Document of The World Bank FOR OFFICIAL USE ONLY Report No: 57484-PG INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED CREDIT IN THE AMOUNT OF SDR 13.93 MILLION (US$21.91 MILLION EQUIVALENT) TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA FOR A SMALL AND MEDIUM ENTERPRISE ACCESS TO FINANCE PROJECT March 30, 2011 Financial and Private Sector Development Unit Poverty Reduction and Economic Management Department East Asia and Pacific Region International Finance Corporation This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization. CURRENCY EQUIVALENTS (Exchange Rate Effective February 28, 2011) Currency Unit = Kina (K) K2.57 = USD1 USD1.57 = SDR1 FISCAL YEAR January 1 – December 31 ABBREVIATIONS AND ACRONYMS ADB Asian Development Bank NCB National Competitive Bid BP Bank Procedures OP Operational Policy BSP Bank South Pacific PBGA Performance-Based Grant Agreement CAS Country Assistance Strategy PCA Procurement Capacity Assessment DCI Department of Commerce and Industry PFI Participating Financial Intermediary DPS Designated Procurement Specialist PIU Project Implementation Unit EOM Environmental and Social Risk Management PNG Papua New Guinea Operations Manual FBS Fixed Budget Selection PP Procurement Plan FI Financial Intermediary PPP Public-Private Partnerships FM Financial Management PSD Private Sector Development FMR Financial Management Report QBS Quality Based Cost Selection QCBS Quality and Cost Based Selection IBRD International Bank for Reconstruction and RFP Request for Proposal Development ICB International Competitive Bid RSF Risk Share/ Sharing Facility IDA International Development Association SC (Project) Steering Committee IFC International Finance Corporation SDP Strategic Development Plan ISoPNG Independent State of Papua New Guinea SEMS Social and Environmental Management System LNG Liquefied Natural Gas SME Small and Medium Enterprise LTDS Long-term Development Strategy SOE State-owned Enterprise M&E Monitoring and Evaluation SPI Summary of Proposed Investment MFI Multinational Financial Intermediaries TA Technical Assistance MOF Ministry of Finance TEC Technical Evaluation Committee MTDS Mid-term Development Strategy TOR Terms of Reference WBG World Bank Group The World Bank Vice President: James W. Adams Country Director: Ferid Belhaj Country Manager Laura E. Bailey Sector Manager: T. Tunc Uyanik Task Team Leader: Hamid R. Alavi INDEPENDENT STATE OF PAPUA NEW GUINEA - SMALL AND MEDIUM ENTERPRISE ACCESS TO FINANCE PROJECT TABLE OF CONTENTS Page I. STRATEGIC CONTEXT AND RATIONALE ................................................................. 1 A. COUNTRY AND SECTOR ISSUES ........................................................................................... 1 B. RATIONALE FOR BANK INVOLVEMENT .............................................................................. 4 C. HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES .............................. 5 II. PROJECT DESCRIPTION ................................................................................................. 6 A. LENDING/GUARANTY INSTRUMENT ................................................................................... 6 B. PROJECT DEVELOPMENT OBJECTIVE AND KEY INDICATORS ............................................ 7 C. PROJECT COMPONENTS AND OUTPUTS .............................................................................. 8 D. LESSONS LEARNED AND REFLECTED IN THE PROJECT DESIGN ....................................... 10 E. ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION ......................................... 11 III. IMPLEMENTATION .................................................................................................... 12 A. PARTNERSHIP ARRANGEMENTS ....................................................................................... 12 B. INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS .............................................. 13 C. MONITORING AND EVALUATION OF OUTCOMES/ RESULTS ............................................. 14 D. SUSTAINABILITY ............................................................................................................... 15 E. CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS ............................................ 15 F. LOAN/ CREDIT CONDITIONS AND COVENANTS ................................................................. 17 IV. APPRAISAL SUMMARY ............................................................................................. 17 A. ECONOMIC AND FINANCIAL ANALYSES ............................................................................ 17 B. TECHNICAL ....................................................................................................................... 18 C. FIDUCIARY ........................................................................................................................ 19 D. SOCIAL .............................................................................................................................. 22 E. ENVIRONMENT.................................................................................................................. 23 F. SAFEGUARD POLICIES ...................................................................................................... 24 G. POLICY EXCEPTIONS AND READINESS ................................................................................ 24 Annex 2: Major Related Projects Financed by the Bank and/ or other Agencies ............... 33 Annex 3: Results Framework and Monitoring ....................................................................... 34 Annex 4: Detailed Project Description ..................................................................................... 37 Annex 5: Project Costs .............................................................................................................. 48 Annex 6: Implementation Arrangements ................................................................................ 49 Annex 7: Financial Management and Disbursement Arrangements .................................... 52 Annex 8: Procurement Arrangements ..................................................................................... 62 Annex 9: Economic and Financial Analysis ............................................................................ 67 Annex 10: Safeguard Policy Issues ............................................................................................ 72 Annex 11: Project Preparation and Supervision .................................................................... 74 Annex 12: Documents in the Project File ................................................................................ 76 Annex 13: Statement of Loans and Credits ............................................................................. 77 Annex 14: Country at a Glance ................................................................................................ 78 Annex 15: Map ........................................................................................................................... 80 Independent State of Papua New Guinea Small and Medium Enterprise Access to Finance Project PROJECT APPRAISAL DOCUMENT Date: March 30, 2011 Team Leader: Hamid R. Alavi Country Director: Ferid Belhaj Sectors: Micro- and SME finance (100%) Sector Manager/Director: Tunc Tahsin Uyanik Themes: Small and medium enterprise support (100%) Project ID: P120707 Environmental category: FI Lending Instrument: Financial Intermediary Loan Joint IFC: Yes Joint Level: Project or Activity implemented together with an IFC activity (Loan/Credit/Guarantee/AAA) Project Financing Data [ ] Loan [X] Credit [ ] Grant [ ] Guarantee [ ] Other: For Loans/Credits/Others: Total Bank financing (USD m.): 21.91 Proposed terms: The credit has a final maturity of 35 years including a grace period of 10 years Financing Plan (USD m equivalent) Source Local Foreign Total BORROWER/RECIPIENTS 4.60 0.00 4.60 International Development Association (IDA) 0.00 21.91 21.91 International Finance Corporation (IFC) 0.00 46.40 46.40 Participating Financial Intermediaries 58.00 0.00 58.00 Total: 62.60 68.31 130.91 Borrower: Independent State of Papua New Guinea Responsible Agency: Ministry of Commerce and Industry PO Box 375 Waigani Papua New Guinea Tel: (675) 325-6099 Ministry of Commerce and Industry Papua New Guinea Estimated disbursements (Bank FY/USD m) FY 2011 2012 2013 2014 2015 2016 Annual 3.8 4.0 7.8 3.0 2.7 0.61 Cumulative 3.8 7.8 15.6 18.6 21.3 21.91 Project implementation period: Start: May 2011 End: June 30, 2019 Expected effectiveness date: May 28, 2011 Expected closing date: December 31, 2024 Does the project depart from the CAS in content or other significant respects? Ref. [ ]Yes [X] No PAD I.C. Does the project require any exceptions from Bank policies? [X]Yes [ ] No The Recipient is exempted from the requirement of submitting the annual audited project financial statements for the risk sharing facility (―RSF‖) component of the Project only, under OP 10.02 on the basis that alternative, more cost effective mechanisms exist that provide equivalent assurance that the funds have been used for the purpose intended. IFC's anti-corruption approach for the private sector will be followed for the RSF component. These Guidelines have been specifically designed for private sector operations and would be more appropriate in this instance. The management, with the endorsement of the MD, requests a waiver of the IDA/IBRD Anti-Corruption Guidelines in favor of using the IFC's anti-corruption approach for the private sector for component 1 of the Project. Ref. PAD IV.G. Have these been approved by Bank management? [X]Yes [ ] No Is approval for any policy exception sought from the Board? [X]Yes [ ] No Does the project include any critical risks rated ―substantial‖ or ―high‖? [X]Yes [ ] No Ref. PAD III.E. Does the project meet the Regional criteria for readiness for implementation? Ref. [X]Yes [ ] No PAD IV.G. Project development objective Ref. PAD II.C., Technical Annex 3 The proposed development objective of this project is to facilitate access to sustainable credit for small and medium enterprises (―SME‖) and thus contribute to incremental growth of SME employment and income. Project description: The proposed project will be a pilot under Phase II of IDA/IFC Pilot Program for RSF which includes a number of countries globally. As such, the proposed design parameters (i.e. risk share, fees, etc.) of the RSF follow the general structure of the previous pilots, and tailored to the circumstances in PNG and the capacity of Participating Financial Intermediaries (―PFIs‖). Furthermore, the proposed project is a pilot of such a financial instrument and if successful, it could be scaled up in the future to include other countries in the Region. The project would demonstrate an effective method to leverage private sector funding to enhance SME contribution to PNG economy. It is expected that the knowledge the PFIs gain during the program will allow them to develop their own procedures and criteria for lending to the sector in the long term in a sustainable manner. The 50 percent loss sharing provides PFIs with the credit protection needed to mitigate the perceived high risk of SME lending in PNG circumstances while also incentivizing PFIs to conduct proper borrower credit appraisal and apply strict loan underwriting criteria (including taking proper security) in establishing the loan portfolio. Major project components are a RSF component and three technical assistance components. Component 1: The RSF will provide a risk coverage for a portfolio of newly-originated loans to existing and start-up SMEs. The objective of the RSF is to immediately accelerate commercial banks‘ lending to SMEs. The RSF structure would reimburse the PFIs for a fixed percentage (50 percent) of incurred losses, which is expected to provide them with the credit protection needed to mitigate the perceived high risk of SME lending. The IDA credit would be used up equally when risk-sharing payments are called by PFIs. Under the proposed arrangements, the IDA funds will be used to provide ‗first loss‘ coverage of up to USD11.67 million (i.e. 10 percent of total portfolio amount), while IFC would provide ‗second loss‘ coverage of up to USD46.69 million equivalent in local currency (i.e., 40 percent of total portfolio amount). It is thus expected that USD11.67 million IDA financing would leverage up to USD116 million of commercial bank lending to SMEs sector (i.e., USD1 IDA pledge for ‗first loss‘ is expected to leverage up to USD11 commercial bank lending). Component 2: Performance-based technical assistance to financial intermediaries participating in the RSF to value approximately USD2.35 million. Component 3: Initiatives to build the capacity of SMEs borrowing under the RSF program to value approximately USD5.15 million. Component 4: Technical assistance to the Department of Commerce & Industry to upgrade its SME strategy and policy making capacity, as well as upgrading its capacity to facilitate implementation of the Project to value approximately USD7.44million. Which safeguard policies are triggered, if any? Ref. PAD IV.F., Technical Annex 10 The following safeguards are triggered: (a) Environment Assessment (OP/BP 4.01); (b) Indigenous People (OP/BP 4.10); and (c) Involuntary Resettlement (OP/BP 4.12). Significant, non-standard conditions, if any, for: Ref. PAD III.F. Board presentation: None Loan/credit effectiveness: The conditions for effectiveness consist of: a) The Risk Sharing Framework Agreement has been executed and delivered and all conditions precedent to its effectiveness (other than the effectiveness of this Agreement) have been fulfilled. b) At least one Risk Sharing Agreement has been executed and delivered and all conditions precedent to its effectiveness (other than the effectiveness of this Agreement) have been fulfilled. c) The Steering Committee, the Project Implementation Unit, and the Technical Evaluation Committee have each been established in a manner satisfactory to the Association. Covenants applicable to project implementation: The conditions for disbursement consist of: a) In the case of Disbursement Category 1 (RSF for BSP): evidence satisfactory to the Association has been provided that (i) the RSF Trust Fund has been established, and (ii) the first Participating Financial Intermediary has adopted a Social and Environmental Management System (―SEMS‖) that is acceptable to IDA; b) In the case of Disbursement Category 2 (RSF with subsequent PFIs): (i) the execution of the Risk Sharing Agreement(s) satisfactory to IDA with the said financial intermediary(ies) and (ii) ) the Participating Financial Intermediary(ies) has(have) prepared a SEMS for the respective PFI that is acceptable to IDA; c) In the case of Disbursement Category 3 (Performance Based Grants to Financial Intermediaries participating in the RSF), the execution of a Performance Grant Agreement between the recipient and the financial intermediaries. d) Appointment of an FM advisor prior to disbursement from Disbursement Category 4. INTERNATIONAL DEVELOPMENT ASSOCIATION PROJECT APPRAISAL DOCUMENT ON A PROPOSED SMALL AND MEDIUM ENTERPRISE ACCESS TO FINANCE PROJECT TO THE INDEPENDENT STATE OF PAPUA NEW GUINEA I. STRATEGIC CONTEXT AND RATIONALE A. COUNTRY AND SECTOR ISSUES 1. Endowed with valuable mineral resources but beset by a legacy of geographic isolation, poor education, and subsistence production, Papua New Guinea‘s (PNG) economic performance has been historically weak, buoyed and deflated by commodity booms and busts (for details see Annex 1). After the Bougainville rebellion of 1989, the economy grew during the first half of 1990s before inconsistent macroeconomic policies and lower commodity prices halted the growth spurt. Following a period of economic contraction (0.5 percent a year on average) from 1995 to early 2000s, PNG returned to growth during the global commodity boom of 2004 - 2008, aided by the prudent macroeconomic management of its terms of trade windfall during the period. Focusing on macroeconomic stability, the Government targeted the non-mineral fiscal deficit at its estimated long-term sustainable level. With fiscal revenues surging from 4 percent of gross domestic product (―GDP‖) in 2004 to 10 percent of GDP in 2008, the authorities capped the growth in fiscal spending, saved windfall mineral revenues in trust accounts that topped 14 percent of GDP in 2008 and paid off expensive public external debt from a high 54 percent of GDP in 2002 to 13 percent of GDP by end 2008. GDP growth surged to an average 7 percent in 2007-08 and the Government formalized its new-found fiscal discipline in a Medium Term Fiscal Strategy (MTFS) for 2008-12. Thus, the country could weather the global financial crisis relatively well due to the buffer built during the commodity boom. 2. But despite the recent improvement in macroeconomic performance and prospects, PNG remains a low-income country with a dual economy, consisting of a modern mineral sector that accounts for a third of value added and three fourths of exports, but with little linkages to the local economy, and a non- mineral sector consisting almost entirely of subsistence agriculture, employing 85 percent of the population, and low-value added services wedded to mineral projects. In addition, the share of manufacturing in GDP remains little changed in a decade, at around 6 percent. 3. Therefore, translating strong macroeconomic performance and extractive industry revenues into a broad improvement in living standards remains a key challenge. The role of private sector, especially small and medium enterprises (SMEs) to address this challenge is critical (for definition of SMEs in the context of PNG, see Annex 1). SME development is notably important in view of low job market participation rate in the formal sector,1 especially among women and youth.2 But SME activity and 1 In 2002 a survey was conducted that showed 6 percent of the working age population in PNG was employed in the formal sector, and the relatively small formal sector of the economy has only been generating about 10,000 jobs for the approximately 80,000 who leave the schooling system each year. 2 Historically, female representation in business life in PNG is low and this is reflected in government participation—only one female is represented among the 109 national parliamentarians. Also, according to the World Bank WDI, in 2000 only 32 percent of women were employed outside of the agricultural sector. Furthermore, it is estimated that less than 5 percent of formal sector SMEs are headed by women, while, in 2008, women accounted for half of the population and labor force. 1 investment is hampered by an array of institutional and structural constraints, among which is the lack of access to finance.3 4. The construction of a USD18 billion Liquefied Natural Gas (LNG) Project starting in 2010, as well as a number of on-going natural resource projects, provide an important opportunity for SME activity and participation and are raising the expectation that PNG‘s economic growth and living standards can be notably raised in the long-term. The project will generate export revenues of about USD3 billion per year on average, more than double the combined record high of oil and gas exports in 2008, and propel PNG to become East Asia‘s second-ranked LNG producer, after Malaysia and past Indonesia. Oil and gas exports would increase more than four-fold, with average annual product value from the LNG project of PGK11.4 billion, compared to total PNG oil and gas exports of PGK2.6 billion in 2006. While the Government and some landowners will benefit from resultant royalty flows, PNG SMEs will struggle to meaningfully participate in the resultant opportunities, unless the private and public sectors, working with development partners, can address existing key constraints, among which is access to finance. Small scale procurement opportunities from the LNG construction phase alone are estimated at over USD 470 million.4 5. The Government of the Independent State of Papua New Guinea (GoPNG) has acknowledged that the development of SMEs would dovetail with the search for linkages to and spillovers from the construction and exploitation of mineral projects and underpin efforts to expand productive activity in the lagging agriculture, manufacturing and service sectors and has included the development of a viable SME development as a key feature in its Long Term Development Strategy (LTDS). SME finance landscape and government programs 6. The current institutional framework and landscape for SME finance includes formal financial intermediation and government programs. GoPNG has developed several subsidized programs to boost SME finance, mainly through the Small Business Development Corporation (SBDC) which was established by an Act of the National Parliament of Papua New Guinea in April 1990. Two of the SBDC‘s programs have been a credit guarantee scheme to eligible small businesses, and a training program to local businesses (known as Start and Improve Your Business – SIYB). The Government has provided intermittent funding to SBDC to underwrite the credit guarantee with the Participating Financial Intermediaries (PFIs) that lend to clients who have received some business training from SBDC. The SBDC program targets new start-ups or existing businesses looking for expansion. SBDC provides up to 80 percent credit guarantee on the loan amount which ranges from K5, 000 to K60, 000, while the borrowers provide up to 20 percent equity. SBDC charges a 1 percent guarantee fee upfront to borrowers and PFIs charge K100 for each approved loan application. The National Development Bank is another government sponsored financial institution that extends financial services to the rural areas in PNG. 7. However, the overall performance of these programs has been mixed and they have not yet effectively addressed challenges that have led to the lack of access to finance by SMEs. A key challenge 3 Globally, formal sector SMEs contribute significantly to sustainable employment growth and make significant direct and indirect contributions to the tax revenue base. In PNG, however, the current density of formal SMEs is very low; at about 2 to 3 per 1,000 head of population. This represents about 5 percent of OECD country density, about 20 percent of East Asia & Sub-Saharan Africa regions; and about 10 percent of Latin America density. There are several reasons for this; a key one being limited access to finance, which the proposed project will aim to address. While reliable data are almost totally unavailable, female entrepreneurs appear to be especially under- represented. 4 Additionally, there is a further approximate USD10 billion of possible other resource sector investments over the next five to seven years that SMEs can tap. 2 is the inability of the under-developed SME sector to respond to the requirements of commercial banks in terms of financial statements, collateral, information and guarantees. Another challenge is conservative commercial bank practices have been incompatible in meeting the financing requirements of SMEs. Customary land ownership and weak property rights to movable assets make the pledging of collateral for loans difficult, unreliable, and expensive. In addition to high costs, the risks of lending to SMEs are perceived to be too high because of a lack of information and data on the local SME market. The deficit of robust data makes it difficult for banks to develop appropriate risk management procedures. In addition, as in other countries, the government-run guarantee programs are often considered unresponsive to the requirements of financial intermediaries in the case of loan default. 8. Certain social and cultural aspects also contribute to access to finance issues. The wantok system5 has added costs to local businesses and uncertainty to commercial lending activities. In addition, women are not equally represented as owners and operators in the formal SME sector; however, they are overrepresented in the informal cottage sector.6 A recent IFC study noted that women in PNG derive limited benefit from the formal economy, mainly operating small scale informal businesses. Women are held back by a male dominated culture, limited ability to control business income, exclusion from decision making and by violence directed against them. Women are further constrained by a legal framework that does not adequately protect their interests, particularly in relation to property rights and employment. Customary law, which frequently discriminates against women, is commonly applied.7 The IFC report recommended a number of legal and regulatory reforms to help address key constraints to gender inclusion. These recommendations are currently being considered by GoPNG, which has also indicated, in the SME Policy and the National Development Plan (NDP), a desire to achieve equality for women, including supporting greater numbers of women in business in the formal sector. Potential for facilitating SME access to finance 9. PNG has a liquid commercial banking sector and the availability of funds is not a major constraint. Commercial banks have excess reserves of over 20 percent but hesitate to reduce these free reserves due to high perceived market risks and therefore do not sufficiently support investment and entrepreneurship, as reflected in a low ratio of private sector credit to GDP (Annex 1). The domestic banks are also generally sound with high capital adequacy ratios with no exposure to sophisticated financial products linked with the sub-prime mortgage market. Bank asset quality has improved dramatically with the non-performing loan (NPL) ratio declining from 16.9 percent in 2000 to no more than 2 percent by September 2009. Commercial banks in PNG have freedom in setting lending rates based on their internal credit risks and cost assessments. Lending rates by commercial banks in PNG are at a comfortable level and range from around 7% to 17%, with almost 75% of total loan portfolio being priced in the range of 9 – 15%. While positive for the commercial banks‘ net interest margin and profitability, the high lending rates are also one of the reasons why access to finance is a challenge for many borrowers in PNG. Therefore there is significant scope for PNG commercial banks to expand their lending to SMEs if the market risks are better understood and mitigated.8 5 Literally translated from Pidgin wantok means ―one talk,‖ but in reality like most pidgin words its definition encompasses a wide scope. Wantok is a term used to denote a person who is from your family or who is a close, or sometimes not so close, friend. Under this PNG convention, a person is obligated to help wantoks if they claim to be in need. This can add costs to business interactions, particularly if one wantok is having a dispute with another and individuals from those factions work closely in business or government. This tradition also causes issues for the promotion of competitive private sector behavior because the practice encourages nepotism. 6 Though reliable data are lacking, it is likely that less than 5 percent of SMEs are owned/managed by women. Women, however, account for about 62 percent of informal enterprises. 7 ―PNG Gender & Investment Climate Reform Assessment.‖ IFC. January 2010 8 Source: Bank of PNG. 3 10. Furthermore, the Central Bank of PNG (BoPNG) has strengthened its prudential regulation for the banking sector and has taken important measures to improve financial infrastructure. It plans to reform the collateral system and develop a national payment system over the next three to four years to facilitate the expansion of banking services. It is expected that the collateral reform will enable the financial institutions to expand services to the ―unbanked,‖ with appropriate risk management procedures. The planned new automated payment system, which is expected to be launched in 2011-2012, will have larger capacity to accommodate transactions such as e-banking and mobile banking, which have the potential to be delivery channels for SME finance services in PNG. Both initiatives, which are supported by IFC, are critical to improving SMEs‘ access to finance, while, at the same time, enabling financial institutions to adequately manage risks. B. RATIONALE FOR BANK INVOLVEMENT 11. The Independent State of Papua New Guinea requested WBG assistance to facilitate access to finance for SMEs by helping to channel the banking sector excess liquidity to this sector, while building on the market opportunity created by the on-going and planned natural resource projects. The request was first made to the WBG (via IFC) in a meeting during the last Annual Meeting of the ADB in Bali, and was formalized through a written request. In addition, during a PNG CAS workshop in December 2009, Development Partners encouraged the WBG to act creatively and aggressively on opportunities in SME finance. The critical need to develop employment opportunities (particularly through SMEs) was noted. The workshop recommended leveraging the benefits of PNG‘s resource development projects for other economic and employment activities, especially SMEs. 12. In response, the WBG has mobilized teams to jointly develop a financial instrument and related technical assistance to facilitate access to finance for existing and emerging SMEs through the formal private sector financial system. The WBG has built up, and documented, a large body of evidence and experience related to SME financing and development. More specifically, IDA and IFC have previously partnered to develop a partial credit guarantee instrument for IDA countries, called risk sharing facilities (RSF). Using IDA credits, RSFs have been set up as part of the first IDA/ IFC Pilot Program in Sub-Saharan Africa. The proposed project will be a pilot under Phase II of this IDA/ IFC Pilot Program for RSFs. Furthermore, the proposed RSF is a pilot that will test a two phase approach for this financial instrument in a PNG context. It will initially start with one participating financial intermediary (PFI) and scale up to include other banks operating in PNG. 13. The IDA-IFC Secretariat has recently reviewed the experience with joint IDA-IFC SME financing programs in similar environments to PNG (in Africa), and there has been a ‗Lessons of Experience‘ note relating to the joint-RSF undertaken and accepted into the IFC ‗Smart Lessons‘ database. Furthermore, the capacity to implement a RSF and the knowledge derived is not held by other development agencies working in PNG, like ADB and AusAID. Overall, the proposed joint WBG approach and RSF fit local PNG circumstances and build off WBG knowledge and experience. 14. The rationale for the joint IDA/ IFC involvement through such RSFs is two-fold. First, as outlined in the previous section, PNG aims to diversify its economy by encouraging the development of SMEs in various sectors of activity to play a much larger role in economic growth and job creation in the country. There is thus a strong justification for using small amounts of IDA resources to create a guarantee scheme that facilitates increased lending to more risky segment of the enterprise sector, which otherwise would not have access to credit. As such, IDA involvement would help to achieve the public policy goals of developing the SME sector and enhancing its contribution to growth and poverty reduction. Second, PNG‘s financial system has excess liquidity; yet, limited lending continues and appears to be an important constraint for further development of the SME sector. In general, SMEs are perceived to be riskier or less profitable than the corporate sector, and thus receive relatively little credit. 4 This situation mainly stems from lack of information about potential SME borrowers and resulting perceptions of riskiness, which ultimately lead to significant market failures. Consequently, economic development and the role this segment could play in poverty reduction remain largely untapped. The IDA/ IFC involvement is thus justified to overcome this market failure by unlocking part of the excess liquidity in the banking sector for the development of the SME sector in PNG, especially in light of market opportunities presented by the ongoing natural resource projects. Historically, domestic small businesses have had limited involvement with resource sector investments in PNG. This has led to social and political tensions, and has also been a lost opportunity. GoPNG, the domestic business sector and PNG‘s development partners all seek a more active engagement role for local SMEs now and in the medium-term, given high levels of investment by the resource sector. 15. IFC has substantial experience in financing SMEs through financial intermediaries, both through direct investments in financial intermediaries or by providing guarantee instruments. More specifically, IFC has implemented several RSFs in various countries for different purposes, including SME finance. The following benefits are expected from IFC‘s participation: a) Structuring the facility: IFC experience in structured finance products in general and RSFs in particular, as well as Access to Finance, places it in a unique position to structure the RSF. b) Demonstrating confidence in and support for the PNG banking sector: IFC risk sharing demonstrates a confidence in the banking and SME sectors and will encourage financiers to expand outreach to SMEs. c) Proactively supporting locally-owned businesses to enable participation in the country’s booming economy. IFC commitment to improving access to finance for all in PNG and particularly assists those local businesses to take up new business opportunities. C. HIGHER LEVEL OBJECTIVES TO WHICH THE PROJECT CONTRIBUTES 16. By improving SME access to finance, the higher level objective of the project is to foster SME growth and employment creation in PNG, which is key to achieving the GoPNG‘s overall objectives of spurring economic growth and poverty reduction. The project is fully aligned with GoPNG‘s stated recognition, in the mid-term development strategy (MTDS), that ―the role of government is to facilitate growth in incomes, including by creating the enabling environment that will increase rewards for productive effort.‖ The CAS9—a joint IFC-Bank undertaking that was drafted after the MTDS—adapts an important facet of the MTDS, which is ―promoting income-earning opportunities,‖ and partnering with the private sector. The primary goal of the Bank partnership in PNG is to support poverty reduction. As such, the WBG CAS for PNG has adopted a two-pillar approach: i) ―promoting and maintaining sound economic and natural resource management,‖ and ii) ―improving the livelihoods and service delivery, especially for rural poor.‖ Support under the second pillar would include, inter alia, support to private sector development. Development of the SME sector will serve to boost income- earning opportunities. 17. In fact, a key element of the Government‘s strategy with respect to SMEs and the private sector is to increase income-earning opportunities through targeted intervention to support private sector development. This is highlighted in the Medium Term Development Strategy (MTDS) and Long Term Development Strategy (LTDS)10, and is a pillar of the CAS.11 9 The Country Assistance Strategy (CAS) was approved by the World Bank Board on December 18, 2007 and covers the period FY08-FY11. 10 The MTDS covers the period from 2005-2010 and the LTDS covers the period from 2010-2030. 11 The Country Assistance Strategy (CAS) was approved by the World Bank Board on December 18, 2007 and covers the period FY08-FY11. 5 18. The project also supports the IFC’s financial sector development strategy in PNG. IFC‘s strategy for the financial sector in the Pacific is geared towards partnering with strong local financial institutions to: (i) increase access to finance amongst the underserved market segment; (ii) provide a wider range of financial products to the existing client base; (iii) increase outreach by regional expansion; and (iv) enhance the internal operational capacity of local players so as to improve corporate governance and risk management standards. The proposed project also fits well with the World Bank Group Country Strategy for Papua New Guinea (―PNG‖) which has identified the SME sector as a priority focus area. 19. The project design is based on proven SME lending techniques by integrating the special features of local business and cultural factors, aiming at sustainable financing to SMEs, and implementing methodologies that allow banks to provide financial services to SMEs more cheaply and profitably. It will also increase the capacity of the SMEs to realistically meet the requirements of the banks through training and assistance in communicating their needs to the banks. Additionally, the PFIs will also receive support, through a performance-based approach, in developing their product offerings to SMEs. II. PROJECT DESCRIPTION A. LENDING/GUARANTY INSTRUMENT 20. The project‘s main instrument is a risk share facility (―RSF‖) which would provide a pledge of a guarantee to cover 50 percent of losses of a portfolio of new SME loans by PFI in the program. The total size of the portfolio would be up to PGK 300 million (approx. USD116.7 million as per current exchange rates). Under unfunded risk-sharing agreements with each PFI, IFC would cover 50% of all principal losses in the portfolio, resulting in an aggregate gross exposure of up to PGK 150 million (approx. US$ 58.37 million) for IFC. The IDA credit of up to USD11.67 million would cover first losses and will be financed through a financial intermediary loan (―FIL‖). The PFIs are expected to provide loan financing of up to USD116.7 million against credit guarantees provided by the project (i.e., the total portfolio of new SME loans covered by the RSF). Table 1: Funding and Risk Sharing Structure of the RSF IFC: 40% (net exposure) PGK 120 million 2nd loss Participating FIs: 50% (approx. USD46.69 million) PGK 150 million (approx. USD58.37 million) IDA: 10% 1st loss PKG 30 million (approx. USD11.67 million) ← 50 % → ← 50 % fronted by IFC → Note: IFC will pay to PFIs 50% of any losses incurred on the SME portfolio covered under the RSF (gross exposure), but IFC will be reimbursed by IDA for 10% of the incurred losses reducing IFC's net exposure to 40%. 21. In addition, IDA will provide support for capacity building through financing technical assistance. The project has allocated PGK 3.93 million (or USD1.53 million) of IDA funds for technical assistance to build the capacity of the PFIs. The project will also provide for IDA support for SME capacity building and mentoring (including gender specific activities), with IDA funding of PGK13.2 million (USD5.15 million). Last, IDA funds will provide support to the Government agency (Department of Commerce and Industry – ―DCI‖) responsible for managing and monitoring project 6 implementation in amount of PGK9.15 million (USD3.56 million) for capacity building and to ensure the project is managed effectively. A full description of project components is provided below and in annexes 4a-d. B. PROJECT DEVELOPMENT OBJECTIVE AND KEY INDICATORS 22. The main development objective of the proposed project is to facilitate access to sustainable credit for SMEs and thus contribute to incremental growth of SME employment and income. The Project aims to increase: (a) sustainable flow of credit to the SME sector; and (b) the number of formal sector SMEs including women-owned businesses. An expected outcome of achieving these objectives is to increase: (c) incremental employment generated by SMEs participating in RSF; and (d) incremental SME revenue and assets generated by SMEs participating in RSF. The project would achieve this objective by addressing key bottlenecks to SME financing in PNG by sharing banks‘ perceived risk related to SME lending and improving capacity of banks to service the SME sector. On successful completion of the project, the principal outcomes would be increased lending, both in terms of number and value of loans, to SMEs by participating banks on market-based terms. Progress towards achieving the principal project outcomes will be measured through agreed key performance indicators (Annex 3). The timing of the project should also allow firms to capitalize on the market opportunities expected to be generated through the recently initiated natural resource projects.12 The intermediate outcome indicators and their targets are described in the results framework (Annex 3) and comprise the following: (i) number and share of borrowers, including women managed businesses; (ii) average outstanding portfolio balance of beneficiary SMEs; (iii) share of non-performing loans (NPL); (iv) share of portfolio at risk; (v) annual sales revenues and employment of beneficiary SMEs; (vi) change in current value of assets of beneficiary SMEs; (vii). the participation rate of women in SMEs and percent of women owning or operating formal sector SMEs; (viii) numbers of SMEs that have received project capacity building support obtaining loans from PFIs; and (ix) the existence and quality of DCI‘s SME policy and strategy. 23. The project‘s ultimate target group will be PNG-registered SMEs who are either already in, or see an opportunity in joining, the formal sector. SME definitions and reliable data are deficient. For the purpose of this project, the following definition is adopted for a SME eligible to participate: (a) formally registered under Companies Act of 1997; (b) an entity not more than 50% owned by the GoPNG; (c) is at least 51% owned by citizens of PNG; (d) annual business turnover of maximum of K15 million; and (e) not a wholly owned subsidiary of a larger corporate entity. Background work by IFC suggests there are between 6,000 to 20,000 such SMEs that are currently active. Anecdotal evidence suggests that very few of these SMEs are owned/managed by women (likely to be less than 5 percent). 24. An intermediary target group will be the private sector financial intermediaries (FIs) invited to participate in the project. These must not only be acceptable to IDA/ GoPNG, but subsequently meet IFC‘s due diligence/ appraisal criteria. Criteria for selection of these intermediaries are detailed in Annex 4. These criteria have been agreed by GoPNG, IDA and IFC. There are currently 4 FIs that would meet these criteria. Three of these four have already confirmed their interest in participation. The proposed project will, however, start with only one of these FIs (BSP, which is most advanced in its implementation readiness) on a pilot basis and will expand to others in a later stage. 12 For example, in the case of ExxonMobil LNG Hub Project, according to the ExxonMobil National Content Plan, during four-year construction phase (2009-13) PNG companies are expected to have access to business opportunities at an estimated K1.26 billion (approximately USD479 million), and during the estimated 30-year production phase (2014-43) PNG companies are expected to benefit an estimated K200 million (approximately USD76 million) per year for goods and services. For more details on the impact the LNG hub will have on the PNG economy and the opportunities SMEs will have as a result see Annex 4. 7 C. PROJECT COMPONENTS AND OUTPUTS 25. The Project is designed to improve SME access to finance which would contribute to broader development of the sector and the PNG economy as a whole. The project is presented as an RSF inscribed into a wider technical assistance to build capacity for SME financing. Detailed description of the project components and the list of participating financial intermediaries and selection criteria are in Annex 4 and in project files. Major project components would be: Component 1: Risk Sharing Facility (IDA: USD 11.67 million; IFC: USD 46.69 million) 26. This component will support newly originated SME loans by PFIs in an estimated amount of up to PGK 300 million (approx. USD116 million). It will establish a risk sharing facility (RSF) to partially guarantee a portfolio of newly-originated loans to SMEs and therefore encourage eligible local private sector commercial banks and finance companies to expand lending and leasing finance to SMEs. This is expected to immediately accelerate commercial banks‘ lending to emerging and established SMEs. The RSF structure would reimburse the participating banks for a fixed percentage (50 percent) of principle losses, which is expected to provide them with the credit protection needed to mitigate the high perceived risk of SME lending. The remaining 50 percent of credit risk on their portfolio provides an incentive for PFIs to conduct proper credit appraisal and apply strict loan underwriting criteria (including taking proper security) in developing the loan portfolio. This is expected to minimize the moral hazard (the risk that providing the guarantee could result in deterioration in the quality of bank loans to SMEs) and adverse selection (the risk that banks pass on their worst performing loans to the RSF). 27. Under the proposed arrangements, IFC would cover 50% of all principal losses in the portfolio, resulting in an aggregate gross exposure of up to PGK 150 million (approx. USD58.4 million) for IFC. Under a Risk Sharing Framework Agreement between IDA, GoPNG, and IFC, GoPNG would agree to use IDA funds to provide ‗first loss‘ coverage of up to USD11.67 million (i.e., 10 percent of total portfolio amount),13 resulting in an IFC net exposure of approx. USD46.69 million equivalent (i.e., 40 percent of total portfolio amount). It is therefore expected that USD11.6 million IDA financing would leverage about USD116.67 million of commercial bank lending to the SME sector (i.e., USD1 IDA pledge for ‗first loss‘ is expected to leverage more than USD11 commercial bank lending). 28. GoPNG and the Project Team identified a maximum of 4 eligible FIs. Three of these four have confirmed their interest in participating, but two of these (ANZ and Westpac) have asked for more time to address their internal strategic and organizational issues. The joint IDA/ IFC team, in consultation with the GoPNG, has therefore identified Bank South Pacific (―BSP‖) for the start of implementation, with an allocation of 50 percent of the total facility. The BSP SME loan portfolio of up to PGK 150 million (approx. USD58.37 million) would be guaranteed through an up to USD 29.18 million RSF by IFC, out of which GoPNG would assume up to USD5.84 million first losses (i.e. approx. 10%) through a credit from IDA. IFC‘s net exposure (second loss) would therefore be approx. USD23.34 million (40%). BSP has been subject to in-depth due diligence by IDA (based on OP8.30 requirements) and separately by IFC and, as the main bank with SME clients in PNG, it is expected to have a sufficient number of applications for transactions that can be approved following the signing of a RSF agreement with IFC. On May 13 2010, IFC committed an investment with BSP of USD110 million in equity and USD30 million in A- loan. USD55 million in equity was for IFC‘s own account, whereas the other USD55 million in equity 13 Note: the final level of proposed IDA funded 1 st loss may change based on on-going discussions and agreement between IDA and IFC as to the most appropriate first-loss threshold for this operation. The threshold will however be no more than 10 percent or USD11.6 million. 8 were for the account of the IFC Capitalization Fund. To avoid, any conflict of interest, the RSF has been processed by a different IFC team than the previous investment. 29. To encourage competition, the remaining amount of the RSF (approx. USD58.37 million) will be available to other eligible FIs, on a first-come-first-served, with the same structure; although the first-loss threshold could be different, but not exceeding 10 percent of total portfolio) based on historical default rates experienced by these other FIs and their capacity and appetite for SME lending. An evaluation of utilization during the first 18 months will be made to ensure that all participating banks make good use of the amount of the credit coverage offered under the risk sharing agreements. If necessary, the project would reallocate coverage between the PFIs at that time. In addition, the fee structure of the facility will be designed in such a way that it would be too costly for PFIs to maintain unused limits. 30. The RSF will be restricted to firms formally registered in PNG (including land-owner companies) or joint ventures. There will be no sector or market limits except for the areas that are restricted by IDA and GoPNG in order to comply with social and environmental safeguard policies. 31. The RSF will remain in effect for fourteen (14) years for both IDA and IFC financing. The PFIs will have a 36 months ramp-up period during which all new eligible loans will be included into the portfolio covered under the RSF. The longest tenor of qualified loans extended by the eligible PFIs will be ten years. Although PFIs are given up to 36 months to bring new loans under guarantee coverage, there will be a comprehensive joint IDA, GoPNG and IFC performance review of RSF demand and portfolio quantity and quality 18 months after Board approval/ signing of facility agreement. The review will decide whether PFIs should stay active for the remaining period in case of performance issues; conditions of which will be defined in legal agreements between IFC and PFIs. Component 2: Technical assistance for financial institutions is estimated to cost USD2.35 million, of which USD1.53 million will be financed by IDA/ GoPNG 32. This component consists of performance-based technical assistance tailored to the first PFI, and potentially to subsequent PFIs. Component 3: Capacity building for SMEs is estimated to cost USD5.15 million, all of which will be financed by IDA/ GoPNG 33. This component consists of four sub-components: (a) SME management and financial skills training; (b) focused SME mentoring and coaching; (c) targeted training for women entrepreneurs; and (d) support for provincial government commerce staff. SMEs in PNG face significant constraints in terms of business and financial management capacities; as such this component will aim to develop capacity for participating SMEs. The Project will support SMEs who receive loans under the RSF or are referred by: (a) a FI participating in the RSF, (b) the relevant Chamber of Commerce, or (c) the relevant PNG Business Council office. 34. Participation in the capacity building/technical assistance trainings is expected to be about 40 percent of SME borrowers under the risk share facility. More specifically, it is estimated that, over a five year period, 300 SMEs will participate in the training, 150 SMEs will participate in focused mentoring and coaching, and 300 women will participate in targeting training for entrepreneurs. Component 4: Support to GoPNG Department of Commerce & Industry is estimated to cost USD7.44 million, of which USD3.56 million will be financed by IDA 9 35. The purpose of this component is to upgrade DCI capacity to implement and monitor the project, and its capacity to implement an updated SME strategy and policy. 36. Within GoPNG, the Department of Commerce and Industry (DCI)14 has responsibility for SMEs, and it has been designated as the implementing counterpart agency for the Project. A project implementation unit (PIU) has been established within the SME branch of DCI. The key responsibilities/outputs of the PIU are: surveys (baseline and regular follow-ups); SME capacity building activities; gender initiatives; updated SME policy & strategy; oversight of generic FI capacity building activities; overall monitoring, evaluation & reporting; and GoPNG procurement. 37. The component will specifically provide support to PIU in the following areas: a. Management and coordination of the day-to-day implementation of the Project, including financial management, accounting, procurement, monitoring and evaluation, supervision activities, and audits of Project accounts and reporting, through the provision of technical assistance. b. Capacity building to conduct SME surveys and develop baseline performance indicators for the Project. c. Provision of assistance for the development of, and obtaining necessary approvals for, an updated national SME policy and strategy. d. Provision of assistance for facilitating and supporting the operations of the Project Steering Committee. 38. To build internal capacity at DCI not just for this project but beyond, the PIU will receive support from consultants in several positions. It is envisaged that the PIU will have support from SME policy, M&E, gender, procurement, and financial management specialists. TORs/RFP for each of these positions will be developed by DCI in conjunction with support from the Bank. In addition, a project steering committee (SC) will be established to review progress, discuss emerging issues, and recommend actions to improve project implementation. D. LESSONS LEARNED AND REFLECTED IN THE PROJECT DESIGN 39. The IFC and IDA have collaborated on a number of RSF programs elsewhere. Using IDA credits, RSFs have been set up between IDA, IFC and the Governments of Madagascar, Mali and Ghana as part of the IDA/ IFC Pilot Program in Sub-Saharan Africa, and are being prepared in the region (Cambodia). As such, the proposed design parameters follow the general structure of these pilots. 40. The IDA-IFC Secretariat has recently reviewed the lessons learned and experiences from joint IDA-IFC RSFs.15 Early outcomes based on review of a sample of IDA/ IFC RSFs are encouraging and consistent with the outcomes of global best practice. However, a need was identified to roll out the pilot to additional IDA countries and for specific sectors (e.g., energy efficiency facilities), in order to provide a broader evidence base. PNG was selected as one of these countries because of the opportunities PNG SMEs will have to capitalize on the market demand that to be borne from the recently initiated extractive industry resource projects. The lessons learned from IDA/ IFC RSFs pilots show that well- designed RSFs can accomplish important public policy objectives of financial sector deepening and development of SME sectors. Successful RSFs are built on strong private sector participation and a 14 The department is headed by a Secretary, who reports to the Minister of Commerce and Industry. 15 IFC-IDA. TASK FORCE REPORT: Review on the Use of IDA funds for Risk Sharing Facilities and Partial Credit Guarantee Projects. July, 2009. 10 supportive legal environment. PFIs will need to show a track record in prudent lending and commitment to increase lending in the target sector. The experience also shows that participation of state-owned financial institutions can be problematic due to issues related to loan recovery and corporate governance, which could encourage inappropriate risk taking. 41. The approach to project design and preparation was shaped by previous endeavors undertaken by the Bank in PNG. Apart from ensuring genuine Government commitment to project objectives and approach, previous experiences in PNG highlighted the need for: i) recognizing and addressing GoPNG capacity issues at project design; ii) being innovative and proactive regarding risk management; iii) working with and strengthening existing GoPNG systems and agencies, rather than replacing them or introducing new ones; and iv) more substantive collaboration with IFC. Lessons learned from RSFs globally also point out that borrowers‘ capacity to present a credible loan application packages, including proper financial statements and business plans, to participating banks is a key to the success of RSFs. Similarly, building technical and processing capacity of banks to identify promising SMEs with the potential for sustainable growth, proper loan monitoring, and carrying out prudent enterprise and sectoral level risk assessment are also critical part of the success of RSFs. It is thus important that well-designed RSFs are linked to technical assistance activities that will assist in capacity building and development of financial products that meet the needs of SMEs and PFIs. 42. Experience shows that up-front capitalization (disbursement of IDA funds) of the project funds into a reserve account is the most effective way in which this program can function. As with any risk sharing program, the financial intermediary providing credit coverage serving as a guarantor must have sufficient market credibility in terms of its available reserves for participating banks to accept its loan guarantees. For commercial banks to accept the guarantees of the program, funds must be unencumbered and transparently available to back the guarantees. 43. Stringent eligibility criteria are required to ensure that only FIs that meet a set of agreed financial and operational criteria would be allowed to participate (based on OP8.30 and IFC Investment Guidelines). This also ensures the quality and viability of the loan portfolios to be selected for the partial guarantee cover. 44. Finally, lessons learned from the on-going pilots show that effective IDA-IFC partnership needs to go beyond the preparation phase and include arrangements for joint supervision teams in order to ensure close alignment of facility objectives with respective institutional development goals. Furthermore, although the RSF will be managed by IFC, it is important that the Government has a clearly defined role (se jointly with the IDA and IFC teams) in the monitoring and utilization of the facility by PFIs to ensure that a facility would meet and contribute also to their policy goals. E. ALTERNATIVES CONSIDERED AND REASONS FOR REJECTION 45. Two alternative project design options were considered and rejected. First, it was considered to proceed with a stand-alone component for technical assistance under the project. The GoPNG did not show interest in this option. Second, feasibility of a different risk share structure between IDA, IFC and participating banks was considered. Among the alternatives discussed were: (i) larger first loss coverage in exchange for larger total guarantee coverage; and (ii) smaller first loss and overall coverage. These alternatives were rejected based on the following findings after consultations with the eligible banks and the IFC: (i) at least fifty percent guarantee coverage is necessary to get eligible banks interested in the facility mainly because the SME market is untested (and lending risk is perceived to be high) and this level of coverage was considered important; (ii) sufficient information to price risks for complicated structures are not available; and (iii) altering a structure of RSFs beyond what was successfully implemented in previous models may bring additional operational risks, processing and administrative 11 costs that could be difficult to justify. Hence, it was decided to follow the simple structure that has been already tested before. Nonetheless, the facility can be modified in the future as the experience builds up. 46. The proposed project design builds on the global experience of the WBG with SME finance and support programs. It also recognizes that PNG does have a generally well regulated and supervised financial system or multiple strong private financial intermediaries. Also, overall, there is relatively high liquidity in the financial market with the implication that WBG credit lines are not appropriate. The proposed project also takes into account the stated desire to better financial intermediaries by growing their SME portfolios in line with expanding market opportunities, which will have a positive impact on overall economic growth. In addition, each component was also tailored to the PNG environment. (a) Component 1: The RSF was developed specifically for economies that require incentives to boost lending by banks in a specific sector (SME) of that country. Pilot projects in six African countries provided guidance on project design and preparation. (b) Component 2: Capacity building for PFIs is performance-based to address the risks inherent in working in PNG given its complex social and cultural factors. (c) Component 3: SME capacity building includes a focused mentoring and training program as well as training for women entrepreneurs. (d) Component 4: Support to GoPNG is stronger than initially envisaged with multiple consultants and Bank staff poised to assist DCI to address capacity constraints. III. IMPLEMENTATION A. PARTNERSHIP ARRANGEMENTS 47. This is a joint project with IFC. For the purpose of carrying out the RSF, the GoPNG will enter into a Risk Sharing Framework Agreement with the Association and IFC, which will include the obligation of IFC to: a) Establish, and administer on behalf of the GoPNG, a trust fund, under a trust fund administration agreement to be entered into between IFC and the GoPNG, on terms and conditions satisfactory to IDA, for the purpose of holding funds to be used to satisfy the GoPNG obligations concerning the first-loss coverage under the RSF. b) Enter into a Risk Sharing Agreement, in form and substance satisfactory to IDA, with each PFI, and exercise its rights under each such Risk Sharing Agreement in such a manner as to protect the interests of the GoPNG and IDA. c) Ensure that each PFI carry out their respective parts of the Project in accordance with the provisions of the IFC's anti-corruption approach for the private sector. d) Ensure that RSF component of the Project is implemented in accordance with the provisions of the Risk Sharing Framework Agreement and the relevant Risk Sharing Agreements. e) Ensure that each PFI apply a specific Social and Environmental Management System (SEMS) that is consistent with the requirements and procedures set out in (i) the Environmental and Social Risk Management Operations Manual (―EOM‖). 12 g) Carry out periodic supervision of each PFI. B. INSTITUTIONAL AND IMPLEMENTATION ARRANGEMENTS 48. Project oversight. The Department of Commerce and Industry (DCI) will act as the recipient and executive agency for the project. The DCI will be responsible for providing the strategic guidance and leadership for launching and implementation of the facility. The specific functions of the DCI would include, inter alia: (i) identifying Government policy goals to guide implementation and monitoring strategies of the facility; (ii) participate in project monitoring and evaluation process; (iii) creating awareness of the facility; and (iv) providing strategic guidance to IDA/IFC teams to ensure that the facility supports its policy goals. In order to carry out these functions, the DCI would appoint a small counterpart team (Project Implementation Unit or PIU), who will work closely with the IDA/IFC team to monitor the performance of the facility and provide support for task teams. IFC and IDA will make best efforts to create an institutional capacity within DCI to prepare and manage similar facilities. 49. During the project implementation, a Steering Committee (―SC‖) will be established and chaired by the Secretary of Commerce and Industry and composed of representatives of the Department of National Planning and Monitoring, the PFIs, the Consultative Implementation and Monitoring Council (public-private dialogue forum), and the PNG Business Council. The SC will meet once every six months and will be responsible for policy guidance and overall project oversight, and will ensure communication and cooperation among stakeholders. The committee may also make recommendations to improve project implementation to the Minister of Commerce and Industry and IDA. The SC‘s secretariat role will be assumed by the PIU. 50. Operational modality. The overall coordination and reporting for the project will be carried out by the PIU. The PIU will be responsible for project execution, including procurement, financial management, and monitoring and evaluation, of the various activities supported under the project. The main activities of the PIU will be: (a) maintenance of records and accounts for all transactions related to the PIU; (b) preparation and production of consolidated annual financial statements and quarterly FMRs; (c) contracting and supervision of components under its responsibility; (d) management of disbursements for components under its responsibility and replenishment applications for the special account; and (e) monitoring and evaluation of the various activities supported under the project. The institutional arrangements were selected based on the responsibilities and comparative advantage of each organization in order to provide the best product offerings to the client. For more details on the project implementation, see Annex 6. 51. With respect to the RSF, the GoPNG will be the Recipient of the IDA credit funds while IFC will be the agent for the GoPNG for the RSF component of the project. Pursuant to a Risk Sharing Framework Agreement to be entered into between IFC, GoPNG and IDA, a trust fund will be set up by the IFC on behalf of GoPNG. IDA will transfer the credit/grant proceeds to cover GoPNG‘s ‗first loss‘ portion of funds (up to USD11.6 million in disbursements), on behalf of the GoPNG, to a trust fund account administered by IFC.16 52. The IFC, in its capacity as facility agent, will, on behalf of GoPNG as obligor, sign a Risk Sharing Facility Agreement with each selected PFI and will pay all acceptable loss claims from the trust account, subject to its verification that the losses are legitimate and payable under the agreement. As such, it acts as a liaison between PFIs and the GoPNG during the project implementation for the portion of payment of losses funded by IDA. When losses are incurred by PFIs, requiring a pay-out under the 16 There will be one Trust Fund account for the whole RSF. 13 risk sharing structure, IFC will verify that calls on losses by banks are legitimate based on the conditions, which are presented in Annex 6. 53. IFC, in its capacity as facility agent, will be responsible for all operational aspects of the management of the trust fund and RSF with PFIs, which would include, inter alia, monitoring the utilization of the RSF by PFIs, verifying the calls on first loss, and payment of all acceptable loss claims from the trust account. IFC will administer the facility and will exercise the same care in the discharge of this function as is required when it acts as a fiduciary of third party funds, as well as in the administration and management of its own funds. Furthermore, IFC, in its capacity as obligor, will commit its ‗second loss‘ risk sharing portion (up to USD46.4 million) as a guarantee investment reserved for the PFIs. 54. The project implementation support and monitoring of the performance of PFIs will be carried according to following principles: (i) review of the quarterly portfolio reports and annual audited financial statements provided by PFIs, which will be shared with the MEF for their review; (ii) carry out joint IDA/IFC supervision missions; (iii) carry out periodic monitoring of the loan utilization by beneficiaries between supervision missions; and (iv) comprehensive mid-term review which will take place 18 months after the project effectiveness. 55. The core implementation arrangements and responsibilities for specific technical assistance components are as follows: (a) Financial Intermediary Capacity Building: FIs have core implementation responsibility and must report against agreed performance and outcome results. IDA funds will be largely disbursed through Direct Payments on delivery of agreed performance/outcomes. (b) SME Capacity Building: GoPNG will administer and implement for service providers procured under the project. (c) GoPNG support: The above-mentioned PIU within the SME Branch of DCI will be responsible for overall project implementation and associated project initiatives. 56. The project is to be implemented from May 2011 to June 2019 to allow sufficient time for completing the TA work. The project is expected to fully disburse by 2016. The closing date, however, will be December 2024. This closing date reflects the date until which all obligations by IFC to make any further payments under the Risk Sharing Agreement have terminated. C. MONITORING AND EVALUATION OF OUTCOMES/ RESULTS 57. A systematic monitoring and evaluation plan will be a core part of program implementation. The objective of monitoring and evaluation is to: (i) monitor the progress of project implementation and provide timely feedback to stakeholders (GoPNG, IDA, IFC), facility agent (IFC) and project implementers (PFIs); (ii) assess and summarize the achievements (outputs, outcome and impact/final outcome); and (iii) draw lessons in project design and implementation that can guide future replication efforts in other countries and regions, given the pilot nature of the project. PFIs and consultants managing various technical assistance and surveying components will have prime responsibility for generating and providing core data. The PIU will take responsibility for compiling, analyzing, and reporting this information to the SC, the World Bank, and other relevant stakeholders. In addition to MTR, regular evaluations of Project outcomes and impacts will be undertaken every 18 months. An international monitoring and evaluation specialist will be recruited into the PIU on a short-term basis (6 month contract) to help plan and initiate this work, and build needed capacity within the PIU alongside 14 other recruited specialists (FM, procurement, and gender). Additionally, the PIU will contain four regional monitoring and evaluation staff. 58. The Results Framework and measurement proposals show where the required data will be sourced and by whom (see Annex 3). The TA providers and PFIs will play an important role in establishing baselines. IFC will work closely with BSP, and subsequent PFIs, to help ensure that appropriate portfolio impact data can be obtained and reported on regularly. Similarly, GoPNG and/ or IDA will have to ensure that M&E consultant(s) are hired at the end of the project to measure the impact on SMEs that received financial products from the partner banks, through polling samples of SMEs that compare clients and non-clients. D. SUSTAINABILITY 59. The PFI has a high level of commitment to the Project by expressing strong commitment to SME development and placing the Project as top priority. This was documented early in the project preparation stages through the identification, pre-appraisal, and appraisal missions. Key stakeholders in the local communities also support the project: DCI, key local FIs, and business associations. Additionally, GoPNG has expressed its strong interest via a formal written request. E. CRITICAL RISKS AND POSSIBLE CONTROVERSIAL ASPECTS 60. Working in PNG is inherently high risk and the project team has undertaken or planning various risk mitigation measures to ensure the project will be successfully implemented. The overall project risk is moderate. At the country level, in addition to intermittent security lapses, there are the following substantial or high risks and their mitigation measures which are expected to render these risks moderate: i) A weak history of GoPNG‘s commitment to Bank projects implies substantial risk. However, the relationship between WBG and GoPNG has improved and both parties are committed to working together and with other development partners to achieve the country‘s development objectives, as expressed in the MTDS for 2005-2010 and the national MDGs. As such, this becomes a moderate risk. The CAS for FY2008-2011, which is the first full CAS since 1999, is expected to lead to deeper interactions with GoPNG, given that it is designed as the first in a series covering the next 15 to 20 years. ii) Macroeconomic risks, especially with respect to possible effects of the natural resource projects on exchange rates are also substantial. ACIL Tasman modeling, used by ExxonMobil in assessing the LNG project, indicated that growth in demand in the oil and gas sector and high rates of public and private expenditure could put upward pressure on the exchange rate, causing it to appreciate. A stronger Kina, together with a tendency for the gas development to draw capital and labor away from the primary production sectors such as agriculture and forestry, could have the potential to reduce the export competitiveness of those sectors. These are concerns that will be monitored through project supervision. As such, from the project point of view, the risks will be moderate. iii) Weak investment climate and low SME capacity presents high risk. The mitigation measure planned under the project is capacity building to SMEs who qualify, as well as TA to PFIs. Furthermore, the structure of the RSF ensures that the PFIs book good assets. The PFIs will be required to comply with the operating procedure of the RSF as stated in IFC-PFI agreements, and remain liable for 50 percent of the outstanding loan. Finally, the activities and programs of other donors is expected to enhance the investment climate. The residual risk is therefore 15 expected to be moderate. iv) Historically, there have been high risks associated with political conflict, economic and social disruptions, lack of ownership of reform, weaknesses in public fiduciary systems, ineffective donor coordination, and, until recently, insufficient large-scale or long-term engagement on the part of the Bank Group to achieve traction on difficult development issues. Several mitigation measures have been put in place or are envisaged to lower the residual risk to moderate: (a) a focused, streamlined project design; (b) TA to DCI and the PIU; (c) compliance with OP 8.30 to reduce country risk and ensure that PFIs will operate more effectively; and (f) financial management and procurement corrective measures to raise GoPNG capacity to the acceptable Bank level. 61. At the project level, there are the following risks: i) Government and PFI implementation capacity issues, including procurement and financial management capacity of the Government present high risk. The technical assistance envisaged under the project, including those for the implementing agency and PFIs, is expected to mitigate these risks. In addition, a PIU, with staff in sufficient number and terms of reference satisfactory to IDA, including a Procurement Specialist of at least five (5) years of successful experience in handling procurement in a Bank financed project. A separate Technical Evaluation Committee (TEC) will be established within DCI and members will undergo training on the use of Bank‘s procurement procedures; advance procurement would be implemented for goods required in equipping the PIU and critical consultancy contracts. The expected level of risk following these measures will be substantial to moderate. The private sector partner beneficiary agreement for the conduct of competitive bidding acceptable to the Bank shall be a pre-condition to participation to the project. ii) There is also moderate Risks associated with the RSF component itself include the following. First, the RSF may not become sustainable. Second, there is possibility of low utilization of the RSF. Third, there is a risk that other than BSP, other PFIs will not participate in the project. Fourth, the RSF could result in increased credit risk in the portfolio. To mitigate these risks, a number of measures will be adopted in the project which are expected to render the risks low. In addition to technical assistance supported under the project, changes will be contemplated to loan eligibility criteria and product offering and structure for new PFIs, if necessary, to ensure that it meets the needs of SMEs and banks, and stimulate the demand for the facility. Moreover, IFC will make best efforts to bring at least 1-2 additional eligible PFIs under the RSF during first 24 months from project effectiveness. It will carry out periodic outreach activities in parallel to seek interests from additional eligible banks. Based on lessons learned from Africa RSF pilots, the first bank usually plays a demonstration effect, stimulating interest for others to follow. Finally, the criteria for determining eligibility of banks and/or loans/portfolios would ensure that the RSF does not create opportunities for moral hazard or adverse selection. Portfolio selection will be based on statistical principles aimed at avoiding adverse selection and PFIs would have to retain at least 50 percent of the exposure at all times. iii) SME loans could also raise social and environmental issues. The sub-projects are expected to be predominantly Category B-type projects whose environmental and social risks can be managed by compliance with IFC Performance Standards and World Bank Group Environmental, Health and Safety Guidelines. The guiding safeguard document prepared for the project is EOM that contains the general principles PFIs are expected to follow. In order to effectively use EOM as guidance to its staff for managing environmental and social risk, each PFI shall develop its own internal SEMS. The SEMS describes key features such as: social and 16 environment policies and procedures; organization structure and staffing for managing environmental and social risk; skills and competencies in social and environmental areas; training and awareness of the institution‘s investment, legal, and credit officers on the organization‘s SEMS; reporting systems to managers; and performance monitoring procedures. The SEMS may also include supporting tools such as checklists, templates and guidance notes to assist the loan/credit officers to assess and manage environmental and social risks. A more detailed description of these mitigation measures is discussed in Sections IV-D and IV-E below. The residual risk therefore is expected to be low. F. LOAN/ CREDIT CONDITIONS AND COVENANTS 62. The conditions for effectiveness consist of: a) The Risk Sharing Framework Agreement has been executed and delivered and all conditions precedent to its effectiveness (other than the effectiveness of this Agreement) have been fulfilled. b) At least one Risk Sharing Agreement has been executed and delivered and all conditions precedent to its effectiveness (other than the effectiveness of this Agreement) have been fulfilled. c) The Steering Committee, Project Implementation Unit and Technical Evaluation Committee have each been established in a manner satisfactory to the Association. 63. The conditions for disbursement consist of: a) In the case of Disbursement Category 1 (RSF for BSP): provision of evidence satisfactory to IDA has been provided that the Participating Financial Intermediary has prepared a SEMS that is acceptable to both IDA and the IFC; b) In the case of Disbursement Category 2 (RSF with subsequent PFIs): (i) the execution of the Risk Sharing Agreement(s) satisfactory to IDA with the said financial intermediary(ies) and (ii) the Participating Financial Intermediary(ies) has(have) prepared a SEMS for the respective Participating Financial Intermediary that is acceptable to both IDA and the IFC; c) In the case of Disbursement Category 3 (Performance Based Grants to Financial Intermediaries participating in the RSF), the execution of a Performance Grant Agreement between the Recipient and the financial intermediaries. d) Appointment of an FM advisor prior to disbursement from Disbursement Category 4. IV. APPRAISAL SUMMARY A. ECONOMIC AND FINANCIAL ANALYSES 64. The primary economic benefit from the Project will come in the form of improved access to finance. This should in turn lead to: a) increased production for the SME sector resulting in higher GDP growth; and b) more income-generation/employment opportunities for the private sector. Both are stated as goals of GoPNG‘s MTDS, and LTDS, as well as the joint Bank-IFC CAS. See Annex 9 for details on the methodology and assumptions for calculating the benefits of the Project. 17 65. Cost-benefit analysis of this SME Access to Finance project presents some limits not only due to its innovative nature of the Project and the challenging conditions in PNG, but the lack of available data on the SME sector. Another difficulty is quantifying the economic benefits resulting from the technical assistance offered to PFIs, participating SMEs, and relevant government stakeholders. Also, it is challenging to reasonably quantify the direct effects of the different project activities on production and job creation due to the lack of availability of concrete baseline data, which the project seeks to develop to avoid this challenge for future Bank projects in these sectors. With these caveats in mind, the cost-benefit analysis has been carried out to approximate the net present value (―NPV‖) of the USD116 million RSF and qualitative assessments of the other Project components. 66. The project generates a net present value estimated at about USD608 million or K1,600 million. The NPV was calculated by running a simple model calibrated using available data and based on conservative assumptions (for details see Annex 9). The Project‘s expected benefits are also borne out of the level of outreach and employment generation. It is estimated that between 600 and 2,000 SMEs will receive new loans under the RSF, based on the assumption that the average loan size will be approximately USD58,000 (K150,000). In addition, the level of employment generation is expected to be in the range of 6,000 to 16,000 new jobs.17 B. TECHNICAL 67. The proposed project is a Financial Intermediary Lending (FIL) from the perspective of the Bank’s operational policies. Hence, it should be in compliance with OP 8.30 which governs the Bank‘s operations that involve financial intermediaries. The OP 8.30 review confirms that the project design and implementation arrangements are in compliance with the policy. 68. The Project design involves addressing SME financing and development problem from both the supply and demand sides. It tackles the short term challenge of kick-starting bank financing to SMEs. The elements of the project have been successfully tested internationally in other projects to promote access to finance for SMEs. For example, the technical assistance for capacity building in FIs improves access to financial and non-financial services for SMEs, and such technical assistance has been successfully provided by various projects in other countries to address the supply and demand side issues facing SME finance. The design of the pilot RSF has been based on lessons learned from international best practice to maximize the leverage impact of the facility. 69. The project’s main instrument, the RSF, is specifically designed to address the key challenge in PNG regarding financing of SME activities. The choice of a guarantee facility vis-à-vis other instruments, such as a line of credit, was made given the fact that PNG‘s financial system has sufficient liquidity. Hence, it was noted that funding of credit to such activities is not a problem, but the problem lies in getting banks to place already available funds into these activities. Thus, the provision of risk sharing facilities serves both as a risk mitigation tool and as an incentive to get banks involved in lending to SMEs, building on the market opportunities presented by the LNG and other natural resource projects. 70. The structure of the RSF ensures that the PFIs are prudent when booking assets. The PFIs will be required to comply with the operating procedure of the RSF as stated in legal agreements with 17 The range is based on a conservative estimate that each beneficiary SME will expand employment by an average of 4-8 employees. The range is also dependent upon the percentage of the RSF that is disbursed, see Annex 9 for a detailed description (high case scenario is based on 100% disbursement and the low case scenario is based on75% disbursement rate). 18 IFC, and remain liable for 50 percent of the outstanding loans, which maintains an incentive for PFIs to conduct proper credit appraisal and apply strict loan underwriting criteria (including taking proper security) in establishing the loan portfolio. This is expected to minimize the moral hazard (the risk that providing the guarantee could result in deterioration in the quality of bank loans). Adverse selection (the risk that banks pass on their worst performing loans to the RSF) is mitigated by requiring that all eligible loans be included into the portfolio. C. FIDUCIARY 71. Financial Management. The Bank team concludes that the financial management (FM) capacity of the implementing agency (DCI) is acceptable despite certain risk factors,18 provided that the mitigation measures described below are met. The assessment was conducted during the appraisal mission and in accordance with ―Financial Management Practices in World Bank-Financed Investment Operations” issued by the Financial Management Sector Board on November 3, 2005 and as further rationalized in the ―Principles Based Financial Management Practice Manual‖ issued by the Board on March 1, 2010. In addition, under the Bank‘s OP/ BP 10.02 with respect to projects financed by the Bank, the team found that the FM systems – including accounting, financial reporting, and auditing systems – were adequate to provide the Bank with accurate and timely information regarding project resources and expenditures, subject to agreed actions and mitigating measures. 72. The assessment of DCI‘s FM capacity determined that the FM-related risks to the project are ―substantial;‖ however, mitigating measures have been included in the project design to reduce the risk to a ―moderate‖ level. The primary mitigation measure is to contract an FM advisor acceptable to IDA to support the PIU to: (a) set-up project accounts by developing the accounting system most likely through an excel spreadsheet and filing system for project documentation.; (b) prepare a simple operational manual; (c) assist with initial Withdrawal Applications; (d) work with and assist in development of capacity of the internal audit section of DCI through the development of an internal audit plan for the project; and (e) complete the interim financial reports, assist in preparation of year-end financial reports including ensuring financial documentation is complete for audit by the Auditor General‘s Office, and provide other inputs as needed. Other ongoing measures include improving and strengthening internal control procedures and the capacity of the auditor general‘s office via on-going Public FM reform funded by the Australian Government through AusAID. Annex 7 summarizes the financial arrangements for the project, including a risk assessment and mitigating measures to reduce the financial management risk. 73. With respect to the RSF component, GoPNG will entrust IFC to administer the RSF on behalf of itself for the purposes of the project. IFC will establish and administer a trust fund (including sub-trust funds for each PFI) to hold IDA/GoPNG first-loss contributions. IFC, as part of the World Bank Group, has similar fiduciary requirements and processes as IDA, and has the institutional capacity to observe IDA‘s requirements. On that basis, IFC will be responsible for producing and submitting to IDA and GoPNG financial reports and statements in accordance with WBG trust fund policies and procedures. 74. Specific conditions will be put in place to ensure that IDA‘s relevant financial management conditions for the use of funds (as well as broader IDA policies) are satisfied and will be included in the eligibility criteria for the PFIs and SME loans. Furthermore, arrangements for audit and reporting requirements, as well as the monitoring and evaluation framework, which are included in RSF Framework Agreement, will ensure that IDA‘s institutional requirements in this respect will be observed throughout the implementation of the project. It should be noted that these conditions are already part of the requirements of OP8.30. At the end of the project, the IDA amount allocated to the RSF trust fund 18 For a detailed account of the risk factors relating to FM and the necessary corrective measures, see Annex 7. 19 account that has not been drawn for purposes of covering calls for payment under the risk sharing facilities will be cancelled and returned to IDA. 75. Amounts held in the trust fund may be invested and reinvested pending payment of claims under the Risk Sharing Agreements. Fees payable to IFC for establishing and administering the trust fund shall be paid from interest income accruing in the trust fund. Funds held in the trust fund, including income from the investment and reinvestment of amounts in the trust fund (net of administration fees paid to IFC) shall be retained in the trust fund and shall be used solely for purposes of satisfying the obligations of GoPNG as obligor under this agreement. Furthermore, income from up-front fees, facility fees and commitment fees paid by PFIs shall be shared between IFC and GoPNG in proportion of remaining GoPNG Funds to the aggregate maximum portfolio balance under the RSFs, in respect of any quarterly period for which such facility fees and charges are paid. 76. Disbursements. The disbursements into the RSF trust fund will be made based on an individual PFI credit guarantee coverage as they enter under the RSF upon signing the legal agreement with IFC after project effectiveness. The aggregate disbursement amount will be equal to IDA first loss coverage. IDA would not make any disbursements beyond first PFI unless and until a second and subsequent eligible PFI had become a party to project legal agreements, including those with IFC, satisfactory to IDA. In order to ensure a productive use of IDA funds, undisbursed amount of financing, or a portion of it, would be cancelled and returned to IDA, unless IDA, IFC and the GoPNG agree on a later date. At the end of the project, at year 14, the IDA amount allocated to the RSF reserve account that has not been drawn for purposes of covering calls for payment under the risk sharing facilities will be cancelled and returned to IDA. 77. The project will include four (4) disbursement categories. The first will be for the IDA contribution (the first-loss coverage) to the RSF entered into with the BSP. The second will be for IDA contribution to the RSF for the second (and/or subsequent) PFI that would enter a Financing Agreement for RSF. The third will be for performance-based grants, and the fourth is for goods, consultants‘ services training and incremental operating costs and which form basis of the expenditures to provide capacity building of SMEs and DCI and the operating costs of the PIU. 78. Procurement. The Bank team concludes that partnering with DCI will be possible, despite its procurement knowledge and capacity for Bank projects being currently weak,19 if capability is elevated to an acceptable level; to achieve an acceptable level of capacity, DCI will need to follow the procurement plan (PP) agreed to between DCI and the Bank, complete requisite trainings, and ensure mitigation measures described below are met.20 The assessment was conducted during the appraisal mission and in accordance with the World Bank‘s ―Guidelines: Procurement under IBRD Loans and IDA Credits,‖ dated May 2004 and revised October 2006; ―Guidelines: Selection and Employment of Consultants by World Bank Borrowers,‖ dated May 2004 and revised October 2006 and May 2010; and the provisions stipulated in the Legal Agreement. There has been a noticeable, recent gap in World Bank projects in PNG and this is the primary reason for DCI‘s lack of experience with Bank procurement procedures. During the assessment, it was found that procurement capacity could be raised to a satisfactory level within DCI with close support. 79. The assessment of DCI‘s procurement capacity determined that the procurement-related risks to the project are ―high;‖ however, mitigating measures have been included in the project design to reduce to 19 For a detailed account of the risk factors relating to procurement and the necessary measures, see Annex 8. 20 Two procurement training sessions are planned prior to Negotiations, with one completed as of the date of this PAD. 20 the risk to a ―substantial‖ level. Mitigating measures to reduce the level of risk related to procurement are four-fold: a) include an internationally-recruited procurement specialist for the PIU that has at least 5 years of successful experience handling procurement for Bank-financed projects; b) establish a Technical Evaluation Committee within DCI and train its members; c) employ advance procurement for critical consultancy contracts and goods vital to PIU operation; and d) ensure that the creation and review of the first 18-month procurement plan is conducted by a technical specialist and cleared by a designated procurement specialist (DPS). In addition to the abovementioned mitigation measures, the Project team will work closely with DCI during the project preparation phase and the frequency of procurement supervision may need to be higher than for other aspects of the project. For more information see Annex 8. 80. Anti-Corruption. While the Bank and IFC apply identical restrictions to their respective clients with regard to prohibitions against engaging in corruption, the guidelines developed by the two institutions are tailored to the types of clients with whom they engage – the Bank‘s guidelines being tailored to its sovereign clients and IFC‘s guidelines being tailored to its private sector clients. IDA—in full consultation with the Department of Institutional Integrity (―INT‖)—has confirmed that the IFC‘s stringent guidelines and internal controls are fully consistent with the IDA requirements. In light of the above, Management, with the endorsement of the Managing Director, is asked by the Task Team to request a waiver of the IDA/IBRD Anti-Corruption Guidelines in favor of using the IFC's anti-corruption approach for the private sector for component 1 of the Project. IFC's anti-corruption approach for the private sector and IDA Anti-Corruption Guidelines will therefore be applied at two levels: a) With respect to Component 1 (RSF) of the Project (technical assistance to PFIs), IFC's anti- corruption approach attached to the Risk Sharing Framework Agreement will apply. As such, each PFI will: i. maintain and comply with internal policies, procedures and controls for anti-money laundering and combating the financing of terrorism (―AML/CFT‖) consistent with its business and customer profile, in compliance with national laws and regulations, and in furtherance of international AML/CFT best practice for such businesses; ii. not engage in (and shall not authorize or permit any affiliate or any other person acting on its behalf to engage in) with respect to any transaction contemplated by the Risk Share Agreement, any sanctionable practice; iii. should IFC notify it of its concerns that there has been a violation of the provisions of (i) or (ii) above, it shall cooperate in good faith with IFC and its representatives (including, without limitation, staff of IBRD‘s Integrity Vice Presidency) in determining whether such a violation has occurred, and shall respond promptly and in reasonable detail to any notice from IFC, and shall furnish documentary support for such response upon IFC's request; iv. institute, maintain and comply with appropriate internal procedures and controls to ensure that each Borrower is not engaged in and does not engage in with respect to any loan included in a Portfolio, any sanctionable practice; and v. agree that if it becomes aware that any such Borrower has engaged in any sanctionable practice with respect to a loan included in a Portfolio (1) to promptly notify IFC; (2) promptly request that the Borrower provide it with information regarding the sanctionable practice in question and (3) provide IFC and its representatives (including without limitation, staff of 21 IBRD‘s Integrity Vice Presidency) with information concerning such activity as IFC reasonably requests, including documents, records and any other information relating to such activity as may be requested and/or obtained from such Borrower; b) For other components of the Project, ―Guidelines on Preventing and Combating Fraud and Corruption in Projects Financed by IBRD Loans and IDA Credits and Grants,‖ dated May 2010, will apply. D. SOCIAL 81. The primary beneficiaries of the RSF are SMEs in PNG. Providing improved access by SMEs to small loans is expected to be of direct economic benefit to SMEs and their employees. The loans will help these SMEs purchase raw materials or provide term capital to upgrade their processing equipment or expand their business, which may create additional employment. 82. The guiding safeguard document prepared for the project is an EOM that contains the general principles FIs are expected to follow while participating in the RSF. The principles set out in the EOM must be adopted and implemented by each PFI. Accordingly, each PFI shall develop its own internal SEMS which reflects the principles and requirements of the EOM and must be satisfactory to IDA/IFC. The SEMS describes key features such as: social and environment policies and procedures; organization structure and staffing for managing environmental and social risk; skills and competencies in social and environmental areas; training and awareness of the institution‘s investment, legal, and credit officers on the organization‘s SEMS; reporting systems to managers; and performance monitoring procedures. The SEMS may also include supporting tools such as checklists, templates and guidance notes to assist the loan/ credit officers to assess and manage environmental and social risks. 83. Upon application by FIs to participate in the RSF, environmental and social specialists from IFC and IDA will engage with the institution and convey IDA and IFC’s social and environmental requirements as embodied in the EOM. The applying institution will be responsible for developing the required SEMS and integrating it into the institution‘s lending operations to screen loan applications and manage environmental and social risks in a manner consistent with this manual. Once the SEMS is developed, the applying institution will send it to the IFC and IDA for review. A satisfactory SEMS, approved by the applying institution‘s own management and accepted by IFC/IDA, will be a condition of effectiveness for the RSF agreement between the IFC and the participating institution. IFC/IDA‘s requirements for participating banks to implement a satisfactory SEMS for managing environmental and social risk consistent with the EOM have been disclosed in a Summary of Proposed Investment (SPI) on IFC‘s website (www.ifc.org) and the World Bank‘s InfoShop (infoshop@worldbank.org). 84. Most activities that will be supported by the Project are not expected to require land acquisition or cause impacts that will trigger OP 4.12. Similarly, the nature, scale and scope of activities expected to be supported under the Project are such that it will be unlikely to have significant impact on communities of indigenous peoples unless it involves acquisition of land or change in use of lands under traditional ownership or use by local PNG clans or associations. However, the exact list of activities to be covered by the RSF, and their locations, is not known at the time of appraisal, and PFIs may receive applications for credit financing that result in impact that triggers OP 4.12 or OP 4.10. Prior to consideration of any subproject to which WB OP 4.10 (Indigenous Peoples) or OP 4.12 (Involuntary Resettlement) is applicable, the PFI should notify IFC/IDA to obtain guidance, technical assistance, and review and clearance of any WB safeguard instruments that may need to be prepared prior to appraising any such subproject. No loan application that is found to have such a potential may be processed further 22 by the PFI until the relevant safeguard instruments are approved by the IFC/IDA. IFC/IDA would have the right to not agree to have the loan application included under the RSF portfolio if they consider that the risk is unacceptable to the WBG. 85. PFIs will maintain all loan application documents including those required for social safeguards compliance, without regard to whether they are screened for further assessment by the IFC and IDA team. The IFC and IDA team has the right to review them as part of the annual supervision mission. E. ENVIRONMENT 86. The project has been classified as Category FI although it does not fit the typical model of Category FI. The IDA Credit/Grant will not be used for direct lending to SME-sponsored subprojects; rather, IDA funds contributed to the RSF would reimburse PFIs for a fixed percentage of incurred losses from a portfolio of new loans issued by PFIs to SMEs. The project triggers OP 4.01 (Environmental Assessment). Although it is unlikely that the project will include subprojects that involve involuntary resettlement or impacts on indigenous peoples, the IDA team had decided to trigger these policies (OP 4.12 and OP 4.10) and incorporate procedures in the EOM and SEMS for collaboration between the IFC/ IDA team and the PFI as noted above in the discussion of Social issues above. 87. It is anticipated that the majority of transactions covered by the RSF will have environmental or social risks associated with them that are readily identified and addressed by the application of IFC Performance Standards and World Bank Group Environmental Health and Safety Guidelines. However, it is recognized that there are SME activities in which the environmental and social risks could be significant and require commensurate assessment and management (e.g., labor and working standards, inappropriate disposal of wastes from food processing facilities, or unhealthy or hazardous working conditions). IFC and the IDA teams, with the IFC taking the lead, will collaborate on assessing the PFI capacity and commitment to manage environmental and social risks related to sub-projects. 88. The EOM requires PFI staff to contact as soon as possible IFC staff if a prospective Category A transaction is identified in the screening process, or if a loan application may involve land acquisition, physical displacement of people or restrictions on their livelihoods, or direct impacts on communities of indigenous peoples or their traditional lands. IFC environmental and social specialists will then engage with IDA counterparts to ensure that requirements of both institutions are met prior to loan processing by the PFI. Furthermore, IFC and the IDA would have the right to not agree to include loan application under the RSF if it is decided that the risk is unacceptable to the WBG. 89. A draft EOM was prepared and disclosed in the InfoShop and in PNG in the Public Information Center on October 29, 2010. The IFC and IDA team collaborated on the review and approval of the draft EOM. Consultations with prospective PFIs on the draft EOM‘s approach to environmental and social risk management was carried out as part of awareness raising activities about the RSF. PIU plans to provide additional opportunities for ongoing consultations on the EOM‘s approach to environmental and social risk management. Subsequently, the draft was revised to address Indigenous People (OP4.10) and Resettlement (OP4.12) more explicitly. The revised EOM will be disclosed in the InfoShop and in the local Public Information Center on April 7, 2011. IFC‘s disclosure of SPIs, as described in the above discussion of Social Issues, also serves as a mechanism to disclose the participation of a financial institution into the RSF. 23 F. SAFEGUARD POLICIES Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/ BP 4.01) [X] [] Natural Habitats (OP/ BP 4.04) [] [X] Pest Management (OP 4.09) [] [X] Indigenous Peoples (OP/ BP 4.10) [X] [] Physical Cultural Resources (OP/ BP 4.11) [] [X] Involuntary Resettlement (OP/ BP 4.12) [X] [] Forests (OP/ BP 4.36) [] [X] Safety of Dams (OP/ BP 4.37) [] [X] Projects on International Waterways (OP/ BP 7.50) [] [X] Projects in Disputed Areas (OP/ BP 7.60)* [] [X] G. POLICY EXCEPTIONS AND READINESS 90. Exceptions. The Recipient is exempted from the requirement of submitting the annual audited project financial statements for the RSF (i.e. Part 1 of the Project), under OP 10.02, paragraph 4, on the basis that alternative, more cost effective mechanisms exist that provide equivalent assurance that the funds have been used for the purpose intended. Such mechanisms include the assurance on the use of funds to be provided through: (i) single audit under the World Bank Group; and (ii) annual audited financial statements of the PFIs with an additional assurance report on the eligibility of the loan loss claims under the RSF. Such assurance engagement would be conducted by the existing audit firm(s) of the PFIs provided that the firm and the ToR used are acceptable to IDA. Specific conditions which ensure that IDA‘s relevant financial management conditions for the use of funds (as well as broader IDA policies) are satisfied will be included in the eligibility criteria for the PFIs and SME loans. 91. Anti-corruption Guidelines: IDA staff has sought and received management endorsement to seek waiver of the World Bank‘s Anti-corruption Guidelines from its Board of Directors to allow IFC, who will be implementing Part 1 of the Project on behalf of PNG, to utilize their own anti-corruption approach which have been specifically designed for private sector operations and would be more appropriate in this instance. IDA has confirmed that IFC‘s stringent guidelines and internal controls are fully consistent with IDA‘s requirements. 92. Readiness. The project fully meets the Regional Criteria for readiness for implementation. Project concept and objectives are specific and components have been well-defined. Project design fully reflects lessons from ongoing and completed Bank Group projects and best practices in the SME finance area, worldwide. Implementation arrangements for the project are in place. GoPNG is highly committed to the project. The results assessment arrangements have been completed, M&E institutional obligations have been spelled out, indicators have been specified, and baseline data collection has commenced. The updated PID has been sent to InfoShop. * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas. 24 Annex 1: Country and Sector or Program Background 1. While Papua New Guinea’s (PNG) is endowed with valuable mineral resources PNG, it suffers from a legacy of geographic isolation, poor education, and subsistence production. As such, PNG economic performance has been historically weak, buoyed and deflated by commodity booms and busts. Growth averaged an anaemic 1.4 percent per year in the 15 years from independence in 1975 until the Bougainville rebellion of 1989, while the population increased by 2.5 percent annually during the period (Figure 1). The expansion of copper production and the commissioning of new gold and oil projects revived economic growth in the first half of the 1990s before inconsistent macroeconomic policies, including highly expansionary fiscal spending and an unsustainable fixed exchange rate policy, and eventually lower commodity prices halted the growth spurt. From 1995 until 2002, the economy contracted by 0.5 percent a year on average, cutting GNI per capita from USD1,000 in the first half of the 1990s to USD510 by 2002, about the level attained at the time of independence in 1975. Figure 1: Growth Performance 2. PNG returned to growth during the global commodity boom of 2004-08, aided by the prudent macroeconomic management of its terms of trade windfall during the period. Focusing on macroeconomic stability, the Government targeted the non-mineral fiscal deficit at its estimated long- term sustainable level. With fiscal revenues surging from 4 percent of GDP in 2004 to 10 percent of GDP in 2008, the authorities capped the growth in fiscal spending, saved windfall mineral revenues in trust accounts that topped 14 percent of GDP in 2008 and paid off expensive public external debt from a high 54 percent of GDP in 2002 to 13 percent of GDP by end 2008. GDP growth surged to an average 7 percent in 2007-08 and the Government formalized its new-found fiscal discipline in a Medium Term Fiscal Strategy (MTFS) for 2008-12. The strategy constrains the non-mineral fiscal deficit to 4-8 percent of GDP, on the assumption that the structural ratio of normal mineral revenues is at 4 percent of GDP. Mineral revenues above 4 percent of GDP are to be used for one-off expenditures, 70 percent for additional public investment and 30 percent for debt reduction. 3. The country weathered the global financial crisis relatively well thanks to buffers built up during the commodity boom years. As external demand slumped and exports dropped by 18 percent in 2008, the Government withdrew the equivalent of 8 percent of GDP from its trust accounts to fund a fiscal stimulus program that concentrated on infrastructure and social development projects. While the effort has drawn some criticism for its size and for the traditional weaknesses in financial reporting and 25 accountability at the village level, the boost to domestic demand allowed GDP growth to ease moderately to about 5 percent in 2009 and GNI per capita to stabilize at around USD1,100 in 2008-09. A significant portion of the stimulus has since been withdrawn as the 2010 budget targets a fiscal balance. Other factors also helped the economy withstand the global downturn, including the continued growth in domestic credit, although at a slower pace than in the preceding years, and the relative insulation of the banking system from external liquidity shocks. 4. However, PNG remains a low income country with a dual economy. The mineral sector, developed by foreign investment and operated by international companies, constitutes the modern segment, accounting for a third of value added and three fourths of exports. However, the sector remains an enclave, with the domestic content of production limited, the contribution to local employment low, and the level of profit repatriation high. Consequently, the Government budget acts as the main channel by which mineral revenues benefit the domestic economy. The non-mineral sector, on the other hand, consists almost entirely of subsistence agriculture and low-value added services. Agriculture employs 85 percent of the population but crop production is limited with little downstream processing of produce except for exports. In services, construction is wedded to mineral projects and the contribution from niche tourism is marginal. More seriously, the share of manufacturing in GDP remains little changed in a decade, at 6-7 percent. The processing of imported inputs into final products is confined mainly to food, packaging, and construction materials. 5. Translating strong macroeconomic performance and extractive industry revenues into a broad improvement in living standards remains a key challenge. The relatively small formal sector of the economy has only been generating about 10,000 jobs for the approximately 80,000 who leave the schooling system each year. The Government‘s Vision 2050 document identifies human and social capital development as a pillar for future economic advancement. The economy lacks skilled labor— adult literacy is low at 60 percent in 2008 and little improved from 57 percent in 2000—and universal primary education is a distant target. Moreover, tribal conflict and law and order problems remain a serious concern. The country‘s customary system of landownership makes it difficult to purchase or lease land for economic purposes, let alone use land as collateral for financing. Governance is weak and the quality of public services is often low despite the fact that public consumption accounts for nearly 15 percent of GDP and state employment absorbs two-fifths of formal sector employment. Overregulation, low levels of public sector investment, and poorly developed basic infrastructure—the capital city is not accessible from the majority of the country by road—deter private activity and investment. 6. In the context of Vision 2050, PNG also aims to broaden the sources of growth for the domestic economy over the long term. The country‘s Strategic Development Plan (SDP) for 2010 - 2030, for instance, targets to quintuple agricultural production and to triple manufacturing output over the next twenty years. The plan also aims to process about 80 percent of forestry shipments, harness fishery resources for tuna exports, and attract some 1.5 million tourists during the period. While the details of these programs are yet lacking, the search for non-mineral sources of growth alone represents a heady step. In this regard, a focus on the development of SMEs is essential.21 Moreover, because most large companies usually start out as small enterprises, the ability of SMEs to grow becomes crucial to economic progress. In PNG‘s case at this juncture, the development of SMEs would dovetail with the search for linkages to and spillovers from the construction and exploitation of mineral projects and underpin efforts to expand productive activity in the lagging agriculture, manufacturing and service sectors. In fact, a key element of the Government‘s strategy with respect to SMEs and the private sector is to increase income- earning opportunities through targeted intervention to support private sector development. This is 21 In the context of PNG, SMEs are defined as registered companies with at least 3 and up to 150 employees. 26 highlighted in the Medium Term Development Strategy (MTDS) and Long Term Development Strategy (LTDS),22 and is a pillar of the CAS.23 7. SME development is notably important in view of low job market participation rate in the formal sector,24 especially among women25 and youth. Forty percent (40 percent) of the population is under the age of 15 and this is expected to double in the next 20 years. Youth employment and underemployment are already large concerns as only one in ten school graduates is likely to find a job in the private sector.26 Similarly, employment opportunities in the informal sector are limited, which together with low formal sector participation, have contributed to low morale, incentives for petty crime, and a security problem. Consequently, the promotion of income-earning opportunities and private sector development is an essential element of PNG‘s poverty reduction and private sector development strategy, both of which are addressed by this project‘s primary objective of increasing the access to finance for SMEs. 8. The construction of a massive Liquefied Natural Gas (LNG) Project starting in 2010 provides an important opportunity for SMEs and is raising the expectation that PNG’s economic growth and living standards can be notably raised in the long-term. Sponsored by an international consortium led by ExxonMobil, the USD18 billion project attempts to harness the country‘s abundant natural gas reserves (ranked 43rd globally at 227 million cubic meters of proven reserves) with a facility that will produce 6.6 million tons of LNG per year starting in 2013 or 2014. The project will generate export revenues of about USD3 billion per year on average, more than double the combined record high of oil and gas exports in 2008, and propel PNG to become East Asia‘s second-ranked LNG producer, after Malaysia and past Indonesia. Recent estimates suggest that real GDP growth could increase by almost 1 percentage point a year during construction through 2014 and then perhaps by 15-20 percent per year during the 30-year life of the project. While the Government and some landowners will benefit from resultant royalty flows, PNG SMEs will struggle to meaningfully participate in the resultant opportunities, unless the private and public sectors, working with development partners, can address existing key constraints, among which is access to finance. The Independent State of Papua New Guinea (GoPNG) indicates an understanding of both the opportunities and risks, and viable SME development is a key feature in its LTDS.27 22 The MTDS covers the period from 2005-2010 and the LTDS covers the period from 2010-2030. 23 The Country Assistance Strategy (CAS) was approved by the World Bank Board on December 18, 2007 and covers the period FY08-FY11. 24 In 2002 a survey was conducted that showed 6 percent of the working age population in PNG was employed in the formal sector. 25 Historically, female representation in business life in PNG is low and this is reflected in government participation—only one female is represented among the 109 national parliamentarians. Also, according to the World Bank WDI, in 2000 only 32 percent of women were employed outside of the agricultural sector. Furthermore, it is estimated that less than 5 percent of formal sector SMEs are headed by women, while, in 2008, women accounted for half of the population and labor force. 26 This situation has fueled the expansion of urban youth gangs, which in turn further stifles the ability for the private sector to expand as insecurity weakens the business enabling environment and reduces the likelihood of the financial sector extending loans to viable SMEs because of the risk involved. 27 SME sector is not well-developed in PNG. Globally, formal sector SMEs contribute significantly to sustainable employment growth and make significant direct and indirect contributions to the tax revenue base. In PNG, however, the current density of formal SMEs is very low; at about 2 to 3 per 1,000 head of population. This represents about 5 percent of OECD country density, about 20 percent of East Asia & Sub-Saharan Africa regions; and about 10 percent of Latin America density. There are several reasons for this; one key one being limited access to finance, which the proposed project will aim to address. While reliable data are almost totally unavailable, female entrepreneurs appear to be especially under-represented. 27 9. Reliable SME data is very limited. Information collected by the WBG from various alternative sources provides wildly varying estimates of the number of existing firms that fit within the target market segment. Based on Table 1, it is estimated that the existing market segment is at least 6,000 firms. By sector, the distribution of formal SMEs is shown in Table 2. Table 1: Estimates of the Number of Formal SMEs Source Number of Active Formal SMEs Investment Promotion Agency annual returns 28 Approx. 20,000 IFC GDP Comparator Estimates 29 Approx. 20,000 to 10,000 Tax Office annual returns 30 Approx. 12,000 Exxon LNG Local Content Team estimate Approx. 6,000 Existing financial institution clients Approx. 5,000 Firms registered on LNG Project data base Approx. 500 Table 2: Estimate of the Sectoral Composition of Formal SMEs Sector % of Total Retail/ Wholesale trade 35.0 Transport 15.0 Building & Construction 12.5 Manufacturing 10.0 Business Services (e.g. security) 10.0 Hospitality 7.5 SME 5.0 Other 5.0 Total 100 Source: Bank of PNG data interpreted/ extrapolated by World Bank consultant. 10. The potential for rapid growth of SME is significant. Small scale procurement opportunities from the LNG construction phase are estimated at about USD0.5 billion. Additionally, there is a further approximate USD10 billion of possible other resource sector investments over the next five to seven years that SMEs can tap. 11. PNG has a liquid commercial banking sector and the availability of funds is not a major constraint. Liquid asset data of commercial banks in PNG are presented below. Commercial banks have excess reserves of over 20 percent, but hesitate to reduce these free reserves due to high perceived market risks. Commercial banks in PNG have the freedom in setting lending rates based on their internal credit risks and cost assessments. Lending rates by commercial banks in PNG are at a comfortable level and range from around 7% to 17%, with almost 75% of total loan portfolio being priced in the range of 9 – 15%. While positive for the commercial banks‘ net interest margin and profitability, the high lending rates are also one of the reasons why access to finance is a challenge for many borrowers in PNG. Besides lending, they are making profit mainly from foreign exchange trading and Treasury bills. Therefore there is significant scope for PNG commercial banks to expand their lending to SMEs if the market risks are better understood and mitigated. 28 ―PNG SME Definition & Market Snapshot,‖ C. Blacklock. IFC; January 2010. 29 Numbers of formal SMEs in countries with similar GDPs. Source: IFC SME data base. 30 Blacklock. Ibid 28 Table 3: Liquid Assets of Commercial Banks Commercial Liquid Asset (in Liquid Asset Required Liquid Cash Reserve Banks million kina) ratio Asset Ratio Requirement 2007 4626.555 51.65% 25% 3% 2008 4967.761 48.58% 25% 3% 2009 6144.948 50.81% 25% 3% Source: BPNG Quarterly Economic Bulletins 2007-Sept 2009 Note: 2009 data is as of September 2009 12. Despite high liquidity, financial institutions do not sufficiently support investment and entrepreneurship, as reflected in a low ratio of private sector credit to GDP (Figure 2). High liquidity in financial institutions illustrates the high perceived risks of lending, and a large majority of the population have very limited access to formal financial services (Figure 3). The domestic banks are also generally sound with high capital adequacy ratios with no exposure to sophisticated financial products linked with the sub-prime mortgage market. Bank asset quality has improved dramatically with non- performing loan (NPL) ratio declining from 16.9 percent in 2000 to no more than 2 percent by September 2009 (Source: BoPNG). Figure 2: Domestic Credit Provided by Banking Sector (% GDP) 29 Figure 3: Ease of Getting Credit Figure 4: Private Sector Credit Growth 13. Financial Sector Policy, Regulation, and Infrastructure Development. The Central Bank of PNG (BoPNG) has strengthened its prudential regulation for the banking sector and has taken important measures to improve financial infrastructure. It plans to reform the collateral system and develop a national payment system over the next three to four years to facilitate the expansion of banking services. Similar to many developing countries, movable assets are not yet recognized as collateral for bank lending in PNG, and the customary land ownership and lack of registration of property make it especially difficult for financial institutions to use them as security for lending. In addition to the inclusion of movable assets for collateral, ―fungible assets,‖ like order ledgers that demonstrate prospective business, can be used to improve access to credit to segments that lack traditional resources. It is expected that the collateral reform will enable the financial institutions to expand services to the ―unbanked,‖ with appropriate risk management procedures. With respect to the payment system, BoPNG‘s current system is manually run and is not capable of accommodating the rapid development of the country‘s banking business. The planned new automated payment system will have larger capacity to accommodate transactions such as e-banking and mobile banking, which have the potential to be delivery channels for SME finance services in PNG. The design of the new national payment system is complete and will be launched in 2011-2012. Both initiatives, which are supported by IFC, are critical to improving SMEs‘ access to finance, while, at the same time, enabling financial institutions to adequately manage risks. 14. SME finance landscape and government programs. The current institutional framework and landscape for SME finance includes formal financial intermediation and government programs. GoPNG 30 has developed several subsidized programs to boost SME finance. The Small Business Development Corporation (SBDC) was established by an Act of the National Parliament of Papua New Guinea in April 1990. Its overall performance has been, at best, mixed. Two of its programs have been a credit guarantee scheme to eligible small businesses, and a training program to local businesses (known as Start and Improve Your Business – SIYB). The Government has provided intermittent funding to SBDC to underwrite the credit guarantee with the PFIs that lend to clients who have received some business training from SBDC. The SBDC program targets new start-ups or existing businesses looking for expansion. SBDC provides up to 80 percent credit guarantee on the loan amount which ranges from K5, 000 to K60, 000, while the borrowers provide up to 20 percent equity. SBDC charges a 1 percent guarantee fee upfront to borrowers and PFIs charge K100 for each approved loan application. The National Development Bank is another government sponsored financial institution that extends financial services to the rural areas in PNG. 15. SME finance challenges. These programs have not effectively addressed challenges that have led to the lack of access to finance by SMEs. A key challenge is the inability of the under-developed SME sector to respond to the requirements of commercial banks in terms of financial statements, collateral, information, guarantees, etc. Another challenge is conservative commercial bank practices have been incompatible in meeting the financing requirements of SMEs. Customary land ownership and weak property rights to movable assets make the pledging of collateral for loans difficult, unreliable, and expensive. In addition to high costs, the risks of lending to SMEs are perceived to be too high because of a lack of information and data on the local SME market. The deficit of robust data makes it difficult for banks to develop appropriate risk management procedures. PNG‘s financial institutions have the potential to extend their financial services to small and medium sized business in PNG, but need to improve their understanding of the risks associated with SME lending because under the status-quo, banks assess the risk to SMEs as being very high because of, in part, the lack of information about this market segment. Thus far the local banks have not actively developed products for SME clients; however, small teams have been allocated to manage SME client relations, and this indicates a desire and intention to service SMEs. In short, the banks are currently unable to adequately meet the SME market segment needs, despite trying, due to market uncertainties, lack of appropriate products and approaches, issues relating to SME managerial and financial capacities, and issues in obtaining and enforcing collateral. 16. Complex social and cultural factors. Certain social and cultural aspects also contribute to access to finance issues. The wantok system31 has added costs to local businesses, in particular SMEs, as well as uncertainty to commercial lending activities. As previously mentioned, customary land ownership and weak property rights to movable assets make the pledging of collateral for loans difficult, unreliable, and expensive. In addition, there is significant gender inequality and issues stemming from that in PNG. This is exacerbated by fewer education32 and employment opportunities for women, as well as the violence often perpetrated against women. The female adult literacy rate is estimated to be 53.4 percent, compared with 62.1 percent for males. As previously noted, PNG ranks the lowest in the Pacific region on gender parity in secondary schools enrolment (0.79). Women are not equally represented as owners 31 Literally translated from Pidgin wantok means ―one talk‖, but in reality like most pidgin words its definition encompasses a wide scope. Wantok is a term used to denote a person who is from your family or who is a close, or sometimes not so close, friend. Under this PNG convention, a person is obligated to help wantoks if they claim to be in need. This can add costs to business interactions, particularly if one wantok is having a dispute with another and individuals from those factions work closely in business or government. This tradition also causes issues for the promotion of competitive private sector behavior because the practice encourages nepotism. 32 ―The Millennium Development Goals: Progress in Asia and the Pacific 2007‖, UNESCAP, ADB, UNDP 31 and operators in the formal SME sector; however, they are overrepresented in the informal cottage sector.33 A recent IFC study34 noted the following, below. ―Women in PNG derive limited benefit from the formal economy, mainly operating small scale informal businesses. Women are held back by a male-dominated culture, limited ability to control business income, exclusion from decision making and by violence directed against them. Women are further constrained by a legal framework that does not adequately protect their interests, particularly in relation to property rights and employment. Customary law, which frequently discriminates against women, is commonly applied.‖ 17. The IFC report recommended a number of legal and regulatory reforms to help address key constraints to gender inclusion. These recommendations are currently being considered by GoPNG. GoPNG have also indicated, in the SME Policy and the National Development Plan (NDP), a desire to achieve equality for women, including supporting greater numbers of women in business in the formal sector. 18. Gender parity and women’s access to equal rights, credit, and market are not isolated to PNG, but are issues in every country. Awareness of gender issues is important when considering improvements to the business environment and promotion of private sector development. Women‘s entrepreneurship has been recognized as an important untapped source of economic growth and women‘s share of the labor force has increased in recent years to 40 percent worldwide in 2006.35 Despite the positive trend, women‘s economic activities are not equally distributed across productive sectors; laws, regulations, and social customs restrict women‘s ability to, for example, conduct business, resulting in a blow to potential economic activity. Gender equality in employment brings about efficiency gains; conversely, exclusion from employment or employment opportunities (e.g., access to credit for a women- owned/ operated SME) can reduce the pool of applicants, distort the allocation of talent and the productivity of human capital, and thereby reduce the average productivity of the workforce by stunting overall economic potential and growth.36 Keys to empowering women entrepreneurs include access to education and financial independence—this project can assist with the latter through its gender dimension. In short, countries that do not capture this ―missed potential‖ are not fully capitalizing on one-half of their human resources and run the risk of undermining their competitive potential. 33 Though reliable data are lacking, it is likely that less than 5 percent of SMEs are owned/managed by women. Women, however, account for about 62 percent of informal enterprises. 34 ―PNG Gender & Investment Climate Reform Assessment.‖ IFC. January 2010 35 Simavi, Sevi, et al. ―Gender Dimensions of Investment Climate Reform: A Guide for Policy Makers and Practitioners.‖ The World Bank. October 2010. 36 Ibid. 32 Annex 2: Major Related Projects Financed by the Bank and/ or other Agencies 1. Donor Programs. The Asian Development Bank (ADB) is preparing two projects with GoPNG relating to access to financial services. One is a lending project targeting microenterprise development in rural areas, and the other is a technical assistance project on PNG collateral reform with BoPNG and MOF. The key elements of the lending project include: i) enhancing financial literacy among micro- business; ii) assisting business development of microenterprises, for example marketing and financial planning; and iii) training of trainers program. The ADB project will work with MFIs (Nationwide and PMI) to lend to local microenterprises (loan size 1.5 >1.5 >1.5 >1.5 >1.5 Annually Reports from FIs Participating FIs & IFC o Capacity X Annually Consultant & BSP building management Activities reports  Improved SME Annually Consultant GoPNG managerial & financial reports skills: o Overall numbers X 110 190 185 210 95 trained o Numbers X 50 75 75 75 25 women trained X 30 o % trainees 40 50 60 60 obtaining loan  Improved GoPNG X Baseline SME SME SME policy & Final yr GoPNG surveys, GoPNG capacity to support SME sector policy policy & strategy survey policy documents sector survey & strategy implementation and & reports to IDA completed strategy approved started M&E drafted Mid-term report PIU fully surveys staffed and M&E report 36 Annex 4: Detailed Project Description COMPONENT 1: Risk Share Facility 1. The RSF is a partial credit guarantee facility proposed to be offered by the International Development Association (IDA) and International Finance Corporation (IFC) of the World Bank Group (WBG), in association with the Independent State of PNG (GoPNG). 2. The RSF will aim to support and encourage eligible local private sector commercial banks and finance companies to expand lending and leasing finance to small and medium enterprises (SMEs). Minimum loan/lease sizes will be K50,000 , with loan/lease terms of from 12 to 72 months for most loans. It is also expected that it will be restricted to formally registered PNG firms (including land-owner companies) or joint ventures. 3. Under the RSF, credit enhancement support will be provided to selected private sector PFIs through a 50 percent loss guarantee on specified SME loan portfolios. 4. It is anticipated that the RSF will have a total overall size of up to about USD116.67 million; indicatively shared as follows: (a) PFIs: USD58.37 million (b) IFC: USD46.69 million (c) IDA (GoPNG): USD11.67 million 5. Criteria for eligible PFIs have been agreed to by GoPNG, IDA and IFC. Based on these criteria, there are currently 3 eligible PFIs, which have confirmed interest in participating – Bank South Pacific (BSP), Westpac Bank PNG, and ANZ Bank PNG. Of these, BSP has formally indicated an intention to enter into negotiations with IFC. For BSP, a RSF of 50 percent of the overall total project RSF is proposed. This would imply a total BSP portfolio of up to USD58.37 million; with GoPNG/IDA providing a 1st loss cover of USD5.86 million, and IFC providing USD23.34 million. 6. IFC is responsible for evaluating, structuring, and negotiating RSF agreements with each PFI. Once in implementation, IFC will have full oversight and management responsibility for the RSF. The on-lending rate by PFIs to final borrowers will be determined by PFIs based on the principle that the final interest rate should not be below prevailing inflation and should be adequate to cover all PFI costs and provide a profit margin adequate to encourage lenders to compete in this market to ensure sustainability of the program even after the RSF ends. 7. PFI eligibility criteria: FIs that were selected as being eligible to participate in the project were required to meet a set of management and financial criteria. These criteria were designed to reflect the banks‘ management interest in and commitment to lending to the SME sector on market terms. The FIs were required to provide their full business strategies and plans for the future and their rationale for participating in the SME Project. The criteria, which are provided in the box below, are in accordance with OP8.30 requirements and have also been adapted to the local regulatory requirements by BoPNG. The assessments of FIs examined their strategic fit to the SME finance project, the quality of management, quality of assets, the management of asset and liability, the profitability and efficiency of its operations, and risk management and internal controls. 37 8. Based on agreed eligibility criteria, GoPNG confirmed (letter from Secretary DCI, dated 8 April 2010) that there were four FIs that were eligible to participate in the RSF component – ANZ, Bank South Pacific (BSP), Credit Corporation, and Westpac. Credit Corporation subsequently indicated it did not wish to participate in the RSF at this stage. The other three banks—ANZ, BSP, and Westpac—expressed interest in participating and were assessed accordingly. Overall assessments showed that each bank is eligible for participation in the RSF. 9. The project will commence with BSP. It is anticipated that other eligible FIs will join within the next 24 months. Box 1. Based Financial Capacity Building of Criteria COMPONENT 2: PerformanceAgreed Grant for Institution Eligibility FIs  Bank or finance company licensed to operate in PNG.  Meets all BoPNG, and other GoPNG, requirements (including prudential standards) for commercial banks or finance companies; is current with all required Central Bank & other GoPNG filings, and is not in breach of any PNG laws/ regulations.  Majority private sector owned. With regard to PNG operations:  Had a minimum shareholder equity (share capital, plus retained earnings) of K350 million as at last reporting period.  Had a minimum outstanding portfolio of SME loans or leases (1) of K50 million as at last reporting period.  Achieved a Return on Average Equity (ROAE) of at least 20 percent over each of the past 3 reporting periods.  Achieved a Return on Average Assets (ROAA) of at least 1.5 percent over each of the past 3 reporting periods.  Had a maximum non-performing loan portfolio (2) of 5.0 percent over each of the past 3 reporting periods.  Operates registered offices in at least 2 commercial centres outside Port Moresby. Other factors to be taken into consideration will include:  Senior management commitment to SME lending, with a demonstrated track record of booking SME assets as well as a strong pipeline of prospective SME loans;  Corporate governance arrangements & practices meeting international standards;  Significant experience of medium-term and long-term lending, extending beyond two years is desirable and should be demonstrable in the current loan portfolio;  Demonstrated commitment to expanding loan portfolio volumes while maintaining high portfolio quality;  The presence of information systems that can provide a detailed analysis of the existing portfolio performance; and  Have strong credit review and credit monitoring systems which can be relied upon to ensure continued high quality of the asset book. Note: (1) SME loans and leases from K20,000 to K2.0 million (2) Percent loan portfolio in default 90 days or more = total portfolio in default/total portfolio 38 10. One of the factors contributing to limited SME access to financial services in PNG, and similar countries, is a lack of up to date knowledge and expertise within financial institutions (FIs) relating to international good-practice in the SME banking field. Internationally over the past 10 years or so, significant advances have been made in areas such as product development and marketing, market segmentation, credit scoring, risk management, organizational structures and management information systems. 11. In the absence of this knowledge and expertise, well managed private sector FIs have seen the SME market as too risky and lacking adequate profit potential. On the other hand, those FIs that have developed or acquired this knowledge have been able to successfully deepen their engagement in this market segment. At the same time, those FIs that have entered the SME market without adequate management, controls, knowledge and skills, have usually suffered significant commercial losses. 12. The Project will incorporate a component designed to address this constraint: namely, a program of support to Bank South Pacific Limited (BSP). The total costs of this component are estimated at USD2.35 million (K6.05 million). Of this total, it is estimated that IDA will fund USD1.53 million (K3.92 million) and beneficiary institutions will fund USD0.83 million (K2.13 million). Performance Based Grants 13. The basis for the capacity building of PFIs will be performance-based grants. In particular, the Government, through DCI, will provide, on a non-refundable grant basis, to each eligible PFI, proceeds of the IDA grant allocated to respective components, under a Performance Based Grant Agreement (―PBGA‖), on terms and conditions satisfactory to IDA. 14. The PBGAs will be implemented with due diligence and efficiency and in accordance with sound technical, economic, financial, managerial, environmental and social standards and practices satisfactory to IDA, including in accordance with the provisions of the Anti-Corruption Guidelines applicable to recipients of loan proceeds. In the case of PBGA for PFIs, starting with BSP, IFC's anti-corruption approach for private sector will apply. Bank South Pacific (BSP) 15. BSP is PNG‘s largest commercial bank and is the only registered bank that is not a subsidiary of a foreign bank. For the RSF component, it will be initial PFI. 16. The overall objective of this sub-component will be to develop and roll-out small business banking methodologies, products and services that will enable BSP to increase its current SME lending portfolio (about K300 million) to about K550,000 and to do this efficiently and profitably. 17. Activities to be undertaken over about a 24 month period, include the following: (a) Market demand surveys and SME banking strategy; (b) Establishment of a small business banking unit; 39 (c) Development, trialing and roll-out of new SME banking products and marketing approaches; (d) Adaptation, trialing and roll-out of an automated credit origination and decision-making methodology and process (including a credit scoring methodology); and related work to improve the quality and efficiencies of loan origination, processing and portfolio management procedures; and (e) Staff training/ knowledge transfer related to the above. 18. A full-time resident specialist advisor will be recruited. This specialist will be supported by several shorter term consultants. 19. Estimated costs are USD2.34 million (K6.02 million). 20. GoPNG (using IDA funds) will fund 65 percent of these costs, up to a maximum of USD1.53 million (K3.92 million). The IDA funds will be disbursed on the basis of a reimbursable Performance Based Grant Agreement (PBGA), whereby: (a) BSP will be responsible for the TOR, selection, recruitment, management and payment of the consultants, subject to prior GoPNG approvals of the TORs; (b) Apart from an initial disbursement, IDA payments will be made retrospectively in several tranches upon BSP providing satisfactory evidence of delivery of agreed performance indicators as detailed in the PBGA. COMPONENT 3: Capacity Building for SMEs Training to Established Formal Sector SMEs 21. The Project‘s regular training program would focus on established formal sector SMEs that are already operational, and which would benefit from support aimed at strengthening the business and obtaining finance via the RSF (either as new borrowers, or repeat borrowers). 22. Participants in the program would be required to: (a) Demonstrate that they meet the Project‘s SME definition (b) Be referred by: (i) a FI participating in the RSF; (ii) the relevant Chamber of Commerce; or (iii) the relevant PNG Business Council office; (c) Provide adequate information relating to their current business (sector, location, employee numbers, turn-over, and current sources and amounts of external financing); and (d) Demonstrate commitment by making a contribution of K500 to the costs of the training. 23. Topics to be covered would likely be:37 o Business planning & financial analysis o Cash flow management 37 Course content/structure would be reviewed both during the start-up phase and after 12 months of operations, and adjusted if found appropriate. Additionally, at the 12 month review, the effective demand and rationale for this type of class-room based training would be examined. 40 o Budgeting o Inventory control o Logistics and supply-chain management o Basic bookkeeping & management information systems o Managing people (including dealing with family/ relations) o Financial products; and how to work with FIs o Sales & marketing o Legal & tax issues 24. Courses would be of about 5 day‘s duration. They would be offered in Port Moresby & Lae to start with, then other centers according to demand. It is currently estimated that about 300 SMEs would participate over a 5 year period. Background project preparation work indicates there are several PNG based training providers who have relevant existing basic modules and case-studies that could be adapted for the Project‘s needs. 25. Even though significantly more focused and demand-driven than most of the business training activities currently being undertaken in PNG, the above program still carries risks in terms of effective demand and impacts. Along with all other SME capacity building activities (see following), it would be subject to an evaluation after about 12 months of operation. 26. Several groups and subjects would be excluded so as to maintain focus on the Project‘s core target market segment, and because other existing programs are active in these areas. These will be: (a) Start-up businesses38; (b) Courses on general entrepreneurship; (c) Youth, rural and community based courses; and (d) Sector-specific courses. Mentoring/ Coaching 27. Aside from class-room type group training, international experience indicates that follow- up, more intensive, one-on-one mentoring can deliver high impacts if appropriately structured and delivered. A limited amount of this type of work is currently happening in PNG. 28. While there is general agreement on the positive impacts of such one-on-one mentoring, there are some practical challenges in delivering it to any significant scale in a PNG context: (a) A pool of skilled and experienced business people, with relevant local business knowledge, people-skills and credibility, is required. (b) It is time intensive. A full-time mentor could, at most, probably handle a maximum of 10 clients at any one time. A part-time mentor could perhaps handle only one client at a time. Experience 38 Programs targeted at women would be an exception to this. 41 suggests that each SME operator requires a structured mentoring program of at least 6 months duration. (c) It is expensive relative to other forms of capacity building support. Any significant subsidy needs to be transparent and closely monitored, and justified on the basis of ‗public benefits,‘ such as incremental employment generation. 29. Notwithstanding the above issues, and because of the potential high impacts, the Project will incorporate a significant one-on-one mentoring program, with the following key features: (d) Restricted to participants who have obtained a loan under the RSF and who have been referred by the relevant participating FI; (e) restricted to participants who contribute K1,500 to the costs of the mentoring program (such costs could be funded via the RSF loan); (f) participants will need to agree to providing appropriate data on business turnover and employment for 24 months after completion of the mentoring program; (g) each mentoring session to be at least 3 hours at the business premises; and for a maximum of 75 hours over a total duration of up to 12 months; and (h) the Project will monitor and evaluate impacts; especially in respect of incremental employment and revenue generation. 30. It is estimated that approximately 150 SMEs would participate in this program over a five year period. Preparation work suggests there are several qualified entities currently operating in PNG who could manage and deliver such a program (some perhaps in joint-ventures with external partners). There is, however, a risk around the availability of sufficient adequately qualified mentors and, as for the other proposed programs, a 12 month review would be undertaken. Gender 31. As previously noted, women in PNG face significant, and often special, constraints in terms of starting a business, obtaining finance, and growing a successful business. While it is not proposed that the RSF finance facility incorporate gender-specific lending targets, it is proposed that: (a) lending to women via the RSF will be specifically monitored, (b) that the technical assistance to FIs participating in the RSF incorporate gender specific components; (c) that Project related surveys will incorporate gender- specific elements; (d) that the Project‘s support to GoPNG incorporate assistance for expanding and enhancing existing women‘s business networking organizations; and (e) that the Project incorporate a gender-specific training and related support component. 32. With regard to (e) above, the project will support a modified version of the general SME training courses outlined in paragraphs 9 through 12 above. Modifications would include: (a) Emphasis on core financial literacy (including ‗money management‘), starting a business, business planning, and how to approach and work with FI‘s. (b) Participation restricted to women. (c) Shorter in total duration (say, 3 to 4 days), and delivered on weekends. (d) Participants would need to be already operating a business (though not necessarily a formal SME), and would need to be referred by a registered FI, a Chamber of Commerce or Business Council, or a recognized and registered women‘s business forum. (e) Participants would need to pay a K50 fee. 42 (f) Participants, who successfully complete the program, would subsequently be eligible to participate in the general SME mentoring program, provided they met eligibility criteria for the program. 33. It is estimated that approximately 300 women would participate in these programs, over a 5 year period. Provincial Government ‘Train-the-Trainers’ 34. Provincial Government Commerce Division personnel are responsible for supporting private sector SME development at provincial and district levels, by assisting with feasibility studies, loan applications, company registrations, and similar. While many of these personnel participated in the ILO sponsored MYOB program (paragraph 2 above), they have received extremely limited refresher training over recent years. The Project would therefore incorporate a component to update the skills of these provincial staff, to enable them to provide improved support to micro and small enterprises in their regions. Up to 40 staff is expected to benefit from refresher training programs that would, in part, be similar to the SME training programs outlined in paragraphs 9 through 12 above. Results Measurement 35. The Project Implementation Unit (PIU), and the contractors delivering the above programs, would be required to monitor and report on the following: (a) Participants completing the above programs, with initial targets being: (a) formal sector SME training: 200; (b) SME mentoring: 150; (c) gender focused training: 300; and provincial Government staff training: 40. (b) Participants‘ ratings of programs; with target of at least 70 percent satisfactory/very satisfactory rating. (c) Numbers of SMEs subsequently obtaining a loan via the RSF; with a target of 200. (d) Incremental employment generated by participants in the mentoring/ coaching program (this will require effective monitoring over a 24 month period following completion of mentoring assignments); with target of 1,000 incremental full-time equivalent jobs. (e) Numbers of women subsequently starting a formal business; with target of 100. Implementation Arrangements 36. The PIU within the Department of Commerce and Industry would be responsible for the overall management, reporting and evaluation of this component. Actual delivery and day-to- day management responsibility would be rest with qualified external entities, with such services procured in accordance with GoPNG and IDA procurement policies and procedures. Estimated Costs 37. Total costs of this component are estimated at USD5.15 million (approximately K13.2 million); allocated as follows: 43 Start-Up/ Preliminary Expenses: USD0.15 million SME Training: USD0.76 million Mentoring/Coaching: USD2.40 million Gender Program: USD0.63 million Provincial Government Staff Training: USD0.30 million Base Costs: USD4.26 million Contingencies: USD0.89 million Total Program Costs: USD5.15 million COMPONENT 4: Capacity Building of GoPNG 38. Within GoPNG, the Department of Commerce and Industry (DCI) has responsibility for SMEs, and it has been designated by GoPNG as the implementing counterpart agency for the Project. The department is headed by a Secretary, who reports to the Minister of Commerce and Industry. Also reporting to the Minister are the Chairs (or Heads) of the Investment Promotion Agency, the Small Business Development Corporation, and the Industrial Centres Development Corporation. Project Oversight 39. A Project Steering Committee (SC) will be established. The SC will be chaired by the Secretary DCI. Apart from the Secretary, other regular members of the SC will include: (a) Representatives of each participating FI (b) A PNG private sector representative (PNG Business Council) (c) A representative from the Department of Planning (d) A representative from the public-private dialogue forum – ―Consultative Implementation & Monitoring Council‖ (CIMC). 40. The Project Implementation Unit (PIU) within DCI (see below) will act as the Secretariat for the SC, which would meet quarterly. The SC would review progress, discuss emerging issues, and recommend actions to improve project implementation. Any recommendations of the SC would go jointly to the Minister & the World Bank. Project Management 41. A PIU has been established within the SME branch of DCI. One full-time officer, with administrative support, is currently assigned to the unit to assist with Project preparation activities. Other staff (see paragraphs 17 & 18 below) will be subsequently assigned or recruited to the PIU. The key responsibilities of the PIU will be as follows: 44 (a) Surveys (baseline and regular follow-ups) (b) SME capacity building activities (c) Gender initiatives (d) Updated SME policy & strategy (e) Oversight of financial institution (FI) capacity building activities (f) Overall monitoring, evaluation & reporting (g) GoPNG procurement and disbursement Surveys 42. As noted elsewhere, there is currently very limited quantitative SME formal sector data available. Such information is required to help better inform sector policies and strategies. An initial survey of the sector is being conducted as a priority exercise. The survey is be aimed at collecting and analyzing the following: (a) Numbers of SMEs (b) Location (c) Sector (d) Women owned/ managed (e) Employment (f) Revenue/ turnover (g) Sources of finance (h) Impediments to growth 43. Subsequently, similar follow-on surveys would be undertaken in the third and fifth years of the Project. These follow-on surveys would incorporate a specific sub-set of firms that have participated in the Project RSF and associated capacity building activities. These surveys would be an important tool for monitoring and evaluating Project outcomes and impacts, and for providing a sound base for subsequent initiatives. 44. The PIU, assisted by specialist external consultants, has been responsible for design of the surveys, for managing a team of national, provincial and district staff who are undertaking the surveys, and for analyzing the resultant data and for reporting survey results to the SC and other relevant stakeholders. SME Capacity Building 45. As detailed in Component 3, the Project would support SME capacity building programs, including: SME training, SME mentoring, and gender-specific training. The PIU would be responsible for tendering, procuring and managing external consultant agencies to undertake these programs; for monitoring progress, and for regularly reporting results to the SC and other relevant stakeholders. 45 Gender 46. The Project will support capacity building/training programs specifically targeted at women entrepreneurs. Also, Project surveys will specifically monitor women-owned SME businesses and the impact of the Project on women entrepreneurs. Participating FIs will be asked to specifically identify loans to women (number, amount, sector and location) under the RSF. 47. It is possible that additional Project support may be warranted in areas such as business women‘s networking organizations (including professional women working in FIs) and entrepreneurship. However, given the tight time-line under which this Project has been prepared, it has not been possible to adequately define or prepare any such additional work. Consequently, the Project will allow for a gender specialist staff position (and shorter term specialist support) in the PIU, and also make a provisional cost allocation for additional gender work. Such additional work will need be agreed between GoPNG and IDA prior to its commencement. SME Policy and Strategy 48. It is over 10 years since GoPNG prepared a comprehensive SME policy and strategy.39 An updated policy and strategy is required, especially in the light of the expected economic impacts of the LNG and other resource projects, and the priority need to maximize resultant opportunities for PNG business growth and employment generation. The PIU will recruit a senior SME policy specialist to assist DCI and other stakeholders in preparing, and gaining approval for, an updated policy framework. Project Monitoring and Evaluation 49. Detailed results measurement proposals are provided in Annex 3. While participating FIs, and consultants and staff managing the various capacity building and survey components, will have prime responsibility for generating and providing core data, the PIU will take responsibility for compiling, analysing and reporting this information to the SC, the World Bank, and to other relevant stakeholders. Additionally, regular evaluations of Project outcomes and impacts will be required. An international monitoring and evaluation specialist will be recruited into the PIU on a short-term basis to help plan and initiate this work, and build ongoing capacity within the PIU. Project Procurement 50. The PIU will be responsible for Project related procurement, disbursement and related activities in accordance with IDA procurement policies and procedures. Specialist procurement and financial management officers will be on the PIU staff. As appropriate, these officers will participate in procurement and financial management training delivered by the World Bank. PIU Staffing 51. The PIU will have the following staffing complement: 39 ―SME Policy.‖ Ministry of Trade & Industry. September 1998 46  Project Manager  M&E officers (4)  Short term (6 months) international M&E specialist  Gender specialist  Short term (3 months) financial institutions specialist  Short term (6 months) international gender specialist  Short term (12 month) accounting/ financial management officer  Procurement officer  Financial management advisor  Administrative support (2 positions)  Driver 52. PNG experience indicates that delays in staff recruitment and assignment are not uncommon. There may well be a need therefore to seek early reassignment of existing DCI staff to the PIU and/or to utilize short-term consultants to assist during the early stages of Project implementation. Estimated GoPNG/ PIU Costs 53. Total costs of this component are estimated at USD7.44 million (approximately K19.12 million), of which IDA will fund USD3.56 million (approximately K9.15 million), allocated as follows: Start-up expenses: USD0.13 million Staff: USD2.54 million Consultants: USD0.72 million Equipment: USD0.56 million Surveys: USD0.65 million Operational expenses: USD1.59 million Baseline Costs: USD6.21 million Contingencies: USD1.23 million Total Estimated Costs USD7.44 million 47 Annex 5: Project Costs Local Foreign Total Project Cost By Component and/or Activity USD million USD million USD million 1. SME Risk Sharing Facility 116.67 2. Performance Based Grant for Capacity building of 2.35 financial institutions 3. Capacity building for SMEs 4.26 4. Capacity building for GoPNG (implementation 6.21 capacity and SME policy development) Total Baseline Cost 129.55 Contingencies 1.36 Total Project Costs 130.91 Interest during construction Front-end Fee Total Financing Required 130.91 48 Annex 6: Implementation Arrangements Project Implementation Period 1. The project will be implemented over a period of fourteen (14) calendar years and fifteen fiscal years, completed by June 30, 2019 and closed by December 31, 2024. Project Oversight 2. The Department of Commerce and Industry (DCI) will act as the recipient and executive agency for the project. The DCI will be responsible for providing the strategic guidance and leadership for project implementation and launching and implementation of the facility. The specific functions of the DCI would include, inter alia: (i) identifying Government policy goals to guide implementation and monitoring strategies of the Project; (ii) participate in project monitoring and evaluation process; (iii) creating awareness of the facility and technical assistance to support SME access to finance; and (iv) providing strategic guidance to IDA/IFC teams to ensure that the facility supports its policy goals. In order to carry out these functions, the DCI will appoint a small counterpart team (Project Implementation Unit or PIU), who will work closely with the IDA/IFC team to monitor the performance of the facility and provide support for task teams. IDA and IFC will make best efforts to create an institutional capacity within DCI to prepare and manage similar facilities. Core Project Implementation 3. Core implementation arrangements and responsibilities for specific components are as follows: Component 1: SME Finance Risk Share Facility: PFIs responsible under primary IFC administration and oversight are initially BSP, and also anticipated to subsequently include other eligible PFIs; Component 2: Performance-based Grant for Financial Intermediary Capacity Building: PFIs have core implementation responsibility for reporting against agreed performance and outcome results, and IDA funds will be disbursed directly upon delivery of agreed performance/ outcomes as confirmed by the PIU Component 3: SME Capacity Building: GoPNG will be responsible for procuring consultants to undertake and report on this component. Component 4: Capacity Building of GoPNG: The PIU will be established within the SME branch of DCI and will act as the Secretariat for the SC, which would meet quarterly. The SC would review progress, discuss emerging issues, and recommend actions to improve project implementation. Any recommendations of the SC would go jointly to the Minister of DCI & the World Bank. The PIU has the following responsibilities: surveys (baseline and follow-up); SME capacity building; gender initiatives; updated SME policy and strategy; oversight of generic FI capacity building; overall monitoring, evaluation, and reporting; and procurement. Operational aspects of the RSF 4. The GoPNG will be the recipient of the IDA credit/grant funds while IFC will be the agent for the GoPNG for the RSF component. Pursuant to a Risk Sharing Framework Agreement to be entered into 49 between IFC, GoPNG and IDA, among other things, a trust fund will be set up by the IFC on behalf of GoPNG. IDA will transfer the credit/grant proceeds to cover GoPNG‘s ‗first loss‘ portion of funds (up to USD 11.6 million), on behalf of the GoPNG, to the trust fund account which will be administered by IFC. In its capacity as facility agent, IFC will be responsible for all operational aspects of the management of the trust fund and RSF with PFIs, which would include, inter alia, monitoring the utilization of the RSF by PFIs, verifying the calls on first loss, and payment of all acceptable loss claims from the trust account. IFC will administer the facility and will exercise the same care in the discharge of its function as it exercises with respect to the administration and management of its own funds. Furthermore, IFC, in its capacity as obligor, will commit its ‗second loss‘ risk sharing portion (USD 46.69 million) as a guarantee investment reserved for the PFIs. 5. IDA proceeds will be disbursed to the trust fund account administered by IFC on behalf of GoPNG in order to ensure availability of funds at all times, which would serve as reserves to be used against executed Risk Sharing Agreements (RSA) between the IFC and PFIs. These funds would be later used to provide first loss coverage under executed RSAs. The proceeds of IDA fund contribution to the RSF will be subject to financial control mechanisms acceptable to IDA. 6. IFC, on behalf of GoPNG, may invest and reinvest all or part of the funds deposited in the trust fund pending disbursement. This means that World Bank Treasury can invest the un-disbursed amount in safe liquid instruments (e.g. overnight deposit, T-bills, etc.) until the guarantee is called. The fee and interest income on the IDA portion of the facility will belong to the GoPNG. It shall be credited to the Trust Fund and shall be used solely for the agreed purposes of the RSF during the period of project implementation until termination of the IFC administration of the facility (14 years), which would include paying back IDA credit portion for losses incurred under the facility. Furthermore, any up-front fees, facility fees and recovered amounts attributable to the first loss coverage shall be credited to the trust fund account. 7. At the end of the project, at year 14, the IDA amount allocated to RSF trust fund account that has not been drawn for the purposes of covering calls for payment under the risk sharing facility will be cancelled and returned to IDA. Until that time, amounts necessary to ensure first-loss coverage under the risk sharing facility would remain in the guarantee reserve account until such time as the risk sharing agreements terminate or the portfolios covered by the risk sharing mature and all outstanding liabilities have been met. Monitoring and Evaluation Agreements 8. Supervision. The World Bank will devote estimated 8 staff weeks per year for supervision of credit progress through FY 2019. IFC will have a separate supervision budget. The Bank and IFC will undertake annual joint supervisions. 9. Monitoring. Overall project monitoring is based on indicators confirmed at appraisal (see Annex 3) and the project implementation plan to be finalized by the PIU and agreed to during negotiations. Monitoring will be carried out by the SC and assisted by consultants as necessary. Progress under each project component will be monitored and coordinated by the PIU under the guidance of the SC. Progress reports will be prepared by the PIU every six months, and submitted to the World Bank within one month thereafter. No later than six months after the closing date of the project, the GoPNG will prepare and furnish to the World Bank a report on the execution of the project, its costs, and the benefits currently and to be derived from it. The report should include a post-project assessment by an independent M&E consultant on the impact of the financial products that PFIs extended to SME borrowers using project resources. 50 10. Mid-term review. A mid-term review will be carried out no later than December 2012 by the World Bank, together with the GoPNG, IFC and the other involved parties. In addition to covering all areas included in annual reviews, the mid-term review will assess the implementation status of the project components and institutional and financial arrangements. Prior to the mid-term review, GoPNG (via the PIU) will contract a consultant to review and assess the progress of implementation and prepare the necessary documentation for the review. The review will evaluate progress in reaching project objectives and, if not achieved, identify measures needed to reach objectives. Careful attention will be paid to: (i) the performance of the PFIs in delivery of the RSF component objectives; (ii) project restructuring to deliver overall project objectives; and (iii) the performance of GoPNG in addressing fiduciary responsibilities. This will involve visits by specialists to selected sites for first-hand assessment of executing entities‘ performance. 51 Annex 7: Financial Management and Disbursement Arrangements I. Introduction 1. This report summarizes the financial management arrangements in place for the proposed PNG SME Access to Finance Project. The scope of the work is set out in the ―Financial Management Practices in World Bank-Financed Investment Operations” issued by the Financial Management Sector Board on November 3, 2005 and as further rationalized in the ―Principles Based Financial Management Practice Manual‖ issued by the Board on March 1, 2010. Under the Bank‘s OP/BP 10.02 with respect to projects financed by the Bank, the borrower and the project implementing agencies are required to maintain financial management systems — including accounting, financial reporting, and auditing systems — adequate to ensure that they can provide the Bank with accurate and timely information regarding project resources and expenditures. These arrangements are deemed acceptable if they are capable of correctly and completely recording all transactions and balances relating to the project. In addition, such arrangements are acceptable if they can facilitate the preparation of regular, timely and reliable financial statements and safeguard the projects assets; and are subject to auditing arrangements acceptable to the World Bank. II. Overall conclusion 2. Overall, the financial management system will meet the financial management requirement as stipulated in OP/BP 10.02 subject to implementation of the agreed actions and mitigating measures. 3. In addition to the risk due to the weak overall country control environment the key financial management risk in this project arises from the lack of experience of the implementing agency in the management of donor funded projects. III. Risk Assessment 4. Taking all factors into consideration, the initial Financial Management risk of the project is rated as Substantial which can be reduced to Moderate with the implementation of mitigating measures. The table below details the financial management risk assessment for the program. 52 Type of Risk Risks Summary Comments Residual Condition of Rating and Risk Mitigation Risk Negotiations/ Rating of Effectiveness A. INHERENT RISKS (risk that arises from environment in which Project is situated) Country Level High High PNG has struggled in the The planned new IFMIS with a last ten years to improve revised chart of accounts its PFM but its aligning classification with functioning remains poor international standards, if although the 2009 PEFA implemented as planned will assessment notes a address some of the major number of improvements. weaknesses by providing reliable While the legal basis of information for monitoring PFM is sound and budget execution by the includes a Fiscal Department of Finance and line Responsibility Act there ministries, through reducing data is a general failure to entry inaccuracies and speeding observe rules and a up data reconciliation. general lack of integrity in the budget process. Failure to adequately address corruption by the political elite is also perceived as a significant issue. However there is increasing demand for good governance, promoted by a free press, NGOs and others. Entity Level Substantial Moderate 1. Implementing Entity A short term Financial FM advisor to (DCI) has no experience Management (FM) advisor will be contracted of implementing World be employed at crucial times and commenced Bank project, but it has throughout the project and will employment experience with provide advice on the setting up before implementing other of the accounts, provide capacity disbursement development partner- building for the DCI , prepare a from funded projects (e.g., project operations manual and expenditure China EXIM Bank). Staff work with the internal audit unit category 5. also has some project to develop an internal audit plan financial management for the project funds. experience, with two staff having accounting qualifications (Masters degree). Project Level Substantial Moderate Project Size: US The FM advisor will be equivalent of USD 21.6 employed to set up the million of IDA funding accounting structure for 53 Type of Risk Risks Summary Comments Residual Condition of Rating and Risk Mitigation Risk Negotiations/ Rating of Effectiveness an addition to USD 46.4 components 3& 4 (TA to SMEs million of IFC funds and PIU). Project Complexity: The project has one The IFC will establish and implementing agency administer on behalf of the and four components. GoPNG a trust fund for the The RSF will be purpose of holding funds managed through the concerning the first-loss IFC however as this is coverage under the Risk not a common structure Sharing Facility. An this adds some exemption was sought and complexity to the received for audit of the RSF project. There 5 component of the project. disbursement categories. OVERALL INHERENT Substantial Moderate RISK B CONTROL RISKS (risk that the Project’s financial management system is inadequate to ensure funds used economically and efficiently for intended purpose) 1 Budgeting Substantial (1) DCI needs to strengthen the Moderate Budget preparation is a overall planning and budgeting relatively weak in the system. Training can be GoPNG budget process, provided by the FM Advisor in and hence there is a risk financial planning & budget cost estimates may be preparation. inaccurate. (2) The Bank team and Project staff will work together closely to establish project cost tables for components 3 & 4, detailed work program, and quarterly budgeting for the first 12 months. There is a risk that project DCI will complete and submit a funds will not be proposal to National Planning to incorporated into the ensure project funds are included government budget. in the budget. Bank staff will follow up with DCI to ensure this occurs. 54 Type of Risk Risks Summary Comments Residual Condition of Rating and Risk Mitigation Risk Negotiations/ Rating of Effectiveness 2 Funds Flow Substantial A Trust Instrument is to be Moderate There is a delay in the signed by the Department of setting up of the Finance to enable the opening Designated Account of a Designated Account and causing a delay in the for funds to flow directly to that commencement of account. The flow of funds to the project. Funds are misused from (1) Withdrawal Applications will the designated account. be reviewed by the Department of Treasury, who have experience in this process. (2)Direct payments are likely to be used for the capacity building of financial institutions component. 3 Accounting Substantial (1) The FM advisor will set up Moderate FM Advisor (1) There is currently no the project accounts using appointed and existing adequate spreadsheets. commenced accounting system in (2) Accounts to be maintained work before place within DCI that will separately from the DCI disbursement capture project accounts accounts. from category in a format that meets (3) Monthly Bank 4. IDA requirements. Reconciliations required of project accounts. (4) Intensive Bank FM (2) Financial management supervision of the project in the and accounting first 12 months. procedures may not be (5) FM advisor have additional well understood by all inputs when the first IFR is due involved in and also to assist in the implementation. preparation of financial statements and documentation for the first audit of the project accounts. 4 Internal Controls Substantial (1) The country internal control Moderate DCI uses government procedures will be adopted procedures as outlined in where practicable for project the General Orders, activities but these will be however there is often reviewed by the FM advisor and poor compliance of tailored if necessary to meet internal control specific project requirements. procedures within the (2) An Operational Manual will Dated covenant PNG public service. be prepared by the FM advisor one month after which will include an outline the the employment There is an internal audit project‘s internal controls. of the FM section however this is (3) The FM advisor will work advisor. new and still developing, with the internal audit division to hence while they can develop an internal audit plan for provide some assurance the project. there is still a need for 55 Type of Risk Risks Summary Comments Residual Condition of Rating and Risk Mitigation Risk Negotiations/ Rating of Effectiveness improved capacity within the division. 5 Financial Reporting Substantial (1) Spreadsheets will be used to Moderate Agreed IFRs The Project FM team has record transactions and develop reporting limited experience reports. The structure of these format at producing project accounts and reports will be negotiations. financial reports. developed by the FM advisor. (2) Quarterly Unaudited Interim Financial Reports (IFRs) will be required. The reporting format will be agreed upon at negotiations. 6 External Audit Substantial There are ongoing efforts to Moderate There is a concern about strengthen AGO and building its a quality of the audit capacity under the PFM reform reports and a risk of component of the ECP severe delays in the (Enhanced Corporation production of Project Program) funded by AusAID. units‘ audit reports by the AGO. An exemption was sought and received for audit for the RSF There will not be component, however the adequate independent fiduciary risk will be transferred verification of the RSF to IFC as the trustee to execute funds. the funds. CONTROL RISK Substantial Moderate OVERALL FM Substantial Moderate PROJECT RISK 5. GoPNG will entrust IFC to administer the RSF on behalf of itself for the purposes of the project. IFC will establish and administer a trust fund (or if deemed necessary, sub-trust funds for each PFI) to hold IDA/ GoPNG first-loss contributions. IFC, as part of the World Bank Group, has similar fiduciary requirements and processes as IDA, and has the institutional capacity to observe IDA‘s requirements. On that basis, IFC will be responsible for producing and submitting to IDA and GoPNG financial reports and statements in accordance with WBG trust fund policies and procedures. 6. Specific conditions which ensure that IDA‘s relevant financial management conditions for the use of funds (as well as broader IDA policies) are satisfied will be included in the eligibility criteria for the PFIs and SME loans. Furthermore, arrangements for audit and reporting requirements, as well as the monitoring and evaluation framework, which are included in RSF Framework Agreement, will ensure that IDA‘s institutional requirements in this respect will be observed throughout the implementation of the project. It should be noted that these conditions are already part of the requirements of OP8.30. 7. At the end of the project, at year 14, the IDA amount allocated to the RSF trust fund account that has not been drawn for purposes of covering calls for payment under the risk sharing facilities will be cancelled and returned to IDA. 56 8. Amounts held in the trust fund may be invested and reinvested pending payment of claims under the RSF agreements. The income from such investment and reinvestment shall be retained in the trust fund. Furthermore, income from up-front fees, facility fees and commitment fees paid by PFIs shall be shared between IFC and GoPNG in proportion to the credit risk coverage provided by GoPNG funds and IFC funds in respect of any quarterly period for which such facility fees and charges are paid. Funds, facility fees and charges by PFIs and any income from investment and reinvestment of such funds held in each sub-trust fund comprising part of the trust fund shall be used solely for purposes of satisfying the obligations of GoPNG in respect of the relevant Risk Sharing Agreement, which could include covering the eligible guarantee losses on IDA credit portion of the facility. IV. Country Issues 9. Papua New Guinea‘s legislative and regulatory framework for financial management is robust. There is a standard financial management manual that is maintained by the Ministry of Finance and Standard Financial Management System (―PGAS‖) is used by all public sector agencies. However, the overall financial management control environment, while improving, is still relatively weak due to noncompliant national policies and procedures at line agencies arising mainly from staff capacity issues. The internal audit functions at line agencies are not well developed. The Audit Office‘s capacity is developing, but is hampered by a lack of resources. 10. Although some progress is being made, the perception index rating of corruption by Transparency International is still poor (rated 154 out of 180 countries rated in 2009) due to the perceived culture of ‗patronage‘ (also known as the wantok system40 in Pidgin) and the potential for political interference to adversely impact resource allocation decisions. V. Implementing Agency 11. The Department of Commerce and Industry is a Government Department with over 100 employees. The Department is divided into an Operation section and a Policy and Administration section. It is anticipated project coordinator will be under the Commerce Division in the SME division which comes under the Operational section. The accounts for the project will be maintained by staff from the Administration & Support Services Division, which is under the Policy and Administration section. The advice received from departmental staff is this arrangement will not cause any bottlenecks or issues. However there is a risk of the project coordinator not being able to ensure project accounts are given priority. 12. The DCI currently has some financial management capacity and limited experience in managing funding on government projects using spreadsheets. However there is no experience in managing World Bank financed or other development partner-funded projects which require a withdrawal procedure and management of a designated account. To supplement the capacity within the Ministry and ensure project accounts are given sufficient priority a financial management advisor will be required on a periodic basis throughout the project to assist on the financial management requirements of the project. 40 Literally translated from Pidgin wantok means ―one talk‖, but in reality like most pidgin words its definition encompasses a wide scope. Wantok is a term used to denote a person who is from your family or who is a close, or sometimes not so close, friend. Under this PNG more, a person is obligated to help wantoks if they are in need. This can cause issues for the promotion of competitive private sector behavior because the system promotes nepotism. 57 VI. Budgeting Arrangement 13. The PIU will be required to formulate a budget for components 3 & 4 of the project. There is some experience within the ministry in the preparation of departmental budgets but these are mainly recurrent budgets where no detailed costing from a zero base is required. The Procurement Plan will provide the basis for the budget for the expenditure requiring procurement but additional assistance will be required to ensure accurate costings for the project budget. Staff have experience with monitoring budgets and budget to actual expenditure comparisons will be required as part of the project reporting requirements. Regular reviews of the budget should be done in conjunction with revisions of the procurement plan. 14. While project records will be maintained separately from the DCI accounts the project funds have to be incorporated into the GoPNG budget through a budget bill to Parliament. This will require a submission from the Department of Commerce to the Department of National Planning & Monitoring. VII. Funds Flow & Disbursement Arrangements. 15. A designated account (special account) will be established in Kina at a commercial bank primarily for the costs of components 3 & 4. A trust instrument will be signed by the Ministry for Finance & Treasury to enable funds to flow directly from the World Bank to the project‘s designated account. The ceiling for this account will initially be approx. USD778,000 equivalent (Kina 2.0 million). Direct payments can also be used for larger payments. 16. Component 2, capacity building for financial institutions, will consist of two sub components. Sub-component disbursement will be performance-based and the proposed indicative payment schedules are set out in Annex 4. Disbursement will be subject to meeting agreed deliverables. These will be funded by direct payment. 17. The RSF funds will be held in a trust fund under a trust administration agreement to be entered into between IFC and the GoPNG, on terms and conditions satisfactory to IDA, for the purpose of holding funds to be used to satisfy the GoPNG obligations concerning the first-loss coverage under the RSF. 18. All withdrawal applications will be submitted through the Department of Treasury and include a Statement of Expenditure and supporting documentation as required. Direct payments will require a withdrawal application, invoice, and the relevant performance-based evidence if required from the supplier to enable payment. Before the preparation of the first withdrawal application, the World Bank‘s Financial Management Specialist will provide training on the IDA requirements for project‘s FM and disbursement. 19. RSF funds will be deposited into a trust fund with the IFC funds and managed by the IFC. The project will have 4 expenditure categories as listed below: Category IDA Credit Allocated Percentage of Expenditures to be Financed (inclusive of Taxes) (1) First Loss Coverage for first Participating [USD 5.84 million 100 % of amounts disbursed Financial Intermediary equivalent] SDR 3.71 million 58 (2) First Loss Coverage for subsequent [USD 5.84 million 100% of amounts disbursed Participating Financial Intermediaries (Part 1 of equivalent] the Project) SDR 3.71 million (3) Performance Based Grants to PFIs [USD 1.53 million] 65% of amounts disbursed SDR 0.97 million (4) Goods, consultants‘ services, Training and [USD 8.70 million 100% of amount disbursed Incremental Operating Costs equivalent] SDR 5.54 million TOTAL AMOUNT [USD 21.91 million equivalent] SDR 13.93 million 20. For purposes of this paragraph, the term ―Incremental Operating Costs‖ means incremental expenses incurred by the Project Implementation Unit on account of Project implementation, support and management and reasonably related thereto, including communications, utilities, stationery, and domestic travel costs but excluding salaries of the Borrower‘s civil servants. VIII. Accounting Arrangement 21. The PIU will maintain a separate set of books of account for the project. A financial management advisor will be initially employed to develop the structure of the accounts, provide training to staff and prepare an operations manual; however it is intended staff from the finance section of DCI will maintain the day to day financial records. As this may initially increase the potential risk of inaccurate or incomplete financial records the financial management advisor will be provide additional inputs at strategic times throughout the first year of the project including assistance in the preparation of the first IFR and at the end of the first financial year to assist in the preparation of the project financial reports and documentation for audit. 22. The book of accounts will primarily consist of a cash book and contracts register, however additional records may be maintained as required to meet the needs of management. The accounts will enable reporting by disbursement category, component and activity within the component. The Project will use a spreadsheet to maintain the financial records, as the reporting will not be particularly complex. Monthly bank reconciliations of the Designated Account will be required. The Project accounting arrangements will comply with the IDA Financing Agreement and Government of PNG financial laws and regulations. 23. A project operations manual will be developed by the financial advisor as part of his/her first input. The manual will describe the internal control arrangement, accounting system, including the Project‘s major transaction cycles, fund flow processes, accounting records, supporting documents required to be maintained, financial reporting requirements including the agreed IFR format, accounting processes from the initiation of a transaction to its inclusion in the financial statements, authorization procedures for transactions, financial and accounting policies for the Project, budgeting procedures, 59 financial forecasting procedures, procurement and contract administration monitoring procedures, procedures undertaken for replenishing the Designated Account and auditing arrangements. IX. Internal Controls 24. The DCI uses PNG Government internal control systems, however it was difficult to determine in the initial assessment the extent of compliance with these controls. The PIU and DCI finance staff preparing the project information will where applicable use the Government‘s regular financial rules and procedures that apply to DCI operations, as stated in Public Financial Act. The operations manual will reference the sources of the internal control systems an elaborate where the financial management advisor deems necessary. Any additional controls or IDA requirements specifically for the project will be outlined in the operations manual. 25. The DCI has an internal audit unit, however this section has yet to conduct an in-depth internal audit within the Ministry. The financial management advisor will work with the internal audit unit to prepare an audit plan for the project. In addition the internal audit unit will provide a report incorporated into the Interim Financial Reports (―IFR‖) that outlines any issues that were identified during their review, recommendations and the project‘s actions relating to previously identified recommendations. X. Reporting systems 26. Unaudited IFRs will be prepared by the DCI‘s staff-based on the financial transactions processed through the PIU financial system on a quarterly basis. The financial reports will include an analysis of budgeted versus actual expenditure and budgeted versus expenditure plus commitments for the current period and the cumulative to date by each component and each major activity for components 2,3 & 4. For any material variations an explanation will be provided as part of the reporting requirement. A summary of the actual expenditure by disbursement category will also be included. The IFR will also contain a report from the internal audit unit as outlined in paragraph 25 of this annex. Reports will be presented in Kina except for the disbursement category report which may be shown in USD or SDR. The IFRs will be forwarded to the Bank within 45 days of the end of each calendar quarter. XI. External Audit Arrangements 27. The project‘s annual financial statements will be prepared by the DCI‘s PIU. These will be based on the project‘s IFR. The annual IFR will be subject to a financial audit by the Auditor General‘s Office. The audit shall be accompanied by management letter containing their assessment of the internal controls, accounting system, and compliance with financial covenants in the Financing Agreement, will be submitted to the Bank no later than six months after the end of each fiscal year. 28. The RSF funds will be held by IFC and the trust fund and an exemption was sought and received for the RSF component. Measures to ensure assurance of correct use of funds includes: (i) single audit under the World Bank Group; (ii) annual audited reports of the participating banks with an additional assurance report on the eligibility of the loan claims under the RSF. XII. Financial Management Action Plan 29. A summary of the Financial Management Action Plan is shown below. 60 No. Action Date by which action required Responsible 1. Recruitment of Financial Management Advisor Before disbursement from DCI category 5. 2 Prepare formats of unaudited IFRs that will be By Negotiations DCI & World Bank used for the Project and make them consistent FM Specialist with IDA formats 3 Develop financial operations manual for the Within 1 month of the DCI Financial Project commencement of the Financial Management Management Advisor‘s first input. Advisor XIV. Supervision Plan 30. As the overall risk assessment for this project is substantial, financial management supervision will be provided by the World Bank Financial Management Specialist (―FMS‖) making on-site visits at least three times in the first year and the frequency after that will be modified based on the findings from these supervisions. The initial supervision will include a review of the implementation progress of agreed action plans noted above. In addition the FMS will provide clearance of the TOR for the external audit of the project and review and clear the policies and procedures as incorporated into the FM manual. An annual joint supervision with IFC will be undertaken. 31. Below is the implementation support plan proposed, based on the outcome of the financial management risk assessment. FM activity Frequency Desk reviews Unaudited Interim financial reports review (IFRs) Quarterly Project audit report review Annually On site visits Review of overall operation of the FM system Semiannually, based on the substantial risk rating As needed Monitoring of actions taken on issues highlighted in review of the IFRs and audit reports, auditors‘ management letters, systems audit report, and other reviews Transaction reviews (if needed) On an as-needed basis and in the case of any issue arising Capacity-building support FM training sessions Before Project start and thereafter as needed 61 Annex 8: Procurement Arrangements General 1. Procurement for the proposed project shall be carried out in accordance with the ―Guidelines: Procurement under IBRD Loans and IDA Credits,‖ dated May 2004 and revised October 2006 and May 2010; ―Guidelines: Selection and Employment of Consultants by World Bank Borrowers,‖ dated May 2004 and revised October 2006 and May 2010; and the provisions stipulated in the Legal Agreement". While the Government has been taking actions since 2001 to address country-wide procurement issues through amendments to the 1995 Public Finances Act and the 2005 Financial Instructions, the Procurement Schedule of the Credit Agreement shall include an annex detailing procedures under the national law that are not acceptable to the Bank. The general description of various items under different expenditure categories for the first 18 months are described below and summarized in the attached Procurement Plan. For each contract to be financed by the credit, the different procurement methods, estimated costs, prior review requirements, and time frame are agreed between the recipient and the Bank task team in the Procurement Plan. The Procurement Plan should be a rolling plan that should be updated at least annually or as required to reflect actual project implementation needs and improvements in the institutional capacity of the implementing units. 2. Procurement of Works. Procurement of works is not anticipated under the project, and if any, would be for small works. Procurement of very small works costing below USD50,000 may be awarded based on shopping procedures, by comparing price quotations obtained from several contractors, usually at least three, as defined in paragraph 3.5 of the Guidelines. 3. Procurement of Goods. Goods to be procured under this project include office and information technology equipment, software, furniture, and vehicles. ICB shall be used for procurement of goods estimated to cost USD200,000 or more per contract. NCB may be used for procurement of goods estimated to cost USD50,000 or more but less than USD200,000 per contract where the goods are normally available locally at competitive prices. Shopping may be used to procure goods estimated to cost less than USD50,000 per contract. Specialized equipment and software that are proprietary and obtainable only from one source, subject to prior agreement with the Bank, may be procured though direct contracting method in accordance with paragraph 3.6(c) of the Procurement Guidelines. 4. Goods requirement of the financial intermediaries (FIs) and private sector beneficiaries estimated to cost less than USD 1.00 million per contract, subject to the eligibility requirements as defined in the Guidelines, may be procured according to commercial practices acceptable to the Bank. Pro-forma agreement covering important conditions like evaluation criteria, warranty, and other performance parameters including the Bank‘s Fraud and Corruption and audit right provision shall be included in the procurement documents to be used in the conduct of the procurement process. 5. Selection of Consultants. Consultant services for the project include project management, capacity building and SME training, performance-based technical assistance to institutions in RSF. While Quality and Cost Based Selection (QCBS) will be used for contracts estimated to exceed USD200,000, Quality Based Selection (QBS) and Fixed Budget Selection (FBS) may also be used for consultant services that meet the requirement of paragraph 3.2 and 3.5 of the guidelines respectively. Selection based on Consultants‘ Qualification (CQS) may be used for contracts estimated to cost less than USD200,000 each. Short lists of consultants for services estimated to cost less than USD200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. Services for assignments that meet the requirements set forth in the first sentence of paragraph 5.1 of the Consultant Guidelines may be procured under contracts awarded to individual 62 consultants in accordance with the provisions of paragraphs 5.2 through 5.4 of the Consultant Guidelines. Due to the highly technical nature of the project it is likely that certain small and specialized assignments may, subject to prior agreement with the Bank, be selected through single-source selection of a firm in accordance with paragraph 3.10 of the Consultant Guidelines, or sole source of individual consultants in accordance with paragraph 5.4 of the Consultant Guidelines. 6. Consultant services required by the FI, which will co-share the cost, estimated to cost less than USD1.00 million per contract may be selected according to commercial practices acceptable to the Bank. Pro-forma agreements covering important conditions like evaluation criteria‘ including the Bank‘s Fraud and Corruption and audit right provision, shall be included in the procurement documents to be used in the conduct of the procurement process. However, FIs have the option of using the Bank‘s RFP and selection procedures. Established Private or Commercial Practices for Goods and Consultant Services. 7. To ensure economy and efficiency in the implementation of the project, and transparency in the procurement process, the following are the acceptable private or commercial practices in accordance with Sections 3.12 and 3.13 of the Procurement Guidelines, and Section 3.14 of the Consultants Guidelines. These procedures shall apply for private sector procurement to be carried out by the FIs: (a) Competitive bidding amongst respective FI accredited suppliers and contractors provided that: (i) the accreditation system gives the opportunity for any interested bidder, including foreign bidders to apply for accreditation at any time during the year; (ii) the General Procurement Notice will indicate this arrangement, including an indication of the nature of contracts to be procured; and (iii) the bidding or RFP documents will disclose the criteria for evaluation and award of contract. Competitive bidding shall be used for procurement of goods estimated to cost USD200,000 or more per contract. (b) Shopping or canvass of at least three qualified suppliers or contractors, the selection of which will depend on the nature and/or limitation of supply market of the item to be procured. Shopping may be used to procure goods estimated to cost less than USD200,000 per contract. (c) Direct contracting for items that are proprietary or obtainable from one source provided the contract price is reasonable and in line with prevailing market prices. (d) Use of subsidiary firms or affiliated firms as procurement service provider, provided that said firms apply the above-mentioned acceptable methods and that the service fee or profit markup of these firms are not sourced from the Bank‘s financing. (e) Eligibility requirements as defined in the Guidelines will apply to contractors, suppliers and consultants. Accordingly, the FI contracts should include the World Bank‘s requirements on Fraud and Corruption, audit right, and sanctions/debarment. 8. Operating Costs. Activities relating to managing the project, including staff travel and office utilities, and supporting project operations, based on annual operating cost, will be provided in accordance with existing government prescribed limits and procedures acceptable to the Bank. 9. Advance Procurement Action. The Credit is expected to be presented to the World Bank Board by January 6, 2011 and declared effective by early 2011. To accelerate project implementation, the Department of Commerce and Industry (DCI) proceeded with the initial steps of procurement before 63 signing the related agreement with the Bank. The procurement, including advertising, shall be carried out in accordance with Bank‘s Consultant Guidelines for these contracts and any other procurement that commenced before project effectiveness in order for the contracts to be eligible for Bank financing. The prior review process by the Bank shall also be followed. Assessment of the agency’s capacity to implement procurement 10. The procurement capacity assessment (PCA) conducted at appraisal found that there is limited capacity at Department of Commerce and Industry (DCI) to undertake procurement under a Bank- financed project. DCI, which is the GoPNG agency mandated by law to deal with commerce and industry, has no previous experience with Bank-financed projects. Agency experience is limited to procurement of office equipment and supplies, and consultants‘ services following GoPNG rules. 11. The Bank met with Bank of South Pacific (BSP), one of the four (4) major private financial institutions operating in the country, and a potential financial intermediary under the project. The Mission found the procurement procedures in place in BSP follows the philosophy of ―best value for money‖ through a competitive process. The procedures in place were found to be transparent, efficient, economical and fair in accordance with established private sector practices. In addition, the Mission also conducted an in-depth assessment of the governance, financial performance, credit policy, operational procedures and internal control of BSP. 12. The assessment also found social, cultural and legal barriers for SME lending in PNG, particularly the difficulties with contract enforcement, including threats and harassment by PNG parties wishing to avoid repayment of loans and performance of obligations under a commercial contract. 13. The key issues and risks concerning procurement for implementation of the project have been identified as follows: a. Lack of capacity at the DCI to carry out procurement following the Bank‘s procurement procedures. b. Technical complexity of the project. c. Difficulties with contract enforcement for SME lending. 14. The following corrective measures have been agreed to: (a) A Project Implementation Unit (PIU), with staff in sufficient number and TOR satisfactory to the Bank, including a Procurement Specialist of at least five (5) years of successful experience in handling procurement in a Bank financed project, will be established prior to project effectiveness. The PIU will be mainly responsible for carrying procurement under the project. An interim PIU is now in place and selection of additional staff is in progress. (b) A separate Technical Evaluation Committee (TEC) will be established within DCI. The key staff of the PIU and the members of the DCI TEC will undergo training on the use of Bank‘s procurement procedures immediately after negotiations. (c) Advance procurement in accordance with paragraph 1.9 of the Procurement Guidelines and paragraph 1.12 of the Consultants Guidelines would be implemented for goods required in equipping the PIU and critical consultancy contracts; hence Request for Quotations (RFQ) including technical specifications, and Request for Proposal (RFP) 64 documents and TORs and RFPs should have been drafted prior to effectiveness. Also, the procurement specialist should have been selected by effectiveness. (d) The private sector partner beneficiary agreement for the conduct of competitive bidding acceptable to the Bank shall be a pre-condition to participation to the project. In addition, award of the private sector procurement or commercial practices shall be subjected to Bank‘s post review at a ratio of 1:5. Pro-forma agreement covering important conditions like evaluation criteria including the Bank‘s Fraud and Corruption and audit right provision shall be developed and required for use by the beneficiaries. (e) A detailed review of the first 18-month procurement plan shall be conducted by a technical specialist to ensure that contracts are packaged in an appropriate and optimum manner and then reviewed and cleared by the DPS. Monitoring of progress should be on the basis of the annual procurement plan. In addition to the prior review, post review at a ratio of 1:5 would be carried out. The ratio shall be reviewed and adjusted as required based on the performance of DCI. (f) Project design to center on SME lending and a full section of the PAD will detail on how the risk will be mitigated. Guarantees issued under the RSF will cover up to 50% of net outstanding principal amount of a portfolio of new loans originated by the PFIs. Accordingly, as SMEs in PNG are perceived to be high-risk borrowers and often lack sufficient collateral needed to obtain loans and leases, the RSF will provide banks with credit protection to mitigate the perceived high risk of SME lending. The approximate 50-50 risk sharing, under which participating banks will also be exposed to borrower default, is intended to ensure that PFIs conduct proper borrower credit appraisal and apply strict loan underwriting criteria (including taking proper security) in establishing the loan portfolio. 15. The overall project risk for procurement is high, and subject to implementation of the mitigation measures could be reduced to substantial. Procurement plan 16. The Procurement Plan (PP) developed by the DCI during appraisal provides the basis for the procurement methods. The PP agreed between the DCI, and the Project Team on November 19, 2010 is available at the PIU office in the Commerce Division of the Department of Commerce and Industry of DCI, 2nd Floor Moale Haus, Waigani, Port Moresby, Papua New Guinea. It should also be available in the project‘s database and on the Bank‘s external website. The procurement plan should be updated in agreement with the Project Team, annually or as required, to reflect actual project implementation needs and improvements in institutional capacity. Frequency of procurement supervision 17. In addition to the prior review supervision to be carried out from Bank offices, the capacity assessment has recommended that supervision missions visit the field once a year to carry out post-review of procurement actions. Details of the procurement arrangements involving international competition 18. Goods, Works, and Non-Consulting Services 65 a. Contract packages to be procured following NCB: 1 2 3 4 5 6 Ref. No. Contract Estimated Procureme Review Expected (Description) Cost (USD nt by Bank Bid-Opening Method (Prior / Post) Date SME-G-10-01 Computers / 73,000.00 NCB Prior 14-Apr-11 printers SME-G-10-03 vehicles 57,034.00 NCB Prior 14-Apr-11 b. The first two NCB and those estimated to cost USD100,000 or more per contract, and any ICB and all direct contracting contracts shall be subjected to prior review by the Bank. 19. Consulting Services 1 2 3 4 5 6 Ref. No. Description of Estimated Selection Review Expected Assignment Cost (USD) Method by Bank Proposals (Prior / Submission Post) Date SME-CS-2010-9 TA to Participating 2,400,000.00 QCBS 30-Apr-11 Yes Financial Institutions SME-CS-2010-12 SME Training 760,000.00 QCBS Yes 30-Apr-11 SME-CS-2010-13 SME Mentoring 2,400,627.00 QCBS Yes 30-Jun-11 SME-CS-2010-14 Gender Program 637,000.00 QCBS 30-Jun-11 Yes a. Consultancy services to be provided by firms estimated to cost USD100,000 or more per contract, single-source selection of consultants (firms), and sole-source selection of individuals shall be subjected to prior review by the Bank. b. Short lists of consultants for services estimated to cost less than USD200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions of paragraph 2.7 of the Consultant Guidelines. 66 Annex 9: Economic and Financial Analysis I. Background 1. A large body of literature provides robust evidence that financial development and access to financial services, which this project can achieve, lead not only to income growth, but also to poverty reduction, better health, education, and gender equality outcomes. Empirical finance and growth literature has observed that SMEs in many developing countries face significant financing constraints. World Bank-IFC Enterprise Surveys show that SMEs rank access to finance as one of their top constraints to growth.41 The literature has shown how financial development (i.e., better/easier access to credit) allows enterprises to overcome financing constraints with positive repercussions for investment, innovation, and economic growth. 2. Past impact evaluations of SME financing operations, including RSFs that the World Bank Group has sponsored have been positive; however, there are no past evaluations of SME financing in PNG. As the project supports the acceleration of a process that leads to increased financial access and economic growth, formal quantitative cost-benefit or cost-effectiveness analysis would not capture many of the project's economic benefits. Also, much of the project‘s support is in the form of technical assistance for which it is difficult to establish the causality effect. Therefore, the section measures the expected economic and financial benefits to PNG in quantitative and qualitative terms. 3. Because of the positive impact that targeted financing programs have had for other developing countries, the WBG and GoPNG have partnered to undertake this endeavor (RSF) for the first time in PNG. Financial institutions in PNG have been reluctant to broadly expand lending to the SME market segment because of the following, and so the Project intends to mitigate these factors. (a) High costs and the high risk relative to larger enterprises; (b) Lack of understanding (and accurate/correct risk perceptions) of the SME market, its potential for bankability, and emerging international best practices on SME lending; (c) A mismatch between collateral required by FIs and that held by SMEs; and (d) A limited capacity of SMEs in applying for and utilizing loans. II. Expected Economic Benefits 4. The primary economic benefit from the Project will come in the form of improved access to finance. This should in turn lead to: a) increased production for the SME sector resulting in higher GDP growth, and b) more income-generation/ employment opportunities for the private sector. Both are stated as goals of GoPNG‘s MTDS, and LTDS, as well as the joint Bank-IFC CAS. 5. The Project is expected to benefit different actors in the economy and they are: 41 Analyzing data from all 127 countries in Enterprise Surveys demonstrate that small and medium firms are more constrained than large firms when in accessing financing–23.9 percent of large enterprises listed financing as a major constraints compared to 33.2 percent of small and 28.9 percent of medium firms, differences of 9.3 percent and 5 percent. 67 (a) Government. Analysis of the IDA loan at the government level is not relevant, as the operation is aimed at improving financial intermediation to a specific sector of the economy (SME). The SME sector has proven to be capable of, according to international experience and data, becoming a dynamic force for economic growth and bolstering said sector will help support economic growth. The higher fiscal revenues from better growth outcomes could be expected to reduce fiscal pressures. Additionally, the support the Government will receive from the project in the form of Component 4 is important. The technical assistance will upgrade the Department of Commerce and Industry‘s capacity to implement and monitor the project (as well as improve its ability to coordinate and implement future projects), and, most importantly, its capacity to implement an updated SME strategy and policy.42 Additionally, the support will encourage the creation of baseline data on SME performance to help the Government track SME progress and alter its strategy/ course for development of SMEs if necessary. (b) Participating Financial Intermediaries (PFIs). The benefits include: i) access to new clients; ii) portfolio diversification; and iii) an unique form of capacity building that result in enhanced credit policies and procedures and new profitable SME lending products. (c) Financial Intermediaries (FIs). The benefits include: i) more knowledge of opportunities in the SME sector; and ii) eventually, a more vibrant SME sector to profit from by extending loans. (d) Small and Medium Enterprises (SMEs). The benefits include: (i) access to credit and appropriate financial products; (ii) opportunities for expansion and growth; and (iii) opportunities for capacity building. (e) The public at large. The benefits include: (i) increased credit flows to underserviced firms; (ii) increased access to credit for marginalized groups (especially women entrepreneurs); (iii) increased employment as a result of expanded SME economic activity; (iv) more SMEs joining the formal sector (to gain access to increased credit); and (v) an opportunity for the domestic workforce to further capitalize on extractive industry sector. 6. Improved efficiency of banks in catering to all market segments, specifically SMEs, is an expected benefit. By providing technical assistance to the PFIs, the Project can reduce institutional obstacles that may have previously added to the cost of SME lending. More specifically, the Project can improve the credit culture and risk management systems in the selected financial institutions overall, not just with respect to SME lending. 7. The RSF can change the perception regarding the bankability of SMEs and will lead to expanded and sustainable credit being offered. The project will facilitate credit expansion to SMEs for the PFIs and that will have a demonstration effect (i.e., will prove to the market that lending to the segment can be profitable).43 An IFC study shows that banks that develop strategic focus on the SME sector are reporting income growth rates and high return on assets. As a result the benefit of the RSF is not limited only to the participating FIs and SMEs. 8. Improved eligibility of SMEs to access banks will increase demand for credit. The project will provide capacity building for SMEs. The training will be provided through the PFIs, which are in the 42 The current SME Strategy and Policy is dated September 1998. 43 IFC (2007), ―Benchmarking SME Banking Practices in OECD and Emerging Markets.‖ The study profiled 11 ‗good practice‘ banks and received data from a number of them on income and ROA for operations in small enterprises and medium enterprises. SME operations for these banks were profitable and grew rapidly. In the report, one bank explained, ―SMEs represent 10 percent of our portfolio numbers, but they generate 50 percent of our banking income.‖ 68 best position to know how to help SMEs improve their business skills in accessing credit. This effect is similar to how technical assistance to PFIS/ FIs will improve bank efficiency. 9. The increase in credit will eventually lead to SME business expansion, and ultimately job generation and economic growth.44 The project is expected to enable PFIs to diversify their lending by including a larger segment of the SME market. Literature has established that this shift is good for overall economic growth as SMEs are an important engine of growth and job generation.45 The number of informal SMEs and informal sector employment is much larger than the formal sector in PNG. One aspiration of the Project is that more affordable credit will bring these informal SMEs into the formal sector. This will allow them to grow further, spurring more economic growth, and increasing government fiscal revenues, which could be reinvested into the economy to spur more growth. 10. More equitable development and social stability is a likely byproduct. A particular focus of the Project is on women entrepreneurs. Because of complex social and cultural factors, women are often disenfranchised. Women entrepreneurs have been very successful, primarily in the informal sector. 46 Bringing this previously un-bankable segment of the SME sector into the fold will contribute to economic diversification and social stability. III. Costs and Benefits 11. This section attempts to present a cost benefit analysis which is mostly qualitative. The costs of the project will total USD130.84 million equivalent.47 The components are: a) risk share facility (USD116.73 million); b) technical assistance to PFIs and FIs (USD2.95 million); c) capacity building for SME borrowers (USD5.15 million); and d) support to the GoPNG‘s Department of Commerce and Industry (USD7.44 million). Conducting a standard net present value and internal rate of return analysis for the project is not straightforward. Many of the benefits are not easy to quantify (as seen above), other than making broad estimates of the increases in systemic liquidity, credit, and the ensuing benefits. 12. Some benefits cannot be easily quantified because it is challenging to reasonably measure the direct effects of the different project activities on production and job creation due to the lack of available, concrete baseline data. As such the remainder of the section will focus on costs (RSF) and benefits (to PFIs and SMEs) that can be quantified. 13. Cost of the Risk Sharing Facility (RSF). Of the project‘s components, only the RSF (total USD116.73 million with IDA responsibility at USD11.67 million) and is susceptible to a meaningful NPV analysis. The beneficiaries for this analysis (and of the RSF) are the PFIs/ FIs. As shown in the table below, the NPV of the RSF is positive at USD608.4 million. This means that the project may have the intended effect of demonstrating to FIs in PNG that SME portfolios can be profitable. The assumptions/costs used to in the model are shown in the table below. 44 Job generation and economic growth are the top goals in PNG‘s MTDS and LTDS. 45 Ayyagari, Meghana, Thorsten Beck, and Asli Demirgruc-Kunt. 2007. ―Small and Medium Enterprises across the Globe.‖ Small Business Economics 29: 415-434. 46 Though reliable data are lacking, it is likely that less than 5 percent of SMEs are owned/managed by women; however, women account for about 62 percent of informal SMEs. 47 This does not include interest and commitment fees. 69 Table 1: Net Present Value Analysis of the Risk Sharing Facility Source: Team calculation 14. Benefits to PFIs. The NPV analysis demonstrates the quantitative benefits that PFIs could derive from the Project. The quantified benefits are the substitution of increased amount of credit for informal borrowing, producing a one-for-one increase in borrower incomes. Further benefits, such as the positive impact on incomes from the ability to finance new economic activities and improvements in the supply and pricing of inputs could be substantial but cannot be accurately estimated. The Project will encourage the PFIs, through incentives, to diversify lending away from the current focus on large entities and into SMEs. A portfolio diversification of the banks will lead to broader outreach, employment generation, SME expansion, and overall economic growth. 15. Benefits to SMEs. The benefits of SME borrowers are extremely high because of the substantial difference between the RSF on-lent finance and SME alternative sources of financing (the informal sector or not borrowing at all). Based on the assumptions set in Table 1 above, funds are expected to be on-lent to SMEs at an average rate of 10 percent per year, which is relatively lower than the current borrowing rates in the formal market. The major benefit to SMEs is expected to be increased profitability, which should eventually result in the ability to borrow at an even lower cost to expand business in the future without the RSF. However, this potential is very difficult to quantify. (a) Outreach. It is expected that IDA/ GoPNG‘s contribution of USD11.6 million will generate USD116 million of loans. Based on an assessment conducted during project preparation, the average loan size would be approximately USD58,000 (K150,000). If all USD116 million is disbursed (high case scenario), it is estimated that the Project would create 2,000 additional SMEs active borrowers. If 75 percent of the funds are disbursed (low case scenario), it is estimated that the project would create an additional 1,500 SME active borrowers. 70 (b) Employment generation. Similar to the method used to calculate the outreach in terms of additional active SME borrowers resulting from the RSF, the same can be done for employment generation. It is estimated, based on conservative assessments conducted during the project preparation, that a beneficiary SME would expand employment by 4 to 8 employees. Table 2 illustrates the potential impact the RSF can have on SME and employment generation as well as outreach. Table 2: Potential Outreach and Additional Employment Generation Source: Team calculation 71 Annex 10: Safeguard Policy Issues 1. The potential transactions covered by the RSF are expected to have environmental or social risks associated with them that are readily identified and addressed by the application of IFC Performance Standards and World Bank Group Environmental Health and Safety Guidelines. However, it is recognized that there are SME activities in which the environmental and social risks could be significant and require commensurate assessment and management, e.g., labor and working standards, inappropriate disposal of wastes from food processing facilities, or unhealthy or hazardous working conditions. Therefore, the following is proposed for the RSF component, based on precedents agreed during the preparation of other RSFs (e.g. Cambodia). 2. A model Environmental and Social Risk Management Operations Manual (―EOM‖) which will apply to all RSF activities has been adopted by PNG and reviewed and approved by IDA and IFC environmental and social specialists on the project team. This manual has been adopted by GoPNG prior to appraisal and publicly disclosed (in InfoShop and the Public Information Center in PNG) prior to Board consideration. IFC has incorporated an appropriate disclosure statement in its Summary of Project Identification (SPI), which was publicly disclosed 30 days prior to Board consideration. The principles set out in the EOM must be adopted and implemented by each PFI. Accordingly, each PFI will be responsible for preparing a SEMS that is consistent with the approach to environmental and social risk management as described in the EOM, and that is acceptable to IFC and IDA. Evidence of satisfactory implementation of the SEMS will be a condition of IFC Commitment to each PFI RSF. 3. The project triggers OP 4.01 (Environmental Assessment). Although it is unlikely that the project will include subprojects that involve involuntary resettlement or impacts on indigenous peoples, the IDA team has decided to trigger these policies (OP 4.12 and OP 4.10) and incorporate procedures in the EOM for collaboration between the IFC/ IDA team and the PFI as noted below. 4. The SEMS prepared by each PFI will be reviewed by IFC and IDA specialists to confirm that it requires PFI staff to contact as soon as possible IFC staff if a prospective Category A transaction is indentified in the screening process, or if a loan application may involve land acquisition, physical displacement of people or restrictions on their livelihoods, or direct impacts on vulnerable ethnic groups or their traditional lands. IFC environmental and social specialists will then engage with IDA counterparts to ensure that requirements of both institutions are met prior to loan processing by the PFI, as is described in the EOM. Furthermore, IFC and the IDA would have the right to not agree to include loan application under the RSF if it is decided that the risk is unacceptable to the WBG. 72 Safeguard policies Safeguard Policies Triggered by the Project Yes No Environmental Assessment (OP/ BP 4.01) [X] [] Natural Habitats (OP/ BP 4.04) [] [X] Pest Management (OP 4.09) [] [X] Indigenous Peoples (OP/ BP 4.10) [X] [] Physical Cultural Resources (OP/ BP 4.11) [] [X] Involuntary Resettlement (OP/ BP 4.12) [X] [] Forests (OP/ BP 4.36) [] [X] Safety of Dams (OP/ BP 4.37) [] [X] Projects on International Waterways (OP/ BP 7.50) [] [X] Projects in Disputed Areas (OP/ BP 7.60)* [] [X] * By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on the disputed areas 73 Annex 11: Project Preparation and Supervision Planned Actual PCN review 03/02/2010 Initial PID to PIC 04/28/2010 Initial ISDS to PIC 04/28/2010 Appraisal 04/12/2010 11/17/2010 Negotiations 11/23/2010 11/23/2010 Board/ RVP approval 5/03/2011 Planned date of effectiveness 05/28/2011 Planned date of mid-term review 05/28/2013 Planned closing date 12/31/2024 Key institutions responsible for preparation of the project: Bank staff and consultants who worked on the project included: Name Title Unit Hamid Alavi Senior PSD Specialist, Task Team Leader EASFP Matthias Hedinger Senior Investment Officer, co-TTL IFC Mark Walker Chief Counsel LEGES Hanneke Van Tilberg Senior Counsel LEGES Harvey Van Veldhuizen Lead Environmental Specialist OPCQC Martin Habel Senior Financial Officer IFC Victoria Florian S. Lazaro Senior Social Development Specialist EASPS Glenn Jessee Principal Counsel IFC Gavin Murray Regional Manager IFC Thao Le Nguyen Senior Finance Officer CTRFC Robert O‘Leary Senior Finance Officer CTRFC Maxwell Aitken SME Development Specialist/Consultant EASFP Carolyn Blacklock SME Development Specialist/Consultant IFC Peter Cusak Country Coordinator IFC Luc Vaillancourt Senior Business Development Specialist IFC Tracy Le Business Development Specialist IFC Neil Sood Junior Professional Associate EASFP Katie Shaw Program Assistant EASFP Lynn Gross Program Assistant EASPR Michael Figueroa Information Assistant EASFP Cristiano Nunes Procurement Specialist EAPPR Noel Sta. Ines Senior Procurement Specialist EAPPR Stephen Hartung Senior Financial Management Specialist EAPFM Antonio Ollero Economist EASPR Wei Zhang Financial Sector Specialist EASFP James Lacey Senior Banking Specialist/Consultant EASFP Zhenfang Shi Senior Environment Specialist IFC 74 Bank funds expended to date on project preparation: 1. Bank resources: USD408,673.40 2. Trust funds: 0 3. Total: USD408,673.40 Estimated Approval and Supervision costs: 75. Remaining costs to approval: USD50,000 76. Estimated annual supervision cost: USD75,000. 75 Annex 12: Documents in the Project File Asian Development Bank (2010), ―Asian Development Outlook 2010.‖ Asian Development Bank (2008), ―Foundation for the Future: A Private Sector Assessment for Papua New Guinea.‖ Australian National University, The (2010), ―Pacific Economic Bulletin.‖ Volume 25. Number 1. Biggs, Peter (2008), ―The Financial Sector in Papua New Guinea: A Good Case of Reform.‖ Australian Treasury. Blacklock, Carolyn (2010), ―PNG SME Definition & Market Snapshot.‖ IFC. Exxon Mobil (2009), ―Papua New Guinea LNG Project: National Content Plan.‖ IFC (2010), ―PNG Gender & Investment Climate Reform Assessment.‖ IFC-IDA (2009), ―Task Force Report: Review of the Use of IDA Funds for Risk Sharing Facilities and Partial Credit Guarantee Projects.‖ The World Bank. Independent State of Papua New Guinea (2010), ―The Long Term Development Strategy 2011-2030.‖ Independent State of Papua New Guinea (2004), ―The Medium Term Development Strategy 2005- 2010: Our Plan for Economic and Social Advancement.‖ Independent State of Papua New Guinea‘s Ministry of Trade and Industry (1998), ―Small and Medium Enterprise (SME) Policy.‖ Kendall, Jake, Mylenko, Nataliya, and Ponce, Alejandro (2010), ―Measuring Financial Access Around the World.‖ Policy Research Working Paper 5253. The World Bank. Simavi, Sevi, Manuel, Claire, and Blackden, Mark (2010), ―Gender Dimensions of Investment Climate Reform: A Guide for Policy Makers and Practitioners.‖ The World Bank. World Bank, The (2010), ―Emerging Stronger from the Crisis.‖ East Asia and Pacific Economic Update. Volume 1. World Bank, The (2007), ―Country Assistance Strategy for Papua New Guinea.‖ 76 Annex 13: Statement of Loans and Credits PAPUA NEW GUINEA: Small and Medium Enterprise Access to Finance Project Difference between expected and actual Original Amount in USD Millions disbursements Project ID FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Frm. Rev‘d P107782 2011 PG: Rural Communications Project 0.00 15.00 0.00 0.00 0.00 15.35 0.00 0.00 P110959 2010 PNG Productive Partnerships in Agr. 0.00 25.00 0.00 0.00 0.00 25.05 0.00 0.00 P079140 2008 PNG-Smallholder Agriculture Development 0.00 27.50 0.00 0.00 0.00 25.76 5.12 0.00 P102396 2008 PG Mining Sector Inst Strengthening TA 2 0.00 17.00 0.00 0.00 0.00 14.81 -1.39 0.00 P004397 2002 PG-ROAD MAINT. & REHAB 40.00 37.31 0.00 0.00 0.03 16.46 -21.99 15.32 Total: 40.00 121.81 0.00 0.00 0.03 97.43 - 18.26 15.32 PAPUA NEW GUINEA STATEMENT OF IFC’s Held and Disbursed Portfolio In Millions of US Dollars Committed Disbursed IFC IFC FY Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. Approval FY07 PNG Microfinance 2.00 1.20 1.02 Limited FY09 ECOM Agroindustrial 4.00 4.00 Corporation Ltd (Regional incl. PNG) (for PNG - (for PNG - out of out of 55.00 55.00 total) total) FY09 Kula Fund II Ltd 4.00 3.09 (Pacific incl. PNG) (Pacific/PNG) (Pacific/PNG) FY10 Digicel PNG Ltd 80.00 80.00 FY10 KK Kingston Limited 3.93 3.61 FY10 Bank South Pacific 30.00 88.40 85.70 Limited Total portfolio: 116.00 97.53 0.00 0.00 84.00 93.42 0.00 0.00 Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic. 2005 PNG MicroFinance 0.00 0.00 0.00 0.00 Total pending commitment: 0.00 0.00 0.00 0.00 77 Annex 14: Country at a Glance 78 79 Annex 15: Map 80 142°E 144°E 146°E 148°E 150°E 152°E 0° PAP UA NEW 0 100 200 Kilometers G UINEA SO UT H PA CIFIC O CEA N SELECTED CITIES AND TOWNS 0 50 100 150 Miles PROVINCE CAPITALS Mussau MANUS Island NATIONAL CAPITAL NEW RIVERS 2°S Lorengau IRELAND Admiralty Momote MAIN ROADS Islands Kavieng Vanimo PROVINCE BOUNDARIES Bismark INTERNATIONAL BOUNDARIES Arc New Ireland Aitape hip Laefu el ag Lumi Wewak o Namatanai 156°E SANDAUN Maprik Bismark Sea 4°S Angoram 4°S Ambunti Rabaul Sepik Awar INDO NES I A IA EAST MADANG SEPIK WEST BOUGAINVILLE Cen WESTERN Maliom tral Range N E W B R I TA I N Nantamba Lemankoa is B HIGHLANDS Tabubil ENGA m a r Ra Madang Gloucester Talasea Ewase Wabag k R Koroba mu North Mount Hagen a ng Mt. Wilhelm Saidor Kimbe Hoskins EAST Solomons Tari e (4509 m) 6°S Kiunga Goroka N E W B R I TA I N 6°S Strickland Mendi Kundiawa Sialum Arawa Kainantu New Britain U SOUTHERN I MB EASTERN Nadzab Kandrian Aropa HIGHLANDS CH ur HIGHLANDS Lae Finschhafen P Kik ari Buin Lake o ri Murray MOROBE Ara Kikori Bulolo Wau S ol om on S OL OM ON WESTERN m ia Sea Morobe I S L AN DS 8°S Kerema 8°S Fly Balimo To Merauke Weam GULF NORTHERN Trobriand Bereina Popondetta Losuja Island Morehead Woodlard Kokoda Goodenough Island Sibidiri Daru Gulf o f PORT O Island Bula Papua MORESBY we Kulumadau n Wanigela Fergussson Sta Island NATIONAL nle CAPITAL y R Esa’ala D’Entrecasteaux an PAPUA NEW 10°S Kupiano ge Normandy Islands GUINEA Island Ar a f ur a C o r al Sea CENTRAL Abau Alotau MILNE Misima Island Sea Samarai B AY Bwagaola This map was produced by the Map Design Unit of The World Bank. The boundaries, colors, denominations and any other information Rossel shown on this map do not imply, on the part of The World Bank Island FEBRUARY 2005 Group, any judgment on the legal status of any territory, or any IBRD 33463 A US TR ALI A endorsement or acceptance of such boundaries. Tagula Island 12°S 12°S 142°E 144°E 146°E 148°E 150°E 152°E 154°E 156°E