The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) @#&OPS~Doctype~OPS^blank@pidaprcoverpage#doctemplate Project Information Document (PID) Appraisal Stage | Date Prepared/Updated: 27-Sep-2024 | Report No: PIDIA00865 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) @#&OPS~Doctype~OPS^dynamics@pidaprbasicinformation#doctemplate BASIC INFORMATION A. Basic Project Data Project Beneficiary(ies) Region Operation ID Operation Name Kyrgyz Republic Developing EUROPE AND CENTRAL Kyrgyz Republic P505643 a Sustainable Finance ASIA Market for MSMEs Financing Instrument Estimated Appraisal Date Estimated Approval Date Practice Area (Lead) Investment Project Finance, Competitiveness 31-Oct-2024 12-Feb-2025 Financing (IPF) and Innovation Borrower(s) Implementing Agency The Kyrgyz Republic The Ministry of Finance Proposed Development Objective(s) To support the development of a sustainable finance market for MSMEs by mobilizing green and sustainable private finance, and building the capacity of financial institutions. Components Climate and Sustainable Finance Green Guarantees Project Implementation and Sustainable Finance Capacity Building, and Technical Assistance @#&OPS~Doctype~OPS^dynamics@pidprojectfinancing#doctemplate PROJECT FINANCING DATA (US$, Millions) Maximizing Finance for Development Is this an MFD-Enabling Project (MFD-EP)? Yes Is this project Private Capital Enabling (PCE)? Yes SUMMARY Total Operation Cost 50.00 Total Financing 50.00 of which IBRD/IDA 50.00 Financing Gap 0.00 Page 1 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) DETAILS World Bank Group Financing International Development Association (IDA) 50.00 IDA Shorter Maturity Loan (SML) 50.00 @#&OPS~Doctype~OPS^dynamics@envsocriskdecision#doctemplate Environmental And Social Risk Classification Moderate Decision B. Introduction and Context Country Context 1. The Kyrgyz Republic, a land-locked, lower-middle-income country in Central Asia, was hit hard by the pandemic in 2020. The real Gross Domestic Product (GDP) fell by 7.1 percent in 2020. The economy began recovering with real GDP growth of 5.5 percent in 2021, 12.1 percent in 2022, and back to 4.7 percent in 2023 and exhibited high resilience to internal and external shocks, including Russia’s invasion of Ukraine. In 2024, the real GDP growth is projected to increase to 5.8 percent. Remittances inflows are projected to recover somewhat as Russia’s economy continues to exhibit strong demand for migrant labor. However, growth is expected to decelerate from high levels in the past two years because of constraints on the supply side of the economy1. 2. Poverty in the country increased during the COVID-19 pandemic, and it remains elevated despite strong growth. The COVID-19 pandemic increased the poverty rate from 9.7 percent in 2019 to 25.3 percent in 2020. The poverty rate increased to 33.3 percent in 2021 and remained high at 33.2 percent in 20222. Poverty in the Kyrgyz Republic has strong gender and spatial dimensions, being particularly high in female-headed households, rural populations, and “lagging� regions. Inequality has steadily fallen the Gini coefficient decreased from 37.4 in 2006 to 28.8 in 2021. Moreover, the World Bank's shared prosperity indicator shows that growth was fairly inclusive, with consumption growth for the bottom 40 percent of the income distribution exceeding that of the average across the whole income distribution. 3. The Kyrgyz Republic is highly vulnerable to climate change and natural disasters. It ranks as the third most vulnerable country to climate change in the Europe and Central Asia region, using the simplified index of vulnerability. As 1 World Bank. Kyrgyz Republic Economic Update, Spring 2024. 2 Ibid. Page 2 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) a mountainous country, the Kyrgyz Republic is highly vulnerable to climate change, natural disasters, and natural resource degradation, driving vulnerable populations in rural areas that depend on natural resources for their livelihoods to face increasing risks. While the Kyrgyz Republic’s contribution to global greenhouse gas (GHG) emissions is small, heavy use of coal for heating contributes to the country having one of the highest winter air pollution rates in the world, with severe impacts on local health. Strengthening climate change mitigation and adaptation mechanisms, including more efficient management of natural resources, investments in adaptation, and reducing emissions in energy and agriculture, are not only needed to strengthen the resilience of livelihoods and ecosystems but also present an opportunity to support a more diversified, greener growth path. Sectoral and Institutional Context 4. A robust and sustainable economic growth and development in the Kyrgyz Republic requires addressing rising climate and environmental risks and taking advantage of opportunities for green growth3. The primary challenge in adopting sustainable finance practices is the limited expertise and awareness of sustainable finance opportunities among enterprises in the real sector and financial institutions, which leads to an inadequate supply of relevant financial products. This issue is further exacerbated by the high costs associated with green certifications and compliance. Additionally, insufficient government support and incentives to promote the sustainable finance market aggravate the problem. For instance, the Government spending on climate-related actions has been low and falls short of financing commitments stipulated in the Nationally Determined Contribution (NDC). Meeting climate commitments under the updated NDC would be costly, with estimated financing required in the range of US$10 billion, of which 37 percent from domestic resources4. 5. Efforts are underway to create an enabling environment for sustainable finance. The most important initiative is the approval of the green taxonomy, with the Ministry of Economy and Commerce (MoEC) leading the effort, supported by the Asian Development Bank. The taxonomy is crucial in the context of the Kyrgyz Republic due to the benefits associated with greater standardization, increased investment, improved risk management, and streamlined regulatory compliance. The approval of the taxonomy is also expected to enhance transparency and disclosure; therefore, the accounting and reporting of Scope 3 emissions should be planned for the medium term to be better aligned with the best international practices. The National Bank of the Kyrgyz Republic (NBKR) issued guidelines on Environment, Social, and Governance (ESG) risks assessment in the banking sector in October 20235. It is also contemplating joining the Network for Greening the Financial System (NGFS), a network of central banks and financial supervisors that aims to accelerate the scaling up of green finance and develop recommendations for central banks' role in climate change. The Ministry of Finance is leading green budgeting with technical assistance from the World Bank. The Climate Finance Center, a government organization of the Kyrgyz Republic, is coordinating the activities/projects funded by global climate funds with EBRD technical support. Several line ministries also lead sector-specific green finance programs (e.g., Green Energy Fund, sustainable agriculture program) supported by donors. The Kyrgyz Stock Exchange has joined the Sustainable Stock Exchange Initiative and issued Sustainable Reporting Guidelines for listed companies in 2023. The market has seen one green bond and one gender bond issued in the Kyrgyz Republic in 2022 and 2023, respectively, by two local commercial 3 Here green growth refers to an economic strategy that prioritizes sustainable development, where natural resources are used responsibly, carbon emissions are reduced, and ecosystems are protected, while balancing social equity and governance standards. 4 Updated Nationally Determined Contribution 2021 (pages 6-7), incorporating both mitigation and adaptation measures. 5 The Guidelines specify minimum standards that banks should meet for the sound management of ESG risks within the current prudential framework and recommend how banks can integrate ESG into their business planning and environment, organizational structures, internal governance, and risk- management frameworks. The Guidelines are based on international best practices and have also considered standards issued by other central banks. Page 3 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) banks and listed on the Kyrgyz Stock Exchange6. More thematic bond issuance is planned in 2024-2025, but mainly by commercial banks. 6. Globally, National Development Financial Institutions (NDFIs) are leading providers of climate finance, providing close to 20 percent of the total climate finance7. NDFIs have the scale and influence to play a transformative role, especially in developing economies, where public actors provide 60 percent of total climate financing, almost half of which is by NDFIs. In this regard, the State Development Bank (SDB) and the Open Joint Stock Company (OJSC) Guarantee Fund (GF) have a critical role to play in facilitating establishment of sustainable finance market by narrowing the large financing gap that exists in the Kyrgyz Republic. The Green Finance Fund (GFF), Kyrgyz government’s special purpose vehicle to mobilize funding for green and sustainable projects, is also expected to provide important contributions, utilizing alternative finance instruments such as equity investment and long-term lending. Financial support channeled and intermediated by NDFIs will reach the real sector through banks, given the dominance of the latter in the financial markets. However, the recent development of non-bank financial institutions suggests that their role, especially of private equity and other capital market players, should not be underestimated. 7. The SDB and the GF are working towards becoming green financial institutions. SDB finalized and approved its policy on green financing and sustainable development in April 2024. It has subsequently adopted their internal green taxonomy and developed a wholesale green loan program with commercial banks in June 2024. The program is to be launched in late 2024. The GF is planning to develop green credit guarantee products for local banks. This is timely as Kyrgyz financial institutions are building up capacity in ESG and are offering some green financing products (see Annex 2). The Union of Banks, as an NGO representing interests of Kyrgyz banks and as a member of the Sustainable Banking and Finance Network (SBFN), has developed knowledge-sharing and capacity-building programs for member banks on ESG risks assessment, sustainable finance, disclosure and reporting with international partners and donors since 2017 and has established in April 2024 the ESG Academy as a training center for financial institutions, supported by IFC. 8. The SDB and the GF will need to become a catalyst in creating a sustainable finance market in the Kyrgyz Republic, not only to narrow the large climate financing gap but also to ensure that Micro, Small, and Medium Enterprises (MSMEs) including women and vulnerable populations are not left out in their adaptation to climate change and transition to a green economy. The project’s focus on MSME’s is also motivated by the firm clustering and labor concentration in the most polluting sectors such as agriculture and industry. For instance, about 40 percent of the labor force of the country is employed in the agriculture businesses. Both SDB and GF are given clear mandates by the government to provide financing to MSMEs. MSMEs contributes to 90% of job creation and 43% of GDP in the Kyrgyz Republic according to national statistics in 2022. However, access to credit for growth and investment has been a major challenge for MSMEs in the Kyrgyz Republic. The World Bank Business Enterprise Survey 2023 indicates that, while 97.4 percent of firms have an account at a financial institution, only 13.3 percent of firms uses banks to finance investments. This figure is much worse for small businesses at mere 1 percent8. Further, the green module that was undertaken in the World Bank Business Enterprise Survey 2019 exhibits that Kyrgyz firms are prone to suffer from losses due to extreme weather events much more so than other Europe and Central Asian countries. About 13 percent of Kyrgyz firms experienced monetary losses due to extreme weather events compared with 3 or 4 percent of firms in lower end of the spectrum (see Figure 1). In 2023, firms reported that extreme weather events reduced 17 percent of sales. 6 https://www.kse.kg/en/Sustainable 7 The World Bank, Finance and Prosperity (forthcoming) 8 The World Bank, Enterprise Survey (2023). https://www.enterprisesurveys.org/content/dam/enterprisesurveys/documents/country/Kyrgyz- Republic-2023.pdf Page 4 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) 9. The market readiness for creating and developing a sustainable finance market has significantly improved in a short time as observed by the increasing number of banks and MFIs that are preparing sustainable finance products. As of June 2024, an additional 5-6 commercial banks and several MFIs are already at an advanced stage of product design or actively seeking to offer sustainable finance products. Nonetheless, concerted efforts are needed to scale the market and support MSMEs so that they are not left out but become a competitive force in the local, regional, and global markets. C. Proposed Development Objective(s) Development Objective(s) (From PAD) 10. To support the development of a sustainable finance market for MSMEs by mobilizing green and sustainable private finance, and building the capacity of financial institutions. Key Results (i) an increased share of sustainable finance in the financial sector; and (ii) the number of financial institutions that offer new sustainable finance products to MSMEs based on the capacity building received under the project. D. Project Description 11. Component 1: Green and sustainable finance (US$30 million). This component will provide i) wholesale sustainable finance to mobilize private capital and ii) a financial contribution to the Green Finance Fund (GFF). This component will also include the following subcomponents: • Subcomponent 1.1: Wholesale co-financing to Participating Financial Institutions (PFIs). This subcomponent will provide financing to PFIs through an Apex financial institution. In particular, under this subcomponent, the project will provide eligible PFIs with access to a wholesale facility operated by the SDB, targeting the greening of local firms to develop new sustainable finance products. • Subcomponent 1.2: Funding Contribution to the GFF. The Government is establishing the GFF with support from the United Nations Development Programme (UNDP). The GFF is expected to provide both debt and equity financing and will likely have the following windows: i) MSMEs (both existing and startups), and ii) infrastructure projects. This subcomponent will support the first window. 12. Component 2: Green Guarantees (US$19.5 million). This component will help the GF introduce green guarantee products through i) a Portfolio Risk Sharing Facility (PRSF), and ii) individual guarantee products. This component will also include the following subcomponents: • Subcomponent 2.1: Green PRSF for MSMEs. A green guarantee window would be added to the existing PRSF which was created under the Emergency Support for MSMEs’ project9. Given the nature of the 9 The on-going Emergency Support for MSMEs Project created the first PRSF in the Kyrgyz Republic, managed by the GF. Page 5 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) portfolio based partial credit guarantee facility, all eligible green MSME loans from PFIs will be automatically included in the green PRSF facility. • Subcomponent 2.2: Individual green guarantees. This subcomponent will cater to guarantees outside the PRSF’s set parameters, i.e., aimed at MSME individual green guarantees that may be too big for the PRSF10. 13. Component 3: Project Implementation and Sustainable Finance Capacity Building (US$0.5 million). The Credit Line Management Unit (CMLU) at the MOF will implement this component, which will focus on the overall management of the project and capacity building required in the sustainable finance ecosystem, including implementing agencies and PFIs. However, the capacity building will be complemented by the World Bank, IFC, and other multilateral organizations, MDBs, bilateral institutions, and donors who are currently providing technical assistance or plan to do so. @#&OPS~Doctype~OPS^dynamics@pidaprlegalpolicy#doctemplate Legal Operational Policies Triggered? Projects on International Waterways OP 7.50 No Projects in Disputed Area OP 7.60 No Summary of Screening of Environmental and Social Risks and Impacts 14. The project’s environmental and social risks are assessed as Moderate at the Appraisal stage. The standards relevant to the Project are ESS1, ESS2, ESS3, ESS4, ESS6, ESS9, and ESS10. The overall environmental and social impacts of the project investments are expected to be generally positive. The project will be beneficial for both (i) new and existing MSMEs by narrowing the large climate and green financing gap and ensuring that women and vulnerable populations and MSMEs are not left out in their adaptation and transition to a green economy and (ii) PFIs through development and integration of an Environmental and Social Management System (ESMS) aligned with the national requirements and the WB ESF, and creating an enabling environment for sustainable finance. However, some potential adverse environmental risks include temporary ones with site-specific construction of renewable energy installations, renovation of the manufacturing/processing lines, use of pesticides, and soil loss related to agricultural activities. The project is also expected to produce minor environmental impacts such as emission of dust, water use, noise, limited waste generation, and similar that will be readily addressed by national legislation and regulations. Some project activities may cause direct and indirect disturbance of natural habitats. As per national environmental regulation companies developing renewable energy sources are subject to environmental impact assessment and environmental permitting that includes mitigation measures for environmentally significant installations. Minor OHS risks exist in relation to renewable energy construction and installation works, and these will be addressed by national legislation. Possible exclusion of potential beneficiaries, including vulnerable groups as WMSMEs, disabled, and youth, from access to project benefits (credit lines, capacity building) will be addressed through awareness campaigns, transparent communication about project scope, clear 10 The expected threshold will likely be around USD100,000; however, this will need to be further analyzed and discussed. Page 6 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) eligibility and selection criteria, and application procedures. No significant risks related to labor influx, sexual exploitation and abuse/sexual harassment (SEA/SH), child labor, or community health and safety are expected. The project workers (direct and contracted) are expected to be hired locally. The investment activities with potential impacts under ESS5 will not be eligible for project financing. Enterprises are expected to use existing land/facilities in which they currently operate or are locally available. To address the environmental and social risks, the Project prepared a Stakeholder Engagement Plan (SEP) and a Labor Management Procedures (LMP), and during the project implementation, the PFIs’ ESMS will be developed in accordance with the WB ESSs relevant to the project, as per ESS9. The Grievance Redress Mechanism (GRM) will be established to receive, accept, review, and resolve any project-related concerns or feedback and be easily accessible to project-affected parties and workers. The exclusion list for financing under the project, acceptable to the Bank, will exclude sub-projects with land acquisition, involuntary resettlement, livelihood and cultural heritage impacts, and activities involving child and forced labor. The PFIs will categorize any beneficiary MSME activities that involve significant risks and impacts on the environment, biodiversity, community health, and safety, labor, and working conditions and screen these out as ineligible for financing in accordance with the POM. As part of the credit approval procedure, E&S due diligence will be conducted by each PFI for their respective sub-borrowers before decision to finance investments. E. Implementation Institutional and Implementation Arrangements Page 7 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) @#&OPS~Doctype~OPS^dynamics@contactpoint#doctemplate CONTACT POINT World Bank Emiko Todoroki Senior Financial Sector Specialist Tatiana Segal Senior Operations Officer Borrower/Client/Recipient The Kyrgyz Republic Ruslan Tatikov Deputy Minister of Finance r.tatikov@minfin.kg Malik Abakirov Chairman of the Guarantee Fund abakirov@gf.kg Implementing Agencies The Ministry of Finance Bermet Musakozhoeva Director of the PIU b.muzakozhoeva@piu.kg FOR MORE INFORMATION CONTACT The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 473-1000 Web: http://www.worldbank.org/projects @#&OPS~Doctype~OPS^dynamics@approval#doctemplate APPROVAL Task Team Leader(s): Emiko Todoroki, Tatiana Segal Approved By Page 8 The World Bank Kyrgyz Republic Developing a Sustainable Finance Market for MSMEs (P505643) Practice Manager/Manager: Country Director: Hugh Riddell 27-Sep-2024 Page 9