Report No. PID11210 Project Name Mexico-Urban Microbusiness Region Latin America and Caribbean Region Sector Privatization Project ID MXPE68290 Implementing Agency Nacional Financiera (NAFIN), S.N.C. Address: Insurgentes Sur, 1971, Mexico D.F. Tel: 52-5-325-6000 Fax: 52-5-325-7097 Environment Category C Date PID Prepared May 17, 2002 Auth Appr/Negs Date February 11, 2002 Bank Approval Date June 15, 2002 1. Country and Sector Background Mexico is currently among the most economically unequal countries in the world. Source: World Development Indicators, The World Bank, 2001. The productive sector continues to be characterized by a dual structure that seems to have become increasingly differentiated in the wake of trade liberalization and the banking crisis of the 1990s. While Mexico has a dynamic export sector made up of internationally competitive conglomerates experiencing a boom in trade, the export base has remained rather narrow and concentrated in few larger firms. Its poor integration with the domestic economy, which is constituted mainly by micro and small businesses, is reflected in the fact that only 4t of inputs to the export sector are provided by local Mexican firms. Much of this inequality falls in urban areas. Three-quarters of Mexico's population live in cities. The Federal District (D.F.), alone, has an estimated 8.6 million people within District limits. A total of nearly 22 million people live in the Mexico Valle, or about 25t of the nation's total urban population. Intermediate cities (each between 0.5 and 4 million persons) grew at more than 3t per annum over the last decade and now account for nearly 40t of the urban population. Eighty-five percent of the country's GDP is produced in urban areas, where nine-tenths of GDP growth was also generated over the last decade. Cities are also where two-thirds of the country's poor live. Today, 35 million poor individuals live in cities and account for 64t of the country's total poor; about 12 million of these are the country's extreme poor. From an regional perspective, 55t of the urban poor are found in the Federal District and the country's Central Region, including Jalisco, Michoacan, Mexico, Puebla and Veracruz. Within cities, the poor tend to be concentrated in informal settlements on the outer rings of growing agglomerations, and over half of the urban poor work in the informal sector. In these areas, female-headed households absent other adults, poor youth at risk, and crime and violence are particularly evident. Integrating them progressively into the formal economy and improving their earning abilities and quality of life are essential elements to reducing poverty rates and making cities more competitive and livable for all. 2. Objectives The Project would support the increased competitiveness and growth of micro and small businesses (MSBs) in poor urban areas of Mexico. The definition of MSBs for Project purposes is that used by the Government's statistical institute, INEGI, which is based on the number of firm employees: microbusinesses are those where entrepreneurs are self-employed or have up to 15 employees; small businesses are those with 16-100 employees. The Project's specific development objectives would to (i) expand financial services and business development services markets for MSBs, and (ii) reduce the transaction costs of public sector requirements to establish and operate MSBs. 3. Rationale for Bank's Involvement The Government and NAFIN view the Bank's main role as helping to (i) leverage existing programs by increasing analytical work, cross-country experience and internal dialogue on key MSB policy and institutional development issues, (ii) ensure that the MSB agenda is closely linked with social objectives, and that policy/institutional analyses and program development incorporate the interests of a wide spectrum of socio-economic groups in Mexico, and (iii) help to strengthen NAFIN programs by emphasizing market development of services and deepening public-private cooperation in program implementation. 4. Description The proposed Project would contain the three components aimed to substantially increase access to sustainable financial and business development services, and to improve the business climate for microbusiness investment and operation. (l)Build MSB financial markets (la) Capacity-building for MSB lending - short-term techincal assistance course, seminars on best practice toos & materials, exchanges, Institutional Development Matching Grants & Innovation Grants to help expand MSB lending institutional capacity for at least 15 non-bank and banking institutions. (lb) Credit program for MSB lending- Expand outreach & sustainability among non-bank & commercial banking institutions meeting Project eligibility criteria & committed to institutional development programs to build MSB lending. (2) Build MSB business development services markets (2a) Competitiveness learning & innovation program - (a) establisha temporary Program to provide (i) promotion to MSBs on BDS uses & benefits, (ii) continous technical assistance to firms on developing & implementing competitiveness plans, (iii) a 50-50 matching grant window for small business based on individually approved competitiveness plans, and (iv) an 80-20 matching voucher window for low-income microbusinesses; and (b) a Program client assistance and management contract to implement the Program; (2b) BDS innovation pilot: demonstrate broad outreach & sustainability in ICT-based BDS services and delivery technical services, equipment & works to build on existing initiatives a prototype network of ICT-based business development centers providing skills-appropriate business training, product marketing, & information technology services; (2c) BDS innovation pilot - MSB youth apprenticheships for employment promotion - technical services to demonstrate mechanisms to facilitate the transition from unemployment to work through integrated processes of counseling, job preparation, and on-the-job apprenticeships in MSBs. -2 - (3) Improve MSB Investment & operating climate (3a) G2MSB program to reduce barriers to business formation and operations - technical assistance, equipment & works to re-engineer and deliver electronically government services associated with business registration, licensing and permits, labor and tax ragulations, zoning restrictions and the like. (4) Management Unit (operational expenditures) 5. Financing Total ( US$m) BORROWER $9.10 IBRD $75.00 IDA NON-GOVERNMENT ORGANIZATION (NGO) OF BORROWING COUNTRY $22.80 Total Project Cost $106.90 6. Implementation 1. The Project would be implemented by NAFIN. Understandings for program implementation, coordination with related programs and budgetary issues would be covered under an Implementation Agreement between the Ministry of Economy and NAFIN. Additional understandings would be reached using existing instruments [to be defined] between NAFIN's Headquarters and its regional offices for their role in specific implementation. Day-to-day management of the Project would be performed by NAFIN's Technical Assistance Department. NAFIN has developed a sound management capacity for this purpose, including with respect to Bank procurement and financial management practices, through considerable experience in collaboration with the Bank in the execution of other Bank-financed projects. NAFINs Technical Assistance Department is also managing the Bank-financed Southeast Regional Development LIL Project, now in its start-up phase. NAFIN would utilize its existing Project Management Unit (PMU) for the LIL, operating under the responsibility of its Deputy Director General for Business Development, to implement the proposed Project utilizing separate dedicated personnel. The Unit would assign at NAFIN headquarters a dedicated core team consisting of a Project Manager, 1 Program Manager and institutional development specialist for the financial services (second-tier administration of the credit program would be performed by NAFIN's existing departmental services); 1 Program Manager for business development services, 1 Program Manager for the investment climate component, an Administrative Manager, a Procurement Specialist, and 4 support staff. Since it is critical that the Management Unit be fully operative from the start of Project implementation, the staffing of this core team in the Unit, satisfactory to the Bank, would be a condition of loan effectiveness. NAFIN would recruit specialized contractors under Bank Guidelines for the BDS component, whose operating staff would be assigned to NAFIN branch offices, initially in the six initial areas of the Federal District (Mexico City), Jalisco, Mexico, Michoacan, Puebla and Veracruz. 7. Sustainability 1. Mexico's government at the highest levels has voiced its strong commitments which, along with the continuity in the private sector's involvement throughout the preparation process, will help to ensure -3 - sustained momentum under the implementation phase of the Project and of meeting its institutional development goals. The design of the business climate reforms and institutional improvements closely conforms to the Government's E-Mexico initiatives and has strong internal support both within the Federal Government and at many state levels. 2. For the MSB financial markets component, the level of sustainability of participating financial intermediaries will be a key eligibility criterion. This will be measured by the percentage of operating expenses (adjusted for subsidies and the effects of inflation) covered by operating income from interest, fees and commissions (see Annex 2 for description of four institutions that meet this criterion). 3. The Competitiveness Learning and Innovation Program is not intended to be sustained. It has a defined exit policy, deliberately making it a temporary one-time efforts to reduce market failures. However, experience elsewhere with mechanisms of this kind show that they are likely to create three sustainable effects: (i) having helped firms to meet the usually high costs of pre-commercial learning, particularly for entry into the export market, they encourage a durable commitment to new markets as long as operating costs are covered; (ii) having introduced firms to the benefits of using business development services, firms tend to recognize their full value and no longer need subsidies to motivate their use; and (iii) they encourage development of a local market of entrepreneurial learning and businesses support. 8. Lessons learned from past operations in the country/sector Commercial approach to small business and microfinance. Traditionally, government intervention to promote micro- and small businesses This section based upon "Small and Medium Scale Enterprises: A Framework for Intervention", by Kristin Hallberg, The World Bank, May 1999. has focused on the provision of credit through various means -- direct lending through first-tier development banks, second-tier credit facilities channeled through banks and other financial institutions, and portfolio requirements - often supplemented by credit guarantee schemes. Subsidized interest rates and guarantees were common in the past and continue to be used in many countries, reflecting the narrow (likely erroneous) view that the high cost of credit is the main constraint facing smaller businesses. Directed and subsidized credit programs have done little to achieve what should be their fundamental objective: increasing the access to financial services. They inhibit the development of sustainable financial institutions and often foster a "non-repayment culture" among enterprises, rather than generating credit histories for good clients. In the component design, commercial principles will be applied to insure that pricing of the credit line does not become a disincentive to savings mobilization, and that sustainable financial institutions are supported. In the MSD financial markets component, the only subsidy will be in the form of a one-time institutional development matching grant for capacity building activities related to the expansion and decentralization of financial operations. Demand-driven private sector BDS. In addition to credit, governments and donors have often provided BDS through public institutions or nongovernmental organizations. These include training to labor and management; extension, consultancy, and counseling; marketing and information; technology development and diffusion; and efforts to improve business linkages through subcontracting, franchising, and business clusters. There is broad consensus among many supporters that publicly-provided BDS often suffer from being too general and supply-driven, of poor quality, with insufficient awareness of cost - 4 - control. The types of products and delivery mechanisms offered by donors and public institutions may also not be consistent with the needs and willingness-to-pay of MSBs. Instead, a more market-oriented strategy is needed which focuses on increasing MSB access to markets - for the goods and services that micro- and small businesses produce (both domestic and export); for inputs used by such businesses (including information, technology, and competitively-priced materials); and for a diverse range of financial services and BDS which support business growth and competitiveness. MSBs need different types of BDS, institutions and delivery mechanisms than larger firms. The government can accelerate market development by promoting supply innovation and building institutional capacity that encourages the development of private markets for services, and by rationalizing public expenditure on business assistance programs to reduce their distorting effects. 9. Program of Targeted Intervention (PTI) Y 10. Environment Aspects (including any public consultation) Issues The Project would consist primarily of firm-level technical assistance, institution-building among financial service and business services providers, and regulatory changes at the municipal level in regard to formalization of business. Based upon past experience elsewhere, the CLIP is likely to include support to MSBs in the acquisition of internationally recognized certification systems for environmental protection, such as ISO 14,000. Regarding the MSB Financial Services Component, MSBs would not be eligible for financing if they are involved in the production or processing of tobacco products, operate tanneries or other businesses that could cause a negative impact on the environment, or use pesticides or other inputs which are not approved by the World Health Organization (this negative list of subproject investments would be patterned after the one already developed and approved for the Southeast Regional Development Project under implementation with NAFIN). However, the Project would include provisions and activities [to be agreed ata appraisal] which incorporate awareness campaigns, dissemination of good practices and training which enable financial institutions participating under the Project to promote environmental improvements as part of the investments of MSBs financed by the Project and to carryout environmental due diligence accordingly. 11. Contact Point: Task Manager James C. Hanna The World Bank 1818 H Street, NW Washington D.C. 20433 Telephone: 202 473 19 72 12. For information on other project related documents contact: The InfoShop The World Bank 1818 H Street, NW Washington, D.C. 20433 Telephone: (202) 458-5454 -5- Fax: (202) 522-1500 Web: http:// www.worldbank.org/infoshop Note: This is information on an evolving project. Certain components may not be necessarily included in the final. This PID was processed by the InfoShop during the week ending May 24, 2002. - 6 -