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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY PROJECT APPRAISAL DOCUMENT ON A PROPOSED LOAN IN THE AMOUNT OF EURO 37.9 MILLION (US$50 MILLION EQUIVALENT) TO THE KINGDOM OF MOROCCO FOR A MICRO, SMALL AND MEDIUM ENTERPRISE DEVELOPMENT PROJECT (APL 2) Report No: MA AS PART OF THE MICRO, SMALL AND MEDIUM ENTERPRISE FACILITY FOR THE MIDDLE EAST AND NORTH AFRICA REGION ADAPTABLE PROGRAM LENDING (APL) Finance and Private Sector Development Group Middle East and North Africa Region June 8, 2012 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.

2 CURRENCY EQUIVALENTS (Exchange Rate Effective April 30, 2012) Currency Unit = Moroccan Dirham (MAD) 1 Euro = US$ US$ = EUR US$ = MAD FISCAL YEAR January 1 December 31 ABBREVIATIONS AND ACRONYMS AfDB ANPME APL AWB BAM BCP BMCE BMCI CCG CGEM CPM CPS DPL DSB EFI ESMF ESSU EUR FM FSD FY GCC GDP IBRD ICA IFC IMF M&E MAD MENA MFI MIS MoEF MSME NBFI OM ORAF PAD African Development Bank National Agency for the Promotion of SMEs Adaptable Program Loan AttijariWafa Bank Bank Al-Maghrib (Central Bank of Morocco) Banque Centrale Populaire Banque Marocaine du Commerce Extérieur Banque Marocaine du Commerce et de l'industrie Caisse Centrale de Garantie General Confederation of Enterprises in Morocco Credit Populaire du Maroc Country Partnership Strategy Development Policy Loan Banking Supervision Department (Central Bank of Morocco) Eligible Financial Institution Environmental and Social Management Framework Environmental and Social Screening Unit Euro Financial Management Financial Sector Development Fiscal Year Gulf Cooperation Council Gross Domestic Product International Bank for Reconstruction and Development Investment Climate Assessment International Finance Corporation International Monetary Fund Monitoring and Evaluation Moroccan Dirham Middle-East and North Africa Microfinance Institution Management Information System Ministry of Economy and Finance Micro, Small and Medium Enterprise Non-Bank Financial Institution Operations Manual Operational Risk Assessment Framework Project Appraisal Document

3 PCG PDO PEFA PFI PIE PIU SGMA SME SOE TA TOR UAB UIFR USD VSE WB Partial Credit Guarantee Project Development Objective Public Expenditure and Financial Accountability Participating Financial Institution Project Implementing Entity Project Implementing Unit Société Générale Maroc Small and Medium Enterprise Statement of Eligible Expenditures Technical Assistance Terms of Reference Union of Arab Banks Unaudited Interim Financial Reports United States Dollar Very Small Enterprise World Bank Regional Vice President: Country Director: Regional Strategy and Programs Director: Sector Director: Sector Manager: Task Team Leader: Inger Andersen Simon Gray Jonathan Walters Loic Chiquier Simon C. Bell Teymour Abdel Aziz

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5 KINGDOM OF MOROCCO MICRO, SMALL AND MEDIUM ENTERPRISE (MSME) DEVELOPMENT PROJECT TABLE OF CONTENTS I. STRATEGIC CONTEXT... 1 A. Country Context... 1 B. Sectoral and Institutional Context... 3 C. Higher Level Objectives to which the Project Contributes... 6 II. PROJECT DEVELOPMENT OBJECTIVES... 7 A. PDO... 7 Project Beneficiaries... 8 PDO Level Results Indicators... 8 III. PROJECT DESCRIPTION... 9 A. Project Component B. Project Financing Lending Instrument Project Cost and Financing IV. IMPLEMENTATION A. Institutional and Implementation Arrangements B. Results Monitoring and Evaluation C. Sustainability V. KEY RISKS AND MITIGATION MEASURES A. Risk Ratings Summary Table B. Overall Risk Rating Explanation VI. APPRAISAL SUMMARY A. Economic and Financial Analyses B. Technical C. Financial Management D. Procurement E. Social (including Safeguards) F. Environment (including Safeguards) G. Other Safeguards Policies Triggered Page ANNEXES ANNEX 1: RESULTS FRAMEWORK AND MONITORING ANNEX 2: DETAILED PROJECT DESCRIPTION ANNEX 3: IMPLEMENTATION ARRANGEMENTS ANNEX 4: OPERATIONAL RISK ASSESSMENT FRAMEWORK (ORAF) ANNEX 5: SME FINANCE IN MOROCCO ANNEX 6: CAISSE CENTRALE DE GARANTIE ANNEX 7: IMPLEMENTATION SUPPORT PLAN ANNEX 8: COUNTRY AT-A-GLANCE... 44

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7 .. PAD DATA SHEET Kingdom of Morocco Micro, Small and Medium Enterprise (MSME) Development Project (P129326) PROJECT APPRAISAL DOCUMENT MIDDLE EAST AND NORTH AFRICA MNSF1 Basic Information Date: 08-Jun-2012 Sectors: SME Finance (50%), Microfinance (50%) Country Director: Regional Strategy and Programs Director: Simon Gray Jonathan D. Walters Sector Manager/Director: Simon C. Bell/Loic Chiquier Project ID: P EA Category: Lending Instrument: Team Leader(s): Joint IFC: Yes Borrower: Kingdom of Morocco Adaptable Program Loan Teymour Abdel Aziz Responsible Agency: Caisse Centrale de Garantie Themes: Micro, Small and Medium Enterprise support (100%) F - Financial Intermediary Assessment Contact: Centre d'affaires, Boulevard Ar Ryad, Rabat Title: General Director Telephone No.: dg@ccg.ma Project Implementation Period: Start Date: 01-Jul-2012 End Date: 30-Jun-2017 Expected Effectiveness Date: Expected Closing Date: 01-Oct Dec-2017 Project Financing Data(US$M) [ X ] Loan [ ] Grant [ ] Other [ ] Credit [ ] Guarantee For Loans/Credits/Others Total Project Cost (US$M): Total Bank Financing (US$M): Financing Source Amount(US$M) Borrower 0.00 International Bank for Reconstruction and Development Total i

8 Expected Disbursements (in USD Million) Fiscal Year Annual Cumulative Project Development Objective(s) To improve access to finance for MSMEs in Morocco Components Component Name Cost (USD Millions) Support the provision of Partial Credit Guarantees Policy Compliance Does the project depart from the CAS in content or in other significant respects? Yes [ ] No [ X ] Does the project require any waivers of Bank policies? Yes [ ] No [ X ] Have these been approved by Bank management? Yes [ ] No [ ] Is approval for any policy waiver sought from the Board? Yes [ ] No [ X ] Does the project meet the Regional criteria for readiness for implementation? Yes [ X ] No [ ] Safeguard Policies Triggered by the Project Yes No Environmental Assessment OP/BP 4.01 Natural Habitats OP/BP 4.04 Forests OP/BP 4.36 Pest Management OP 4.09 Physical Cultural Resources OP/BP 4.11 Indigenous Peoples OP/BP 4.10 Involuntary Resettlement OP/BP 4.12 Safety of Dams OP/BP 4.37 Projects on International Waterways OP/BP 7.50 Projects in Disputed Areas OP/BP 7.60 Legal Covenants Name Recurrent Due Date Frequency Institutional Arrangements X Monthly Description of Covenant Borrower to cause the Project Implementing Entity (PIE) to carry out the Project through the Project Implementing Unit (PIU) and Environmental and Social Screening Unit (ESSU) and in accordance with the Project Agreement, Operations Manual (OM), Environmental and Social Management Framework (ESMF) and not to amend the same, and to maintain the PIU and ESSU Name Recurrent Due Date Frequency Subsidiary Agreement Description of Covenant 01-Oct-2012 Borrower to make loan proceeds available to PIE under Subsidiary Agreement under terms and conditions acceptable to the World Bank X X X X X X X X X X ii

9 Name Recurrent Due Date Frequency PCG Issuance X Monthly Description of Covenant Selection of Eligible Financial Institutions (EFIs), MSMEs, Sub-loans, and Sub-projects, and issuance of Partial Credit Guarantees (PCGs) in accordance with the ESMF, OM, Loan Agreement and Project Agreement Name Recurrent Due Date Frequency Safeguards X Monthly Description of Covenant Borrower and PIE to comply with ESMF and exclusions listed therein Name Recurrent Due Date Frequency Mid-term Review Description of Covenant Carrying out of mid-term review and preparation of reports before and after such review 31-Mar-2015 Name Recurrent Due Date Frequency PCG Account X Monthly Description of Covenant Maintenance of the PCG Account and ensuring that loan proceeds are made in and out of said account Name Recurrent Due Date Frequency PCG Account Description of Covenant 30-Jun-2017 Reaching agreement on the use of loan proceeds prior to the closing date for funds remaining in the PCG Account at closing Conditions Name Subsidiary Agreement Description of Condition The Subsidiary Agreement has been executed on behalf of the Borrower and the PIE Name Operations Manual Description of Condition Type Effectiveness Type Effectiveness The Project Operations Manual, satisfactory to the World Bank, has been finalized and adopted by the Borrower and the PIE Name Partial Credit Guarantee Account Description of Condition Type Effectiveness The Borrower has provided satisfactory evidence that the PIE has established the PCG Account referred to in Section I.G. of Schedule 2 of the loan agreement, satisfactory to the World Bank Name Project Implementing Entity Description of Condition Type Effectiveness The Project Implementing Entity has established the ESSU in a form and with functions, staffing, and resources satisfactory to the World Bank, and the ESSU is operational iii

10 Name Legal Opinions Description of Condition Legal opinions regarding Loan Agreement, Project Agreement and Subsidiary Agreement Bank Staff Team Composition Name Title Specialization Unit Type Effectiveness Teymour Abdel Aziz Economist Team Lead MNSF1 Cedric Mousset Sr Financial Sector Spec. Sr Financial Sector Spec. MNSF1 Steve W. Wan Yan Lun Operations Analyst Operations Analyst MNSF1 Khalid Alouane Language Program Assistant Language Program Assistant MNSF1 Sara Al Rowais Private Sector Development Spec. Private Sector Development Spec. MNSF1 Julie Rieger Counsel Counsel LEGEM Jean Charles de Daruvar Senior Counsel Counsel LEGEM Eavan O Halloran Senior Country Officer Country Management Unit MNC01 Khaleel Ahmed Chief Investment Officer Chief Investment Officer CFGME Deepa Chakrapani Sr Financial Sector Spec. Sr Financial Sector Spec. FPDOK Nicolas Kotschoubey Consultant Consultant MNSEN Soukeyna Kane Lamyae Hanafi Benzakour Abdoulaye Keita Chaogang Wang Sr Financial Management Specialist Financial Management Specialist Sr Financial Management Specialist Financial Management Specialist MNAFM MNAFM Senior Procurement Specialist Senior Procurement Specialist MNAPC Senior Social Development Specialist Senior Social Development Specialist Hassine Hedda Finance Officer Loan Accounting CTRLA Non Bank Staff Name Title Office Phone City SDV Locations Country First Administrative Division Location Planned Actual Comments iv

11 I. STRATEGIC CONTEXT 1. This document outlines a proposal for an adaptable program loan to the Kingdom of Morocco for the Micro, Small and Medium Enterprise (MSME) Development Project in support of access to finance for MSMEs. This project is the second loan proposed under the MSME Facility for MENA Adaptable Program Loan (APL) structure, as part of the larger MSME Facility for the MENA Region, which aims to provide a comprehensive package of financing and technical assistance for MSMEs across the MENA Region, jointly with the IFC. The first APL under this regional program, a line of credit in the amount of USD 50 million in support of SME finance in Tunisia, was approved by the World Bank s Board of Executive Directors on July 14, In Morocco, the importance of access to finance particularly for MSMEs is both an economic and political priority. The Arab Spring has shown the powerful consequences of exclusion and high levels of youth unemployment in the MENA Region and this was also at the forefront of the street protests in Morocco during Jobs are at the forefront of attention and unemployment is the main political and economic issue facing the new government. Despite a relatively favorable socio-political situation compared to some other MENA countries, the Moroccan population has expressed their demands for improved governance, social inclusion, economic development and employment opportunities. Inadequate access to finance is frequently cited as one of the population s main grievances and the private sector continues to claim it is one of the biggest obstacles to the development of business. 3. The Moroccan government has recognized the importance of financial inclusion for individuals and MSMEs. The new government has confirmed the reform program undertaken to date which is aimed at reaching segments of the population that remain excluded from finance. The cornerstone of this reform program is the improvement of the regulatory environment, financial infrastructure and support mechanisms for MSME finance. This project aims to support this ongoing reform program through a targeted intervention, aimed at assisting the financial institutions in their efforts to reach smaller firms. This financial support is set to be complemented with further policy reforms aimed at improving the enabling environment for MSME finance (see Box 3), and with the provision of technical assistance to improve the capacity of financial institutions to better serve this segment (see Box 4). A. Country Context 4. Morocco has witnessed a period of strong economic growth over the past ten years, and made significant inroads in expanding access to finance for both households and MSMEs. Sound macroeconomic policies and sustained structural reforms have contributed to higher growth, averaging 4.9 percent over , sharply surpassing the average growth rate of the 1990s (2.8 percent). Furthermore, sound fiscal policies led to the consolidation of public finances, allowing the budget to run surpluses in 2007 and 2008 (averaging 0.3 percent of GDP) and, in 2009 and 2010, to withstand well the impact of the global crisis and higher world prices of basic commodities, with manageable budget deficits of 2.2 and 4.7 percent of GDP, respectively. The government adopted a prudent debt strategy and debt of the Treasury steadily declined to 47.1 percent of GDP in 2009 from 62 percent in 2005, before jumping to 50.3 percent of GDP in 2010, reflecting the impact of the recent global economic turmoil. 1

12 5. In the face of the global economic slowdown, the Moroccan economy has proved resilient in The economy grew at 4.8 percent, recovering from the lower 3.7 percent registered in In a context of economic slowdown in European countries, the main driver of Morocco s growth has been domestic private consumption (up 6.5 percent) supported by public policies implemented in early In addition to the stimulus package implemented over the period to support the income of the population and help the most affected sectors 1, the government implemented a new set of measures in the spring of These additional economic and social measures were implemented to respond to demands for political and economic reforms. Thus, the government decided to increase salaries of public employees by MAD 600 net per month and the minimum wage by 15 percent in two steps (10 percent in July 2011 and 5 percent in January 2012). The government also decided to raise the minimum pension from 600 MAD to 1,000 MAD. 6. Inflation continues to be low (0.9 percent in 2011). The Central Bank of Morocco - Bank Al-Maghrib (BAM) - had kept its policy rate unchanged since March 2009 at 3.25 until March 2012, when the policy rate was lowered to 3 percent. Credit to the economy from the banking sector grew by 10.3 percent in 2011 compared to 10.7 percent in With the exception of equipment credit, all other sectors have witnessed accelerated credit growth. This was the case for working capital loans (up 19.9 percent compared to 5.9 percent), housing loans (up 10.1 percent versus 8.7 percent), and consumer lending (up 10.5 percent versus 8.1 percent). Meanwhile, the share of non-performing loans in total loans increased marginally to 4.2 percent from 4.1 percent. 7. However, despite these important macroeconomic outcomes, the Moroccan economy continues to face significant challenges: (i) unemployment, especially among the youth, remains a critical concern (urban unemployment increased slightly to 13.4 percent in 2011 from 13.7 percent a year earlier, with a particularly sharp deterioration for young people), (ii) the budget deficit increased by around 6.8 percent of GDP in 2011 instead of the budgeted 3.5 percent of GDP, fueled by historically high subsidies. Substantial tax revenues and revenues from privatization operations helped finance the 2011 deficit. While Morocco s indebtedness remains under control (the central government debt is projected to rise to around 52 percent of GDP in 2011 from 50.3 percent in 2010), the current universal subsidy system may threaten the medium term fiscal sustainability, (iii) the slowing growth of Morocco s main trading partners is exacerbating the weaknesses of the balance of payments. The structurally high trade deficit is expected to deteriorate further to 23.1 percent of GDP in 2011 (from 19.5 percent in 2010) with the current account deficit also deteriorating to around 8 percent of GDP (from 4.5 percent in 2010). As a result, Morocco s net international reserves decreased to USD 19.7 billion (end 2011), down from USD 23 billion in December They remain, however, at a comfortable level of 5.1 months of imports of goods and services versus 6.8 months the previous year. 8. Medium term macroeconomic prospects of Morocco will be partially affected by the developments in the global economy and particularly in Europe, Morocco s main trade partner. The anticipated stagnation of economic activities in Europe in 2012 and its slow recovery 1 The income support package implemented over was mostly benefiting low income employees. It included an increase in 2008 of 10 percent in the wages of civil servants at the lower end of the salary scale and the minimum wage for private sector employees. Furthermore, the marginal income tax rate was progressively cut from 42 percent to 38 percent. At the same time, the upper end of the exempt income bracket was extended. Measures were also implemented to ensure employment preservation and to support export oriented firms most affected by the international economic crisis (such as guarantees on loans; rescheduling of debt; and help with export insurance). 2

13 thereafter will negatively impact Moroccan exports and thus growth. In addition, for 2012, current forecasts indicate that growth will be adversely affected by the agricultural sector which accounts on average for about 13 percent of GDP. However, to partially compensate the sluggish external demand, Morocco is expected to benefit from the effect on domestic demand of the fiscal stimulus programs implemented over the last few years. At the same time, Morocco is well positioned at the regional level to reap the fruits of its ongoing large reform programs, which the new government intends to continue, to improve economic productivity and consolidate public finances. Indeed, the outlook is predicated on the government sustaining the reform momentum of the last few years to achieve the ambitious public investment programs it devised and to continue implementing the main sector strategies, thus consolidating further economic diversification, growth potential, and domestic demand. Under these conditions, the growth rate is expected to slow to around 3 percent in 2012, before improving to around 5 percent in B. Sectoral and Institutional Context 9. Morocco has made significant progress in developing its financial sector over the past ten years. The total assets of Moroccan financial institutions have grown significantly and exceed 200 per cent of GDP, a ratio that is well above the level predicted by Morocco s per capita income. This progress in financial development has been the result of sound macroeconomic policies and important financial sector reforms earlier in the decade, which allowed Morocco to take advantage of favorable conditions (e.g. abundant liquidity and global economic growth). These financial reforms were supported by the World Bank through two Financial Sector Development Policy Loans in 2005 and 2009, and included the restructuring of state-owned financial institutions, the strengthening of the regulatory framework and the improvement of financial infrastructure. 10. Following a divesture by the Moroccan government, state-owned banks only play a limited role in the banking system. Today, they account for less than 10 percent of the market share, down from a 40 percent market share in The three largest banking groups (AttijariWafa, Credit Populaire du Maroc (CPM) and the Banque Marocaine du Commerce Extérieur (BMCE)), which control 65.5 percent of bank assets, are private. The Ministry of Economy and Finance completed in 2011 its strategy to strengthen the cooperative dimension of the CPM by selling a 20 percent stake in its apex, the Banque Centrale Populaire (BCP), to its regional mutual banks. 11. Morocco has made significant inroads in expanding access to financial services for both individuals and MSMEs. A recent World Bank survey has featured Morocco as a regional leader in providing SMEs with access to credit: the share of SME loans in total loans amounts to 24 percent, which is the highest ratio in the MENA Region (Table 4, Annex 5). Morocco has also been able to maintain the highest rates of microcredit access in the MENA Region, although the sector s rapid expansion has slowed down after the global financial crisis in Morocco stands out in terms of Microfinance Institutions branch networks, comprising 83 percent of the MENA Region s reported total. The leasing and factoring industry, two key sources of financing for MSMEs, are amongst the most developed in the MENA Region. The Moroccan post has been an important provider of savings and payment services for the low income population for many 2 Projections are based on the World Bank Global Economic Prospects 2011 key forecasts. 3

14 years. The recent establishment of a fully fledged Postal Bank aims to provide a more comprehensive set of financial services, including credit, to reach individuals and MSMEs in underserved areas. 12. The country s achievements in expanding financial inclusion for individuals and MSMEs were underpinned by important regulatory reforms and policies. The financial infrastructure was substantially strengthened through the establishment of a modern credit bureau, which provides detailed credit information on individuals and MSMEs to banks and Non-Bank Financial Institutions (NBFIs). The credit bureau also started to collect data from microcredit associations, covering at least 50 percent of loans granted by them. Morocco has also embarked on a far reaching reform of their partial credit guarantee scheme, the Caisse Centrale de Garantie (CCG), which is now the largest guarantee fund in the MENA Region (Box 1). Box 1 : Caisse Centrale de Garantie - Morocco s Partial Credit Guarantee Fund The CCG, a licensed public financial institution, supervised by the Central Bank, is the main provider of partial credit guarantees in the Moroccan financial system. The agency was established in 1949 as a credit institution and one of three institutions providing partial credit guarantees to financial institutions for MSME loans. The CCG also provides guarantees for housing loans. As part of its development plan, the CCG underwent a complete overhaul of its product offering. It has introduced new guarantee products focused on SMEs (no guarantee can exceed 10 million MAD and combined guarantees on a single borrower cannot exceed 15 million MAD, which ensures that guarantees are used for SMEs). The guarantee products have been designed to better match SMEs financial needs according to their life cycle (investment loans, working capital, restructuring, and private equity). The parameters of the guarantees have also been revised in line with best international practices (equity allocations, fees, simplification and harmonization of eligibility criteria). This redesign helped to streamline and strenghten the national credit guarantee mechanism, which was previously considered too complex and fragmented. Further improvements were made in the claims payment process, reducing the administrative burden for client banks. Since the introduction of the new product offering in 2009, the activity of the CCG has increased significantly. The launch of the new product offering coincided with the global economic crisis that resulted in a significant slowdown in economic activity. In this context, the government used the CCG guarantee products as a countercyclical instrument to enable SMEs, especially exporters, to overcome their financial difficulties. The amount of commitments of the CCG for companies almost doubled between 2008 and 2009, driven mainly by the guarantees for working capital loans. While the new design of the guarantee system has had a significant impact on the volume of guarantees, it has not helped to broaden the base of the recipient firms. In fact, the number of guarantees issued annually has almost stagnated between 2008 and 2010, while the average size of guarantees has increased from 0.7 to 1.3 million dirhams. With this backdrop, the CCG is now developing a new partial credit guarantee product to accompany (and leverage on) banks strategies towards very small enterprises (VSEs 3 ), which this project aims to support. This new product, Damane Express, will rely on simplified financial eligibility criteria for borrowers and introduce a new, innovative delegated approach (i.e. individual applications will not be reviewed ex ante by the CCG) and will not differentiate among various types of credit (only requiring that they do not exceed one million MAD). Guarantees will be delivered rapidly by the CCG as soon as it receives electronically the information collected by the bank. This new product follows the directions set for the reform of the Partial Credit Guarantee (PCG) scheme in 2009 and intends to be simple and attractive for banks (which could then use it to more easily include credit products in the financial packages they offer to VSEs). 13. However, despite the significant progress reached, access to financing remains a challenge for certain populations. While Morocco has made significant process in expanding 3 VSEs are defined as enterprises with a turnover of less than less than 3 million MAD (0.4 million USD). VSEs are situated between microenterprises and SMEs. 4

15 access to finance to SMEs, the largest part of bank financing goes to the larger enterprise part of the SME spectrum. Very small enterprises (VSEs) continue to face challenges in accessing credit. They tend to have less collateral, weaker management capabilities and are more vulnerable to information asymmetry, reducing the likelihood of receiving bank credit. They are underserved by the existing financial system, situated between SMEs, which are served by the commercial banking sector, and microenterprises, which have access to credit through an extensive network of microcredit providers. 14. Against this background, the Government requested World Bank support to its wider financial sector development program through an investment loan in support of access to finance for MSMEs by providing partial credit guarantees for MSME loans. The project scope targets segments which remain underserved by the Moroccan financial system, and complements other government initiatives aimed at promoting the development of MSMEs (Box 2). The proposed operation is also a timely intervention in a challenging market environment, which may lead to reduced bank lending to MSMEs, according to recent polls. This operation provides the Moroccan authorities with the resources needed to maintain and scale up the operations of the national SME PCG scheme, ensuring its sustained growth at a time where public funding is increasingly constrained. Furthermore, this instrument allows leveraging lending from banks to MSMEs by up to sixteen times the amounts committed by IBRD 4. Well designed partial credit guarantee (PCG) schemes are considered one of the most market-friendly types of interventions, as they generate fewer distortions in the credit market and are more consistent with a wellfunctioning banking system. Through the provision of risk mitigation tools, PCGs provide a strong incentive for banks to get into the MSME market, while retaining sound incentives for loan origination and oversight. 15. Female entrepreneurs are amongst the key beneficiaries of PCG schemes, which are operated in a large number of countries around the world and have proven to be an effective vehicle for reaching groups which are underserved due to a lack of collateral. Preliminary findings of recent studies appear to confirm these impacts in the case of Morocco. A recently commissioned impact evaluation study has revealed that 72 percent of the loans guaranteed by the CCG would not have been financed by banks in the absence of a guarantee. The CCG also benefits many female entrepreneurs: The share of women-owned SMEs covered by guarantees of the CCG was at 30 percent in 2011, which was significantly higher than the national average of 12 percent 5. In addition to guarantee coverage, women entrepreneurs could be supported further through training and capacity building programs tailored to their needs through the regional MSME TA facility. Although it is not part of the results framework, the project will monitor the share of women-owned SMEs covered by guarantees throughout the life of the project. 16. The proposed operation supports the Moroccan government s increased efforts to support the development of MSMEs. The government has recently drafted a new strategy aimed at supporting the development of VSEs, with measures to enhance their job-creation potential, which include a simplified taxation system, adapted social charges, extended social security 4 The leverage effect depends on the multiplier of the respective guarantee products, which range between 5 to 10 times the reserves. 5 Source: CCG (2011), WB ICA survey (2008) Note: The definition of a woman-owned SME is based on the CCG s and WB s enterprise survey definition which asks whether at least one of the owners is female, or whether any of the females are owners. 5

16 coverage, and specific banking products backed by a guarantee fund, which are in the process of being developed (Box 2). Already the Budget Law 2011 had introduced major incentives for VSE, which include a reduction of the corporate profit tax from 30 percent to 15 percent, tax incentives for businesses that integrate into the formal sector, and tax incentives for individual VSEs opting to transform into a corporation. Box 2: Government s strategy to foster the development of very small enterprises A new government strategy to foster the development of very small enterprises (VSEs) was drafted in September 2011, complementing existing efforts focused on SMEs or innovative companies in high potential sectors. VSEs are considered essential to implementing the government s job creation. Both public and private stakeholders were consulted to inform the development of the strategy. The strategy is organized around three pillars (tax regime, access to finance, pension and healthcare benefits), which aim to encourage VSEs to become formal and facilitate their access to finance. C. Higher Level Objectives to which the Project Contributes Box 3 : World Bank Support for the Moroccan Financial Sector Reform Program The World Bank has supported the Moroccan financial sector reform program through a Sustainable Access to Finance Development Policy Loan (DPL) in the amount of USD 200 million, which aimed at supporting the Government s efforts to expand further households and small and small and medium enterprises access to finance, while ensuring the stability of the financial system. The DPL included the following four pillars: (i) Promoting Access to Finance for Households, including: a) establishment of a full fledged postal bank b) an improved regulatory framework for microcredit associations c) the establishment of a new housing guarantee fund for low income individuals (ii) Enhancing Access to Finance for SMEs, including: a) the introduction of a modern credit bureau b) a comprehensive reform of the CCG s partial credit guarantee scheme for SMEs (iii) Strengthening the Resiliency of the Financial System through further Improvements in Financial Regulation and Supervision (iv) Further Strengthening the Development of Capital Markets Building on the achievements of the first DPL, the Moroccan authorities have requested the World Bank to support a new phase of financial modernization through a new DPL planned for FY 2013, to be organized around the same four pillars. 17. The proposed operation contributes directly to the objectives of the Country Partnership Strategy (CPS) for Morocco (FY ) discussed by the World Bank s 6

17 Board of Executive Directors on January 26, The CPS proposes three thematic pillars 6 aligned with the development priorities of the country. The first pillar states that the structural transformation of the Moroccan economy will require a comprehensive and coordinated set of policies in many areas, underpinned by a financial sector that better serves smaller firms. The proposed operation is targeting precisely the financial inclusion of this underserved segment of the Moroccan economy. The Morocco CPS Progress Report (May 15, 2012), further emphasizes this project s contribution to Bank objectives of promoting job creation, competitiveness, inclusion and women s economic participation. These objectives are also central to the MENA Regional Framework for Engagement, discussed by the Board in February During the CPS period, the funding targeted at VSEs may be complemented at a later stage through technical assistance for participating financial institutions to help them improve the effectiveness of their MSME lending, under the framework of the regional TA window of the MENA MSME Facility, which has already been established. This targeted operation will be complemented by a broader set of policy reforms and actions aimed at improving the enabling environment for MSME finance through the financial sector DPL planned for FY 2013 (Box 3). II. PROJECT DEVELOPMENT OBJECTIVES A. PDO 19. The Project Development Objectives (PDOs) are presented at three levels. The MSME Facility provides the framework for the regional APL which was reviewed by the Board of Executive Directors on July 14, 2011 jointly with the presentation of the first loan to Tunisia (MSME Development Project). As the second APL in the series of a three part MSME Development Program, the proposed Morocco loan (APL 2) will be submitted for the Regional Vice President s approval and to the Board on an Absence of Objection basis: Micro, Small and Medium Enterprise (MSME) Facility: to catalyze financing, risksharing and technical assistance to address policy, legal, institutional, capacity, and informational constraints holding back MSME access to finance in the MENA Region, and thereby to support improvements in MSME employment, competitiveness, and incomes. Adaptable Program Loan (APL): to improve access to finance for micro, small and medium enterprises in the MENA Region. The APL is the IBRD financing mechanism for the MSME Facility. APL 2 (Morocco MSME Development Project): to improve access to finance for MSMEs in Morocco. 6 The three pillars are: a) Enhance growth, competitiveness and employment, b) Improve service delivery to citizens and c) Ensure environmental sustainability in the context of a changing climate. 7

18 Project Beneficiaries 20. The end beneficiaries of the MSME Facility will be micro, small and medium enterprises. A wider definition of beneficiaries would include governments, regulators, and financial institutions benefitting from financing, partial credit guarantee facilities and technical assistance. The end beneficiaries for the regional APL, including the APL 2 for Morocco, will be MSMEs. PDO Level Results Indicators 21. The following results are expected in fulfillment of the PDO. The results framework has been defined for the APL at a regional level and will be applied to each borrowing country under the APL. MSME Facility: At least 4 MENA countries make policy, legal or financial infrastructure reforms to promote access to finance for MSMEs, which are recommended by World Bank Group policy lending or technical assistance. Partnerships developed with at least 2 providers of business services and/or equity financing to high potential or start-up SMEs. APL: USD 50 million additional IBRD lending or guarantees for MSME Finance, within 5 years. At least 2 MENA countries borrowing from the APL, within 3 years. Participating financial institutions (PFIs) increase their MSME Finance portfolio and the number of new Micro and SME borrowers during the APL period. APL 2 (Morocco MSME Development Project): Increase in total number of MSME loans of PFIs by at least 20 percent within 5 years, and Increase in the total volume of outstanding MSME portfolio of PFIs. (MAD million) by at least 10 percent within 5 years. 22. This project is part of the larger MENA MSME Facility, which aims to provide a comprehensive package of financing and technical assistance for the MENA Region, jointly with the IFC. The APL is an IBRD regional financing mechanism that provides a structure for rolling out country level Adaptable Program Loans (APLs). Country level loans under the APL structure can include a line of credit component and a contingent credit (partial credit guarantee) component, or a combination of both, so that the most appropriate instrument can be applied in each market to support MSME Finance. 23. The first APL under this regional program, a loan in the amount of USD 50 million in support of SME finance in Tunisia, was approved by the World Bank s Board of Executive Directors on July 14, The loan was designed as a line of credit to the government of Tunisia for on lending to finance SME loans of eligible financial institutions. The project became effective on April 5,

19 III. PROJECT DESCRIPTION 24. The lending instrument proposed is an adaptable program loan (APL), financed by an IBRD loan of EUR 37.9 million (USD 50 million equivalent), within the framework of the regional APL program of the MENA MSME Facility. This would be the second loan in an anticipated series of APLs across eligible countries. The Kingdom of Morocco meets the borrowing country eligibility criteria for APLs, as outlined in Section III of the PAD for the Tunisia MSME Development Project as part of the MENA MSME facility (Report No TN) 7. This loan will be used to support the provision of partial credit guarantees by the CCG to Eligible Financial Institutions (EFIs) to enable loans by the EFIs to MSMEs for sub-projects. The Project will be financed under an IBRD loan disbursing over a period of five years, on standard IBRD terms for a Variable Spread Loan with 29 years maturity including a 6.5 year grace period. 25. The MSME APL structure would be applied to APL 2 for Morocco, as set out in the diagram below. Figure 1. APL 2 (Morocco MSME Development Project) POLICY LENDING, POLICY REFORMS World Bank Financial Sector DPL, etc IBRD APL $50m Loan Kingdom of Morocco (Ministry of Finance) Endow -ment Implementing Entity (CCG) Guarantees ELIGIBLE FINANCIAL INSTITUTIONS Loans MSMEs MSME FACILITY TECHNICAL ASSISTANCE - Risk Management and Debt Restructuring, Financial Infrastructure, Advisory Services and Training to banks, and other priority TA. - WB, IFC, Donor Partners 7 Borrowing country eligibility criteria for APL loans include: i) IBRD borrowing country in the MENA region, ii) Government or Regulator commitment to improved MSME Access to Finance, demonstrated through specific policy measures, legal reforms, or other good practice public interventions as assessed by the World Bank in economic and sector work or mission reports, and iii) Government or Regulator commitment to environmental and social sustainability. Candidate countries under these criteria will include Egypt, Morocco, Tunisia, Jordan and Lebanon. These are net oil importers and face common challenges of growth, competitiveness, and employment. World Bank Preparation and Appraisal missions will respond to Government interest in borrowing from the APL, and would further assess country eligibility, financing needs, and the appropriate mix of the line of credit component, contingent credit component, technical assistance, and support to innovative and high potential SMEs. 9

20 A. Project Component 26. Component 1 - Support for the Provision of Partial Credit Guarantees (USD ). The project has only one component which will support the provision of Partial Credit Guarantees (PCGs) to participating financial institutions to mitigate their credit risks on loans to micro, small and medium enterprises (MSMEs). The project will finance the losses of the PCGs, the issuance of PCGs will enable loans by EFIs to MSMEs for sub-projects. The project will be implemented through the CCG. The funding from the loan for the PCGs will allow the CCG to scale up its existing MSME guarantee products, which cater to the needs of MSMEs at different stages of their development. There are dedicated guarantee products for loans to start-ups (Damane Crea), for expansion projects of existing SMEs (Damane Dev), for loans to SMEs undergoing a restructuring (Damane Istimrar), for loans to SMEs in the textile industry (Integra- Textile) and for working capital loans (Damane Exploitation) (Table 1). Further details on the characteristics and performance of the different guarantee products are provided in the detailed project description (Annex 2). Table 1. Characteristics of CCG Guarantee Funds for SMEs Damane Créa Damane Dev Damane Exploitation Integra-Textile Damane Istimrar Source: CCG Type of Loan Guaranteed Medium and long term bank loans greater than 1 million MAD Medium and long term bank loans greater than 1 million MAD Working capital -Short-term loans to finance working capital in textile industry -medium/long term loans to finance inventory in textile industry Bank investment/working capital loans except loans secured to public sector or those under litigation Eligibility Criteria Start-ups (or less than 3 yrs operating) Companies with more than 3 years of operation Companies with more than 3 years of operation Companies benefiting from the Convention of support to the Textile sector Companies with more than 3 years of operation Guarantee Fee Guarantee Coverage (flat) Ceiling 70% 2% flat 10 million MAD 60% 2% flat 10 million MAD 60% 0.5% 10 million MAD 70% 1% flat for short term loan guarantee + 2% flat for medium/longterm 40 million MAD broken down as follows: -20 million MAD: short-term loan -20 million MAD: long-term loan 50% 2% flat 10 million MAD 27. The project will also support PCGs for a new innovative guarantee product for VSEs, a segment of MSMEs which is particularly constrained from access to finance. This product will cover all loan types (working capital and investment loans) of up to 1 million MAD. The 10

21 approval procedure for guarantees will be fully automated and standardized, following the mechanism adopted for the CCG s housing credit guarantee product Damane Assakane. 28. The provision of partial credit guarantees will help increase lending to MSMEs by reducing banks lending risks to MSME borrowers. By backstopping financial institutions losses in the case of defaults by MSME borrowers, this project would provide an incentive for banks to engage in short and medium term lending to MSMEs. This instrument allows leveraging lending from banks to MSMEs by up to sixteen times the amounts committed by IBRD Alongside covering PCG claims under guarantees issued under the project, the project will also cover PCG claims under existing guarantees, issued by the CCG prior to the project, provided they are eligible under the Project and comply with the criteria of the Operations Manual (OM) and Environmental and Social Management Framework (ESMF). This will free up funds for CCG to issue further new guarantees, thereby enabling more loans to MSMEs. 30. The project, which will be implemented by the CCG, will support the provision of partial credit guarantees to financial institutions. Eligible institutions will be financial institutions that meet the prudential standards defined by the Central Bank of Morocco (unless otherwise agreed with the World Bank), in line with the WB s Operational Policy 8.30 (OP 8.30) on Financial Intermediary Lending and complying with eligibility criteria which will be set forth in the OM. Activities that will complement the Project 31. The MSME Facility involves a close coordination and collaboration with the IFC, which, in the case of Morocco and independently of the proposed APL 2, aims to engage in a longer term partnership with the CCG in support of the SME sector in Morocco. In the first stage, the IFC-led MENA SME Facility proposes to cover mezzanine risk of specific CCG s SME guarantee funds, taking excess risk coverage on a portfolio of loans. IFC also expects to strengthen the guarantee instruments / schemes offered in the country through CCG by working with CCG and strengthening CCG s capacity as a guarantee agent, helping it to develop more commercially oriented and sustainable SME support instruments in the Moroccan market, deploying structured finance methodology consistent with best practices to establish loss levels and operational norms. This arrangement is expected ultimately to align the efforts of IBRD, IFC (and MENA SME Facility partners), CCG, and banks to utilize and enhance existing schemes in Morocco, without displacement of existing instruments, thereby also precluding duplication and overlaps between schemes in the market. 32. The operation will also benefit from the recently established regional WB/IFC MENA MSME Technical Assistance Facility (Box 4). The facility, which consists of two trust funds, each managed by the IFC and the WB in close co-ordination, provides a well coordinated and comprehensive technical assistance offering throughout the MENA Region aimed at improving access to finance for MSMEs. 8 The leverage effect depends on the multiplier of the respective guarantee products, which range between 5 to 10 times the reserves. 11

22 33. Policy Lending to improve the enabling environment for MSME finance will complement this loan. The resulting policy and legal reforms will strengthen the impact of the financing provided by the APL, by enabling financial institutions to offer financial services to smaller and under-served MSMEs. A new Financial Sector Development Policy Loan building on successful reforms supported by previous DPLs is planned for FY The first pillar will contain measures that promote access to households while the second pillar will comprise measures to enhance access to finance for small and medium enterprises. Box 4: The WB-IFC MENA MSME Technical Assistance Facility The MENA MSME TA Facility aims to provide a well coordinated and comprehensive package of at least $30 million in technical assistance over 5 years, in order to improve access to finance for MSMEs. The proposal focuses on five priority countries: Morocco, Tunisia, Egypt, Jordan and Lebanon but the facility can be extended in a second stage to other MENA countries including Iraq, Libya, West Bank and Gaza. The MENA MSME TA Facility will operate at 3 levels: Enabling Environment: Support for policy reforms of the legal, regulatory and institutional framework for the financial and business sectors, to promote MSME finance. This could include: strengthening the regulatory and supervisory frameworks for microfinance; credit information; secured transactions and leasing; banking regulation; corporate governance; the commercial code; environmental and social compliance; and private equity. Support may also be provided for impact monitoring capacity; risk management training for supervisors; and developing an enabling environment for Shari ah-compliant financing. Advisory Services to Financial Institutions: Strengthening financial institutions to improve access to finance to MSMEs. This includes in-depth advisory services for SME banking with a focus on women entrepreneurs, strengthening risk management and corporate governance practices, and sharing knowledge and best practices through workshops, seminars and training events. It also includes providing microfinance institutions with TA in risk management, product development and responsible finance. The microfinance program is expected to have a broad impact on the sustainability and quality of microfinance institutions product offering. Support and Training to MSMEs: Support for MSMEs through entrepreneur networks, mentoring, and business incubator-type services. This would include broadening the range of business development services in the region to facilitate linkages with investors, new markets and technologies; as well as scaling up incubator operations to reach a larger number of entrepreneurs. It would also link high potential entrepreneurs to mentoring, networks, and risk capital. Moreover, it would provide business training to small entrepreneurs using the IFC Business Edge product, and assist banks to reach out to their SME clients through the use of the web-based IFC SME Toolkit. 34. The team has concluded an assessment of the state of compliance of this project with the requirements of the WB s Operational Policy 8.30 (OP 8.30) on Financial Intermediary Lending, and concluded that the project is in compliance with this policy. The compliance review was reviewed and cleared by the WB s Financial Inclusion Practice on 4 May 2012 and is available in project files. B. Project Financing Lending Instrument 35. The lending instrument is an Adaptable Program Loan (APL) of Euro 37.9 (US$50 Million equivalent), provided on IBRD terms. 12