75 accountants, 3-year program; about 10 chartered accountants, 4-year program; and about 25 graduates in management science, 2 years MBA-type program, first graduation in June 1990). INSCAE's evening program in accounting and in a small number of managerial topics meets strong demand, including from managers and key staff of SHEs and would-be SHE promoters. INSCAE also gives seminars for accountants and managers in the area of computer science, accounting and management but even though much appreciated by the business and financial comunnity, these programs do not meet the demand. The Centre de Formation des Cadres (CFC), a financially autonomous training institution founded in 1981 and established in Antsirabe and in Antananarivo, is providing good quality in-service training seminars mostly to managerial staff of larger enterprises and organizations, but occasionally also to SME participants. In 1987, 41 such seminars were organized in most regional centers on a large variety of management tecbniques attracting close to 500 partici- pants. Increasingly, CFC also provides in-company management consulting services, especially for banks (8 seminars for BTM in 1987). 1.75 On the private sector side, new initiatives from professional associations have taken place in recent years. The Jeune Chambre Economique de Madagascar (JCEM) is active in SME promotion since 1987 and started the publication of a monthly economic and technical review on SME issues. JCEM organized four symposia on SME creation in 1988, attracting as many as 600 participants in major towns and allowing a rare dialogue between owners of SHEs, potential SHE promoters, bankers and representa- tives of technical ministries and local authorities. A practical guide prepared by JCEH on how to create an SME in Madagascar (passport PME), printed in 10,000 copies, enjoys strong demand among would-be SHE entrepreneurs. JCEH has also started an in-plant visits and practical training program abroad and has already sent 12 professionals including some potential SHE promoters for 3-month visits to Switzerland and France in 1988. Finally, the new association of consultancy firms, founded in January 1989, intends to help focussing the services of its two dozen members closer to SHE needs. - 21 - PART II. BANK GROUP LENDING STRATEGY 2.01 IDA's strategy is to support the Government's efforts to rehabilitate and restructure the economy bys (i) promoting policies and programs aimed at reforming incentive structures, setting a more favorable climate for private sector initiative and investments, and providing financial and other support for appropriate policy programs; (ii) supporting se^toral strategies aimed at rehabilitating productive infrastructure and establishing conditions for long-term growth, and providing financial and technical .ssistance for these programs; (iii) strengthening the institutions responsible for sectoral policy formulation and management; and (iv) helping Madagascar to mobilize and to make effective use of donor and creditor financial, technical and debt relief support. 2.02 The proposed Credit would be a departure from previous interven- tions for term financing in Madagaicar. Instead of allocating term financing to separate sectors through--supposedly--specialized financial institutions 4/ at different terms and conditions, the APEX approach would consolidate IDA's term lending in Madagascar for all productive sectors. It would further build on and complement the series of adjustment operations in recent history. 2.03 The proposed project forms an integral part of IDA's country strategy to support the Government's accelerated adjustment process and strategy for sustained growth, increased private sector involvement and improved employment generation. The Government considers IDA's lavolvement essential in defining and implementing an effective and comprehensive financing and promotion plan for the productive sectors coupled with further financial sector adjustments with the possibility of mobilizing additional resources from other donors. A further stage of the program of development of the financial sector would iuclude: measures to improve the mobilization of small savings; broadening of the services offered by financial institutions including export financing, leasing and housing financing; and introduction of new savings and lending instruments and markets, including, inter alia, capital markets. 4/ As was done previously, using BNI for industry and BTM for agriculture lending (para 1.17 and 3.03). - 22 - III. THE PROJECT Project Objectives and Justification 3.01 The principal objectives of the proposed operation are tot (i) complement the Government's on-going restructuring efforts of the economy through provision of funds for investments and reconstitution of permanent working capital in industry and all other productive sectors. AddAtional emphasis is given to support SMEs through specific technical assistance; (ii) help, in coordination with DMF and PSAC conditionality, to improve the efficiency of the financial sector. This includes expanded (term) resource mobilization and improved allocation, further interest rate liberalization, and deepening the competition in the financial sector through elimination of the Central Bank's prior credit authorization prerogative, improvements in the system of credit ceilings and reserve requirements, as well as adjusting other monetary policy instruments; (iii) strengthen institi.ions operating in the financial and SME support sector (in particular their appraisal/supervision capabilities); and (iv) generate new employment opportunities. 3.02 The rationale for IDA's involvement in the project is to help maintain the momentum of the reform process in the financial sector, especially now that the first new private commercial bank has just opened. The Credit would furthermore act as a catalyst, paving the way for more active private sector initiatives not only in the financial sector - through increased private capital participation - but likewise in the industrial and other productive sectors - through helping support proposed reforms in the Chamber of Commerce and Industry, and providing technical assiftance for facilitating the development of private sector activities. Lessons Learned from Previous Proiects 3.03 While this would be IDA's first APEX-type credit to Madagascar, several previous projects included lines of credit available to specific banks. Two of those credit lines were channelled through BNI, the first of which as a traditional DFC loan (Credit 977-MAG of 1980), the second one in the form of a DFC component as part of a hybrid industrial sector adjustment operation (Credit 1541-MAG of 1985). These two lines of credit of US$5.0 million each were chiefly for industrial investment purposes, including SSEs. Similarly, two other DFC loans were made, to BTM for agricultural lending (US$5.0 million for Credit 1064-MAG of 1980 and US$9.0 million for Credit 1804-MAG of 1987). - 23 - 3.04 A project completion report has been prepared for the first of each of these credit lines (PCR No. 7179 for Credit 977-MAG dated April 1988 and PCR No.7768 for Credit 1064-MAG dated May 1989), while each of the follow-up operations is either still in the commitment phase (BTM) or just recently closed (BNI, March 1989). One of the lessons learned from these credits is for IDA to avoid separate treatment of Malagasy banks through different onlending terms and conditions. One of the main findings suggested that BNI's medium and large-sized borrowers who had to assume the foreign exchange risk were virtually bankrupt following major currency depreciations while at the same time price controls were in place. The now proposed unified treatment of banks and their customers across sectors will promote a generalized set of financial sector characteristics (interest rates, exchange risk assumptions, capitalization of disbursements, etc.), that will ensure that investments in all productive sectors will be treated alike. Also, the degree of exclusivity enjoyed by BNi and BTH under previous arrangements will disappear and a higher degree of customer service orientation will result, specifically with the advent of the fourth commercial bank, which is entirely private-owned. Prolect Description 3.05 The project would involve an IDA Credit to the Government of Madagascar of US$48.0 million (SDR 36.4 million). The proposed Credit would have the following componentss (i) an investment component of US$45.0 million equivalent, divided into two portions, to finance (through all eligible banking institutions) projects in productive sectors promoted by majority private enterprises. This investment component would be coordinated and monitored by a Project Bureau in the Central Bank; (ii) a multi-facetted technical assistance component of US$3.0 million equivalent to help support activities that would foster small and medium enterprise development, staff training for participating bank&, strengthening the Central Bank supervision and monetary management capacities, support to the revitalization of the private m,ning sector and, last but not least, assistance in credit implementation-related activities. The overall adminis- tration of the TA component would be handled by the SME Assistance Unit (AU) within the Ministry of Economy and Plan; and (iii) in addition to the above two components, policy conditions would "'e put in place, primarily concerning the financial sector, but bLso related to other activities and decisions supporting private enterprise sector develonment. Sector Policy Measures and Conditions 3.06 Although the proposed Credit is an investment operation, a large number of policy issues has been discussed with the Government during project preparation, and adoption of the proposed policy reforms is - 24 - considered essential to provide not only a smooth project implementation but alao an improved environment in the financial and private enterprise subsectors. 3.07 In the area of financial sector policies, four proposed measures relate to monetary policy and consist of modifying authorization require- ments, money market and rediscount systems, credit ceilings and reserve requirements. These conditions have been discussed with Government in full consultation with the IMF, including a technical assistance mission of the IMF Central Banking Department (CBD) that took place in August 1989. As part of the liberalization process, the CB has already increased the threshold of its prior credit authorization prerogative from 1HG 100 million to 1MG 1.0 billion. As a further step, the threshold would be raised to FHG 5.0 billion by Credit effectiveness. However, while these are encouraging intermediate steps, the prior authorization requirement would be fully abolished by the time of disbursement under the second portion, for reasons discussed in para. 1.48. The money market and rediscount mechanism would be reorganized in accordance with the recommendations of the CBD mission. These include, inter alia, the introduction of a two-way Appel d'Offres (AO) 5/ as a technique to inject liquidity into--or absorb from--the banking system; the use of the AO rate (the weighted average of the bid rates accepted) as the reference rate of the interest rate structure; the setting by the CB of an intervention band to limit excessive day-to-day fluctuations of the interbank rate; the overhaul of the rediscount facility, to change its character from a regular source of funds to the banking sector, to a safety valve for liquidity management to be used under special circumstances to rediscount only Treasury bills; and the introduction of a short-term lender-of-last-resort facility, at a penalty rate. The reorganization of the money market and the rediscount facility is expected to be carried out by October 15, 1990. A covenant to that effect has been included in the legal agreements. 3.08 Credit subceilings for individual banks would also be eliminated under the project (para. 1.36) in a two-step process. Firstly, and as a condition of effectiveness, the current system of individual ceilings by banks would be modified so as to stimulate bank competition. Secondly, with the instauration of new monetary control mechanisms, individual credit ceilings would be suppressed by the time of disbursement under the second portion. Finally, the reserve requirement system would be modified so as to eliminate the perverse effects of the current system described in paras. 1.38 to 1.40. This would be achieved through the establishment of required reserves on a monthly (or shorter period) basis, computed as a percentage of the banks' demand and time deposits. The implementaxtion of this new system of reserve requirements would constitute a condition of Credit effectiveness. 5/ The 'Appel d'Offres (auction sales) is an invitation for banks to bid either on temporary rediscount or on deposits with the CB. - 25 - 3.09 Other financial sector related policy adjustments would include (i) that supervision staff of the Central Bank no longer serve on the boards of banks that they are supervising (para. 1.18) (disbursement under the second portion); (ii) that the results of the monthly Treasury bill auction be published, as the law stipulates (para. 1.46) (effectiveness); and, finally (iii) that the remaining inconsistency in the new banking law (para. 1.32) be removed through an implementing instruction to be issued by Credit effectiveness. 3.10 Private Sector related conditions would consist of (i) providing access to general economic information and indicators to all economic agents by resuming the regular publication of the Central Bank statistical bulletin (para. 1.66), by effectiveness; (ii) reinvigorating the Chamber of Commerce and Industry to become a truly representative body of the private sector and no longer continue as a public institution employing civil servants (para. 1.65), as a condition of disbursement under the second portion; and (iii) establishing the envisaged one-stop Investment Promotion Center with responsibilities and operating procedures satisfactory to IDA (paras. 1.66 and 3.35) as a condition of disbursement of the financial assistance allocated for this Center. APEX Credit Component 3.11 Size of the Component. The demand assessment of the principal participating institutions supports the envisaged size of the credit component of US$45.0 million. Commitments under the four previous credit lines support the above proposed size and reflect the banks' projections, based on potential project pipelines analyzed during the appraisal process. No preestablished allocations among participating intermediaries would be set. 3.12 Institutional Arrangements. The credit component would be made available under an apex arrangement to all sound existing and future financial institutions accredited by the Central Bank. Funds under the Credit would be channelled through the Central Bank to the commercial banks, which would in turn grant loans to the final beneficiaries of the project. The APEX arrangement would be the most suitable for financing numerous majority private projects in the productive sectors, due to the number of financial institutions that would participate and, as their number increases, would provide entrepreneurs better accessibility to term credit on a more competitive basis. 3.13 The Central Bank, through a Project Bureau (PB) (paras. 3.39- 3.42) located in the Credit Department, would act as the APEX institution and administer the line of credit for the Government. The signing of a Subsidiary Loan Agreement between the Government and the Central Bank defining the functions and responsibilities of the latter, under terms and conditions satisfactory to IDA, would be a condition of Credit effectiveness. - 26 - 3.14 Eligible Intermediaries. Any financial intermediary accredited by the Central Bank which complies with the laws and regulations governing banking operations in Madagascar, and has its financial statoments audited, with no qualifications, by independent auditors acceptable to IDA, would be eligible for participating under the line of credit. 3.15 Currently, one of the three state commercial banks (BNI) does not satisfy the eligibility criteria described in the previous paragraph. However, once the corporate restructuring of this bank (para. 1.34) takes place, all existing banks are expected to fulfill the eligibility criteria. An eligible financial intermediary would be able to participate in the project provided it has entered into a participating agreement with the CB that is satisfactory to IDA. This agreement would, inter alia, specify that the participants should: (i) designate qualified staff to manage the credits financed by the project; (ii) perform satisfactory subproject zppraisals and submit required appraisal reports to the PB; (iii) ensure that resources are used by the final borrowers for the purpose intended and that adequate procurement procedures are followed; (iv) supervise subprojects according to required schedule and provide the PB with periodical reports on the status of subprojects; (v) ensure that national environmental regulations and IDA environmental guidelines are followed for subprojects; (vi) help identify the technical assistance needs of small and medium enterprises; (vii) adhere to terms of lending and repayment of loans; and (viii) provide the PB and IDA with such information as they would reasonably request. 3.16 A draft participating agreement has already been discussed with the interested parties and is available in the Project File. All of the banks have stated that they would be prepared and able to comply with these conditions as needed. Receipt by IDA of a satisfactory signed agreement between the CB and a participating intermediary would be a condition of disbursement to such intermediary. 3.17 Eligible Beneficiaries and Subprojects. The line of credit would finance fixed assets and permanent working capital for private and mixed enterpriseF (the latter being defined as those with at least 51Z private capital). All productive activities, including industry, mining, agriculture, as well as transport, trade, public works, tourism and all other services which contribute to the economic development of Madagascar - 27 - would be eligible for financing. The only exception would be the financing of land and housing construction, which would not be eligible. The line of credit would finance (i) fixed assets and associated working capital for new operations, extensions and rehabilitations; and (ii) free-standing permanent working capital for viable existing enterprises in the productive sectors. However, given that the major objective of the project is to finance investment in fixed assets, the total amount of subloans financing free-standing permanent working capital would be limited to a maximum of 252 of the credit component (US$11.3 million out of US$45.0 million). Both foreign and local costs would be eligible for financing, with the latter being limited to a maximum of 80Z of financing by the IDA line of credit. Identical disbursement procedures would be used for investment and free- standing working capital subprojects. 3.18 The enterprises and their subprojects to be financed would have to meet the following conditions: (i) they would be required to demonstrate financial and economic viability (based on indicators such as foreign exchange savings, job creation, investment cost per job, etc.); subloans of over US$100,000 would be required to have an expected financial rate of return of at least 12 percent on total subproject investment; subprojects with a cost of over US$500,000 would be required to have an expected economic rate of return of at least 12 percent on total subprject investment; (ii) the projected debt servicing capacity should be no less than 1.3 over the life of the subproject and the debt to equity ratio should be no more than 3sl, with the ratios calculated on the basis of the enterprise's total debts, inclusive of those to be incurred under the subprojact; (iii) subloans could represent up to 80 percent of the total cost for extension/modernization subprojects, and up to 70 percent for new subprojects. Promoters would be required to finance a minimum of 30 percent of subproject cost in the latter case; and (iv) the amount of each subloan would be limited to a maximum of US$4.5 million, to avoid that any one company would absorb more than 10? of the total credit amount. No limitation would be imposed on the size of the enterprise or the size of the subproject. 3.19 Terms and Conditions of Financing. The IDA Credit would be made to the Government, which would relend the credit component (US$45.0 million) in local currency through the Central Bank to financial institu- tions which in turn would relend it to beneficiary enterprises. The onlending rate to financial intermediaries would be the CB regular reference rate (at present the regular discount rate of 122), and this onlending rate would be reviewed annually (para. 3.24). However, as discussed in para. 3.07, a new money market and rediscount interest rate structure would be .A place during late 1990. In accordance with this - 28 - structure, the new reference rate for banks' credits will be the AO (Appel d'Offres) rate, which will result of the monthly bidding of banks in the money market. When this new structure and reference rate operates at the Government and IDA's satisfaction, the AO rate would be used as the onlending rate to financial intermediaries. With real interest rates in local currency roughly equivalent to real interest rates in international markets, and as the exchange rate and interest rate policies are broadly based on a market-clearance approach, the domestic interest rates would adequately reflect the expectations of devaluation. Provisions in the legal agreements in the form of a covenant will ensure that disbursements would be contingent on the continuation of such policies, and on the future use of the AO rate as onlending rate for the project. In the absence of forward currency markets that would allow final borrowers to hedge currency risks, the Government would bear the foreign exchange risk in exchange for an implicit fee equal to the difference between the CB reference rate (currently the 12Z regular discount rate) and the IDA conditions. This spread (currently 11.25Z p.a.) is expected to more than adequately cover the foreign exchange risk. 3.20 The Government would pass on the funds to the Central Bank at the onlending rate to financial intermediaries (as defined above) minus an administrative fee of one half of one percent p.a. that would accrue to the Central Bank to compensate it for costs incurred and services rendered for the adequate operation of the project through its Project Bureau. 3.21 The Central Bank would receive the funds for a period of 30 years starting on the date of Credit effectiveness. The Central Bank would return the funds to the Government in twenty equal annual installments starting ten years after the effectiveness date of the Credit, so as to allow recycling back of the funds, in the same terms, to financial intermediaries. The Central Bank would relend these funds, through a refinancing mechanism, to the participating intermediaries. 3.22 Funds onlent under the credit component to participating inter- mediaries would have the same maturities as the individual subloans to final beneficiaries. Subloans to beneficiaries would range from a minimum of two to a maximum of twelve years, inclusive of grace periods of up to three years. 3.23 The participating intermediaries would be free to set their own rates to beneficiaries subject to a temporary maximum spread agreed between IDA and the Central Bank. Under the present interest rate structure the maximum spread would be 7 percentage points. It is expected that, prior to the disbursement under the second portiov, participating intermediaries would no longer be subject to the ceiling on the spread they can charge on loans refinanced under the line of credit. 3.24 The Central Bank onlending rates, as well as the maximum spreads chargeable by participating intermediaries, would be reviewed at least every 12 months, and modified by agreement between IDA and the Government - 29 - as necessary to ensure that they continue to adequately compensate the Government for assuming the foreign exchange risk and reflect the cost of resources for financial intermediaries and subborrowers. 3.25 Subloan Processing and Administration. Subloan processing under the project would be coordinated and centralized by the PB, which would serve as the principal link between IDA, the participating intermediaries and the beneficiaries for the project's investment component (para. 3.39 to 3.42). 3.26 Subprojects would be prepared by the beneficiaries, with, if needed, assistance from the SME Assistance Unit of the Ministry of Economy and Plan (AU), and presented to the intermediaries. The financial intermediaries would review the subprojects in accordance with their own loan analysis procedures and internal operating requirements which, except for BNI, have been found satisfactory by the appraisal mission. (BNI's procedures are expected to be substantially overhauled following its restructuring and privatization). Thereafter, intermediaries would prepare a simple appraisal report for presenting the subproject to refinancing under the line of credit. This appraisal report, which would be required for both investment and free-standing working capital subprojects, would be in the standard format prescribed by the PB, which would vary in depth and sophistication depending on the size of subprojects. The report would cover all relevant information about the enterprise and the proposed investment. The PB would review the appraisal reports to verify that all eligibility conditions (including, inter alia, those specified in para. 3.18) are adequately met. This review would be carried out in the form of a check-list approach for subloans of less than US$100,000 equivalent, and through a more in-depth review for subloans above US$100,000 equivalent. The PB would have only an eligibility check review capacity for sub-loans, for which credit risk would be analyzed and borne by the participating financial intermediaries, which would have the primary responsibility for sub-loan appraisal. If the subproject is eligible for financing, the PB will authorize the intermediary to present the loan documents for rediscount at the Credit Department of the Central Bank. 3.27 The first three subloans above US$100,000 equivalent from each intermediary would be, as a general rule, subject to prior IDA review and approval. Thereafter, assuming satisfactory standards, IDA would review a sample of subprojects on an ex-post basis during supervision missions, particularly of larger projects. 3.28 The Central Bank will serve as disbursement and collection agent for the financing granted to intermediaries. The Credit Department, which is currently responsible for rediscount operations, would execute rediscount and collection operations upon approval by the PB. On the basis of the PB's instructions and authorizations, the Credit Department of the Central Bank would debit or credit the appropriate financial intermediary's account without further intervention in the approval process. - 30 - 3.29 Financial intermediaries would be responsible for making supervision visits to enterprises receiving IDA funds. for maintaining records adequate to monitor the evolution of subprojects, and for reporting to the PB on the progress of each subproject and the status of the corresponding subloan. Supervision reports, in a standard format prescribed by the PB, would be required from the intermediaries at least once a year until the loans are repaid. These intermediaries' supervision responsibilities are specified in the participating agreement that intermediaries would sign with the Central Bank. 3.30 In addition, the PB would conduct its own selective follow-up of subprojects in order to monitor the performance of intermediaries' supervision activities. Assistance and Trainint Component 3.31 Design and Special Featuresi. The technical assistance and training component (US$3.0 million) includes subcomponents to support ongoing reforms in mining, industry and finance, and to provide assistance to small and medium enterprises. While only a few items of the overall TA package are directly related to the implementation of the APEX line of credit, all the other ones contribute to the overall objective of the credit, namely to foster private sector initiative. Two items are already financed under a PPF (assistance to the Ministry of Industry, Energy and Mines on mining sector issues, and Central Bank Supervision). 3.32 The program can be grouped into the following categories; (i) support of ongoing reforms in the financial sector; (ii) assistance to the mining sector; (iii) improvement of the overall investment climate and strengthening of the revival of private enterprises; and (iv) assistance to small and medium enterprises. Each of these TA elements is designed to ensure impact and effectiveness based on the following three criteria, (i) fill an important need; (ii) be implemented and controlled with close beneficiary involvement; and (iii) be accessible to a defined target group of beneficiaries without infringement of competition. 3.33 Financial Sector TA Program. The program would consist of three technical assistance components designed to upgrade know-how and capacities within the banking sector. A total of US$600,000 is proposed to be spent for this purpose, as follows: (i) The Supervision and Control Function of the Central Bank would be strengthened through training and professional advice of a specialized accounting and financial advisory company. This will be finauced through a PPF of US$250,000 (approved on February 17, 1989). Specific terms of reference have been agreed and approved and focus on improving on-site Bank inspection (controle sur place) as well as staff training; (ii) Training Seminars in Projiect Evaluation and Credit Supervision would be held at the end of 1990 and repeated in early 1992 for credit analysts of PFI headquarters and regional agencies as well - 31 - as of the Central Bank. These seminars would be implemented by the banking association (Association Professionnelle des Banques, APB) in collaboration with outside consultantsltrainers and would have a foreign cost component of US$100,000. Local cost participation by PIle and the Central Bank would be an estimated US$20,000 for seminar logistics; and (iii) Assistance to the Preparation and Implementation of the New Honey Market, to be put in place by the Central Bank as part of the financial sector reforms (para. 3.07) under the project. In addition to the technical advice to be provided by the CBD of the IMH, the detailed design and the operation of the new indirect system of liquidity management would require specialized training of CB's staff (which will be undertaken at other central banks using similar system) and expanded financial and monetary database information systems. The foreign cost of this assistance amounts to US$250,000. 3.34 Technical Assistance to the Mining Sector (financed through a US$500,000 PPF, approved in June 1988) is being implemented in 1989190 by the Directorate of ML.nes of the Ministry of Industry, Energy and Mines (MIEM). It includess (i) consulting services (US$170,000) to ensure effective implementation of the new mining code through preparing the necessary implementation decrees and a mining investor's guide, as well as a workable strategy for assistance to mining sector SHEs, a market opportunity study for specific minerals and a proposal for reorganizing the existing mining laboratory; (ii) office and laboratory equipment as well as vehicles (US$280,000); and (iii) the printing and distribution of the new mining code, corresponding regulations (decrets) and the mining Investor's guide (US$50,000). 3.35 Private Sector Framework. A key part of the TA proposed under the project is a program specifically directed at strengthening the Private Sector framework and coordination, with an estimated total cost of US$190,000. This component would consist of the following: (i) Approval to restructure the dormant Chamber of Commerce. Industry and Agriculture is expected from the authorities as a condition of disbursement under the second portion. Preparatory documents submitted jointly by the private sector (GEM, SIM, FIVMPAMA) in collaboration with the administration (Ministry of Industry, Ministry of Commerce, Ministry of Agriculture) proposed amended by-laws (statute) that would abolish direct state control over the Chambers of Commerce, Industry and Agriculture, and reinstate its independent status. The restructured Chamber would require up-to-date telecommunication and data processing equipment for its offices in Antananarivo and in regional centers as well as training inputs (scholarships for key staff), in order to resume effective operation. The proposed contribution under the project would be US$40,000. - 32 - (ii) Comunuication and Motivation Campaisa. Under this technical assistance componenc the JCEf would be in charge of a three year communication campaign targeted at the creation and expansion of private enterprises. It would involve (i) a series of promotional missions to up to 12 regional centers, with participation from the technical ministries, the banks, professional associations such as the association of consulting firms, FIVMPAMA, APEM, GEM; (ii) a continuous information campaign usinu local media, including radio and selected press and featuring attention-catching interviews with successful entrepreneurs, quiz, and competitions; and (iii) printed information material targeted at promoters. The three-year campaign would be prepared during the first semester of 1990 and would start following project effectiveness. The total cost, excluding voluntary work by JCEK members, is estimated at US$55,000 of which the IDA contribution would amount to US$50, 000. (iii) One-Stop Investment Approval and Promotion Center (Guichet Unique). Following promulgation of the new Investment Code and Law on the establishment of Industrial Free Zones, the Government decided to set up a special promotion unit designed to streamline and accelerate the various administrative procedures for authorization to invest in Madagascar. It is expected that the Center will become the sole interlocutor and advisor to prospective investors requesting benefits under the new regulations. The guichet would centralize all the administrative work related to the study of conformity of investment proposals and their eligibility under the Code and Free Zone legislation following an accelerated procedure. Though autonomous, the unit will report administratively to the Ministry of Finance and Budget, while its recommendations regarding requests under the Code, to be finalized within two months, would go directly to the Council of Ministers for final approval. Upon approval, the Center would continue assisting investors to implement proposals by aiding in all the necesiary administrative authorizations for building and work permits, water and electricity access, licensing, etc. The guichet would also undertake marketing and promotional activities while initiating further studies to improve regulatory and legal procedures for investment approvals. During negotiations, agreement was reached on the objectives and prelimin&ry terms of reference of the Center. The Credit would finance the necessary equipment and materials for the Center, for an amount of US$100,000. Final agreement with IDA on the terms of reference and procedures of the Center, and the official establishment of the unit, would be conditions of disbursement of this financing. 3.36 Development of Small and Medium Enterprises is the objective of a proposed comprehensive TA program that aims to complement and integrate limited SNE support provided by other donors such as UNIDO, ILO, FED, French assistance and CIDA (see para. 1.71-1.75). This technical - 33 - assistance is to be provided to beneficiaries mostly on a fee-paying or cofinmncing basis, to ensure efficiency in its usage. Selection arrange- ments would include private representation in decision-making bodies. With a total proposed IDA contribution of US$1,340,000, the SME program includes the following four subcomponents: i Scholarship program for overseas in-plant trainina and in-compan visits for SME promoters and technical staff of SMls (US$200,000). The proposed scholarship program would also be implemented by the Jeune Chambre Economique de Madagascar (JCEM) which already enjoys good contacts with regional sections of the JCE of neighboring Mauritius and Reunion islands as well as in Europe. Participants in the planned program for overseas in-plant training and in-company visits will be up to 50 individuals, namely SME promoters with an investment project either at pre-feasibility study, feasibility study or launching stages. Additionally, key tecbnical staff of SiEs would also be eligible. US$10,000 would be earmarked as an IDA contribution towards meeting the cost of a minimal permanent structure for JCEM (office with a secretary). The signing of a Cooperation Agreement between the Government and JCEH defining the functions and responsibilities of the latter in carrying out this scholar- ship program and the communication and motivation campaign (para. 3.35), under terms and conditions satisfactory to IDA, would be a condition of disbursement to JCEK. (i1) Revolving Funds for SME Feasibility Studies. The cost and financing of SME project preparation and starting up present a hurdle for many SME promoters and hinders potential projects at an early stage. The usual fee charged by local consulting firms for a feasibility study for the creation or extension of an SHE (together with the documents necessary for a bank loan and for the approval process required for eligibility to benefit under the Investment Code) can be substantial, from FMG 2-15 million, equivalent to USS1,300-l0,000. Other cost elements involve choice of technology and in-plant training for the promoter or key SME staff, often requiring a trip abroad. Recognizing the problem, two of the local banks (BNI and BFV) have each initiated, on a very small and tentative basis, a revolving fund for co-financing of feasibility studies for good SHE project ideas presented by their clients. Based on the positive experience of these revolving funds and in view of providing an additional stimulus to get projects underway for at least 150 SME promoters, all participating financial institutions would be encouraged to make use of this facility. IDA would co-finance these partially revolving funds for SME feasibility studies of up to one third of the cost, amounting to an estimated total of US$350,000 during project duration. The Implementation and management of these revolving funds would be left to the participating financial institutions with periodic supervision by IDA missions. - 34 - (iii) Program of Extension Services to SMEs. One of the essential elements of effective SME promotion are effective extension services capable of providing technical assistance tailor-made to the needs of target enterprises. Everywhere in Madagascar SHEs have to catch up with state-of-the-art management techniques including accounting, financial management, marketing, export promotion, planning and control of production, with procurement and maintenance systems, as well as with data processing and office management. Many of the approximately 50 local consulting firms and some of the local technical and managerial training institutions have already built up a capability to deliver assistance in many aspects of management, but the majority of SMEs hardly takes advantage of locally available expertise. One of the chief reasons for lov utilization of local consulting resources is the attached price tag perceived as high by most SMEs. A simple scheme to be introduced aims at activating local expertise for improving management techniques of up to 500 SMEs and thus, to potentially contribute to their sustained viability. Under the proposed scheme, participating SMEs may freely contract consulting services from a list of consulting firms and training institutions (issued annually by an independent panel). Consulting fees would be co-financed through the IDA TA component (75Z, up to an annual maximum contribution of US$800 per SME) as would travelling expenses for consulting services provided to SMEs outside the capital (2/3 of cost, up to an annual maximum contribution of US$400 per SME). The SME Assistance Unit in the Ministry of Economy and Plan would proceed to refund the cost contribution to the beneficiary SMEs within 45 days of the presentation of bills already paid by the SME to the consulting firm. The scheme is expected to cost up to US$640,000 for three years of operation (1991-1993) and to co-finance consulting services to SMEs of up to US$1.2 million within that period. The SME Assistance Unit would act as the coordinator of this program. (iv) Support to the SME Assistance Unit (AU) that has recently been transferred to the Ministry of Economy and Plan. Six man-months of short-term expert advice (2 to 3 short missions per year) would be provided to support the permanent staff (a manager, 2 professionals and a secretary) and the AU's material would be improved by additional furniture and necessary office equipment. In coordinating IDA's TA to SMEs, the Unit would: (i) provide guidance to potential SME beneficiaries; (ii) participate in the selection committee for the scholarship program for overseas in- plant training and in-company visits for SME promoters; (iii) act as an executing institution for the program of extension services to SHEs; and (iv) prepare bi-annual reports and statistical data on the activities as well as submit any relevant observation or recommendations. The cost contribution by IDA for the coordination of SME technical assistance would amount to about US$150,000 over the duration of the project (2nd semester 1990 to end 1994). - 35 - 3.37 Summary of Estimated Cost. The technical assistance component is estimated to provide financing over a period of 4 years (including already approved PPF financing) as followss US$ Central Bank supervision reinforcement 250,000 (PPF) Training seminars in project evaluation and supervision 100 000 Preparation and implementation of new Money Market 250,000 TA to the mining sector 500,000 (PPF) Restructuring of the Chamber of Commerce 40,000 Communication Campaign 50,000 One-Stop Investment Promotion Center Ilno.000 Overseas company visits 200,000 Revolving Study Fund 350,000 Extension Services to SMEs 640,000 Support to SME assistance unit 150,000 Unallocated 370,000 TOTAL 3,000,000 3.38 Terms and Conditions. Funds allocated for the technical assistance component would be passed on as a grant from Government to the implementing agencies and beneficiaries and would be available for commitment until December 31, 1994. The component would be managed by the SME assistance unit on behalf of the Government. The unit would review requests for financing from the implementing agencies before submitting them to IDA for prior approval along with a brief justification and qualification of the experts. The unit woul4 also coordinate and process disbursement requests. Proiect Bureau 3.39 To help manage the investment component of the project, it is proposed to establish a Project Bureau (PB) which would be located at the Central Bank and would report to the Director General. The PB activities would be governed by terms of reference acceptable to IDA. Draft terms of reference have been discussed with the CB, and are available in the project file. The Central Bank has agreed to provide offices for the PB, which would be autonomous, with own staff, operating policies and procedures. 3.40 The staff of the PB would consist of a qualified, senior level, project analyst who would be the unit chief (and who has already been identified), an accountant/financial analyLt and support staff. The identification of personnel has already started but is not yet completed. All positions would be filled by local staff from the inception of the bureau. 3.41 The PB would receive a spread of one half of one percent p.a. on the outstanding amount of subloans to cover its administrative expenses. As this spread might not be fully aufficient to cover the expenses during - 36 - the first year of operation, the Central Bank has agreed to absorb any possible front-end cost overruns, as those will be compensated for later on. 3.42 The functions of the Pi would be as follows: (i) ensure adherence of participating intermediaries to established procedures in selecting subprojects and ensure application of appropriate standards, including environmental considerations, for subloan appraisals. The PB would be responsible for getting the technical advice of the relevant authorities (to be established in accordance with the IDA Environment I Project) in its review of environmental considerations of subprojects; (ii) review the eligibility and authorize fJnancing under the line of credit for subprojects submitted by participating intermediaries. For subloans of less than US$100,000 equivalent, the PB would only insure that the requests meet the eligibility criteria (para. 3.18) and would give its approval within five working days from submission. For subloans above US$100,000 equivalent, the PB would review, within a maximum period of ten working days, the requests in more detail, would give its comments on the quality of the appraisal to the participating intermediary and would insure that the ell ibility criteria are met; (iii) administer the Project Special Account (para. 3.51), ensure proper disbursements of funds and supervise and centralize collection and forwarding of supporting documentation; (iv) supervise the participating intermediaries' compliance with the various obligations (para. 3.15) under the project; (v) supervise, on a sample basis, subprojects; and (vi) ensure liaison between IDA and the participating intermediaries on matters related to subprojects. SHE Assistance Unit 3.43 To help implement the technical assistance component of the project, the small/medium enterprise assistance unit at the Ministry of Economy and Plan will be enlarged and take on added responsibility. The unit will also be assisted by foreign experts on a short-term basis. The activit4es of the Unit tunder the project would be governed by a Cooperation Agreement to be signed between the Unit and the Government. 3.44 The SME assistance unit will request, in addition to IDA funding, to receive grant funds from the Swiss cooperation to partly cover other short-term consulting assignments as needed. In addition to the 6 man- months of short-term expert advice, IDA would finance up to a total of US$50,000 of office equipment and materials, and up to US$40,000 for operating costs. - 37 - 3.45 In managing IDA's TA assistance, the AU woulds (i) provide guidance to potential beneficiaries for the preparation of subprojects to be financed under the line of credit; (ii) implement the general SME assistance program as per the Cooperation Agreement between the Government and the Unit; and (iii) coordinate all other aspects of the TA program with the specific implementing agencies (with the APB the organization of seminars for bank staff, with PPIs the feasibility studies revolving funds, with JCEM the information campaign, etc.). Proiect Cost and Financing 3.46 Total project cost is estimated at US$66.3 million equivalent, of which US$46.0 million equivalent (69 percent) wo!:ld be in foreign exchange. The proposed IDA Credit of US$48.0 million would cover 72.4 percent of the total cost of the project. The remainder 27.6 percent would be financed by sub-borrowers (27.3Z) and the SHE Assistance Unit (0.3X). A summary of the project cost and its expected financing are given in the table below: ESTIMATED COSTS AND FINANCING PLAN Local Foreign Total X ----US$ million equivalent------ Estimated Cost: Investments 18.5 44.0 62.5 94.3 Technical Assistance and Training 1.6 1.9 3.5 5.3 SME Assistance Unit 0.2 0.1 0.3 0.5 TOTAL 20.3 46.0 66.3 100.0 Financing Plan: Sub-borrowers 18.1 - 18.1 27.3 SME Assistance Unit 0.2 - 0.2 0.3 Proposed IDA Credit 2.0 46.0 48.0 72.4 TOTAL 20.3 46.0 66.3 100.0 - 38 - Project Implementation 3.47 Project Management. The Central Bank, through the Project Bureau (paras. 3.39-3.42), would be the implementing agency for the credit component and the SME assistance unit in the Ministry of Economy and Plan would be the implementing agency for the technical assistance component. It is estimated that about 14 staff weeks per year of IDA supervision would be required during implementation of the project. 3.48 Procurement and Disbursement. Procurement for subprojects financed under the investment component of the Credit would generally be made on the basis of current procurement procedures of the participating financial institutions. These procedures, which require quotations from three different suppliers, have been reviewed and found acceptable to IDA. Procedures of future, not yet existing financial institutions who wish to participate would be reviewed prior to their signing a participation agreement. However, contracts for goods estimated to cost the equivalent of US$2.0 million or more wculd be required to be awarded through International Competitive Bidding, in accordance with IDA Procurement Guidelines. Procurement of equipment and goods for the SME assistance unit would be made on the basis of at least 3 quotations from reputable suppliers. A statement to that effect will be included in the Cooperation Agreement between the Government and the Unit. Selection of consultants would be made in accordance with Bank Group Guidelines. The table below summarizes the procurement methods. PROCUREMENT METHOD AND DISBURSEMENTS Procurement Method Procurement Element ICB LCB Other ---------(US$ million)------ Subloans n/a - 62.5 (See a/) (45.0) a/ Equipment/Vehicles - - 0.7 (0.2) b/ Consultant Services and 3.1 Technical Assistance (2.8) c/ TOTAL 66.3 (48.0) a/ Standard commercial practice; contracts fcr goods exceeding US$2,000,000 equivalent would require ICB, should they arise. The appraisal mission did not identify any subproject qualifying for ICB. b1 3 quotations. c/ In accordance with IDA guidelines. - 39 - 3.49 The proceeds of the proposed Credit would be disbursed as followss Subloanst 100 percent of expenditures up to 70 percent of total subproject cost for new operations; s 100 percent of expenditures up to 80 percent of total cost of subprojects for extensions. Technical Assistance and training comyonent: 100 percent of the cost of consultants, training and of the c.i.f. cost of goods directly imported; 80 percent of the cost of local goods. 3.50 The project disbursement schedule is based on the relevant disbursement profile for industrial development and finance projects in Africa. It is expected that the investment component would be disbursed in seven years and the technical assistance component over four years. Funds under the credit component would be available for commitment until December 31, 1995. Disbursements would be completed by June 30, 1997. The credit component is divided into two portions (US$18.0 million for the first portion and US$27.0 million for the second one). 3.51 Special Account. To expedite disbursement of funds, a Special Account would be set up in a financial institution acceptable to IDA into which IDA would make an initial deposit of US dollars 2.0 million from the proposed Credit immediately after credit effectiveness. This amount represents an estimated average disbursement of funds over a four-month period. Applications for replenishment of the special account would be submitted on a monthly basis. The Special Account would be audited annually by independent auditors and the audit reports would be submitted to IDA within six months of the end of the fiscal year. Disbursements for expenditures for all contracts for goods and services or individual items under US$50,000 would be made on the basis of Statements of Expenditures (SOEs). The documentation for withdrawals made under SOEs would be retained by the Assistance Unit for ten years and would be reviewed by supervision missions and audited annually. All other disbursements would be made on the basis of fully documented applications. 3.52 Auditing and Reporting. The Assistance Unit and the Project Bureau will have their accounts, as well as the Special Account and SOEs (para. 3.51) audited annually by independent auditors acceptable to IDA and will furnish to IDA certified copies of their audited accounts together with the corresponding management letter within six months of the end of the fiscal year. The Assistance Unit will submit to IDA quarterly and annual progress reports (including financial and budgetary accounts) on the technical assistance component. The Project Bureau will also submit to IDA quarterly and annual progress reports on the investment component. Furthermore, the Project Bureau will review the annual audits of participating financial intermediaries. The Project Bureau and the SHE Assistance Unit together will prepare the required Project Completion Report within 6 months after the closing date of the project. - 40 - Proiect Benefits and Riskc 3.53 Benefits. Improved private sector resource mobilization and allocation are expected from financial sector reform conditionality of this project. Broader access to credit by the private sector is expected through the APEX credit component, which would encourage real sector supply response in the form of investment and reconstitution of permanent working capital within a further deregulated and more competitive, partly privatized, financial system. In addition, the project would generate employment opportunities, thus helping absorb expected unemployment as a result of PE closures in the future. Finally, through targeted SHE assistance, services for this high-potential subsector will be improved. 3.54, Risks. Had.gaszar is undergoing substantial changes in its banklng sector not only through portfolio restructuring of existing banks but also through allowing private capltal to re-enter the sector for the first time since 1972. While the project aims at reinforcing and carrying forward these reforms, there remains a risk that the political will to continue with this process might falter, especially in implementing expected privatization efforts of financial institutions and within the enterprise sector in general. The Government's commitment to reform and achievements during the last five years suggest that the risk is not excessive. PART TV - AGREEMENTS AND UNDERSTANDING REACHED 4.01 During negotiations, the following agreements and understandings were r.eached: (i) Financial Sector Policy relateds - increase of the threshold of the Central Bank's prior authorization prerogative to FMG 5.0 billion (effectiveness) and abolition of this prerogative (disbursement of second portion) (paras. 1.48 and 3.07); - reorganization of the money market and rediscount mechanisms in accordance with the recommendations of the CBD mission, including, inter alia, introduction of the AO system, use of the AO rate as the general reference rate, setting of an intervention band for the interbank rate, overhaul of the rediscount facility by only rediscounting Treasury bills, and introduction of a lender-of-last-resort facility (by October 15, 1990) (para. 3.07); - modification of the system of individual credit ceilings for banks (effectiveness) and abolition of these ceilings (disbursement of second portion) (paras. 1.36 and 3.08); - 41 - - changes in the reserve requirement system to convert it to a system of monthly reserves based on banks' deposits (effectiveness) (paras. 1.40 and 3.08); - Central Bank staff relinquish their board membership from banks they are supervising ex officio (disbursement of second portion) (paras. 1.18 and 3.09); and - regular publication of the results of the Treasury bill auctions (effectiveness) (paras. 1.46 and 3.09); - issuance of an implementing instruction clarifying the inconsistency of art. 51 of the Banking Law (effectiveness) (paras. 1.32 and 3.09); (ii) related to the private enterprise sector. - regular publication of statistical bulletin by the Central Bank (effectiveness) (paras. 1.66 and 3.10); - approval of new statutes for the Chamber of Co=merce and Industry, converting it into a truly private sector representative body (disbursement of second portion) (paras. 1.65 and 3.10); (iii) related to Credit execution: - signature of the Subsidiary Loan Agreement between the Government and the Central Bank (effectiveness) (para. 3.13); - suppression of the ceiling on PFI's spread on subloans (disbursement of second portion) (para. 3.23). 4.02 Conditions of Disbursement: - signing of the Participating Agreement between the Central Bank and financial intermediaries is a condition of disbursement for each intermediary (para. 3.16); - signing of the Cooperation Agreement between the Government and JCEM is a condition of disbursement for the technical assistance managed by JCEM (paras. 3.35 and 3.36); - establishment of the Investment Promotion Center, with terms of reference and operating procedures satisfactory to IDA, is a condition of disbursement of the assistance to this Center (para. 3.35). - 42 - 4.03 Subject to the above assurances and conditions, the project constitutes a suitable basis for an IDA Credit of US$48.0 million equivalent to the Democratic Republic of Madagascar. - 43 - ANNEX I MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT DISTRIBUTION OF CREDIT BY SECTOR (Gross Credit in FMG Billion) Dec. Dec. Dec. June Sept 1985 1986 1987 1988 1988 Agriculture, Livestock & Fishing 64.7 81.7 78.1 68.6 82.9 Mining 5.6 9.0 14.7 14.7 13.8 Building materials 14.0 15.2 17.9 7.5 7.7 Food industry 36.7 34.2 36.4 44.8 52.5 Agro-industry 2.6 2.1 5.7 4.5 5.0 Textiles and Garments 45.7 45.3 56.9 60.5 59.9 Chemicals and Pharmaceuticals 26.7 27.8 36.5 37.1 39.5 Petroleum products 6.0 4.4 5.7 4.8 5.2 Mechanical, metallurgical and 14.6 13.2 20.2 34.5 40.6 electrical industries Other manufacturing industries 10.5 12.7 15.5 19.6 19.4 Construction and Public Works 39.0 42.1 49.1 39.3 40.6 Transport and Transit 11.9 13.8 11.2 9.0 11.2 Trade 63.7 69.8 77.9 72.7 92.9 Others 14.7 17.3 22.1 23.2 24.7 TOTAL 356.3 388.7 447.9 440.9 495.9 Note: Does not include credits below FMG 10 million. Source: Central Bank. - 44 - ANINEX II MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT DISTRIBUTION OF CREDIT BY TERM AND TYPE OF BORROWER (Gross Credit in FMG Billion) Dec. Dec. Dec. June Sept 1985 1986 1987 1988 1988 Private Sector Short Term 170.7 180.3 212.0 242.6 272.0 Medium Term 12.z 11.2 14.0 15.3 18.0 Long Term 2.9 5.2 14.4 17.4 .8.8 TOTAL 185.7 196.7 240.3 275.3 308.8 Public Sector Short Term 143.9 155.3 154.2 115.2 133.6 Medium Term 14.0 17.6 26.7 19.6 19.6 Long Term 12.6 19.1 26.8 30.9 34.0 TOTAL 170.6 192.1 207.6 165.7 187.2 Private and Public Sectors Short Term 314.6 335.6 366.2 357.8 405.5 Medium Term 26.2 28.8 40.7 34.9 37.6 Long Term 15.5 24.3 41.1 48.3 52.8 TOTAL 355.3 388.6 447.9 440.9 495.9 Note: Does not include credits below FMG 10 million. Sources Central Bank. - 45 - MADAGASCAR ANNEX III FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT SUMKARY BALANCE SHEET OF BFV (FMG Billion) Dec. Dec. Dec. Dec. 1985 1986 1987 1988 ASSETS Cash, Central Bank, Treasury 9.9 40.9 21.9 14.6 Banks and Correspondants 2.0 1.4 1.6 3.8 Money Market 0.0 0.0 18.8 17.9 Credits (net of provisions) 86.8 89.1 107.6 116.7 Short term (80.1) (77.3) (93.0) (99.7) Medium term (6.6) (10.7) (14.1) (15.7) Long term 0.0 (1.0) (0.4) (1.3) Securities and fixed assets 2.0 2.7 13.9 15.1 Other assets 19.8 23.3 20.2 21.0 120.4 157.3 183.9 189.1 LIABILITIES Banks 0.0 0.0 0.0 0.3 Central Bank and Money Market 0.0 0.0 0.0 1.1 Demand Deposits 43.6 51.6 65.9 86.2 Time Deposits 30.4 52.1 45.0 45.1 Term Borrowings 0.0 0.6 0.5 0.2 Accounts Payable 7.7 12.5 11.2 10.5 Other liabilities 20.5 19.0 20.6 19.5 Reserves & general provisions 14.9 18.1 37.6 14.0 Capital 3.0 3.0 3.0 3.0 Net profit 0.4 0.3 0.0 9.2 120.4 157.3 183.9 189.1 Note: December 1988 figures are based on preliminary accounts - 46 - ANNEX IV MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT SUMARY BALANCE SHEET OF BNI (FMG Billion) Dec. Dec. Dec. Dec. 1985 1986 1987 1988 ASSETS Cash, Central Bank, Treasury 4.5 15.0 39.4 37.5 Banks and Correspondants 5.1 1.5 5.3 6.7 Money Market 0.0 0.0 1.3 24.2 Credits (net of provisions) 122.2 117.0 142.6 191.7 Short term (112.9) (100.0) (112.5) (138.5) Medium term (2.8) (3.8) (10.8) (11.4) Long term (6.6) (13.3) (19.3) (41.9) Securities and fixed assets 9.8 10.5 22.9 24.7 Other assets 23.6 42.2 62.2 59.1 165.2 186.2 273.7 343.9 LIABILITIES Banks 1.1 1.5 1.1 0.7 Central Bank and Money Market 4.8 0.2 2.6 6.6 Demand Deposits 58.0 64.2 83.4 108.4 Time Deposits 30.9 36.8 43.0 48.8 Term Borrowings 10.1 12.4 24.0 19.0 Accounts Payable 15.3 18.9 36.0 34.1 Other liabilities 25.9 31.9 49.2 77.6 Reserves & general provisions 14.0 15.2 29.1 29.9 Capital 4.5 4.5 4.5 4.5 Net profit 0.6 0.7 0.9 14.2 165.2 186.2 273.7 343.9 Notes December 1988 figures are based on preliminary accounts -47 - ANNEX V MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT SUMMARY BALANCE SUEST OF B71 (FMG Billion) Dec. Dec. Dec. Dec. 1985 1986 1987 1988 ASSETS Cash, Central Bank, Treasury 8.0 11.2 20.2 19.3 Banks and Correspondants 2.7 4.2 7.1 9.8 Money Market 0.0 0.0 2.0 0.0 Credits (net of provisions) 111.4 142.7 159.0 200.8 Short term (97.7) (121.1) (136.3) (172.8) Medium term (10.3) (15.8) (13.7) (18.5) Long term (3.3) (5.9) (9.0) (9.5) Securities and fixed assets 3.4 4.0 25.7 29.9 Other assets 15.2 24.4 17.9 16.2 140.7 186.5 232.1 276.0 LIABILITIES Banks 0.1 0.0 0.8 0.0 Central Bank and Money Market 0.0 0.0 2.7 19.1 Demand Deposits 61.1 82.4 92.8 102.6 Time Deposits 42.0 54.6 60.9 79.8 Term Borrowings 2.3 2.0 2.0 1.8 Accounts Payable 8.3 11.0 13.5 8.8 Other liabilities 12.6 20.2 20.9 28.8 Reserves & general provisions 5.8 5.2 26.0 26.5 Capital 8.4 10.9 12.3 13.2 Net profit 0.2 0.2 0.3 (4.7) 140.7 186.5 232.1 276.0 Note: December 1988 figures are based on preliminary accounts - 48 - ANNEX VI MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE DEVELOPMENT (APEX) CREDIT CENTRAL BANK ORGANIZATION CHART GOVERNOR l Director General | Deputy Directr l General l Technical 1F AdvisorSevc Legal ial Advisor Operations Director of Hissions J Administration - Organisation and Credit ata processing r | Toamasina Studies j Branch I I Insection| - 49 - ANNEX VII MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE (APEX) DEVELOPMENT PROJECT Schedule of Disbursements (Cumulative US$ thousands) IDA Fiscal Year Credit T.A. Cumulative and Quarter Ending Component Component* Total x FY90 June 30, 1990 --- 500 500 1.0 FY91 September 30, 1990 --- 600 600 1.3 December 31, 1990 700 700 1,400 2.9 March 31, 1991 1,350 800 2,150 4.5 June 30, 1991 2,900 1,050 3,950 8.2 FY92 September 30, 1991 4,500 1,300 5,800 12.1 December 31, 1991 6,100 1,400 7,500 15.6 March 31, 1992 7,650 1,450 9,100 19.0 June 30, 1992 9,900 1,550 11,450 23.9 FY93 September 30, 1992 12,150 1,800 13,950 29.1 December 31, 1992 13,700 1,950 15,650 32.6 March 31, 1993 15,300 2,300 17,600 36.7 June 30, 1993 17,300 2,650 19,950 41.6 FY94 September 30, 1993 19,350 2,700 22,050 45.9 Dec .ber 31, 1993 20,900 2,750 23,650 49.3 March 31, 1994 22,500 2,800 25,300 52.7 June 30, 1994 25,400 2,900 28,300 59.0 FY95 September 30, 1994 28,350 3,000 31,350 65.3 December 31, 1994 30,400 3,000 33,400 69.6 March 31, 1995 32,400 3,000 35,400 73.8 June 30, 1995 34,700 3,000 37,700 78.5 FY'6 September 30, 1995 36,900 3,000 39,900 83.1 December 31, 1995 38,300 3,000 41,300 86.0 March 31, 1996 39,600 3,000 42,600 88.8 June 30, 1996 40,700 3,000 43,700 91.0 FY97 September 30, 1996 41,850 3,000 44,850 93.4 December 31, 1996 43,000 3,000 46,000 95-8 March 31,1997 44,100 3,000 47,100 98.1 June 30, 1997 45,000 3,000 48,000 100.0 * Incl. PPF fintncing - 50 - ANNEX VIII MADAGASCAR FINANCIAL SECTOR AND PRIVATE ENTERPRISE (APEX) CREDIT Selected Documents Available in the Proiect File 1. Draft Participating Agreement |. Operating Norms and Procedures for Participating Financial Intermediaries 3. Draft Terms of Reference for the Central Bank Project Bureau 4. Appraisal Format 5. Simplified Appraisal Format