Document of The World Bank ON A CREDIT TO THE. June 25, 2002

Transcription

1 Public Disclosure Authorized Document of The World Bank FOR OFFICIAL USE ONLY Public Disclosure Authorized IMPLEMENTATION COMPLETION REPORT (IDA-29590; PPFI-Q0260; TF-20937; TF-29322) ON A CREDIT IN THE AMOUNT OF SDR 11.9 MILLION (US$16 MILLION EQUIVALENT) Report No: TO THE Public Disclosure Authorized KYRGYZ REPUBLIC FOR THE RURAL FINANCE PROJECT June 25, 2002 Public Disclosure Authorized Environmentally and Socially Sustainable Development Europe and Central Asia 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 at Appraisal, March 31, 1997) Currency Unit = KGS KGS 1 = US$ US$ I = KGS 17.1 (Exchange Rate Effective at Closing, June 30, 2001) Currency Unit = KGS KGS 1 = US$ US$1 = KGS FISCAL YEAR January I - December 31 ACC ASSP ADB CAS DE EU TACIS FDF FINSAC FSO GOK IAS IDA IFAD IFI KAFC KAS KGS MIS NBKR NGO PFI RFI RFP II SAR SDC SDI SDR SFCOP SHG UNDP ABBREVIATIONS AND ACRONYMS Agricultural Consumer Cooperative Agricultural Support Services Project Asian Development Bank Country Assistance Strategy Development Entrepreneur European Union Technical Assistance to the Commonwealth of Independent States Farmers Development Fund Financial Structural Adjustment Credit Farmers' Self-Help Organization Govemment of Kyrgyzstan Intemational Accounting Standards Intemational Development Association Intemational Fund For Agricultural Development Intemational Financial Institution Kyrgyz Agricultural Finance Corporation Kyrgyz Accounting Standards Kyrgyz Som Management Information System National Bank of Kyrgyz Republic Non-govemmental Organization Participating Financial Institution Rural Financial Intermediary Second Rural Finance Project Staff Appraisal Report Swiss Development Corporation Subsidy Dependence Index Special Drawing Rights Small Farmers' Credit Outreach Program Self-Help Group United Nations Development Program Vice President: Country Director: Sector Director: Task Team Leader: Johannes F. Linn Dennis N. de Tray Laura Tuck Hoonae Kim

3 KYRGYZ REPUBLIC KYRGYZ RURAL FINANCE PROJECT CONTENTS Page No. 1. Project Data 1 2. Principal Performance Ratings 1 3. Assessment of Development Objective and Design, and of Quality at Entry 2 4. Achievement of Objective and Outputs 4 5. Major Factors Affecting Implementation and Outcome Sustainability Bank and Borrower Performance Lessons Learned Partner Comments Additional Information 26 Annex 1. Key Performance Indicators/Log Frame Matrix 27 Annex 2. Project Costs and Financing 29 Annex 3. Economic Costs and Benefits 30 Annex 4. Bank Inputs 31 Annex 5. Ratings for Achievement of Objectives/Outputs of Components 33 Annex 6. Ratings of Bank and Borrower Performance 34 Annex 7. List of Supporting Documents 35 Annex 8. Benificiary Survey 36 Annex 9. Summary of Credit Line Implementation 40 Annex 10. Summary of Financial and Operational Parameters Under the Project 41 Annex 11. Detailed Review of KAFC's Financial Statements 43 Annex 12. Status on Conditions for Lifting the Suspension 47

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5 Project ID: P Project Name: RURAL FINANCE PROJECT Team Leader: Hoonae Kim TL Unit: ECSSD ICR Type: Core ICR Report Date: June 25, Project Data Nanme: RURAL FINANCE PROJECT Country/Department: KYRGYZ REPUBLIC Sector/subsector: AC - Agricultural Credit L/C/TF Number: IDA-29590; PPFI-Q0260; TF-20937; TF Region: Europe and Central Asia Region KEY DATES Original Revised/Actual PCD: 04/27/1995 Effective: 08/08/ /08/1997 Appraisal: 03/21/1997 MTR: 12/15/ /15/1999 Approval: 06/05/1997 Closing: 06/30/ /30/2001 Borrower/Inmplementing Agency: Other Partners: KYRGYZ REPUBLIC/KYRGYZ AGRICULTURAL FINANCE CORPORATION (KAFC) STAFF Current At Appraisal Vice President: Johannes F. Linn Johaness F. Linn Country Manager: Dennis N. de Tray Yukon Huang Sector Manager: Laura Tuck Michael A. Gould Team Leader at ICR: Hoonae Kirn Barnabas K. Zegge ICR Primary Author: Ranjan Ganguli; Sandra Broka 2. Principal Performance Ratings (HS-=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HL=Highly Likely, L=Likely, UN=Unlikely, HUN=Highly Unlikely, HU=Highly Unsatisfactory, H=High, SU=Substantial, M=Modest, N=Negligible) Outcome: S Sustainability: L Institutional Development Impact: SU Bank Performance: S Borrower Performance: S QAG (if available) Quality at Entry: Project at Risk at Any Time: Yes ICR S 3. Assessment of Development Objective and Design, and of Quality at Entry 3.1 Original Objective: Background

6 The Rural Finance Project (RFP), the first rural finance operation supported by IDA, was designed during a time of major economic and political change in the Kyrgyz Republic when there were very limited institutional and human resources to support the transition from a centrally-directed command economy to a market economy. Among IDA programs, the Financial Structural Adjustment Credit (FINSAC) pursued banking sector reforms, including the liquidation of Agroprombank, which, until 1994, was the dominant lender to the agricultural sector. Liquidation of the Agroprombank left the rural sector without an institutional lender, and in response, the government provided credit to farmers through the regional administrations of the ministries. This produced dismal results. In addition to the government credit program, seven donor-sponsored rural credit schemes were started, but they were limited in their scope and geographical coverage, utilized diverse mechanisms for lending, recovering loans, and managing risks, and had widely varying on-lending interest rates. Meanwhile, because of their lack of knowledge and understanding of the sector, commercial banks viewed lending to the agriculture sector as too risky and too expensive. Furthermore, most banks did not have an adequate branch network to serve rural clients In order to fill the gap, the government requested IDA support to develop a coherent and sustainable rural finance scheme, which would benefit a large number of beneficiaries throughout the country. A Rural Finance Survey was conducted and a Rural Finance Strategy was developed in 1996 as part of RFP preparation. The results indicated that prospects for establishing a commercially viable rural finance system were good and joint guarantees or group responsibility for each othee's loan appeared feasible and compatible with Kyrgyz culture. As a "stop-gap" measure to fill the void in the rural finance system, the Kyrgyz Agricultural Finance Corporation (KAFC) was created to serve emerging private farms and rural enterprises. KAFC was also designed to lend to groups who had traditionally been excluded from receiving commercial credits. Against this background, RFP, for SDRI 1.9 million (US$16 million equivalent), was approved in June 1997, became effective in August 1997, and closed on June 31, KAFC was the sole financial intermediary envisioned in the PAD and remained so at the project closing. KAFC, despite its short tenure, has established itself as the only sound financial institution that lends predominantly to agricultural and associated borrowers. At closing, the repayment rates were good and the loan portfolio was expanding. Per borrower request, the follow-up Second Rural Finance Project (RPF I) was approved in 1999 and, among other activities, RFP II envisioned the inclusion of additional participating financial institutions (PFIs) in addition to KAFC to increase competition and broaden the credit delivery mechanism. Dialogues with three interested commercial banks were continuing at the time of this ICR preparation. An ICR mission was originally scheduled to take place in September 2001, but due to the September 2001 tragedy, the mission was postponed until March Project Development Objectives. The project had two primary objectives: (a) in the short-term it was to establish an interim institutional arrangement for lending to the agricultural and agribusiness sectors, which, at that time, had no access to commercial bank credit; and (b) in the medium and long term, it was to provide the basis for developing community-based financial services for the rural population. These objectives reflected the essential priorities for the development of a rural finance system in the Kyrgyz Republic as identified, at the time, by both the government and IDA. 3.2 Revised Objective: The project objectives remained unchanged throughout the life of the project; nevertheless, some important modifications were introduced in the project design during implementation and are discussed in Section 4.1 below. -2 -

7 3.3 Original Components: The project had three components: (a) KAFC Component (general credit line); (b) the pilot Small Farm Credit Outreach Program (SFCOP) Component for group-lending; and (c) Policy and Institutional Framework Component. The KAFC Component was designed to provide financial and institutional support to KAFC so that it could support the on-going process of farm restructuring, agribusiness enterprise privatization, and private sector development in the rural areas. Specific activities included: (a) establishment, capitalization, management, and govemance of KAFC; (b) preparation of KAFC lending policies, procedures, and business plan; and (c) provision of a credit line. The credit line was both for short-term working capital loans for purchase of seasonal inputs and for diversified on-farm and agri-business investment lending. The Pilot SFCOP Component was designed to develop, on a pilot basis, community-based rural finance institutions to test the cooperative credit principles and lending to groups. The component was to support establishment of farmer self-help organizations (FSOs), which were gradually to evolve into rural financial intermediaries (RFIs). The Policy and Institutional Framework Component was designed to support priority technical assistance for KAFC, including specific support for the SFCOP. The component was to promote institutional, legal, and policy changes, which would directly enhance successful achievement of the project objectives. Specific activities included extensive support to KAFC in management and lending operations, and training to staff in support for SFCOP implementation. The component was also intended to remove several distortions, such as, interest rate subsidies and farm debt overhang, which were not conducive to the development of a commercially sustainable rural finance system. Two donors provided parallel co-financing for technical assistance for KAFC. 3.4 Revised Components: While there were no major revisions of components, some adjustments were made. With its initial success, KAFC attracted the support of other donors, particularly the International Fund for Agricultural Development (IFAD) and the United Nations Development Programme (UNDP), so an unexpected second group-lending model was added to KAFC operations. Implementation challenges and outstanding issues related to this change are discussed in Section 4.2 below. Donors provided alternative funds for technical assistance and institution building under RFP, and as a result, IDA financing of the third component for technical assistance was reduced to US$40,000 and unutilized funds were reallocated to increase the credit line components. The revised project costs and financing sources are summarized in Annex Quality at Entry: The project was not subject to QAG and QER processes. However, the project design at inception adequately covered financial, economic, social, institutional, and other fiduciary aspects, and it was deemed satisfactory. Furthermore, the country pursued tight monetary policies and annual inflation was brought down from over 100 percent in 1992 to less than 35 percent in Interest rates followed a similar path, hence the macroeconomic prerequisites were in place to roll out the first rural finance operation. 4. Achievement of Objective and Outputs 4.1 Outcome/achievement of objective: - 3-

8 The overall objectives of the project, lending to the agricultural sector and creation of the basis for developing community-based financial services for the nrual population, have been satisfactorily achieved through the establishment of KAFC, a temporary institutional arrangement. KAFC effectively filled the rural financial intermediation gap in the country and has served a large number of dispersed rural clients. In a relatively short period, KAFC managed to achieve the near impossible task of establishing a new institution, which has become the major player in the rural finance market with a solid reputation, public recognition, and trust. The institution has become a household name amongst poor farmers throughout the country, and more importantly, it has established a long-absent disciplined credit culture where repayment and repeated access based on good perfornance were emphasized. Regarding the development of community-based group-lending based on social collateral; the outcome has been limited mainly due to changes in the group-lending strategy of KAFC. The project's vision of community-based and managed financial institutions, operating on the basis of cooperative principles of self-help, democracy, and cost-effectiveness, proved to be much more difficult than expected. The fact that KAFC was receiving different donor-driven support for group-lending may have also reduced the effectiveness of its group-lending operation. KAFC initially had one group-lending model, SFCOP, but later another donor added a second model, Farmers Development Fund (FDF). The KAFC overall group-lending portfolio is now under duress because the design of the two models was significantly different as were the operational procedures, legal and operational status of groups, group formation support schemes, etc. As a result, a substantial degree of confusion and inconsistency ensued and in order to rectify the situation, the government requested IDA support to consolidate KAFCs group-lending into a coherent, efficient, and adequately managed risk-based operation. Restructuring is on-going under RFP II, and donors are fully engaged in the process. The objective to create a commercially viable, cost-conscious agency was partially achieved as KAFC continues to reduce cost and improve operational efficiency. KAFC received substantial development support from the government, which injected cash into KAFC as government equity shares, provided in-kind support, for example buildings, free of charge technical assistance, and capitalization of interest due on subsidiary loans, thereby helping reduce the overall cost of KAFC. As these are forns of subsidies, KAFC had a high Subsidy Dependence Index (SDI). Now that the amount and types of subsidies are declining, so, too, is the SDI index. Overall, KAFC is likely to be sustainable allowing it to continue its mandate to provide commercial credit to rural clients (see section 6 for more discussion). In summary, the project is a good example of the successful utilization of a practical, innovative, stop-gap model, which was also tested in other countries in the region, to fill a complete absence of financial intermediation for post-privatization agricultural clients. Tens of thousands of poor, small-scale farmers and agricultural entrepreneurs in all corners of the country were able to access commercial credit for the first time. This gave them the opportunity to build productive means to earn income, improve living standards and learn about responsibility and accountability as borrowers. 4.2 Outputs by conmponents: Original Targets. The Staff Appraisal Report (SAR) states that the project was to be implemented in four years, providing loans to over 6,000 clients by year 2000 under the general credit line and to at least 200 farmer groups annually under the SFCOP, of which, at least 400 would graduate as RFIs in The average loan size would reach US$5,000. KAFC was to start lending in the second half of 1997 and by end-december 1997 was expected to achieve an outstanding loan portfolio of US$3.0 million equivalent. It was also envisioned that during the first two years, KAFC was to concentrate on seasonal lending. Actual Achievements. KAFC lending activity started briskly and continued to expand rapidly during - 4 -

9 implemnentation. The project's disbursement exceeded appraisal estimates from the beginning. KAFC started lending in mid-1997 and by the end of 1999, it already had about KGS27 million (US$1.5 million) in total outstanding loans, which in the following year grew to KGS 113 million (420 percent growth). By the end of 2000, KAFC loan portfolio more than tripled to KGS 440 million with over 11,600 sub-loans and 10,000 active borrowers. At closing, the average loan size for KAFC's overall portfolio was about US$1,000 equivalent, with average group loans as small as US$230, and average individual loan size as large as US$1420, which were all below the appraisal average of US$5,000 equivalent. In termns of creating outreach, that is, providing access to small-scale farmers in remote areas, the project has achieved excellent results. At closing, KAFC had helped over 15,000 individual borrowers, of which 2,700 were repeat clients, and over 1,750 group clients, of which over 550 were repeat borrowers. The total number of direct beneficiaries, borrowing individually and through groups, was over 30,000, and they were from broad geographical, social, and economic backgrounds. Today, the numbers and the scope of outreach continue to expand. Although KAFC had made loans mostly to borrowers engaged in primary agricultural production, it has now started to lend to agro-processing, agri-business and non-agricultural activities in rural areas. Disbursement During the first year of operation, KAFC withdrew US$2.15 million, and by the second year, the annual disbursement grew to US$7.25 million. In early 1999, an IDA supervision mission discovered that KAFC was withdrawing funds without a full list of sub-loans to match each withdrawal. This issue was addressed promptly by KAFC and resulted in a decline in the disbursement rate in 1999 to US$3.05 million. The slow down in disbursement was also due to the fact that KAFC was liquidating its sizeable holding of treasury bonds (as much as 50 percent of total assets) to disburse for sub-loans. Disbursements were further affected when in June 2000, IDA officially suspended the project following a political decision by the government to issue interest subsidies through KAFC. This violated one of the key agreements of the Development Credit Agreement and triggered the suspension, which lasted three months. As a result, the overall disbursement in 2000 was only about US$2.44 million. Despite these events, KAFC withdrew the full IDA credit and the project was closed on schedule. Component 1: KAFC Component (General Credit Line) The component was designed to support KAFC development to enable it to provide credit on commercial terms in accordance with the terms and conditions of the Subsidiary Loan Agreement with the government. KAFC was established by Government Decree No.303 of July 2, 1996, was formally registered as a joint stock company in December 1996, and was subsequently licensed in March 1997 by the National Bank of Kyrgyz Republic (NBK). KAFC was supposed to be supervised by the NBK as a non-bank financial institution. Although NBK's regular supervision did not start until 1999, KAFC operated according to the prudential norms applicable to banks on capital adequacy, exposure limits, classification of loan portfolio, provisioning and other rules of prudent banking (minus deposit). In addition, in some cases stricter parameters were applied to KAFC, as it initially had to maintain a 33 percent capital adequacy ratio as required in the Subsidiary Loan Agreement, which was well above the NBK's 6 percent requirement for banks. Initially, the Board of Directors of KAFC was to consist of three members representing the Government and three members representing the private sector. The seventh member of the Board would be the Executive Director of KAFC. In reality, the Board members are mostly representing the Govermment, and the Board has generally provided only cursory supervisory functions. KAFC, with a competent management team and a dynamic executive director, was able to chart its own course and expand KAFC into a nationwide credit institution with one of the largest number of clients among all - 5-

10 financial institutions in the country. Initially, KAFC started its lending operations in six oblasts and planned to have 35 staff. At closing, KAFC nationwide network had expanded to 11 branch offices and 249 staff, of which 72 were at headquarters. The project design envisioned a mobile team for collecting and appraising credit applications with an aim to minimize fixed costs; however, this never materialized. The KAFC management was required to prepare a draft lending operations manual and submit it to IDA for review, and the adoption of the manual by the KAFC Board was a condition of effectiveness. It was also agreed during appraisal that external auditors will be hired and retained annually by KAFC to review at random 10 percent of its outstanding loan portfolio and recommend corrective actions. During the implementation, KAFC and the IDA team agreed that the operational manual needed significant modifications reflecting the dynamic changes occurring in the institution and in the market. The revised general operational manual is in place and staff training has commenced. Capitalization of KAFC. The SAR states that the initial registered share capital of KAFC would be US$ 10.0 million equivalent, which would increase as lending increased. In addition to the initial contribution to the share capital by the government, the project provided the first US$2.0 million equivalent withdrawn by KAFC from the IDA Credit and 25 percent of all subsequent withdrawals as the government's capital shares in KAFC. This arrangement, defacto, automatically guaranteed that KAFC would meet the required capital adequacy. In addition, KAFC was also given the mandate to recover outstanding government loans of about US$17 million equivalent, which, once recovered, would also be subscribed as government shares in KAFC. In reality, less than US$700,000 was recovered, the bulk of which was an in-kind payment. At closing, KAFC was 100 percent owned by the government with the paid in capital of US$6.1 million equivalent, with 41 percent capital adequacy. Table 1: Comparison of Financial Requirements at Appraisal and Completion Financial requirements At appraisal As of June 30, 2001 Capital to risk assets (to be lowered to 25% with satisfactory loan portfolio performance) 33% Fully complied with Maximum loan size for individual or corporate borrower to be limited to 10% of the paid-up capital, or US$250,000, 10% Complied with whichever smaller Minimum debt service ratio 1: 1.5, including taxes and liabilities 1:1.5 to all lenders Complied with Loan recovery performance of minimum 75% 75% 88% average maintained for three loan products Source and Use of Funds for KAFC's Lending Operation. Under the project, KAFC received the entire IDA credit amount equivalent to US$15.96 million. The government also injected its own cash resources of approximately US$0.98 million. Several other foreign donors had provided grant-based technical assistance. The IDA funds were provided in the form of subsidiary loans to and charter capital for KAFC as follows: (a) a subsidiary loan for general credit line in the amount of KGS285 million; (b) an interest-free subsidiary loan for SFCOP in the amount of KGS41 million; and (c) government's share capital for the amount of KGS 130 million. Overall Cost of Funding to KAFC. KAFC received the IDA funds from the govemment both as capital and subsidiary loans, including an interest-free subsidiary loan for SFCOP. Because of this blending of funds, during the first year of operation, KAFC received the funds at no cost. During the subsequent years, KAFC effective cost of funds varied from 5.6 percent to 10.3 percent. In comparison, KAFC actual - 6 -

11 interest rates to ultimate borrowers were substantially positive, ranging between 25 percent to 34 percent. This gave the KAFC an average margin as high as 30 percent during the initial year, which declined to only about 15 percent at the time of closing. It is primarily because of the low cost of funding, KAFC was able to generate a positive return on the equity invested by the government. The trend suggests that KAFC would be worth at least the value of the funds injected by the government in two to three years. At appraisal the Subsidy-Dependence Index (SDI) for KAFC was not to exceed 30 percent. Although declining, in reality, the SDIs were much higher. However, by the time of closing, the SDI had declined dramatically to less than 10 percent. KAFC, as a relatively new institution, also pursuing "social" goals, justified relatively high government support. A remaining challenge for the future is how to reduce the government funding support while KAFC streamlines its product line and operations and at the same time, realigns its corporate strategy to maintain a more sustainable loan portfolio, with less emphasis on delivering public goods (see Annex 8 and Annex 11 for more detailed information). Terms and Conditions of Subsidiary Loans. The government has two outstanding subsidiary loans, which were provided to KAFC. The government agreed to bear the foreign exchange risk by on-lending the IDA funds in local currency with a fifteen-year maturity, including five years of grace. The subsidiary loans were supposed to be on-lent to KAFC based on variable interest rates indexed to the annual inflation rate projected by NBK. In reality, the interest rates charged on the subsidiary loan ranged between 12 to 20 percent per annum, which were generally in line with the inflation rates, with the exception of 1999 when inflation suddenly jumped to over 39 percent following the Russian crisis. Loan Portfolio: KAFC has three credit facilities; a general credit line to individual borrowers based on physical collateral and two group-lending facilities based on peer group pressure as social collateral. At closing, KAFC outstanding loan portfolio was predominantly for short-term working capital loans, with less than 20 percent for investment loans, mostly to purchase livestock. Overall, 47 percent of the credit was used for livestock, 21 percent for mixed crop and livestock, 17 percent for agro-processing, and 15 percent for crop production. Over the four years of implementation between 1997 and 2001, KAFC has achieved: Significant Outreach serving a large number of Beneficiaries: * Total number of individual loans of over 16,000, including about 2,700 for repeat borrowers; * Total number of group loans of around 2,300, including about 550 for repeat borrowers; and * Total number of beneficiaries was over 30,000, and growing. Total Loan Portfolio: * Total loans approved in the amnount of KGS 1,290 million; * Total injection of liquidity to the rural sector in the amount of 1,207 million KGS; * As of June 30, 2001, KAFC's outstanding portfolio was 614 million KGS, with 79 percent for the general credit line, 22 percent for group-lending; * Average sub-loan size was KGS68,000 (US$1,420) for the general credit line, KGS23,000 (US$480) per SFCOP group member, and KGS 11,000 (US$230) per FDF group member; * Average interest rate to the ultimate borrower during the implementation was about 29 percent, which had declined to about 20 percent at the time of closing; * Most of sub-loans made were for working capital with increasing shares of investment loans - 7-

12 (mostly for livestock) with the aggregate average maturity of about 1.5 years; and * Achieved average annual growth of 200 percent of loan portfolio. Portfolio Quality: * Loan loss provision was in the amount of KGS44 million, with a net loan portfolio of about KGS 570 million; * The loan provision appears reasonable at 7 percent at the time of closing, and has been declining (the las-based loan provision was 10.2 percent at the end of 2000 and 8.3 percent in 1999); * The proportion of loans outstanding and more than 30 days overdue increased from 3.4 percent as at December 31, 2000 to 6.0 percent as at June 30, 2001; * Maintained satisfactory repayment performance of around 87 percent; and * Adequately covers the cost of funding, administration cost, and risk premium. Project Impact to Date: * Filled the critical gap in agricultural finance; * Provided an opportunity for the government to discontinue publicly administered, subsidized credit; * Started to induce borrowers' behavioral changes regarding prudent borrowing and obligation to repay; * Established a good initial foundation for commercial crediting in the agricultural sector; and * Started to demonstrate to commercial banks that lending to the agricultural sector can be commercially and financially viable. Portfolio Composition. During the initial two years, KAFC was to make only short-term loans until it built its capacity and client base. This trend continued throughout the four years of implementation, and at closing, overall KAFC portfolio was predominantly working capital, with substantial support for livestock. The composition of the loan portfolio by use is summarized in Annex 9. Terms and Conditions of KAFC Lending to Ultimate Borrowers. KAFC assumed the risk of the outstanding loan portfolio to ultimate borrowers. The original design called for sub-loan repayment schedules to be based on the projected cash-flow and borrower's repayment capacity, with matching production/repayment cycles, positive real interest rates with short-term interest rates revised once a year and investment loans based on variable interest rates indexed to the projected rate of inflation. KAFC would add its cost of funds at a margin from 5 to 8 percent. In reality, during the initial years, the KAFC lending operation deviated from the terms and conditions stated in the SAR; namely that most of the loans made under RFP were for working capital and were offered at fixed rates, and all were due at the end of one year without taking the cash-flow cycle into account. In addition, as discussed above, KAFC margins were high. Several adjustments on KAFC terms and conditions were made during the implementation, in consultation with IDA supervision mission teams. Still much progress is needed to reduce KAFC administrative costs and loan loss provisions as discussed below. Repayment rates. While the overall average repayment rate remained well above the target rate of 75 percent, one area of concern at closing was the downward trend of the repayment rates. At closing, the repayment rate of the general credit line was 91.3 percent, which was slightly higher than the 84 percent achieved at the end of Similarly, the repayment rate for SFCOP, the worst of all three, was 86.5 percent, down from 93 percent in FDF, a relatively new product, also showed a declining trend, down from 99.5 percent in the first year of operation to 95.6 percent at closing

13 The declining repayment rates could be due to several factors. First, KAFC had significantly increased the number of loans made immediately following the 2000 Presidential Decree, most of which are now coming due. There are also signs of duress within KAFC from over-stretched institutional and human resources. The loan-to-staff ratio was worsening as each loan officer managed an increasing number of loans and clients; sometimes as many as 400 per loan officer. Subsequently, loan appraisal quality suffered and frequency of field supervision and loan monitoring also declined which aggravated the repayment performance. Meanwhile KAFC has begun to implement additional credit lines sourced from other intemational financial institutions. While diversifying the source of funds and product lines is desirable, KAFC should take a slower pace while the identified capacity gaps, including the MIS, loan monitoring, institutional reorganization with appropriate staffing etc., are adequately filled. This issue has been identified and discussed during supervision and continues to be addressed during the implementation of the RFP II. High Cost of Intermediation. The SAR stated that the loan transaction costs were not to exceed 3 percent of the loan amount. This was overly optimistic and unachievable for a newly created institution like KAFC. As a new institution in the process of developing capacity, KAFC cost of operation included not only the current costs but development costs as well, including staff training, branch expansion, facility costs, MIS, and provision of office equipment. Each year, KAFC managed to lower its costs. According to Kyrgyz Accounting Standards (KAS), KAFC administrative costs declined from 28 percent in 1998 to 16 percent in 2001, which if adjusted to IAS, showed substantially higher but dramatically declining costs from 49 percent in 1998 to less than 21 percent in Irrespective of the accounting standard applied, however, KAFC is still some way away from the target of 8 percent by year-end 2004 (administrative cost plus loan loss provision), which was agreed to during the RFP II negotiations in 1999 (see Annex 11 for detailed financial and operational results). In order to be sustainable, KAFC must pay greater attention to the quality of the loan portfolio and to loan monitoring. Streamlining the internal organizational structure, improving operational procedures, and automation of MIS, among other changes, are measures that KAFC urgently needs to undertake if it is to achieve the aforementioned target It is the ICR mission view that KAFC has not yet achieved the full operational efficiency at the time of closing and has room to improve. This issue continues to be addressed during RFP II supervision. Future of KAFC KAFC's own projections continue to be bullish. According to the 2002 business plan, the KAFC loan portfolio is expected to grow by 81 percent from KGS638 million at year-end 2001 to KGS1,155 million at year-end This is equivalent to an increase of approximately US$12 million. This seems to be a very ambitious target and will require a substantial increase in new disbursements in addition to re-lending of the reflows. KAFC has signed a subsidiary loan agreement with the Asian Development Bank to on-lend about US$10 million equivalent to agri-business clients in Chui Oblast Component II: Pilot SFCOP Component This component calledfor a pilot group-lending operation under the name of Small Farmers Credit Outreach Program (SFCOP). The original project design assumed a superior repayment under a group-borrowing model where repayment is enforced by farner groups. It was also assumed that this approach would mitigate the problems of imperfect borrower information and repayment enforcement. Groups established voluntarily were thought to be more cohesive in the sociological sense and to share a higher degree of mutual trust than -9-

14 those established under covert duress, for example, groups being formed purely to borrow. In order to be effective, the process required the training of members and the adoption of effective repayment mechanisms, including the threat to cut off future access to credit. In such an environment, peer pressure was known to be an effective tool to induce prompt and full repayment. Under this component, however, the actual outcome differed somewhat from the original design. First, KAFC ended up implementing two different types of group-lending with different group formation support, legal status, operational and organizational structures, and fnancial characteristics of typical group members. When the project was designed, KAFC had only one group-lending model, SFCOP, but, as mentioned earlier, during implementation in late 1998, a second group-lending model, FDF, was added. FDF is a part of the IFAD/IDA co-financed Agricultural Support Services Project (ASSP). UNDP provided substantial group formation support for FDF. The addition of the second model led to substantial changes in the SFCOP design. In August 1997, KAFC established a separate SFCOP Department with a Program Manager to implement SFCOP on a pilot basis to develop group-lending methodologies to give poor households access to commercial credit and other financial services. The scope of SFCOP in the pilot phase was to develop farmer self-help organizations (FSOs) with the anticipation that they would be transformed into rural financial intermediaries (RFIs). Two or three local or foreign private Development Entrepreneurs (DEs) were to be contracted to act as financial intermediaries and promoters of FSOs. In order to achieve these goals, the US$2 million equivalent SFCOP credit line was to be supported by US$1 million equivalent in technical assistance (TA) from the project. Instead, a short-term consultant provided TA; and the envisioned legal framework for the formation of FSOs evolved into Agricultural Consumer Cooperatives (ACCs); no DEs were contracted, and the ACC group loan was fully collateralized with physical assets, up to 130 percent of the loan amount by each individual member. Members of the ACC were, for the most part, eligible to receive credit as individuals from the KAFC main credit line. Loan sizes were not much smaller than the smallest loans for individuals (KGS15,000 for first loans to ACC members vs. KGS 20,000 for individuals), and interest rates and terms were identical for a loan product that theoretically required more work. KAFC concurrently negotiated with IFAD and UNDP and started FDF with a US$1.5 million line of credit. In late 1998, UNDP started TA and training in group formation and development in support of rural, village-based self-help groups (SHGs). In February 1999, less than four months after TA started, KAFC began lending to SHGs even though the first tranche of IFAD funds was not received until the end of July. Within one year, KAFC made loans to 349 SHGs with a total number of approximately 2,433 members and disbursed KGS 12.5 million (approximately US$275,000). FDF loans were made for one year at an average interest rate of 29 percent with no physical collateral requirements. While commendable for its initiatives, KAFC was not able to develop a coherent, consistent group-lending model as was envisioned in the project. Availability of alternative credit lines, and a grant for TA based on different group-lending models also added to complexity. By all accounts, the credit delivery mechanism developed under SFCOP and FDF was not sustainable. In addition to being very expensive, the FDF related TA grant was also designed for a specific "volunteei" model. Meanwhile, SFCOP was left without any donor funding to develop cohesive groups and the concept of RFIs, as the second step of the SFCOP pilot program, did not materialize. Therefore, KAFC loan officers at the regional level were responsible for both group formation (for which they had little understanding and no training) and loan review and processing (for which they needed additional training). As a result, there was very little group development, group monitoring also suffered, and repayment of SFCOP and FDF both started to decline. In June 2000, the IDA team recommended that KAFC suspend the new group-lending scheme until a uniform group-lending strategy could be developed. Only reflows from the already existing group loans - 10-

15 were allowed to be on-lent again. During the preparation of the Second Rural Finance Project, all concerned parties, including the government, agreed that a coherent, consistent, group-formnation strategy, as well as developed lending operational procedures were necessary. As a result, a separate component with the aim to restructure the KAFC group-lending operation was included in RFP II. The RFP II design calls for combining SFCOP with FDF to create one consistent sustainable group formation model as well as to establish a meaningful social collateral system. The TA provider has already agreed to modify its group formation support to reflect the new concept of group-lending, which will be based on legally registered groups with statutes and internal operational guidelines with a stronger emphasis on financial and risk management capacity at the group level. The ICR assessment is that during the period of project implementation, the change of focus and emphasis on the quality of groups rather than the number of groups and amount lent was correct. However, after four years of "piloting and testing" and building on the experience gained, the focus should now shift to consolidation, strengthening and internal growth of the group-lending system, rather than on the creation of more groups, especially since small groups would not be sustainable once they begin mobilizing savings and are required to pay for training services provided. Component m: Policy and Institutional Framework Development Component This component was designed to provide institutional development technical assistance to KAFC management, the SFCOP Department in KAFC, Development Entrepreneurs, and the Farmer Self-Help Organizations. In addition, the component was to pursue removal ofpolicy-induced distortions, such as interest rate subsidies, and elimination offarm debt overhang outstanding to the agricultural sector, which were not conducivefor development of a commercially sustainable ruralfinance system. TA for KAFC. Donors provided substantial institutional development support for KAFC. First, during the preparation period, the Japanese Policy and Human Resource Development (PHRD) Grant, which was executed by the Borrower, supported development of three main branch offices, and preparation of a group-lending program. About 11 percent of the grant was used for local consultants, and another 10 percent was spent for a workshop on lending to the agribusiness sector. KAFC appeared to have had more control over the utilization of this grant compared to other funds, and expressed satisfaction about the work of the local consultants although the consultants were agriculturists not bankers. Donor-fimded TA provided expatriate resident consultants for one year to advise and train on financial management, credit operation and personnel management. Four study tours for KAFC staff were also funded. While valuing the support, some staff felt that the TA could have been more relevant and better designed for the absorption capacity of KAFC at that time. TA was based mostly on Western methods, and the unfamiliarity and limited absorptive capacity of KAFC staff initially retarded the effective transfer of technical knowledge. Perhaps the most regretful outcome of this TA was that the most relevant component, credit management, was not effectively implemented. A credit manual was prepared, but even after revision, most of the lending staff was not able to follow the manual in their daily work. It became clear that not having an appropriate operational manual was one of the most critical constraints, which led to inconsistent procedures, duplications, and higher processing costs. Ultimately, this issue was rectified towards the end of the project with alternative, intensive support by the IDA team. An operational manual for the group-lending was still incomplete at the time of closing. Another TA program provided substantial support to assist in the establishment of branch offices in Issyk-Kul, Osh, and Jalal-Abad; this support later expanded to support the establishment of six branches. The TA helped, among other things; (a) KAFC develop an organization and staffing plan; (b) prepare a set

16 of manuals; (c) devise an implementation plan for the group-lending; (d) provide an adequate format and example of an annual Business Plan; (e) support the marketing division of KAFC; (e) prepare and implement a training program for KAFC staff; (g) provide computers and other equipment in two branch offices; and (h) provide three long-term resident advisors. The consultant team advised KAFC to restructure its internal organizational configuration twice during the life of the contract, revised the credit manual, wrote a group-lending manual, drafted a new business plan for KAFC, and even discussed KAFC privatization. Consultants also initiated agribusiness lending by providing direct support to potential investors and participating in loan assessments, which helped establish a loan portfolio of more than KGS50 million. After the consulting TA was completed, however, this work was not replicated. Approximately US$306,500 was spent on the development of a group-lending program. At closing, a general consensus is that the assistance provided was neither relevant nor effective, and the impact was dismal. As discussed earlier in this report, the "group-lending" developed for SFCOP by the consultant deviated from the traditional, micro-credit based on group-lending methodology as stipulated in the SAR. Further exacerbating the situation, KAFC regional staff were not adequately trained in group formation or development, monitoring of these poorly developed groups was inadequate, and responsibilities and collateral liabilities were less clear than with individual loans. All these deficiencies were reflected in the repayment rate declining from 93 percent in 1998, in the first year of implementation to 86 percent in As discussed earlier, however, these shortcomings of the group-lending operation are being addressed in RFP II. In summary, KAFC received a tremendous amount and a wide variety of technical assistance and training, particularly during the initial years, and some key areas of institutional development benefits were realized. Nonetheless, KAFC still lacks the most fundamental aspects necessary for a successful lending institution, that is (a) a coherent organizational structure with trained staff; (b) consistent intemal controls and management structure with adequate oversight and supervision capacity; (c) adequate risk assessment capacity for investment loans; (d) streamlined operational manuals and their adaptation for daily operation; and (e) MIS, or efficient loan processing procedures which would relieve over-burdened loan officers who each handle from 200 to 400 clients. Clear lessons also emerged from KAFC experience that TA should be "relevant" and designed based on the recipient's needs and absorption capacity and that consultants should have relevant skills and country knowledge. On the recipient side, KAFC should have a more open position about expatriate consultants and try to gain from the opportunity to leam about different methods and know-how from more advanced countries rather than over-relying on intemal and local resources. Other Major Events that Affected the Project Implementation In April 2000, the govemment issued a Decree "On timely and effective carrying out of the springfield works in the agricultural sector in the year 2000" to provide interest rebates for farmers on loans received from KAFC for the spring planting season in The event may have been influenced by the then upcoming political election, and despite publicly expressed IDA concems, the Decree became effective and triggered the official suspension of the IDA Credit in June 29, Withdrawals from the credit lines, Categories I (a) and 1 (b) were suspended. In order to minimize the distortions and negative impact on the KAFC's financial situation, IDA, together with the govemment, agreed on a set of eligibility criteria for the interest subsidy beneficiaries, that included that: (a) only farmers who received loans from KAFC for spring planting, in the time period between January I and June 15, 2000 would be eligible; (b) the interest subsidy would only apply to interest accrued in 2000; (c) the interest subsidy would only be provided after the borrowers have timely repaid the loan principal and interest; and (d) amount of the subsidy would not exceed 50 percent of the amount of interest payable in These damage-control measures were included in the official suspension letter and IDA put forward specific conditions to be fulfilled by the

17 Borrower and KAFC to lift the suspension. The full contents of the suspension conditions can be found in Annex 12. The suspension was lifted on October 12, 2000, following compliance with the required conditions. Immediately following the Decree, there were dramatic increases in KAFC's lending volume. KAFC approved over 4,872 loans during the first six months of 2002 compared to 2, 566 made in the entire year of Two-third of the loans made during the first half of 2000 were also for the first time borrowers of KAFC. The post Decree disbursernent more than tripled from the same period the previous year, and was about 150 percent greater than KAFC's own projected disbursement for the period. The Decree has led to sudden and significant increases in credit demand by mostly new borrowers, who were expecting the 50 percent of interest rebates from the government. At the end, only about 480 borrowers representing about 10 percent of those approved were eligible to receive the interest rebates. KAFC lacked the necessary number of qualified lending staff to evaluate carefully the borrowers and to appraise and process such a huge volume of loan applications in such a short time. Therefore, the main concern was the likely problems that would arise in collection when these loans become due. While it is difficult to link the cause and effects of the Decree, KAFC loan portfolio has definitely suffered from declining repayment performances during the post Decree period. Although relations among the Borrower, KAFC,and IDA may have suffered as a result of the decree and suspension, valuable lessons were learned from this unfortunate experience. 4.3 Net Present Value/Economic rate of return: See Section Financial rate of return: Project Analysis Loans made to individuals or groups were not analyzed during appraisal, as the project was a credit line operation in which the exact nature of sub-loans was not predictable. The project provided a large number of small-size loans, which supported a wide variety of activities; therefore an aggregate analysis of the project's cost and benefits was not attempted at the ICR stage. At closing the credit lines have achieved over 88 percent (vs. appraisal target of 75 percent) repayment rates, confirming that the funded activities, mainly agricultural production, were feasible and generated adequate returns to allow for timnely repayments. Consequently, a fann model analysis was not deemed necessary to reconfirm the viability of investments. Alternatively, for the preparation of this ICR, two groups of randomly selected beneficiaries were interviewed based on standardized questionnaires. They were asked to provide information on the uses of the loan funds, benefits (tangible and intangible) gained from the project, areas to be improved, etc. The respondents unanimously expressed high levels of satisfaction and highlighted the positive impact the loans provided through KAFC on their income, living standards and quality of life. Beneficiaries declared that they, as individual borrowers, could not have obtained credit from other institutional sources and that borrowing from private lenders, if and when available, would have been much more costly. Furthermore, the majority expressed their trust in KAFC while the banking sector as a whole was seen as untrustworthy and uncaring toward the rural population. Overall, the project has effectively filled the gaps of rural finance intermediation while establishing a solid foundation for instituting a credit culture with regards to both lenders and borrowers. For more information on beneficiary impact, please refer to Annex 8, Beneficiary Survey

18 Financial Analysis of KAFC The SAR clearly stated that KAFC was to achieve financial sustainability. During implementation, KAFC prepared yearly business plans, and their financial results were audited by intemational auditing companies and were reviewed by IDA. As a new institution created only in late 1997, KAFC has achieved remarkable financial and operational results. While KAFC has benefited and continues to benefit from preferential support from the government in the form of capital, interest free loans for SFCOP, and access to other governmental funds and assets (i.e. their building), KAFC can maintain itself financially and operationally if the unachieved efficiency gains are fully realized. Based on actual financial data, KAFC is likely to achieve independent, financial sustainability. A more complete analysis, including comparative financial results between 1997 and 2001 and a summary of audited financial statements of KAFC, can be found in Annex 11, and full audited reports are available in the project files. 4.S Institutional development impact: The institutional development impact of the project is high. Institutional development was one of the key objectives of the project starting with the creation of KAFC. When KAFC was created, its headquarters was in a rented office and it only had two regional branch offices with a total of 30 staff. Over four years, KAFC has acquired a building for its headquarters and has grown to 11 regional offices with 249 staff handling all aspects of financial operations, including asset and liability management. The internal organizational structure has been changed on a few occasions to reflect the changing needs of KAFC with its growing portfolio and expanding markets. Necessary institutional capacity building was provided, including support for the development of (a) a more coherent management structure, (b) improved reporting and monitoring systems, (c) internal control and audit procedures, and (d) separate front and back office functions. With the decentralization of loan approval, operational procedures were also restructured to reduce redundancies and inconsistencies. While much progress has been made, there are areas for further improvement. Some of the on-going institutional development support includes: (a) MIS system modernization with a target date of full adaptation around mid 2003; (b) operational manual streamlining and adaptation at all levels; (c) restructuring of the group-lending window with coherent loan appraisal and risk monitoring procedures; (d) preparation of coherent group-lending procedures, including group risk assessment; and (e) development of a staff training program. What is still lacking is the independent supervision and regulation of KAFC, as it is still a non-bank financial institution. While not directly supervised by NBK, KAFC continues to operate based on the prudential norms applicable to banks and is occasionally inspected by the Banking Supervision department of NBK. The Board of Directors of KAFC meets regularly to discuss KAFC operational and financial results, but most of the discussions are more on procedures and aggregate issues without providing the necessary strategic support and business guidance. 5. Major Factors Affecting Implementation and Outcome 5.1 Factors outside the control of government or implementing agency: The 1998 Russian crisis profoundly affected the performance of the regional banking sectors, including that of the Kyrgyz Republic. KAFC, on the other hand, was influenced to a much lesser extent than the commercial banking sector, as it was somewhat "isolated." Since KAFC was the only financial intermediary in RFP, the impact of Russian crisis on the project was insignificant, with the disbursements from the project account even exceeding the plan. The crisis, however, delayed the possibility of participation of other commercial banks in the project, therefore, although discussions are being held with

19 interested commercial banks, KAFC continues to be the sole PFI to date. 5.2 Factors generally subject to government control: Generally, KAFC was given full authority over project management and implementation, and the government, although the sole shareholder of KAFC, did not influence or exercise any control on the day-to-day operation of KAFC. However, as discussed earlier, an ill-conceived government interest subsidy program implemented during the election in Spring 2000 led to the official suspension of the project. Through the experience, albeit difficult for both sides, both the Borrower and IDA learned to be more vigilant about the original spirit and development objectives of the project and the ultimate long-term goal of developing a sustainable rural finance system. The actual impact of the suspension on the KAFC loan portfolio was less devastating than it could have been, as IDA and KAFC immediately enacted damage control through the articulation of strict eligibility criteria. All concemed parties, particularly the govermnent, are now keenly aware of the financial and institutional vulnerability of micro-finance institutions. 5.3 Factors generally subject to implementing agency control: KAFC, under dynamic leadership, evolved quickly to become one of the key players in the financial market in the country. KAFC has been delivering an increasing amount of credit to farmers at an extremely fast pace with growth as high as 80 percent per annum, reaching over 30,000 farmers throughout the country. Farmers in all corners of the country know about KAFC, respect it, and trust it. This is a phenomenal achievemnent. These achievements did not come cheaply. The overarching KAFC strategy has been to expand lending to the agricultural sector at all costs. KAFC had received substantial subsidies from the government, such as government equity, interest free loans, and its headquarters building in Bishkek. In addition, the government capitalized interest due on the subsidiary loan from KAFC as government equity and has allowed KAFC to acquire from the 26 buildings from the government that used to belong to the defunct Agroprombank at a fraction of their cost. The ICR review of sub-loans revealed that sub-loan files were generally in good order with a few cases of missing procurement or environmental documentation, loan monitoring reports, and a limited number of examples of a miscalculated debt service ratios. The review confirmed a sincere effort by KAFC to comply with the letter and spirit of the project. Most important, KAFC successfully targeted the intended beneficiaries: first-time, rural borrowers, seeking small loans. This type of client was not the financial institutions' typical priority client. Nevertheless, KAFC actively sought out such borrowers with dynamic community-level marketing. Much of the success of the project is, therefore, largely attributable to the conscientious efforts made by KAFC. Notwithstanding these achievements, KAFC still needs to improve loan appraisal capacity, efficiency, and portfolio quality. KAFC may also be deviating from financial discipline, and less strictly adhering to the selection criteria of sub-loans as evidenced during the suspension of These concems have been extensively discussed and continue to be monitored under the implementation of RFP II. A remaining challenge is that both the govenmment and KAFC have strong objections to using IDA funds for technical assistance. Consequently, KAFC depends on donor grants for which they often lack full management control. 5.4 Costs and financing:

20 Of the IDA credit of SDRIl 1.9 million (US$16 million), SDRI 1.87 million was on lent to ultimate private farmers and agribusiness. The balance of SDR0.03 million (US$40,000) was used for institution building and technical assistance. During the project implementation, two reallocations were made from Category 2 (goods) and Category 3 (consultants) to Category 1-A (Sub-loan Part A, KAFC general credit line). The originally earmarked technical assistance from the IDA funds was reallocated once the Borrower found alternative donor grants to support the original institutional capacity building component. At completion, the total project cost amounted to US$21.95 million, exceeding the appraisal estimate due to the expanded scope of the technical assistance obtained by the Borrower from donor grants (see Annex 2 for details). SAR projections assumed donor co-financing of US$2.6 million for the two and one-half year period. The government's contribution to the project financing was about US$0.8 million, covering, in part, the initial capital and operating expenditures of KAFC and tax exemptions of goods purchased with project funds. 6. Sustainability 6.1 Rationalefor sustainability rating: Based on positive trends at the time of closing, both financial and operational sustainability of the project is likely. The government is firmly committed to the economic, social, and political reforms, and continues to pursue the maturing process of legal, regulatory, and institutional development to create a conducive environment for the rural finance system to flourish. For the overall banking sector development, the project had a limited impact except for one important aspect. KAFC demonstrated to commercial banks that lending to small-scale borrowers engaged in agricultural production could be profitable, and diversification of client basis and sectors, as well as increasing covariance of risks, could lead to reduced exposure to the lenders. KAFC became effective one year before the Russian crisis of 1998, but it has not only survived the crisis, but it has done so with very limited negative impact. This was mainly due to the consistent KAFC business strategy of "know your clients" and frequent on-site interactions with them. While this model proved to be expensive, it also contributed to a relatively robust loan portfolio with high repayment rates. KAFC has the financial and, at least minimal, institutional capacity to sustain rural lending, and its capacity continues to improve. Sustainability is also evident from the successful institutionalization of commercial credit principles on the part of both the lender and borrower. Ultimately, KAFC sustainability will depend mainly on its ability to maintain its full autonomy, a quality loan portfolio, and an operational efficiency based on a trained staff, a rational internal organizational structure with adequate internal controls and corporate governance, as well as sound management. At the time of RFP closing, KAFC was at an advanced stage of achieving these benchmarks. 6.2 Transition arrangement to regular operations: Under the follow-up project, RFP II, the necessary complementary steps are being taken to ensure that fundamental foundations for future ruralmicro-finance operations will be in place. RFP II will close on June 30, Several efforts are being made to improve the performance of both KAFC and the project. Progress is being made to engage commercial banks in order to increase the number of PFIs and to increase competition among them. Extra efforts are being made to restructure the group-lending operation of KAFC

21 in addition to improving the sustainability and effectiveness of social collateral-based group-lending. Two Moldovan consultants who implemented a successfiul rural finance operation have recently completed a mission to Kyrgyz Republic, and advised, among other things, on the development of legal status for groups, prudential norms and a basic accounting, monitoring and reporiing system of the groups. KAFC, being a non-bank, is not allowed to mobilize savings and is therefore not able to diversify its sources of funds other than through IFI-supported credit lines. The government has already requested, and KAFC is keen, to be transformed into a bank. IDA remains committed to supporting such efforts once the necessary conditions for the transformnation have been met Because of the KAFC track record, commercial banks have expressed interest to participate in the rural lending, indicating that the country is now one step closer to mainstreaming rural lending within the banking sector. Banks, in turn, will discover that sub-loans made in rural areas have the same repayment rates as urban industrial loans; at the same time, they will be diversifying their portfolios and broadening their client bases thereby helping to reduce risk. Having found an economic rationale and an incentive for rural lending, banks have already begun their marketing efforts in rural communities. 7. Bank and Borrower Performance Bank 7.1 Lending: IDA was able to process the project from identification (May 1996) and appraisal (March 1997) to Board approval (June 1997) relatively quickly per the request of the Government. The main elements of the project design were relatively simple and took into account information gathered in the Agribusiness Survey (1996), which revealed the most critical issues that the sector was then facing. Lessons leamed from the pilot project started during preparation and were also taken into account during finalization of the project design. IDA also conducted the Poverty Assessment to ascertain the real needs of the poor segments of the population. This highlighted the most pressing problems of reduced rural incomes, rising hidden unemployment, underemployment and poverty levels, reduced life expectancy, an aging, dependant population, and other social and psychological hardships associated with the transition process. A dialogue was maintained with stakeholder organizations and NGOs throughout project preparation. The project design also reflects innovative features based on other ECA rural finance models that have successfully implemented a temporary rural financial model, which later became mainstream in universal banks. RFP was also fully consistent with the Country Assistance Strategy (CAS), which was discussed and approved by the Board in CAS focused on four priority areas: adjustment lending, agricultural/natural resource management, energy, and social sectors. Recovery in the agricultural sector is a critical element of the IDA assistance program for economic growth and poverty reduction. Within the CAS framework, the IDA assistance strategy for the rural sector consists of policy-based lending in support of structural reforms and investment lending in key sectors. Being consistent with CAS, the project supported strengthening of the financial system, fostering economic growth, creating employment, and promoting income-generating opportunities in rural areas. These efforts, in turn, helped reduce poverty while improving the living standards of the rural population as confirmed by the updated survey of households and statistical basis prepared by the government. 7.2 Supervision:

22 IDA had two project teams that worked on RFP. The second team, which took over the project management in late 1999, is also responsible for the preparation and supervision of RFP n1. The fact that members of the same task team were supervising both Rural Finance Projects, in which KAFC was a key implementing agency, facilitated the more frequent supervision while being more cost efficient. In general, the composition of the IDA missions in terms of skills and expertise allowed for the effective supervision and identification of issues to be addressed to ensure the successful outcome of the project. In addition, the missions made special efforts to strengthen coordination and cooperation among the various agencies involved in project implementation. Supervision was carried out at least every six months, except for a nine-month gap immediately following the September 2001 tragedy in the U.S., and more frequently whenever the need arose. Nine supervision missions, including a mid-term review (MTR) in February 1999 were undertaken during the four-year project implementation period. In addition, IDA organized two study tours for KAFC and government staff to Latvia and Moldova where other successful rural finance operations were being implemented. By the time MTR took place, KAFC had already disbursed over 70 percent of the IDA credit. With this brisk disbursement, the President of the Republic requested an immediate follow up project. Hence, RFP II for SDR million was rapidly processed and approved by the IDA Board on June 24, Due to various reasons relating to the official suspension of the RFP, RFP H did not become effective until March The current pace of RFP II is satisfactory, with more than 30 percent of the IDA funds disbursed at the time of the RFP I closing. 7.3 Overall Bank performance: Overall, IDA performance is rated as satisfactory on project design, appraisal, and implementation. Borrower 7.4 Preparation: The Government has, from very early on, been committed to rural development in general and to the project in particular. At the time of appraisal, the agricultural sector of the Kyrgyz Republic accounted for about 30 percent of the GDP and one-third of employment. If agribusiness was added, the overall contribution of agriculture to GDP was as high as 50 percent. It was noted then that farm productivity and profitability were major problems due to, among other things, constraints relating to a lack of credit for private farmers. The poverty index was on the rise with over 50 percent of the nation's households officially considered poor, and over 50 percent of these classified as "very poor." The government's strategy at that time called for specific measures that target the poor as primary beneficiaries. The government also matched its policy and strategy commitment with financial support. It provided US$0.8 million during the establishment of KAFC and, among other assistance, furnished office space as well as other logistics and strategic operational guidance for KAFC. 7.5 Government implementation performance: Despite the Decree of 2000, which led to the official suspension of the project, the overall performance of the government during implementation was also satisfactory. The suspension lasted only three months during which time substantial remedies and institutional strengthening steps for KAFC were undertaken. The Government delegated responsibility for implementation of the project to KAFC, which was also the key financial intermediary of the credit lines. KAFC was supervised by the Board, which at times appeared to be overly formalistic and less concerned about financial and operational details, but in most cases fully

23 delegated to KAFC the responsibility to implement the project objectives and goals. 7.6 Implementing Agenicy: Much of the success and outcome of the project is due to KAFC performance. KAFC performed well considering that KAFC was a newly created non-bank financial institution with new staff, which also had to build up a nationwide network of branches. Appraisal, supervision and loan monitoring of its borrowers were generally carried out in a satisfactory manner. Record keeping was satisfactory, accounts and management information were kept in a timely manner, and audits were prepared and submitted on time and according to IDA requirements. KAFC has been gradually reducing its administrative costs plus loan loss provision, working towards the goal of reaching 8 percent by end The overall performance of KAFC was satisfactory. It is surprising that in light of the difficult situation in the rural areas, and the agricultural sector in particular, KAFC succeeded in a relatively short time to lend to over 30,000 small-scale, geographically dispersed farmers and rurl entrepreneurs, both individuals and groups. The commitment of KAFC for further development of the rural finance system remains strong. 7.7 Overall Borrower performance: Overall Borrower performance is rated satisfactory. 8. Lessons Learned The generally successful outcome of the first IDA supported rural finance project in a Central Asian country could provide relevant lessons for other rural/microfinance operations in the future. Lessons learned include: On policy and credit environment > Macro-economic stabilization and market liberalization are prerequisites for effective financial intermediary operations, and these conditions were introduced early on in the Kyrgyz Republic, and generally have been maintained; > Four key elements of a successful rural finance project are: (a) legally based property ownership; (b) a functioning legal system; (c) functioning financial institutions; and (d) a system of effective farm advisory and business development support. Most of these were in place in Kyrgyz Republic, but still needed to be strengthened further; > As the RFP suspension demonstrates, government subsidized interest or credit programs significantly undermine the core objective of building.a sustainable rural finance system and hinder the development of a disciplined credit culture; and > Continuous policy dialogue is key in a country like the Kyrgyz Republic, where there were still lingering legacies of central planning and strong government control, as well as a challenging legal and regulatory environment. On project design and constraints > Rural/microfinance is highly relevant in countries with relatively high incidence of rural poverty,

24 and could help create employment, develop human capital, foster market competition, and promote broad-based economic participation. The project contributed towards these goals; Typically, rural clients are physically dispersed, require small-size loans with high transaction costs, and are subject to high weather related risks and limited covariance/concentrated risk of agricultural production. In order to develop an effective rural finance project, RFP addressed some of these constraints; Rural finance projects should increasingly shift emphasis from primary reliance on credit lines toward a more comprehensive approach, including policy/regulatory reforms, and capacity building. RFP was one of the first rural finance projects for the Kyrgyz Republic; The project demonstrated that lending to agriculture and rural businesses could be profitable. The project could have benefited more from having multiple financial intermediaries to create competition among banks and to provide wider access to credits by clients; When a subsidy is provided in the project for a financial intermediary, there should be a clear sun-set clause with a specific, mandatory financial target for the financial institution to phase out the subsidy. KAFC has been successfully reducing its dependence on subsidy; There is a trade-off between building a sustainable rural loan portfolio and outreach to the poor; Cultural and social diversity must be taken into account when designing a project for it to be relevant and practical with concrete demonstrable results. RFP and KAFC were both relevant for the Kyrgyz Republic at the time of project preparation; The establishment and mobilization of social forces to create participatory rural development require considerable time, commitment, and TA. Continuous effort and resources are needed to motivate poor, rural populations to participate in community-based local development activities; and There needs to be a balance between expanding the number of new groups and strengthening the existing ones. Although the project was successful in creating groups, many of them have a very small number of members and are not likely to be sustainable. Priority should now be given to strengthening and consolidating the existing groups. On project implementation aspects The quality and personal commitment of staff, on both the IDA and Kyrgyz Republic sides, and the continuity of many of these staff from the beginning, were essential to the success of this project; The strong drive for results, with hands-on involvement of the teams on both sides, also contributed to the positive outcome; Ownership of a project by the borrower is an essential element for successful outcome; and Segmented rural finance markets, with multiple, uncoordinated donor programs could be counter-productive and need to be better coordinated through open dialogue, sharing of information, and development of effective partnerships. To ensure sustainability and reduce

25 reliance on donor funds, a clearly defined exit plan and transfer strategy of institutional and human capacity to the recipient should be required for all donor programs. 9. Partner Comments (a) Borrower/implementing agency: The following section was prepared by the Kyrgyz Agricultural Finance Corporation (KAFC). Project Objectives and Design 1.1 Objectives The project objectives were: (a) in the short-term, to establish an interim institutional arrangement for lending to the agricultural and agribusiness sectors which had no access to commnercial bank credit; and (b) in the medium and long-term, to provide the basis for developing community-based financial services for the rural population. The project was designed at a time when limited institutional and human resources were available to support the transition from a centrally-directed command economy to a market economy and the newly emerging capital markets were insufficient to meet the needs of market system rapidly developing in response to enterprise privatization. In the years immediately following independence, the GOK was the primary provider of credit to the agricultural sector, intermediated mostly by Agroprombank. There were almost no other banks involved in the agricultural credit at that time. Agroprombank, despite its extensive rural branch network, lacked the experience in commercial loan appraisal and suffered from a high default rate. In 1996 the GOK undertook a comprehensive financial sector reform (Financial Sector Adjustment Credit, Cr KG) designed to address the serious lack of confidence in the sector, the oligopolistic nature and insolvency of commercial banks and the substantial bad debt problem. As part of this reform program, Agroprombank was liquidated and placed under receivership. In the wake of the Agroprombank's closing in 1994, Government has channeled credit to farmers through the Regional Administration (oblast and rayon akimiat), whereby loans have been administered by regional and district authorities. In 1995 several Rural Credit Cooperatives (RCCs) were established among farmers under the directive of the Ministry of Agriculture and Food. These approaches have had dismal results, in terms of credit reaching the target groups and of loan repayment. Other commercial banks, however, were not prepared to fill the void created by the closing of Agroprombank. Existing banks had no rural branch network, no expertise in agricultural lending, and no understanding of the type of assets available as collateral in the countryside. Their technology and expertise were geared toward large-scale industrial and trade finance. Moreover, the baking sector was generally weak and not in a position to expand and move into new markets. Against this backdrop, the project established a non-bank financial institution - Kyrgyz Agricultural Finance Corporation (KAFC) - to serve the newly emerging private farmers and rural enterprises. KAFC was intended as a temporary institution that would serve the rural sector for a limited period of time and then be absorbed into the commercial banking sector. It was also intended to develop a Small Farmer Credit Outreach Program (SFCOP) aimed at reaching groups of farmers who could offer joint and several liability (i.e. social collateral) in lieu of physical collateral

26 1.2 Design (a) KAFC Component established to provide credit on commercial terms to support private sector development in the rural sector. The project provided a line of credit of SDR 9, thousand. KAFC provided short-term/seasonal working capital loans to private farmers and agribusiness enterprises and medium/long-term investment loans for on-farm and agribusiness development. Support for KAFC's institutional development for capacity building and implementation support was provided through grant funds of US$ 540, (actual US$ 562,995.68) from the Swiss Development Cooperation (SDC), JPY 41,700, (actual JPY 41,694,769.00) Japanese Government and ECU 1,496, from the European Union TACIS. (b) SFCOP Component processed of establishing an institutional framework for providing rural financial services on a commercially sustainable basis in the rural areas. The project supported SFCOP's lending program of SDR 1, thousand. (c) Insdtudonal and Policyframework The project supported technical assistance under KAFC and SFCOP components, and promoted institutional, legal and policy changes, innovations which involved revision of the KAFC charter, adoption of an appropriate corporate and management structure for KAFC, and adoption of appropriate operational policies and procedures for KAFC. The project provided of SDR thousand. While the project component remains as it was designed at the time of the SAR, the all components were redesigned. This was a pro-active initiative of the Borrower to restructure the components before it affected the performance of the entire project. According to official request of the GOK the IDA reallocated the proceeds of the Credit as set out in the table in paragraph one of Schedule 1 to the Credit Agreement as follows: SDR 339, from Category 1-B (SFCOP), SDR 50, from Category 2, Goods under Part A (ii) of the Project, SDR 730, from Category 3, Consultants' Services under Part B (ii) of the Project and SDR 37, from Category 4, Refunding the PPF, to Category 1-A, Sub-loans Under Part A (i) of the Project. Accordingly, the amounts allocated to the different categories are as follows: Category l-a (KAFC component) - SDR 10,708,015.01; Category 1-B (SFCOP component) - SDR 1,140,307.16; Category 2,4 (Institutional and Policyframework) - SDR 51,677.83; 2. Achievement of objectives The project is successfully completed. There was established an institutional arrangement for lending to the agricultural and agribusiness sectors which had no access to commercial bank credit. The project established KAFC as a major financial institution that lends to farmers and rural enterprises. KAFC functions primarily on a commercial basis, extend credit based on rigorous financial appraisal, fully cover its costs of funds, administrative margin, and provisioning with its on-lending rates. Credit officers were explicitly trained to understand agricultural markets for outputs, inputs, rural assets offered security

27 Experience with this project show that the demand for rural credit not only exists but is strong and urgent. The project has successfully demonstrated that agricultural financing can be commercially viable. The SFCOP was intended to extend credit to borrowers who lack physical collateral or other assets required as security by accepting joint and several liability through group lending based on social collateral. In practice, however, this component has been slow to develop and group-lending remains heavily based on full physical collateral, with the same terms and conditions KAFC offers to and demands of individual borrowers. Therefore, the objective of increasing access to credit based on social collateral has not achieved. This may have been due in part to the overloading of KAFC with responsibility for group formation and support and to a lack of trained staff who fully understand the concepts of group borrowing and social collateral. There is also a lack of understanding among rural people of the benefits and responsibilities of being a group member. 3. Implementation Summary of Project (as of June 30, 2001) 3.1 KAFC Component Lending operations by KAFC have been proceeding at a satisfactory pace. Since inception (March 1997) until June 30, 2001 has disbursed 15,107 sub-loans for a total amount of KGS million, of which USD 14.3 million has been disbursed from the Credit account. The outstanding balance was about KGS million. The average loan amount was KGS 63 thousand with average repayment period was 15 months. Loan repayment rate was about 86.63%. 3.2 SFCOP Component The activities of the Small Farmer Credit Outreach Program, implemented by KAFC started in March Since beginning and until June 30, loans had been made totaling KGS million, of which USD 1.5 million has been disbursed from the Credit account. The outstanding balance was about KGS 67.2 million. Average loan amount per group was KGS 230 thousand. Loan repayment rate was 82.53%. 4 Project costs and financing 4.1 Project costs At SAR the total costs of the project were estimated at US$ 21.0 million, actual project costs are estimated at US$ 18.5 million. Lines of credit accounted for 86% of total project costs, at SAR estimate of 78%. Institutional Development costs were US$ 2.6 million or 14 % of total costs, at SAR estimate of US$ 4.7 million or 22% of total costs. Moreover according to Japanese Grant Agreement dated October 4, 1995 Japanese Government has provided grant funds amounting JPY 41,700,000 (actual JPY 41,694,769) to finance the cost of carrying out the technical assistance to Rural Finance Project. These grant funds have not been appropriated at SAR. 4.2 Project Financing SAR: The proposed IDA credit of US$ 16.0 million equivalent would finance 76% of total project costs. The credit would consist of US$15.0 million for lines of credit and US$1.0 million to finance TA for SFCOP and vehicles and equipment for KAFC. The Swiss Development Cooperation (SD C) had provided a grant of about US$0.6 million to cover KAFC technical assistance and training. The European Union-TACIS would provide about US$2.0 million equivalent to finance KAFC and SFCOP technical -23 -

28 assistance and training. GOK, KAFC and final beneficiaries would finance US$2.4 million equivalent, or 11% of total project costs, mainly covering support for administrative budgets of KAFC and SFCOP and contributions by final beneficiaries to sub-loans. An IDA PPF, amounting to US$70,000 has been advanced to KAFC to purchase requisite computer equipment and software and it would be refinanced upon Credit effectiveness. Actual: From the beginning of RFP-I implementation and until June 30, 2001 the total financing were: Amounts financed by the IDA: Component of the Project EDA resources (USD) Category 1 A of the Project ,16 Category I A of the Project SFCOP ,00 PPF ,00 Total ,16 Amounts financed by the Govermnent of Kyrgyz Republic in KGS: Name source Amount (KGS) Funds ,00 Buildings ,00 Accrued %% under subsidiary loan invested to the ,87 Share Capital of KAFC Recover of old budget loans ,67* Return old budget loans in the form of merchandises ,05* Total ,59 * According to Subsidiary Loan Agreement the GOK has transferred as share capital contribution to KAFC the proceeds of loan recoveries made by KAFC from the budgetary agricultural credit to be lent by the Ministry of Agriculture and Water Resources and Regional Administration during amounting KGS ,72. Amounts financed by Swiss Development Cooperation: Name Amount SD) TA and training ,68 Total ,68 Amounts financed by European Union - TACIS: Name Amount (ECU) TA and training ,00 Total ,00 Amounts financed by Japanese Government: Name Amount (JPY) TA and training ,00 Total ,

29 5. Bank and Borrowers Performance 5.1 World Bank Performance * Since 1997 the overall performance of the Bank, in general, and the project supervision team, in particular, has been highly commendable. Indeed, WB has been very instrumental in making KAFC a stronger institution with a deeper impact in rural development. * The WB project supervision team has consistently shown foresight and fresh ideas. With a wealth of experience and cross-country knowledge, the team has been able to a very comprehensive manner. Likewise, new standards and measures have been established which are highly relevant to current conditions. * The recommendations and insights of the team have been strategic and highly beneficial. * The team has shown flexibility and open-mindedness in assessing KAFC's attainment of objectives and targets. * The team has a good understanding of the macro environment wherein KAFC operates. With its understanding of the Kyrgyz economy, the team is very able to situate KAFC in the appropriate context. * The team has been very effective in undertaking strategic discussion and coordination with GOK. * The team has always shown the diligence and effort in fully explaining to KAFC officers and personnel the methodologies, empirical process and underlying logic in their supervision reviews. 5.2 Implementation Agency's Performance * The overall performance of KAFC for the period since 1997 has been highly satisfactory. In the agrarian operations, the performance was highly commendable and structural adjustments were undertaken. These have set a platform for sustained growth. * KAFC was designed to succeed where commercial banks could not and performance to date has exceeded expectations. Since its creation, KAFC has established itself as a major financial institution that lends predominantly to agricultural and associated borrowers. Repayment rates have been good, and KAFC's lending portfolio has expanded. The credit disbursements were well ahead of the appraisal estimate. * The KAFC filled a critical gap in agricultural finance, provided access to funds for small-scale borrowers, including outreach to small private farmers, facilitated the phasing out of publicly administered, subsidized credit, induced changes in borrower's understanding of prudent borrowing and obligation to repay, established a good initial foundation for commercial crediting in the agricultural sector, demonstrated the financial viability of commercial lending to the agricultural sector. 6. Lessons Learned The main lessons leaned from this project are: * Agricultural and agribusiness sector have had access to commercial bank credit; * Agricultural financing can be commercially viable; * Demand for rural credit not only exists but is strong and urgent; * RFP face difficulties because: (a) profitable opportunities for lending are lacking; (b) banks are unaccustomed to rural lending and do not know the clientele; and (c) borrowers do not know how to prepare business plans which allow them to accurately assess the profitability of borrowing and to interface productively with banks; -25 -

30 * The loan portfolio should be diversified in terms of size, types of economic activities, clients and geographical areas. * Establishment of Farmer's Self-Help Organizations and Rural Financial Institutions for providing rural financial services on a commercially sustainable basis in the rural areas was not successfully implemented. Group lending can be sustainable if members of the groups share common visions and goals, i.e. credit groups should be meaningful borrowers and community institutions, rather than empty structures that meet the needs of an influential members of the community, and achieving sustainable group lending requires substantial technical assistance and training at community levels. (b) Cofinanciers: N/A (c) Other partners (NGOs/private sector): N/A 10. Additional Information

31 Annex 1. Key Performance Indicators/Log Frame Matrix Outcome I Impact Indicators: IndicatordMatrix Projected In last PSR ActualLatest Estimate KAFC, a non-bank finandal institution, a The Kyrgyz Agricultural Finance Corporation The KAFC has been established, and is stop-gap measure, established. (KAFC) Is actively lending to rural borrowers. actively lending to rural dients Provide farmers and agribusinesses wth Active loan accounts at the end of 2000 Access to credr have been provided to a total access to credit around 8,000, with about 5,500 new of 12,844 (indmdual and group) first-tme borrowers, and more new clients bofrowers, involved In farming, agrbushiess, being provided with access to credit funds in trade, non-agricultural businesses the future Develop community-based rural finandal Creation and finandcng of new groups of Two (SFCOP and FDF) group borrowing Instiutions borrowers being carried out nationwide, with models exist in the country, have been about 450 borrowing groups existing at the tested, and lessons leamed to be end of 2000 implemented in future group ending operations Establish commerdal lending practices and Commercial lending practices are installed, Bofrowers have leamed the responsibilty for induce behavbiral changes among dients proved by the large number of commercial repayment as proven by the high (above about commercial borrowing and bonrvers from the KAFC main credit line 85%) loan recovery rate In KAFC fbr all credh responsibility for repayment lines

32 Output Indicators: _ _ Indicator/Matrix Projected In last PSR ActuaULatest Estimate 1. Number of clients by accounts will exceed The number of borrowers under the Over 15,000 dients have been serviced 6,000 in commercial credit line to increase by 25% under the commercial (individual) credit line. each year Throughout the implementation penod, the growth rate of the number of culents has on average been by 200% every year. 2. A diversified portfolio in terms of loan size The loans range from US$ 400 to USS and type; average loan size of US$ 5,000 by , with the average of USS At appraisal, 79% of loans disbursed have been provided for working capital needs. 3. Average loan recovery not less than 75 Minimum repayment rates of 85% The average loan recovery rate of 88% for all percent three loan products. 4. Positive on-lending interest rates and Interest rates to be progressively adjusted to Interest rates have been at the lower end of margins that cover loan transactions cost, risk reflect relevant market rates on-lending rates of commercial banks and and cost of funding. positive in real terms throughout the implementation period; KAFC margin ranged between 15-20% on average. 5. Loan transaction costs not to exceed 3% of Loan transaction costs at par with transaction loan amount for the commercial operations. costs of commercial banks 6. KAFC's subsidy dependence index not to In 2000, the subsidy dependence index was exceed 30 percent for commercial operations. 32.4% Although It Increased mid-2001, has dedined to 7.5% at the end of Training of 100% of KAFC loan officers All KAFC lending and financial management and 100% of financial management and and accounting staff have been trained. Staff accounting staff during the first year of Is sent to refresher courses regularly operation. Minimum of 75% of ail staff to attend refresher courses each year. 8. Graduation rate into RFIs will be at least The ACCs existing under the project have 400 in 2000 (for community-based rural not developed into true community-based finandal institutions). independent rural financial intermediaries. and have remained just credit groups. 9 In the community-based rural financial SDI has not been calculated for the ACCs institutions, the subsidy dependence index not (SFCOP), as they were not true rural to exceed 65% in financial intermediaries, but borrowing groups. 10. On-lending Interest rate will be at par with By the end of the project, credits have been commercial interest rates in 2000 for the provided to 518 rural credit groups (ACCs) community-based nural financial institutions. 11. Number of FSOs established will be not less than 200 each year of project On-lending rate at par with the lower end of commercial interest rate bracket from KAFC Implementation. to ACCs. End of project

33 Annex 2. Project Costs and Financing Proect Cost by Com onent (in US$ million equivalent) KAFC Component Pilot SFCOP Component Policy and Institutional Framework Development Component Total Baseline Cost Physical Contingencles 0.70 Price Contingencies 0.70 Total Project Costs Total Financing Required Project Financin b Component (in US$ million e uivalent) ikafc Component Pilot SFCOP Component Policy and Institutional Framework Development Component Note: The Government column also includes any co-financing provided by KAFC and the project beneficiaries

34 Annex 3. Economic Costs and Benefits The Staff Appraisal Report (SAR) projected that most of the credit line funds would be used for investment loans, and a separate revolving fund account would be established for short terms loans. The farm models (including the IRR calculations) were prepared at appraisal (Annex 3, SAR), focusing on four main types of agricultural products: wheat, vegetable, sheep, and potatoes. Farm model results reflected the real situation at the time of appraisal but they were no comparable with the results at closing. Kyrgyz agricultural sector underwent tremendous changes, including terms of trade, prices, labor productivity, etc. At the closing, since the project supported over 17,000 separate sub-loans involving about 30,000 individual beneficiaries, two Beneficiary Surveys (for individual clients and group clients) carried out as an alternative to farm models. Two-third of respondents confirmed that use of the funds led to improvement in their living standards and income levels, and more than a half stated that they would borrow again. The respondents also were fully aware of their repayment responsibilities although about 10 percent felt that the repayment terms were not favorable. In summary, the survey confirms that the project had real impact on creating economic activities in remote rural areas, which contributed towards improving their livelihood. Borrowing in groups also allowed individuals who could not borrow from KAFC to access working capital and investment credit. The surveys confirm outstanding issues with the group lending as discussed elsewhere in this report. At closing, KAFC's outstanding loan portfolio was predominantly for short-term working capital loans, with less than 20 percent for investment loans, mostly to purchase livestock. Forty-seven percent of the credit was used for livestock, 21 percent for mixed crop and livestock loans, 17 percent for agro-processing, and 15 percent for crop production. Because of a large number of loans made, an aggregate rate of return was not estimated. While it is difficult to precisely estimate the number ofjobs created and additional income generated, both the direct and indirect impacts of the project are expected to be substantial. The project provided access to loan funds for about 30,000 beneficiaries who borrowed individually and through groups, to initiate or expand economic activities in rural areas. The sound repayment rates and the fact that many of the beneficiaries are borrowing again demonstrate the economic and financial soundness of various activities. KAFC, after four years of operation, has become a strong financial agency filling the critical gap in rural finance intermediation. It has achieved an excellent outreach of rural clients widely dispersed throughout the country. Through its operation, KAFC has established a sound initial foundation for commercial crediting in the agricultural sector, started to induce borrowers' behavioral changes regarding prudent borrowing and obligation to repay, and was able to demonstrate to commercial banks that lending to the agricultural sector can be commercially and financially viable. Furthermore, the project provided an opportunity for the govermnent to discontinue publicly administered, subsidized credit, hence leading to positive fiscal impact on the budget

35 Annex 4. Bank Inputs.) Missions: l Stageof Project Cy'cle No. of Persons and Specialty Performance Rating (e.g. 2 Ecbnomists, I FMS, etc.).ijmplementatio6n Development. Month/Year ^Count ;Specialty. - Progress m Ob3tive Identification/Preparation June Task Team Leader; Agricultural Credit Specialist, Banking Specialist (consultants) December Task Team Leader, Economist April Task Team Leader April-May Rural Banking Specialist (consultant) July Task Team Leader November Task Team Leader, Economist, Analyst; Credit Specialist, 2 Rural Credit Specialists (consultants) Appraisal/Negotiation March Task Tam Leader, Economist, Operations Officer, Financial Analyst May Task Team Leader, Country Counsel, Senior Disbursement Officer, Procurement Specialist, Translator/Interpreter Supervision November-Decem 2 Task Team Leader, S HS ber 1997 Operations Officer June Task Team Leader, Operations S HS Officer February Task Team Leader, 2 Rural S S Finance Specialists, 2 Financial Management Specialists, 3 Social Development Specialists, Sector Analysis Specialist, Operations Officer August-September 7 Task Team Leader, Rural S S 1999 Finance Specialist, Banking Specialist, Environmental Specialist, Agribusiness Consultant, Monitoring and Evaluation Specialist, Operations Analyst April Task Team Leader, Senior S S Treasury Manager, Rural Finance Consultant, Banking Consultant, Agribusiness Specialist, Operations Analyst September-October 4 Task Team Leader, Senior S U

36 ICR 2000 Financial Officer, Financial Analyst, Agribusiness Specialist January-February 3 Rural Finance Spicialist, Senior S S 2001 Financial Officer, Financial Analyst June Task Team Leader, Financial S S Analyst February Task Team Leader, Senior S S Financial Management Specialist, Banking Specialist, Financial Analyst, Business Development Specialist (b) Staff: Stige of Project Cycle ActuaVLatest-Estimate No. Staff weeks - US$ (000) Identification/Preparation n/a AppraisalVNegotiation n/a 63.7 Supervision n/a ICR n/a 62.3 Total n/a

37 Annex 5. Ratings for Achievement of Objectives/Outputs of Components (H=High, SU=Substantial, M=Modest, N=Negligible, NA=Not Applicable) Rating O Macro policies O H OSUOM O N * NA 0 Sector Policies O H OSU*M O N O NA O Physical O H *SUOM O N O NA Z Financial O H *SUOM O N O NA Institutional Development 0 H * SU O M 0 N 0 NA O Environmental O H *SUOM O N O NA Social O Poverty Reduction ZGender F Other (Please specify) Outreach Z Private sector development OI Public sector management M Other (Please specify) rural/microfinance, grassroot financial services O H *SUOM O N O NA OH *SUOM ON ONA * H OSUOM O N O NA 0 H O SU O M 0 N 0 NA 0 H O SU O M 0 N * NA O H *SUOM O N O NA

38 Annex 6. Ratings of Bank and Borrower Performance (HS=Highly Satisfactory, S=Satisfactory, U=Unsatisfactory, HU=Highly Unsatisfactory) 6.1 Bankperformance Rating Lending OHSOS OLU OHU Supervision OHS OS O U O HU 3 Overall OHS OS OU O HU 6.2 Borrowerperformance Rating Z Preparation OHS OS O U O HU [J Government implementation performance O HS OS O U 0 HU Z Implementation agency performance OHS OS O U O HU Z Overall OHS OS 0 U O HU A temporary suspension of three months was lifted after the Borrower satisfactorily met all the conditions

39 Annex 7. List of Supporting Documents 1. Staff Appraisal Report - Kyrgyz Republic: Rural Finance Project - Report No: KG - May 15, Agreed Minutes of Negotiations between the World Bank and the Government of Kyrgyz Republic 3. Credit Agreement - Kyrgyz Republic: Rural Finance Project (Credit number 2959-KG) - July 3, Subsidiary Loan and Equity Investment Agreement between the MOF and KAFC - July 31, Country Assistance Strategy - April Report No KG 6. Kyrgyz Republic: Rural Credit Social Assessment - January Environmental Assessment Social Assessment Agribusiness Survey Kyrgyz Republic: Rural Finance Survey Kyrgyz Republic: Rural Finance Strategy Farm Profitability Assessment - September KAFC Operational Manual Rural Credit Guidelines KAFC Environmental Review of Agricultural Projects: A Procedural Manual - March Mid-term Review Report Project Appraisal Document - Kyrgyz Republic: Second Rural Finance Project - June 1, Audited Financial Statements for Rural Finance Project for Years Ending 1998, 1999, 2000, Audited Financial Statements for KAFC for Years Ending 1998, 1999, 2000, Agricultural Support Services Project Loan Agreement between KAFC and IFAD - July 3, Agricultural Area Development Project Loan Agreement between Kyrgyz Republic and Asian Development Bank Project Agreement - Agricultural Area Development Project between Asian Development Bank and KAFC - May 16, Subsidiary Loan Agreement between Kyrgyz Republic and KAFC - Agricultural Area Development Project - August 14, Development Of Community-Based Financial Services for the Rural Poor - Consultant Report - March Technical Assistance (TA) Assistance Support for the Institutional Development of the KAFC - Consultant Report - March Financial Results of the Rural Finance Project at Completion - Consultant Report - March Beneficiary Surveys for Three KAFC Credit Lines - April Review of the Kyrgyz Agricultural Finance Corporation - Consultant Report - March UNDP: Participatory Poverty Alleviation Programme - Evaluation Mission Report - March UNDP: Alleviating Poverty by Joint Efforts: Enhancing Partnerships for Social Development in the Villages - Conference Report - September Note on the Expansion of UNDP Participatory Poverty Alleviation Programme in Kyrgyzstan in Results of Analysis of the Kyrgyz Republic's Legislation, Relating Microcrediting and Materials of Practice of Activity of Organizations Giving Microcredits - March 9, UNDP: Assessment of Needs and Solutions for a Microfinance Credit Reporting Network in Kyrgyzstan - April 22,

40 Additional Annex 8. Beneficiary Survey - April 2002 As a part of the ICR preparation, a survey based on questionnaires was carried out through a local NGO on two types of beneficiaries: (a) General KAFC credit line for individual loans (57 clients); and (b) Small-Farm Credit Outreach Program for group loans (16 groups). I. KAFC General Credit Line for Individual Loans Who are they: (a) More than 50 percent of the borrowers were farms created after 1997, after the project was prepared; (b) More than 98 percent were legally registered as private entities percent peasant's-farms; 43.9 private entrepreneurs; 1.8 percent - limited liabilities companies and joint-stock companies. (In one questionnaire the line was not marked). (c) Borrowers had mixed farms (38.6 percent), sheep breeding farms (35.1 percent), other agricultural (10.5 percent); minor percent for agricultural processing, production of the silkworm, beer and trade. Credit Access history: (a) Among the borrowers 316 percent were the first time borrowers (b) 47.4 percent received credits twice (c) 15.8 percent - three times (d) one client - four times Average loan sizes received by borrowers were: (a) 43.9 percent were for average loans between KGS 51 to 250,000; (b) 36.8 percent were small borrowers receiving KGS 6,000 to 50,000; (c) only THREE clients (5.3 percent) received large loans KGS 500,000 to 7 million. Interest rates: Interest rates prior to 2000 was as high as 37 percent (1.8 percent respondents) while majority borrowers paid 32 percent. With the interest rates started to come down in 2001 and continued in 2002, about 35 percent of borrowers paid interest less than 25 percent while the average paid by the rest was around 27 percent per annum. Total amount of the borrower's balance sheet: Out of 57 interviewed, five clients had assets greater than KGS I million (about US$20,000) with the largest asset being KGS3.7 million (about US$74,000); about 28 percent had the asset ranging between KGS 300,000 to 600,000 (US$6,000-12,000) with about 40 percent of borrowers had asset smaller than KGS 270,000, most cases less than KGS 100,000 (US$2,000). Loans repayment: 89.5 percent of borrowers replied they did not have problems with loans repayment; 5.3 percent (3 respondents) had some problems; and another 3 did not replied. Out of those persons who had problems with the loan repayment, reasons were reduction of prices for livestock, problems of selling wheat seeds, and the third one had problems other debts. Evaluation of the benefits from the KAFC loans For assessment of the benefits, respondents were asked to choose among- significant, considerable, limited and minimal: (a) 34.8 percent rated benefits from the loan as " significant "; (b) 19.9 percent rated " considerable "; (c) 45.4 percent rated limited benefits from the loans' and (d) 24.5 percent rated the impact as "minimal"

41 Respondents who rated minimal impact were those engaged in export (54.4 percent), access to new markets (35.1 percent), improvement of the equipment and technology (45.6 percent), creation of new products (38.6 percent). One third (29.8 percent) of respondents indicated the minimal loan impact in creation of jobs. Respondents who rated limited impact think the limits were in the creation of new jobs (29.8 percent); diversification of business activity (28.1 percent); access to new markets (24.6 percent); sales growth and profitability (19.3 percent); and productivity growth and compatibility growth (21.1 percent). Among those who indicated a considerable impact of the loan, the majority believes that the project assisted them in improvement of planning of their activity (45.6 percent); improvement of management (38.6 percent); and also assisted in solving problems of the working capital (43.9 percent). Among them, 42.1 percent indicated profitability grow'th; 40.4 percent gained productivity growth; 36.8 percent reported that they have become more competitive; 33.3 percent indicated sales growth; but the respondents reported that KAFC loans had a lesser impact on improvement of equipment and technologies (12.3 percent) and exports (1.8 percent). What have they tried before KAFC. A high proportion (82 percent) of respondents sought other loans before turning to KAFC. Of the 57 respondents (some checking more than one source), alternative sources of funds were: relatives (86.0 percent); loans from friends (82.0 percent); local lenders (79.0 percent) and self-financing (51.0 percent). 18 percent has never sought other sources of financing before approaching KAFC for loan. On possibility of achievement without KAFC loans: 65.0 percent of questioned borrowers replied that they could not have achieved what they have without the KAFC loans percent thought they could have achieved the same without KAFC. Rating the experience of receiving loans from KAFC: - "excellent": percent; - "good": percent; - "satisfactory": 11.0 percent; - "bad": less than 1 percent Those rated "bad" thought that KAFC's requirements for getting the loan were excessive, required large financial expenses, and took too long. But most respondents think that KAFC staff was well informed and useful in providing consistent consultations. Processing Time. 18 people responded to the question on how long did it take in average from submission date of the full package of documents to the approval of the KAFC loan committee: - 7 to 15 days: percent - 16 to 30 days:45.61 percent - 30 to 60 days :10.52 percent - up to 240 days: 3.5 percent Recommendations: Among the respondents, 44.0 percent of borrowers felt that KAFC should reduce the document requirements; 24.6 percent of borrowers felt that KAFC should reduce the interest rates;

42 10.5 percent felt that KAFC should reduce the processing time; 7.0 percent felt that the loan repayment period should be extended II. Small Farm Credit Outreach Program (SFCOP) Who are they: (a) Most of the respondents were members of the groups that had been established in 1998 (50 percent); 25 percent of the respondents had their groups registered in 1999; 18.7 percent - in 2000; and 6.3 percent - in 2002; (b) All groups were legally registered, 75 percent in private and 25 percent in collective form of ownership; (c) 28.3 percent of all group members were women; (d) Majority of the respondents were members of the same village (68.75 percent) or neighbors (43.75 percent); percent of the respondents said there were friends among their group members. Why was the group established: (a) A primary reason was to obtain a credit (75 percent); (b) 37.5 percent of the groups have been established to work together in land cultivation and livestock-breeding; (c) Only one group has been established to participate in public (community) work. Responsibilities of group members: (a) 81.3 percent of the respondents thought that "approval of those who are creditworthy" were their main responsibility; (b) more than a half (56 percent) consider themselves responsible for ensuring timely and mandatory repayment of credit by the individual members to be able to access other lending programs in the future. What economic activities were the group members involved in: (a) Majority of the group members (81.3 percent) were involved in meat and/or dairy fanming; (b) 67.7 percent were in livestock breeding; (c) 86.7 percent in sheep breeding; (d) 62.5 percent in horticulture; and (e) 6.3 percent in crop production. Average loan sizes varied significantly percent of respondents obtained credit of KGS 15,000 per group member; 31.3 percent had KGS 20,000 per a group member; equal share of borrowers (12.5 percent) obtained credits of KGS 5-10,000, KGS 25-30,000, and KGS 40,000 per one group member. Interest rates: (a) More than a half (56 percent) of the respondents obtained credit at the interest rate of 28 percent, (b) 43.8 percent of the borrowers obtained their credits at the interest rate of 32 percent; (c) 25 percent obtained credits at the rate of 21 percent; and (d) 18.8 percent obtained credits at the rate of 19.0 percent. Loan repayment: 12.5 percent of group members failed to repay their part of credit; and the other 87.5 percent were able to repay their share of credits on time

43 Evaluation of the benefits from the SFCOP loans: The majority of the borrowers (81 percent) were provided with work; 75 percent of the borrowers managed to improve their living standards resulting from increased income from economic activities; 68.8 percent are now sure they can better provide their families; while 31 percent had an opportunity to earn more. In addition to the improvement in their own welfare, one fourth (25 percent) of the borrowers created jobs for other people. Rating the experience of receiving loans from KAFC: Majority (81 percent) of respondents identified their relationships with the KAFC as "reasonably good", while 12.5 percent and 6.25 percent said their relationship with KAFC were "perfect" and "satisfactory" respectively percent of the borrowers interviewed said that they would borrow from KAFC in the future. Processing Time: 43.8 percent of the borrowers waited for the KAFC Credit Committee's decision for 30 days after they had submitted the full package of documents; 12.5 percent waited for 60 days; and the remaining borrowers waited for 45, 15 and 12 days (12.5 percent equal share each group). Recommendations: (a) 18.8 percent of the borrowers interviewed recommended shortening the loan application process; (b) 12.5 percent of respondents recommended KAFC to provided longer-term loans. Future of the groups: Responding to the questions whether the borrowers planned to work as a group in the future, 81.3 percent of the borrowers replied in the affirmative, while 18.8 percent answered in the negative. These responses were supported with a strong intention to borrow, as a group in the future by 81.3 percent of respondents while the remaining 18.7 percent had no intention to obtain group credits anymore. In respect of the purpose for borrowing in the future, 62.5 percent of the respondents mentioned their intention to expand their livestock production, while another 12.5 percent of the borrowers were planning to do agricultural work

44 Additional Annex 9. Summary of Credit Line Implementation (in Thousands KGS) Jan-June TOTAL Total Number of Borrowers, approved (cumulative) 386 1,791 5,002 10,811 15,334 15,334 Total Number of Borrowers, disbursed (cumulative) 352 1,625 4,656 10,014 14,045 14,045 Existing Borrowers, approved In each period ,223 1,715 3,323 Existng Borrowers, disbursed in each period ,223 1,715 3,323 New Borrowers, approved in each period 386 1,405 3,211 5,809 4,523 15,334 New Borrowers, disbursed in each period 352 1,273 3,031 5,358 4,031 14,045 Total Number of Projects, approved (cumulative) 402 1,862 5,387 12,419 18,657 18,657 Total Number of Projects, disbursed (cumulative) 368 1,696 5,041 11,622 17,368 17,368 Projects, approved in each period 402 1,460 3,525 7,032 6,238 18,657 Projects, disbursed in each period 368 1,328 3,345 6,581 5,746 17,368 Total Amount of Loans, approved, KGS 33, , , , ,593 1,289,969 Total Amount of Loans, disbursed, KGS 30, , , , ,757 1,207,560 Commercial loans Number of loans approved 402 1,319 2,875 6,038 5,680 16,314 Number of loans disbursed 368 1,187 2,749 5,612 5,131 15,047 Total amount aproved, KGS 33, , , , ,251 1,020,598 Total amount disbursed, KGS 30, , , , , ,268 Average Loan size (approved) Average interest rate (%) 30.0% 28.0% 29.1% 32.1% 29.3% 29.7% Average grace perod (months) Average maturity (years) SFCOP loans Number of loans approved Number of loans disbursed Total amount aproved, KGS 27,651 59,259 59,789 24, ,322 Total amount disbursed, KGS 26,851 52,053 55,889 30, ,683 Avearge loans size per ACC, approved, KGS Average loan size per borrower in the ACC, KGS Average interest rate (%) 28.0% 28 6% 32.3% 31.5% 30.0% Average grace period (months) Average maturity (years) FDF loans Number of loans approved ,597 Number of loans disbursed ,542 Total amount aproved, KGS 13,596 49,734 34,718 98,048 Total amount disbursed, KGS 12,486 48,168 32,955 93,609 Avearge loans size per group, approved, KGS Average loan size per borrower In the group, K S Average interest rate (%) 29.0% 32 0% 29.5% 30.0% Average grace period (months) Average maturity (years) Purpose of loan Total number of loans approved 402 1,460 3,525 7,038 6,238 18,663 Total amount approved, KGS 33, , , , ,592 1,290,217 Crop production (number) , ,038 Total amount 13,641 32,905 36,515 74,668 36, ,167 Livestock production (number) ,257 3,620 3,528 10,541 Total amount 11,575 58, , , , ,519 Processing industry (number) Total amount 7,870 44,270 53,478 51,578 60, ,934 Mixing Production (Crop and Livestock Production) ,116 1,770 4,611 Total amount 790 6,611 44, ,742 98, ,

45 Additional Annex 10. Summary of Financial and Operational Parameters Under the Project Table 1. Interest rate on the subsidiary loan paid by KAFC to MOF: Agreed in the legal agreements: Floating, based on the actual rate of inflation as confirmed by NBKR. Actually: Based on the projected inflation rate Indicators Actual inflation rate, % Contracted interest rate payable to the MOF,% Effective COF paid to the MOF, % Average KAFC on-lending rate, % Effective KAFC margin, % (4-3) Note: 2001 information as of December 31. Sources: Year end results - annual audit report, and KAFC Table 2. Summary of Balance Sheet, KGS million SUMMARY BALANCE SHEET (KAS) * Total assets Total equity Total loan portfolio (net) Net profit International Accounting Standard (IAS) Comparatives Total assets Total equity Total loan portfolio (net) Net profit * As of December 31, 2001, for consistency and comparison purposes with the other years. Table 3: GOK Contributions, US$ thousand equivalent Contribution Items Agreed Actual at Appraisal Initial start-up expense coverage 23.7* 23.7 Initial share contribution From IDA credit proceeds - (US$ 2 mil +25% of drawdowns 4,750 4,844.2 From GOK loan recoveries , From GOK loan recoveries , From GOK loan recoveries ** Capitalization of interest on the Subsidiary Loan Transfer of retained earnings of KAFC

46 From IFAD credit proceeds - 100% of drawdowns 0 1,516.1 Buildings 0 2,433.4 Total GOK Contribution 22,162 11,070.7 * Equivalent of KGS 400,000 at end-1996 exchange rate of KGS ** This amount includes US$ 122,620 equivalent in goods (from the GOK loans in kind) collected but not yet sold. Table 4. Quality of Loan Portfolio, KGS million * Loans Provisions (KAS) Net loans (KAS) Provisions as a % of loan portfolio (KAS) 0.8% 10.6% 8.0% 7.6% 4.0% Provisions (LAS) Net loans (IAS) Provisions as a % of loan portfolio (IAS) 3.0%1 11.0% 8.6% 10.2%1 4.5% * As of December 31, 2001, for consistency and comparison purposes with the other years. Table 5. Subsidy Dependence Index, SDI, KGS million Jun 30, Concessional borrowed funds (average), a KAFC rate of interest payable to GOK, m 17.0% 14.7% 20.0% 20.0% 12.0% 12.0% Weighted average annual concessional interest 0.0% 12.7% 18.1% 16.7% 5.0% rate, c 10.0% Average annual equity, e Reported annual profit, p Sum of all other annual subsidies, k Average outstanding loan portfolio, LP Average on-lending interest rate, I 15.3% 26.0% 24.9% 32.0% 13.0% 27.4% SDI = (a(m-c)+((e*m)-p)+k)/(lp*i) 257.4% 58.0% 22.5% 32.4% 75.2% 7.5% Note: excludes USS exchange rate losses of GOK Table 6: Summary of Administrative Costs (including loan loss provision) 12/ / / /2001 KAS-based administrative efficiency incl. loan 27.6% 20.7% 18.6% 15.7% provision IAS-based administrative efficiency incl. loan 49.6% 24.2% 24.8% *20.5% provision

47 Additional Annex 11. Detailed Review of KAFC's Financial Statements BASIC FINANCIAL STATEMENTS AND EFFICIENCY ANALYSIS (Thousands KGS) as of June 30, INCOME STATEMENT Inteest income from treasury bils and NBK securities , , , ,517.0 Interest income ftom deposits and REPO deals , , , ,6308 Interst inome from lending 2, , , , ,1008 Other Interest Income Other operafing Income , , ,858.1 Income from other operatons , ,4859 6, ,907.7 > Total operating Income 3, , , , ,221.6 Interest expenditure for deposits of banks and ST lri Interest expenditure for subsidiary loan 7, , , ,136.4 Interest expenditure 0.0 7, , , ,136.4 Personnel and afdnistralve expenses 3, , , , ,441.6 Facedassetand eupment expenses , , , ,570.7 Loan recovery and pledge costs PrvisIns for loanlosses , , , ,390.4 Loan costs ,91&4 13, , ,188.5 Othroperational costs , , VATand other taxes 195 1, , ,5659 3, Total operating expenditures 4, , , , ,259.4 > Not Income(lssJ)bef e tax &xt rad. Items , , , ,962.2 Profit tax , ,273.5 Extraordinary costs 1.0 > Net Income4loss) , ,934.8 U87.7 BALANCE SHEET Cash Corespondent accounts 9, , , , ,208.8 Deposits and REPOs 2, , , , Treasury bils and NBK Notes 9, , , ,397.3 Loans 26, , , , ,023.2 less: prvisions , , , ,334.4 Fixed assest and other property 16, , , , ,122.9 Accrued income 1, , , , ,449.5 Other assets, ind. intangible , , ,899.8 > Total assets 65, , , , ,795.4 Deposts and loans from govterment 2, , , , ,435.6 of which Subsidiary loan RFP1 -Commerdal credi line , , , ,533.5 Subsidiary Loan RFP I -SFCOP 1, , , , ,9020 Payment of interest to govemment 15, , ,136.4 Other liabillbes 14, , , , ,187.6 => rotal labliltles 17, , , , ,

48 Capital and reserves 49, , , , ,413.6 Retained eamings loss of last year ,934.8 Retained eamings lossofcurrentyear , , > Total captal 48, , , , ,035.9 t Total liabilities and capibl 65, , , , PROFrTABILITY AND EFFICIENCY ANALYSIS => Operating return on average assets employed -1.0% 0.4% 3.4% 23% 04% => Net retum on average assets employed -1 0% 0.1% 35% 14% 01% => Operaing return on average equdy -4.1% 1.6% 13.5% 9.4% 18% => Net retum on average equity 4.1% 0.5% 14.1% 57% 0 2% Adminisave expenses excl. loan provisn (cost of lend.) 4, , , , ,732 7 = Administrative effidency (exd. loan prvision) 31.4% 281% 17.0% 144% 64% Administrative expenses ind. oan provon (cost of lending) 4, , , , ,123.1 => AdmInisraive offidency Und loan provision) 36.9% 44.7% 238% 21.5% 11 8% Note: above calculaonm based on average year-end loan portlio => Onlending margin (On-lending rate less Administrative effdency Id. loan prvion) -21.6% -18.8% 1.1% 10.5% 1.3% CAPITAL ADEQUACY AND CAPITAL ANALYSIS CAPITAL ADEQUACY Pisk-weighted value of assets (using NBK welghtings) 46, , , , ,0284 Capital adequacy - On total capital 10417% 63 96% 52 90% 44.43% 41 20% Capital adequacy -On pure (tier 1) capital % 63.67% 46.89% 42.39% 41.10% Compareto NBKretfrns-Ontotalcaptal n/a 49.27% 49.04% 45.76% 4247% Compare to NBK rehuns - On pure (bar 1) capi n/a 59.97% 48 51% 42 47% 41.22% COST OF FUNDS AND LENDING MARGINS Interest expenditure for subsidiary loan (above) 0.0 7, , , Average balance of GOK loans 1, , , , ,628.1 => Income statement (book value) cost of GOK loans 0.0% 12.7% 18 1% 167% 51 Compare wfth contracted GOK rate of interest 170% 14.7% 20.0% 20 0% 1Z0% GOK Financing of KAFC (i.e. share capital contributlons -subsidized GOK loans) 51, , , , ,849.2 Average value of GOK Finandng of KAFC 25, , , , ,009.5 => Effective cost of GOK Finandng 0.0% 5.6% 10.3% 91% 2.7 Average loan portfolio 13, , , , ,901.5 Average on-lending Interest rate 15 3% 26.0% 24.9% 32 0% 13.0 => Effectve margin (average on-lending Interest rate less effectve cost of GOK Financing) 15.3% 204% 14.6% 22.9%

49

50

51 70' KYRGYZ REPUBLIC KG RURAL FINANCE PROJECT 80 - UZBEKISTAN ~~~K ZAKSTA TAJ IAA KI STA ToTrzAlmTo OF L S KGO RURALKU FIANE RJET0 S \ a F Isk (~~~~~~~~~~~~~~~~~~~~~~~HBoLk K " ak 0 SELECTED CITIS 1 50 UZEITHER s 0,9 ROD n,>,,( -> - RAILROADS Chu 28 2,401 o D u 2b o s - ^ - INTER ATIONAL B UNDARIESBatken 451,057 IRA g ~ l \ C H I N A < 7rO q Totul (KGS} 1,114 15,820 g AFGHANISTAN 50 tj o~~~~~~~~~~~~~~~~~~~~~~~~~~~ 100 1o o ~ ~~~~~~ i5 ~ ~~~~ Z10 160\ ~ ~ ~~~~~~~~ '' ' ' RAILROADS Chui 288 2,401 ABAD Lake Kara.-Sa