WORKING PAPER ON A NEW PRIVATE SECTOR DEVELOPMENT STRATEGY

Transcription

1 CARIBBEAN DEVELOPMENT BANK WORKING PAPER ON A NEW PRIVATE SECTOR DEVELOPMENT STRATEGY From Transitional Adjustment to Long-Term Competitiveness: Organising Production for Sustained Growth and Development Vice-President (Operations) bruntod@caribank.org (246) Project Review Officer Brambla@caribank.org (246) Mr. P. Desmond Brunton Miss Anne Bramble

2 CURRENCY EQUIVALENT [Dollars ($) throughout refer to United States Dollars unless otherwise stated] ABBREVIATIONS ACP - African, Caribbean and Pacific bn - billion BAS - Business Advisory Services BMCs - Borrowing Member Countries CARICOM - Caribbean Community CDB - Caribbean Development Bank CIF - Caribbean Investment Fund CRNM - Caribbean Regional Negotiating Machinery CSME - Caricom Single Market and Economy CTCS - Caribbean Technological Consultancy Service Network DFI - Development Finance Institutions ε - Euros ECCB - Eastern Caribbean Central Bank EIB - European Investment Bank EU - European Union FDI - Foreign Direct Investment FI - Financial Intermediaries FTAA - Free Trade Area of the Americas GDI - Gross Domestic Investment GDP - Gross Domestic Product IFI - International Financial Institutions mn - million MDB - Multilateral Development Banks MFI - Microfinance Institutions MGP - Microfinance Guarantee Programme MSE - Micro- and Small-scale Enterprise NGO - Non-Governmental Organisations OCR - Ordinary Capital Resources OECD - Organisation for Economic Cooperation and Development OECS - Organisation of Eastern Caribbean States PPIAF - Public-Private Infrastructure Advisory Facility PSD - Private Sector Development R&D - Research and Development RSE - Regional Stock Exchange SFR - Special Funds Resources SME - Small and Medium-Scale Enterprises TA - Technical Assistance US/USA - United States of America WTO - World Trade Organisation APPENDICES 1. Institutions Assisting The Private Sector In The Caribbean Region 2. Extract From Lending Policies: (Revised May 1, 2001) - Private Borrowers

3 EXECUTIVE SUMMARY Private Sector Development (PSD) is an integral component of the Strategic Plan of the Caribbean Development Bank (CDB) and the Strategies for Poverty Reduction, and Governance and Institutional Development. CDB s present private-sector strategy focuses mainly on indirect and direct lending. The latter is very small relative to the total loan portfolio. Its involvement with the private sector, is mainly through financial intermediation which has increased over the years. In the context of globalisation, there was need for CDB to evaluate its existing strategy and develop a more responsive and comprehensive approach to PSD in its Borrowing Member Countries (BMCs). In addition the recent epoch-making events of September 11, 2001, have changed forever the global landscape, and have highlighted the insecurity and vulnerability of the Borrowing Member Countries (BMCs), Many enterprises that are considered large in the Caribbean are really quite small in global terms. Size, economies of scale, ready access to information and technology, the ability to create physical and intellectual capacity, and continuous innovation, will make a considerable difference in the competitiveness of enterprises. Exposure to global competition requires that the enterprises invest heavily in retooling, reengineering of processes and training just to maintain their local market share and build their export potential. Micro-, small- and medium-sized enterprises will be especially vulnerable where internal and external economies of scale or scope are difficult to achieve. The main policy objectives of CDB and its BMCs have focused on sustained economic growth, poverty reduction, and security. A continuously growing economy requires on-going change. A critical element in the process which fuels change and development is flexibility and adaptability: the capacity to recognise and seize opportunity, to adopt and adapt systems and processes, to innovate, to learn from the lessons of failure and to capitalise on successes. Private sector capacity is therefore critical to economic growth. The specific objective of the proposed PSD Strategy is to improve the global competitiveness of the Region s productive private sector on a sustainable basis and reposition Caribbean economies into the main stream of the world economy. The proposed PSD strategy has been designed to facilitate medium and longterm interventions that would seek to further CDB s broader objective of fostering economic growth and promoting social development of the BMCs. Development of a strong and dynamic private sector is critical to long-term economic growth, a necessary condition for sustained poverty reduction. In achieving this objective, CDB will pursue a three-pronged strategy aimed at supporting efforts by governments and the private sector, as a partner, client and resource, to: (a) Create an Enabling and Supportive Policy Environment: CDB will focus on; (i) (ii) (iii) Policy dialogue; Governance; and the legal and regulatory framework. Government policies have an important role to play in creating the appropriate environment for private investment, stimulating the competitive capabilities of indigenous enterprises and making the transition to competitive social and economic structures. Fostering a more robust private sector is high on the agendas of governments in all BMCs. CDB proposes to improve the overall economic management capacity of the BMCs by increasing its economic work in

4 the BMCs, including technical assistance (TA), and by engaging in more frequent policy dialogue. In addition, CDB will support activities/initiatives which will update and strengthen the legal and regulatory framework within which investment and business decisions are taken. This is an essential component in attracting investment into CDB s BMCs. (b) Catalyse Larger Investment Flow: CDB s mobilisation of resources, including its privatesector lending must also be informed by the changing face of finance in response to globalisation, both internationally and regionally. The structure and nature of the financial sectors in the OECD countries have evolved, as witnessed by the growth in cross-mergers, acquisitions and alliances, forcing changes to the rules and regulations that govern the sector. A similar trend is evident in the Region, at least with respect to the three largest economies of Barbados, Jamaica and Trinidad and Tobago. CDB s private sector operations will generally be guided by the principle of additionality and its role as a catalyst. Financial intermediation will continue to be the most cost-effective and efficient way of channeling CDB s resources to the micro-, small and medium-sized business in the BMCs. (c) Develop Businesses and Products: CDB s strategy on business and product development will focus on enhancing competitiveness by: (i) (ii) facilitating the establishment of new, sustainable, productive enterprises; and strengthening existing enterprises. The small and medium-scale sector which plays an important role in absorbing labour and generating income for poorer households will be particularly vulnerable. CDB will continue to provide TA to facilitate strengthening and building capacity for this sector. The key success factors in implementing the proposed strategy will be: (a) (b) (c) (d) resource availability; responsiveness to the private sector; adaptable policies, procedures and processes; and partnership with the private sector, private-sector institutions, donors and International Financial Institutions (IFIs) to ensure the most effective use of resources available to the BMCs. Positioning the Bank to effectively respond to the challenges facing the private sector in the BMCs demands bold and innovative changes in CDB s operational environment and orientation. This will involve a critical examination and subsequent adjustments to its financial policies, private-sector orientation, and financial and human resource allocation.

5 1. INTRODUCTION The Borrowing Member Countries (BMCs) of the Caribbean Development Bank (CDB) face many challenges as they enter the new millennium. The most notable of these are the phenomena now referred to as globalisation and trade liberalisation and more recently, a marked slow down in the economies of the major trading partners. This situation is likely to be exacerbated by the terrorist attacks on the United States of America (USA) and its psychological impact on the entire society. Trade preferences are being eroded as a result of commitments made under the World Trade Organisation (WTO) and the emergence of free trade areas and regional/hemispheric economic cooperation agreements. The new Cotonou Agreement signed in 2000 marked a major shift in the rules and nature of the trading arrangements between the European Union (EU) and the African, Caribbean and Pacific (ACP) Group of Countries. Most of CDB s BMCs are ACP members. Whereas ACP trade with the EU has historically been characterised by preferential access for ACP goods to EU markets, the principle of reciprocity will underpin future trade relations. The imminent formation of the Free Trade Area of the Americas (FTAA) will further expose the BMCs to wider international competition. Within the Caribbean Community and Common Market (CARICOM), the agreement to create a CARICOM Single Market and Economy (CSME) will increase competition in the Region, to the possible disadvantage of the smaller and less developed territories While most of CDB s BMCs are comparatively well-positioned to take advantage of the opportunities that accompany globalisation, some may require assistance in coping with the challenges of transformation. Notwithstanding specific knowledge gaps, most of the BMCs are endowed with relatively well-educated populations and have a tradition of democratic government with mature political institutions. They generally have satisfactory economic and social infrastructure. Close proximity to the North American market and contacts with major European markets are additional advantages. Increasing regional and international competition in goods and services, however, will reduce job security and penalise inefficient domestic producers. To benefit from scale economies, it will be necessary to have free movement of capital and labour, and to continually adjust to a rapidly changing global environment while preserving earlier gains. Under such circumstances, what is required are measures aimed at increasing efficiency, enhancing productivity and promoting innovation. In achieving this, the private sector in CDB s BMCs will have to restructure their operations, cut costs and adopt new technologies. Strong public private sector partnerships will have to be developed to harness the resources of the state in achieving global competitiveness and assisting in the formulation of national policies and strategies that are conducive to social and economic development With globalisation and the liberalisation of world trade and the new imperative to survive on the basis of international competitiveness rather than preferential treatment, and on trade rather than aid, it is the productive private sector which must lead the Caribbean towards the production of quality goods and services that can compete on international markets. Sustained expansion in output requires the reorganisation of production arrangements, including changes in technology, social relationships and behaviour patterns. In short, it requires a continuous process of social and economic transformation demanding a great degree of adaptability which calls for the capacity to recognise and seize opportunities, to adopt and adapt systems and processes and, most importantly, to innovate. The private sector is also being called on to fill the gap in terms of capital accumulation through both indigenous investments and the attraction of foreign direct investment (FDI). The challenge confronting CDB in partnership with the public and private sector is thus to create an environment that will enable and support the private sector in achieving and sustaining international competitiveness.

6 In its Strategic Plan, (the Plan), CDB commits itself to the systematic reduction of poverty in its BMCs through social and economic development. Among the five (5) strategic objectives outlined in the Plan and intended to contribute to the achievement of this overarching goal of reducing poverty, is that of fostering more rapid growth of the economies of the BMCs. To achieve this objective, CDB will have to develop new ways of encouraging productive private enterprise in BMCs through the strengthening of the private sector, including private sector institutions 1/ and the stimulation of private investment. This requires CDB to develop a much stronger multi-dimensional relationship with the private sector as a partner, client and resource A coherent strategic framework is required to guide CDB s activities in the area of private sector development (PSD). This document articulates a proposed framework and is intended to engender discussion on CDB s proposed PSD Strategy. Feedback and inputs from the Board will be incorporated into a revised Working Paper which will serve as a basis for consultations with the regional private sector. Once these consultations are completed, the Strategy Paper will be presented to the Board. Operational policies, guidelines and implementation issues relating to organisational changes and operational skills requirements will also be addressed in a subsequent Board Paper to be presented to CDB s Board of Directors. 1/ The distinction is made between private sector enterprises and the institutions or associations that represent the private sector (eg. Chambers of Commerce, Manufacturers= Associations, Producers= Associations).

7 CHARACTERISTICS OF THE PRIVATE SECTOR IN CDB s BMCs 2.01 In the context of this paper, the private sector refers to the sphere of economic activity where physical and/or financial capital are privately owned, and where business decisions are made for private gain. It is that part of the economy whose activities are under the control and direction of non-governmental economic units. According to this definition, the private sector includes local micro- and small-scale informal entrepreneurs, individually- or family-owned small and medium-sized enterprises, locally established and resident businesses with non-caribbean origins or affiliations and non-resident, non-caribbean, foreign-owned enterprises which operate as branches or subsidiaries of multinational companies. 1/ 2.02 While there is no comprehensive analysis of the nature and composition of the private sector in the Caribbean, it may be divided into five (5) main categories 2/ : (a) (b) (c) (d) (e) the small-scale and informal sector, which represents the largest group both in terms of numbers and share of employment. This sector plays an important role in absorbing labour and generating income for poorer households. Small businesses cover a wide range of economic activities such as agriculture and agro-processing, manufacturing, retail/distribution, tourism, construction, transportation and other services. By their very nature, it is difficult to estimate with any precision the size and composition of this category of private sector enterprise; locally-owned and operated enterprises, which tend to be concentrated in agro-processing and light manufacturing (particularly screwdriver-type consumer goods industries associated with import substitution strategies), the distributive sector, the provision of small and mediumscale tourist accommodation and other activities in the hospitality industry (e.g. restaurants and entertainment), construction and related activities and financial services (for example, credit unions). This includes the formal indigenous private sector, as many of the better known enterprises around the Region would be included in this category. Many enterprises in this category are sole proprietorships or family-owned and managed companies; locally owned and operated enterprises which are transnational in scope and have accumulated substantial resources in the manufacturing, tourism and services (financial and professional) industries; non-caribbean affiliated enterprises, including joint ventures, which tend to be concentrated in the tourism sector, manufacturing, commercial and agricultural activities. In some BMCs, there are diversified trading companies encompassing numerous activities from automobiles and farm equipment to retail of food and consumer goods; and the non-resident, non-caribbean private sector, which dominates in offshore assembly industries, financial services, large hotels and some heavy industry, particularly mining and 1/ 2/ World Bank (1993), Caribbean Countries- Policies for Private Sector Development. Report No LAC. The World Bank, Country Department III, Trade, Industry & Energy Division. World Bank (1993). Caribbean Countries- Policies for Private Sector Development. Report No LAC. Washington, D.C.: The World Bank, Country Department III, Trade, Finance Industry and Energy Division.

8 - 4 - extractive industries. Many of these, particularly in the hotel and manufacturing sectors, would have benefitted at some time from investment incentives of one kind or another. Knowledge of export markets, marketing techniques and access to distribution channels abroad have given them a strong advantage over local enterprises. Enterprises in this category are typically large employers and play an important role in the upgrading of local technology and managerial skills. In many cases, enterprises that originated in this way have evolved into wholly or majority locally-owned enterprises. Enterprises described in categories (c) to (e) above are generally more formal, with organisational structures including professional management, whereas enterprises of the types described in categories (a) and (b) are more likely to be family-owned, -operated and -managed, with the exception of financial services which have formal organisational structures.

9 FACTORS AFFECTING THE DEVELOPMENT OF THE PRIVATE SECTOR 3.01 The development of a vibrant private sector has been hampered by: (a) (b) (c) (d) (e) (f) (g) a long history of mercantile activity; protectionist policies of past decades; relatively high unit costs of production; the narrow range of domestic and export production caused by the small size of the market and the limited resource base; the lack of competition and, in some cases, the strong orientation towards oligopolistic and monopolistic behaviour on the part of enterprises; the absence of well-developed and regulated capital markets, leading to the unavailability of investment, particularly equity capital; and the absence of a culture of innovation as evidenced by limited investments in research and development As globalisation proceeds and the economies reach a stage where regional and international integration becomes inevitable, the weaknesses of the private sector become more apparent. The following sections attempt to highlight the major constraints which must be addressed in order to facilitate the sustained development of the private sector in the BMCs. FINANCIAL CONSTRAINTS The Cost of Capital 3.03 The cost of capital is a major element in the determination of the hurdle rate required for an enterprise to undertake a project. It is the rate of interest paid on the capital employed in an enterprise. Several factors contribute to the high cost of capital in the BMCs, including high real domestic interest rates which may be caused by the high cost of financial intermediation and/or the maintenance of inappropriate exchange rates. The other key determinant of the cost of capital is risk, which can be defined as the deviation of actual returns from expected returns. This deviation can be caused by any number of reasons, and can be classified into two categories: those that are specific to the investment being considered (project, competitive and industry specific risks); and those that apply across all investments (market and international risks) Large enterprises in the BMCs have direct access to local and international financial markets. On the other hand, small and medium-sized enterprises have limited access to capital markets both locally and internationally, in part because of the perception of higher risk, informational barriers and the high cost of intermediation. As a result, small and medium-sized enterprises find it very difficult to obtain long-term finance in the form of debt or equity. Many finance long-term projects/expenditure by rolling over short-term commercial bank credit, a practice that is potentially hazardous both to the banks and the borrowers.

10 Some of the larger enterprises in the BMCs may also find the cost of obtaining financing from international markets costly because of perceived international risk: the additional uncertainty created by unanticipated changes in exchange rates and political risk in foreign markets. Using the international country credit risk ratings, a default spread could be derived for most of CDB s BMCs. The implicit country credit ratings for September 2000 indicate that, of all BMCs, only The Bahamas, Barbados, Cayman Islands and Trinidad and Tobago have investment grade ratings 1/. The others would be listed in the speculative grades. As a result, country risk premiums would range from 0.9% to 8.5% above that of an equivalent US Treasury Bond 2/. Given these implied country credit ratings, many enterprises in CDB s BMCs - and especially in the Organisation of Eastern Caribbean States (OECS) Member Countries - would have either very limited access to international capital markets or no access at all. Transaction cost of currencies 3.06 The BMCs have a number of currencies, some of which are not accepted outside of the individual countries. While some foreign exchange markets have been deregulated (or, at least, are less regulated) foreign currency regulations remain in place in most. Bureaucratic complications and high transaction costs still remain. These tend to affect small and medium-sized enterprises more than the large enterprises. Lending Policies 3.07 Commercial banks are unquestionably the main source of financing for businesses operating in the BMCs. However, their lending policies as they relate to the terms on which capital is available to the private sector presents a major constraint. The two (2) main points to be considered are security and loan repayment periods: (a) (b) Inability to meet commercial bank security requirements is the most frequently-cited reason for private businesses failing to obtain bank loans. Although several types of assets qualify as acceptable in theory, in practice freehold land or land and buildings appear to be the preferred form of collateral. The focus tends to be on collateral rather than cash flows. Commercial banks in CDB s BMCs mainly supply short- to medium-term credit in keeping with their policy of matching assets and liabilities. Loan repayment periods rend to be shortterm generally, varying from one to five years and up to seven years in certain cases, normally without grace period. Rolling over may be used to extend the term of the loan. Availability of Appropriate Financial Instruments 3.08 While there is evidence of excess liquidity in some BMCs, there is an apparent failure by the financial system to match investment and enterprise needs with appropriate financial instruments. Private sector operations in CDB s BMCs rely heavily on self-financing for both start-up and expansion, with most of the initial capital coming from the principal owners and their families. This is especially so in the case of smalland micro-enterprises. Studies conducted in both Jamaica and Trinidad and Tobago, for example, confirm that 1/ 2/ Bernard Butticker (1996): Implicit Rating of Emerging Markets, 5BC Prospects Number 6: Swiss Bank Corporation Aswath Damodaran (1999): Applied Corporate Finance: A Users Manual, Wiley

11 - 7 - personal savings and assistance from relatives are the main sources of start-up capital for small-scale enterprises 3/. Once established, enterprises continue to exhibit a high degree of reliance on internally-generated funds to finance operations, which may limit their ability to retool or expand operations Many businesses have failed because they were too highly leveraged. Equity investments have played a less significant role and very little equity has been provided on a structured basis to the small- and mediumsized business sector. Venture capital funds are relatively under-developed in the Region. In Jamaica and Trinidad and Tobago, there are a number of private institutions that have provided venture capital financing to small- and medium-sized enterprises, but the under-development of the regional capital markets constrains liquidity. Capital Markets in the Region 3.10 The capital markets in the BMCs are relatively underdeveloped, with small fledgling stock exchanges in The Bahamas, Barbados, Cayman Islands, Jamaica and Trinidad and Tobago, and rudimentary capital market infrastructure in the other countries. CDB served as administrator of the Eastern Caribbean Central Bank (ECCB) Capital Market Development Project which was partially funded by the Inter-American Development Bank through the Multilateral Investment Fund. It included the establishment of an over-thecounter Call Exchange, appropriate securities legislation and an education and awareness programme. The Eastern Caribbean Securities Exchange is expected to be established in the final quarter of The capital markets that currently operating in the BMCs are characterised by: (a) (b) inappropriate, and in many cases, outdated and discriminatory financial and capital market laws and regulations; and limitations in some countries with respect to the ability of non-nationals to acquire and hold real property and/or financial instruments. NON-FINANCIAL CONSTRAINTS Managerial Capacity 3.12 The new global economic environment poses a serious challenge to private sector managers in CDB s BMCs. Different skills are now required. Poor management represents a major obstacle to the future development of the private sector, particularly in the OECS countries where most small- and/or medium-sized businesses are family owned and are managed by one person, although there is some evidence that this is slowly changing. At the level of the private sector representative institutions/associations in CDB s BMCs, there is the need for significant institutional strengthening. They are generally underfunded, understaffed and lack the capacity for rigorous policy research and analysis, strategic policy formulation and effective advocacy 3/ Institute of Social and Economic Research (1993), Study on the Small and Micro-enterprises Sector in Jamaica (funded under the Government of Jamaica/Government of the Netherlands Micro-enterprise Programme); University of Warwick Research Institute/University of the West Indies Institute of Social and Economic Research (1996), Characteristics and Constraints of Small Businesses in Trinidad and Tobago: Final Report of a National Baseline Survey and Sector Assessment Study for the Small Business Development Programme in Trinidad and Tobago (funded under the European Union Programme of Assistance to the Government of Trinidad and Tobago).

12 - 8 - work. They are therefore unable to support the private sector s effective involvement in policy dialogue with government and other social partners. Market Size and Protectionist Policies 3.13 The small size of the domestic markets combined with the protectionism typical of small Caribbean economies, up until relatively recently, have created market imperfections with the following consequential effects: (a) (b) (c) lack of competition leads to inefficiency and higher costs, as enterprises are not driven by the dynamics of competition to optimise efficiency and introduce new technology and improved production systems. An enterprise s international competitiveness depends, inter alia, on its capacity to continually innovate in production techniques as well as products; the small size and skewed structure of the market inhibits the ability of small, developing economies to attract resources from external sources, particularly private foreign investment. The limited size of the national markets does not make small countries attractive investment locations; and the high import content of domestic production and consumption, undiversified economic structure and lack of competitive markets in small economies such as CDB s BMCs mean that there are rigidities in resource allocation, which make the adjustment to global competition more difficult and protracted. 4/ Human Resource Availability and Productivity 3.14 Low labour productivity is also considered a major constraint, as it more than offsets any advantages obtained from wage rates. The unavailability of adequate labour is therefore a significant non-financial constraint to PSD. In spite of achievements in education and training, there remains a fundamental problem of matching output to identifiable labour market needs. A key factor in an enterprise s ability to develop or adapt improved technology, and improve overall productivity is worker-skill. The skill base - technical, managerial and organisational - is critical to raising the competitiveness of the enterprise. Enterprises with skill shortages and deficiencies need to address these limitations quickly and should therefore be encouraged to undertake appropriate training activities Cost of Infrastructure 3.15 The relatively high cost of infrastructure in the BMCs can hamper effective PSD by imposing additional constraints on efficient production and distribution. Apart from the traditional types of economic/physical infrastructure (e.g. roads, airports, seaports), reliable and reasonably priced electricity, telecommunications, water and transport are vital if businesses are to be competitive in the modern, globalised market economy. The cost of providing physical infrastructure tends to be higher in smaller countries than in larger ones, thus frequently making them unattractive to private investors. The relatively high costs of utility 4/ Richard Bernal (2000), Globalization and Small Developing Economies: The Challenges and Opportunities, Paper prepared for the Meeting of the Caribbean Technical Committee on Small States, Barbados (January 10, 2000).

13 - 9 - services (electricity and telecommunications in particular) result in higher unit costs of production and impact directly on international competitiveness. Transportation costs (in both time and money) can also be serious constraints to PSD in CDB s BMCs. Smaller economies pay higher transportation costs because of the relatively small volume of cargo. In fact, small economies spend more on transportation and freight costs as a percentage of exports than large countries. Caribbean countries pay far more for transportation for their imports than the world average of 5.4% of free on board. Among the contributing factors are the small size of the vessels, small scale of cargoes and the lack of equivalent return cargo. 5/ Nevertheless, most businesses have to rely on imported raw materials or inputs for production and export their finished products, which tends to reduce the rate of return on many types of investments. In the case of perishable products, the absence of an effective and reliable transportation system can make or break a business. Research and Development (R&D) 3.16 The absence of a strong R&D culture has negatively affected PSD. As indicated above, international competitiveness requires continuous improvement and innovation in developing new industries and products, and improvements in the marketing of products and services. This implies significant investment in R&D, as knowledge capital is one of the most important ingredients for growth and development in today s global economy. The modern economy has been described as a knowledge economy. Sustainable economic growth in such an economy is dependent on the application of knowledge and technology to new or improved products and services that can compete internationally, as well as on marshalling information which can be used to help producers position themselves dynamically in the global marketplace. CDB s BMCs have, by and large, been slow to embrace the knowledge economy and have not invested significantly in R&D. Although it is difficult to estimate the (per capita) gross expenditure on R&D as a percentage of GDP among BMCs, it is unlikely to be anywhere near the levels of some of the more developed market economies (where it was estimated in the early to mid-1990s as being in the vicinity of 2-3%). While recognising that small Caribbean enterprises will never be able to achieve and sustain high levels of investment in product development or other kinds of R&D, it is essential for R&D to become a way of life for enterprises of all types in the effort to enhance international competitiveness. Specifically, the development of new products based on local raw materials and tastes will be required if BMCs are to successfully penetrate and carve out niche markets overseas. Marketing 3.17 As the Region moves from primary commodity production to the export of higher value-added goods and services, marketing becomes more important. Private sector enterprises in CDB s BMCs need to develop brand images that can be recognised internationally and are associated with high quality. There are already a few outstanding examples of this within the Region, but enterprises require sustained assistance in developing product brands capable of penetrating international markets. Protection of these brands through appropriate trade mark registration and other intellectual property devices is of paramount importance if investment in product development is to yield maximum benefits. CONCLUSIONS 3.18 Many enterprises that are considered large in the Caribbean are really quite small in global terms. Size, economies of scale, ready access to information and technology, the ability to create physical and intellectual capacity, continuous innovation and the ability to update existing products, will make a 5 / Bernal, ibid.

14 considerable difference in the ability of the enterprise to compete in the global market place. Exposure to global competition requires that the enterprises invest heavily in retooling, re-engineering of processes and training just to survive in their local markets and more so, in order to export. Micro-, small- and medium-sized enterprises will be especially vulnerable where internal and external economies of scale or scope will be difficult to achieve. Larger enterprises are better able to generate new products, source capital and form mergers or strategic alliances to generate new products and source inputs from existing organisations and networks. Competitive advantage is more likely to occur where the economy is large enough to sustain clusters of industries through horizontal and vertical relationships and where there is a network of related and supporting industries

15 OVERVIEW CDB S PAST EXPERIENCE WITH THE PRIVATE SECTOR 4.01 The current situation of CDB s private sector involvement is a reflection of both demand and CDB s changing perceptions of its mandate. During the 1970s and early 1980s CDB saw its direct lending to the private sector as a vehicle for fostering local ownership in the context of the changing political status of its BMCs. Thus, in the 1970s, most of the direct private sector loans were provided to individuals or small companies for investment in small hotels and agricultural production enterprises. The majority of the investors had only limited or no experience in the activities financed by CDB. This absence of a track record significantly increased CDB s risk. The average size of loans approved during this decade was $0.153 mn. By the late 1970s and early 1980s CDB started to diversify its private sector lending to include manufacturing (including agro-processing) and services. The underlying philosophy, that of facilitating the indigenous ownership of business enterprises, remained the same. The average size of loans approved during the 1980s increased significantly to $1.1 mn By the early 1990s, it was recognised that the high cancellation rate on approved private sector projects, the relatively poor quality of the portfolio and the perception that CDB s policies and procedures did not facilitate private sector lending, all suggested the need for a policy review. This review culminated in Board Paper BD35/90 - Review of CDB s Private Sector Operations - presented to the Board of Directors on May 14, An immediate effect of the revised policies was a dramatic reduction in the number of direct private sector projects considered by CDB. For the entire decade of the 1990s, only three direct private sector projects were approved and one of these was classified as a private sector project because of the type of risk exposure, even though the company was 100% owned by the government. The average size of the loans approved during the 1990s was $5.6 mn. The revised private sector lending policies were not responsive to the needs and demands of the private sector and did not encourage direct lending. CDB s processes and procedures remained unchanged and therefore limited its ability to be timely and responsive The revised policy recommended that CDB expand its indirect lending to include the channelling of funds for long-term development lending and for export credits to private sector channels such as commercial banks. This was reinforced in Board Paper BD 26/91 entitled Directional Plan/Strategy- CDB to the Year That Paper envisaged that, in fulfilling that part of its mission related to assisting in the development of the financial sector and financing the productive sector, CDB would endeavour to channel a greater proportion of resources to the private sector through a broader range of financial intermediaries, to provide a wider range of services to a more diverse client base. To give effect to this decision, Board Paper BD 53/91 - Lending to Private Financial Intermediaries - was prepared. That paper outlined the basic lending policies that should be applied to private financial intermediaries. The proposals were approved by the Board of Directors on July 18, Highlights of the policy are shown at Box 1. Since then, CDB has approved $59 mn in new loans to private financial intermediaries. Cancellations had to be effected in the case of two of the institutions resulting in net approvals of $57 mn. Of the remaining eight intermediaries, four are located in Trinidad and Tobago, two in Barbados, and one each in Jamaica and St. Lucia.

16 BOX 1 Highlights of Lending Policies to Private Financial Intermediaries Normally financial institutions that are majority owned and controlled by nationals and located in CDB s BMCs are eligible for CDB financial intermediary loan; Loans outstanding limited to no more than 40% of ordinary reserve while maintaining the existing country exposure limits; Restrict loans outstanding to any one private financial intermediary, to no more than $10 mn or 10% of ordinary reserves, whichever is lower; Limit the maximum loan approved in a single operation to an institution to $5 mn in such manner that the unsecured portion does not exceed $2.5 mn Interest rate: CDB s OCR public sector rate without a premium to intermediary loans to private financial institutions Commitment Fee: Fee applied on an annual basis to the difference between the planned and actual disbursements 4.04 CDB s involvement with the private sector may be classified into indirect lending, direct lending, guarantees, TA, participation in equity investments and funds and lending for private infrastructure. The policies that have guided CDB s private sector interventions are derived from the policy and operational statements as shown in Box 2. The current policy with respect to private borrowers, is reproduced at Appendix 1. BOX 2 CDB s Policies and Operational Statements Agreement Establishing CDB Articles 14 and 15; CDB s Lending Policies (revised May 2001); CDB s OCR Financial Policies and Operating Guidelines (Paper BD 106/86 and Board Minutes (May 1995); CDB s Sectoral Lending Strategies for the Medium Term (BD 58/89, including Add.1); Review of CDB s Private Sector Operations (BD 35/90); Directional Plan/Strategy - CDB to the Year 2000 (BD 26/91 Rev.2); Lending to Private Sector Financial Intermediaries (BD 53/91); Operational and Ordinary Capital Resources Financial Projections, (BD 63/95); Guidelines for Equity Operations (Paper BD28/76). INDIRECT LENDING 4.05 Indirect lending refers to lending to other financial intermediaries for on-lending to small and medium sized private sector businesses. Over the period , financial intermediary lending amounted to $412 mn in net approvals and represented 23% of total approvals. The sectoral distribution of CDB s intermediary lending is shown in Figure 1 and reflects a focus on the agricultural (37%) and manufacturing and tourism sectors (32%).

17 Figure 1: Sectoral Distribution of Indirect Private-Sector Loans, Agriculture 37% MSE 2% Education 12% Housing 17% Manufacturing and Tourism 32% MSE Education Housing Manufacturing and Tourism Agriculture 4.06 CDB s intermediary lending can be classified into government-owned and privately-owned institutions. Where government-owned FIs are used, CDB loans may be either to the government for use by the FI or directly to the FI or to the FI under a government guarantee. Security to privately-owned FIs is usually by way of a guarantee from other acceptable guarantors or by trust arrangements with respect to the subloans financed. Privately-owned institutions do not benefit from sovereign guarantees. Therefore, under current guidelines, there are more stringent limits to the level of exposure to a private FI, than to governmentowned institutions Development Finance Institutions (DFIs) were established by governments to provide investment finance to productive sector enterprises and to ensure that financial resources were available for small business ventures. They have been a major channel for CDB's funds to the private sector and represent approximately 73% of the total CDB lending portfolio to the private sector in the Region. The client base of the DFIs have consisted of small hotels, manufacturing enterprises, agriculture and fisheries. However, in recent years, many of the BMCs have lost their competitiveness in key sectors traditionally served by DFIs. As a result of this change, the DFIs have to realign their activities to new areas which would require greater care and sensitivity in credit appraisal and loan pricing Attempts by CDB to use non-governmental organisations (NGOs) have been unsuccessful, as the NGOs rely heavily on grant funding for sustainability. Credit unions are increasingly demanding the attention of CDB and other donors, particularly with respect to the role they can play in micro-finance. Within recent years, privately-owned development banks, merchant banks and commercial banks have been used for intermediating CDB funds, as not only do some operate regionally, but they fill a niche between the upperlending limits of government and privately-owned financial intermediaries and the minimum cost-effective lending limits of CDB.

18 Indirect lending is currently the preferred and most cost effective method for CDB to reach the micro-, small- and medium-scale sectors, given the: (a) (b) (c) (d) wide and disperse location of CDB s BMCs; relatively small size of the individual subloans, which would have relatively high processing and supervision costs and therefore prohibit CDB s direct interventions; CDB s limited staff complement; and need for more effective coverage of the financial needs of the BMCs. DIRECT LENDING 4.10 Direct lending to the private sector began with the first loan in Over the period CDB s net approvals totalled $62.3 mn to 38 private sector projects in agriculture, manufacturing, mining services and tourism, representing 3.2% of CDB s loan portfolio. Most of CDB s BMCs have benefitted from direct lending to the private sector. The sectoral distribution of private sector loans approved (Figure 2) shows that of the 64 projects, 13 (34%) were for agricultural enterprises (including fishing), 17 (45%) for tourism, 7 (18%) for manufacturing (including agro-processing), and one (3%) for mining. Figure 2: Sector Distribution of Direct Private Sector Loans Tourism 45% Mining 3% Manufacturing 18% Agriculture 34% Mining Manufacturing Agriculture Tourism GUARANTEES 4.11 In December 1999, CDBs Board of Directors approved the establishment of a Microfinance Guarantee Programme (MGP) for microfinance institutions (MFIs), on a pilot basis (Paper BD 73/99). Under this programme, CDB would provide a guarantee for a line of credit from a commercial lender to a specialised MFI. The MFI would on-lend these funds to micro enterprises. To date, no guarantees have been issued. An evaluation of several MFIs in CDB s BMCs revealed that micro-finance is in its infancy. In recognition of this, efforts by donors are underway to build institutional capacity, which will incorporate micro-finance best practice and other procedures necessary for sustainability.

19 TECHNICAL ASSISTANCE 4.12 CDB does not normally provide non-reimbursable TA directly to individual private enterprises. To date CDB has provided three TA loans to the private sector. The major reason for this is that all CDB loans must be adequately secured and private-sector enterprises are reluctant to tie-up assets as security for TA purposes. CDB can and does provide TA to private-sector groups, such as sectoral associations and cooperatives and in some instances to regional institutions which have the private-sector as the principal beneficiary The Caribbean Technological Consultancy Service Network (CTCS) is the major mechanism through which TA is provided to the private sector by CDB and this is targeted mainly at the micro- and small-scale enterprise (MSE) sector, though some medium-scale enterprises have also benefitted. CTCS provides a mechanism by which the knowledge and skills already existing within the BMCs can be mobilised and applied to the needs of MSEs throughout the Region. MSEs can access information, training or a range of hands-on expertise that can assist in technology transfer or adaptation, marketing management systems, the preparation of business plans and other facets of TA at affordable costs that are subsidised by CDB During the period , CTCS responded to 1,668 requests for in-field, hands-on assistance to enterprises. CTCS has also supplied written pre- and re-packaged information in response to 1,549 requests and has planned and executed 61 workshops and seminars in which a total of 1,992 persons have been trained. The contribution of CTCS to overall development in the MSE sector of the Region has been unique and invaluable. CTCS has assisted micro and small businesses with affordable practical advice at various stages of their development. Evaluations of the service by independent consultants and evaluation of individual interventions by clients have been very favourable. Since its inception, there has been growing demand for CTCS services. In addition to the activities of CTCS, there continues to be a considerable demand for TA for institutional strengthening of the DFIs. PARTICIPATION IN EQUITY FUNDS AND INVESTMENTS 4.15 The level of equity that CDB can take in a single investment using Ordinary Capital Resources (OCR) is restricted to $50,000. Consequently, CDB's equity investments in individual companies to date has been very limited. Use of CDB s Special Funds Resources (SFR) is not so restricted (except for the Unified Special Development Fund which cannot be used to subscribe for equity), but equity positions using SFR have been limited to government-owned companies, except in the case of a privately-owned financial services company that was formed to take over the operations of the United Nations Development Programme/UNDP/Inter- American Investment Cooperation Business Advisory Services in Trinidad and Tobago With the inclusion of 5 mn euros (ε) as risk capital in the last European Investment Bank (EIB) loan, CDB had a source of funds that it could use to take equity positions in private enterprises of up to ε500,000 per enterprise. One attractive feature of these resources was the fact that CDB was risk-indemnified so that repayment to EIB was contingent on the success of the investment. CDB has made investments of the US dollar equivalent of ε500,000 each in shares in a Jamaican company undertaking a hotel development and a regional corporation based in Barbados and has Board approval for investments of ε500,000 in shares in a hotel development company in Barbados. The commitment date has now expired and the balance of funds, amounting to ε3.5 mn, has been cancelled.

20 CDB has also participated in two equity funds - $3 mn in the Tiona Fund and $4.5 mn in the Caribbean Investment Fund (CIF) managed by a subsidiary of ICWI Group LTD. Both funds are closed-end funds established to provide equity resources to private companies across the Region. The CDB contribution was facilitated by the creation of a special fund using resources allocated by the Board of Governors from surplus net income of the OCR. The Tiona Fund is being reorganised following the withdrawal of the Commonwealth Development Corporation (CDC) and the Fund Manager. All capital is being returned to the shareholders. It is too early to judge the performance of the CIF Two factors constrain equity operations in the Region. First, there is the reluctance of the owners of many small and medium-sized companies, most of which were developed as family enterprises, to allow outside equity holders because of fear of diluting control. This partly accounts for the very high gearing ratios exhibited by many Caribbean enterprises, a characteristic that severely restricts growth. Secondly, the underdevelopment of a regional capital market (as discussed at paragraph 3.10) constrains liquidity and precludes efficient exit strategies. FINANCING PRIVATE INFRASTRUCTURE 4.19 The participation of the private sector in infrastructure is at early, but varying stages in the BMCs and therefore there has not been many requests for financing from CDB. To date, CDB has approved a loan of $10 mn for the financing of one such project in the power sector. CDB has also received a request for technical assistance for the institutional strengthening of a utility regulatory body. LESSONS OF EXPERIENCE 4.20 The following lessons have been compiled from CDB s experience over the period and that of other IFIs, which are relevant to the BMCs: (a) Financial Intermediaries: DFIs (i) (ii) Institutional Strengthening: institutional capacity and governance affects the performance and sustainability of DFIs and the provision of TA will have to be an integral component of intermediation. It is important to strengthen local intermediaries, since they are closer to the ultimate borrowers and savers and better understand the risks. Political Interference: many of the DFIs experience a high degree of political interference which affects the portfolio quality and eventually the operational and financial viability of the institution. Political and social considerations almost invariably impinge on the lending process when a government directs credit, A credit culture has to be cultivated. General (iii) Documentation Requirements: CDB s documentation requirements are viewed as onerous by FIs and increase their operating costs. More effective supervision and monitoring should be instituted.