PROGRAM IMPACT ASSESSMENT. I. Introduction

Transcription

1 Second Private Sector and Small and Medium-Sized Enterprises Development Program (Subprogram 2) (RRP LAO ) PROGRAM IMPACT ASSESSMENT I. Introduction 1. This Program Impact Assessment (PIA) presents a framework for assessing the impact of the proposed second Private Sector and SME Development Program Cluster (PSME2) on stakeholders. The PIA documents the formulation of the PSME2 and provides a mixture of quantitative and qualitative assessment of potential benefits and costs of program outputs on the SME business community. The PSME2 also include a TA loan amounting to $4.378 to institutionalize the reforms completed and make them sustainable. The framework and economic methodologies used for this PIA follows the regulatory impact assessment (RIA) tool now used by Governments in over 50 countries to assess the impact of proposed regulations and other interventions on the economy. 1 This also includes the approach to defining and measuring costs of proposed interventions. 2. The remainder of this PIA is as follows. Section II briefly summarizes the key features of the RIA methodology used for this PIA. Section III and IV presents the PIA including identifying potential benefits and costs to SMEs from the PSME-2. Section V provides a justification for the entire PSME2 cluster financing plan of $30 million drawing on the PIA. Financing plan of Subprogram 1 (SP1) approved in 2011 was for ADF grant of $10 million and an ADF loan of $5 million. Proposed financing plan for subprogram 2 (SP2) is ADF loan of $15 million. II. Methodology 3. A PIA is both a process and a tool that encourages a structured approach to developing programmatic interventions that systematically assesses potential winners and losers from the program and costs and benefits of the proposal to ensure the intervention can achieve its impact and outcome. The premise of the impact assessment concept is that a proposed regulation, law or other intervention such as programs should be justified on the basis that net benefits to the economy can be demonstrated. A guiding principle of the assessment is that policy adjustment costs to government and stakeholders should be minimized where possible. In this way, the proponent of the program is encouraged to provide a more rigorous rationale for the intervention. The impact assessment steps relevant to this PIA include: Defining the problem. The problem to be addressed and the related regulation objective should be identified as first steps in the program development process. Defining the impact and outcome of the proposed program. The next step is to define what impact and outcomes are to be achieved. Presenting the options. This should be followed by consideration of a range of options at least cost for achieving the impact and outcomes. Assessment of costs and benefits of the proposed program. An analysis of the likely economic, social and environmental consequences should be presented. This should include identifying the winners and losers from the proposal. The analysis should attempt to estimate the costs and benefits of the proposed program and provide a net benefit, if data are available. 1 For information on RIA used in other countries see for example, Office of Best Practice Regulation (2009), Best Practice Report Department of Finance and Regulation, Australia Government, Canberra.

2 2 The depth of analysis presented in a PIA will depend on the design features of the program and data availability. Generally, a PIA should provide estimates of the following: 2 Quantitative costs for each stakeholder (if available); Quantitative benefits for each stakeholder, if data is available (such as in literature reviews, technical assistance reports, benefits transfer, consultation, and expert advice). Quantitative estimates should be viewed as indicative only; or Qualitative costs or benefits, when quantitative costs and benefits are not available. The selection of analytical tools to assess benefits and costs will depend on the design features of the program and available data. Commonly used tools include the standard cost model for estimating the cost savings from licensing reforms, cost effectiveness model, and cost-benefit analysis. 3 Macroeconomic and micro household simulation models are also used for complex and significant interventions such as for tax and trade reforms, although this is not commonly used by public sectors in advanced economies. The RIA approach defines costs to include costs borne by the Government and stakeholders. These costs can be categorized as follows: Government and statutory agencies Administrative costs incurred by Government and relevant statutory agencies in implementing the program. Enforcement costs incurred by Government and relevant statutory agencies in monitoring compliance and enforcing regulations under the reform program. Direct fiscal costs of the program such as investment costs to set up new agencies, permanent budget increases, reduced budget revenue from fees, cost of public education programs etc. Stakeholders (such as SMEs) Compliance costs incurred by businesses in complying with new obligations under legislation and regulations. These can be the administrative costs such as business staff time and overhead costs incurred in applying for and obtaining business licenses, business delayed costs in waiting for the granting of the license, and adjustments to production processes and product specification or quality required to comply with new regulations. Distributive impacts of reforms. Programs will also have important distributive effects that should be identified and if possible quantified. This will also mean identifying the winners and losers from the reform. The distributive impact of the reforms on gender is of concern to the PSME 2 program cluster. For example, high cost regulations generally discourage women entrepreneurs more than males from formalizing their enterprises and 2 Treasury Board of Canada Secretariat (2009), RIAS Writer s Guide. Canadian Government, Ottawa 3 Treasury Board of Canada Secretariat (2009) Canadian Cost-Benefit Analysis Guide: Regulatory Proposals; website at

3 3 therefore limit their access to finance and business development services. Reforming the licensing regime may therefore have a major positive impact on women entrepreneurs. Consultations with stakeholders (government agencies, SMEs, households, industry and consumer groups etc). The impact statement should describe stakeholders consulted with, what were the dissenting views and how were these views were dealt with in revisions to the intervention (of they were not incorporated then this needs to be mentioned). 4. The program development process should at least ensure that the benefits to the community of any program actually outweigh the costs, and give some assurance that the options chosen will yield the greatest net benefits to society. III. Program Impact Assessment The Developmental Impact of the Program 5. This section presents the PIA for PSME2. It summarizes the problem, identifies the intended impact and outcome of the proposed PSME2, options reviewed, stakeholders consulted, and presents a mix of quantitative and qualitative assessment of potential benefits and costs to SMEs of the PSME2, including updates for SP2.. IV. The Problem 6. Key to Lao PDR s private sector growth is development of small and mediumsized enterprises (SMEs). The SME sector dominates economic activity in Lao PDR and accounts for substantial employment. According to latest available data, 99% of enterprises in Lao are small enterprises employing less than 10 workers. A large number of SMEs are not registered primarily because of the high cost in the licensing process thereby limiting access to finance and business development services. The seventh National Socio-Economic Development Plan (NSEDP7) emphasizes private sector and SME development and growth as the key mechanism for job creation, income growth and poverty reduction. Two of the main targets of enterprise development in NSEDP7 are: (i) to have 13 % of annual growth in the SME subsector; and (ii) to have 85% of the total business sector workers engaged in SMEs 7. The challenge for Lao PDR is to manage its resource boom in a way that sustains economic growth in the non-resource (SME) sector, creates productive jobs, and continue poverty reduction difficult tasks with half of the population under age 20 years and more than 80% employed in the informal sector. The booming resource sector is transforming the Lao PDR economy. Resources are expected to shift away from the tradable goods sector (export and import competing industries) towards the non-tradable goods sector (construction, services and utilities etc). This resource reallocation will be driven through a long term appreciation in the real exchange rate and real wages. The Lao PDR economy will be challenged by the impact of the resource sector on the competitiveness and growth of the nonresource sector and in particular the SME sector. The government anticipates significant future revenues to the budget from hydro-power investments and mining in the form of taxes, royalties and dividends over the next decade. The revenue flows provide Lao PDR s for its first time in its modern history a tremendous opportunity for it to finance its development goals, raise per capita incomes, and reduce poverty as the diamond boom had done in another landlocked economy Botswana. At the same there are important lessons from international experience for Lao PDR in supporting private sector growth when there is a large commodity resource sector. A resource boom as as the one experienced from 2006 to 2008 can affect the growth conditions of the

4 4 non-resource sector if it leads to an excessive appreciation of the real exchange rate. An excessive appreciation of the exchange rate may slow growth of the non-resource tradable goods sector (manufacturing and agriculture). The manufacturing sector (especially garments) is particularly vulnerable to an excessive real appreciation. While unit labor costs in the Lao PDR garment sector is on par with Cambodia and other regional neighbors, 4 the sector operates on relatively lower profit margins and since wages are paid in Kip, an excessively appreciated exchange rate would raise unit labor costs in dollar terms squeezing profit margins. Furthermore, the resource boom which includes revenues to government is transitory in nature. Whist the resource sector has grown rapidly, contributing significantly to exports and fiscal revenue, their contribution is expected to decline in the medium term. Consequently, the nonresource sector will be required to expand its contribution in the future, as well as play a pivotal role in employment generation and in making the economic growth of the country both sustainable and inclusive. 8. The extent of the transformation and how it will affect the country s economy will depend on: (i) the magnitude, duration and cyclical pattern of the mineral resource boom; (ii) the extent to which the resource revenue flows appreciate the real Kip exchange rate and how that exchange rate appreciation transmits to the tradable goods sector; and (iii) what kind of policies the government implements to promote competitiveness in the non-resource sector especially the SME sector in the face of an appreciating exchange rate. 9. Reports including ADB reports on the Lao PDR economy have identified key impediments to SME growth. A 2010 ADB investment incentives survey identified key location factors considered by investors as important in making their investment decisions in Lao PDR. The majority of investors surveyed considered Lao PDR above average on political stability, trade and investment openness, growth in tourism sector, preferential market access, and law and order. The majority of investors surveyed considered Lao PDR at or below average performance on access to land and property (property rights), cost of raw materials, environment and quality of life, cost of credit, cost of labor and adequate supply of skilled labor, and lack of transparency in government and policy making. These findings are consistent with those in the GIZ Enterprise Survey of 2011, which is a follow on from its 2009 survey, providing information about changes in perceptions/awareness about business constraints. The GIZ survey also reported SME limited use of commercial business development services and the majority of micro and small firms do not keep proper book keeping records. 10. Participatory policy development. Formulation of SME policy in a transparent and participatory manner and across relevant line ministries is critical to ensure there is a consistent approach to SME policy development and ownership among different constituents The Government s first National SME Development Strategy ( ) was completed in It included some (but not all) of the elements of good practice policy development. It was developed and endorsed through an extensive consultation process. It included activities of which some had time-bounded schedules. Key lessons from the first SME strategy include: (i) a broad-based strategic framework and road map for SME development; (ii) the framework and road map should be a results-based strategy where interventions have time-bounded implementation schedules with measurable expected results and impacts on SME development; (iii) the formulation of the strategic framework should be achieved through a consultative process with input from stakeholders; and (iv) a monitoring and evaluation mechanism should be established. Subsequent to this strategy, government developed the SME Development Plan 4 ADB Survey of Issues in Trade Policy and institutions Affecting SME Competitiveness in Lao PDR, Consultation Mission Report, April Manila.

5 5 of which includes defined targets and measures. The plan is incorporated into the NSEDP7 which has been approved by the government. Key features of the plan include: (i) promoting women entrepreneurs; and (ii) RIA to improve business environment for SMEs. The approval of the plan as part of NSEDP7 instead of a standalone document further enhances coordination of SME sector with government overall priorities. In addition, the SME monitoring unit continues to publish quarterly updates on the implementation of the SME development plan. 11. Gender mainstreaming SME policy and other interventions. Empirical work on gender in business in numerous developing economies show that policy and public interventions often create unintended biases against women entrepreneurs. For example, high business compliance costs of regulations typically deter more women than men entrepreneurs form formalizing their enterprises. Implications of this include limited access to formal credit and financial services, limited access to business development services (as the enterprises are not registered or have tax certificates), and as they do not have tax certificates are often excluded from public provisioning of SME development services and in Lao PDR often full under the estimated tax system (tax assessment not based on accounting records but a discretionary criteria). Thus, reducing red tape introducing gender mainstreaming in policy development and regulatory review will assist in addressing the inherent gender bias in SME development. This should be reflected in increasing numbers of registered enterprises owned by women. 12. SME technical capacity constraints to growth. The underdeveloped market for private sector businesses development services (BDS) also explains the lack of innovative (albeit basic) activity. According to the GIZ enterprise survey of 2009, while about 74% of firms surveyed reported using a business development service provider (BDS), only 5% of this total were a commercial BDS provider, 12% were publicly provided BDS and 80% of BDS were informal sector providers (spouse, friend etc.). The Survey of 2011 showed approximately the same number with the average use of BDS across all enterprises at only 73.9%. The government s approach under the SME strategy ( ) was to provide BDS services in the absence of a private market for such services. These interventions had mixed results and the government is rethinking its approach. Its focus now is on supporting the development of the private market for BDS rather than public provisioning of services. The network was launched in 2012 and now includes a variety of service providers including vocational training for women. 13. SME access to finance. The GIZ Enterprise Survey of 2011 reported that 57% of micro businesses and 45% of small businesses from those surveyed expressed that lack of capital is a significant constraint SMEs face legal and capacity constraints in accessing credit, and these need to be addressed if SMEs are going to benefit from recent banking sector developments. Constraints include weak protection of creditors rights, which means that banks largely rely on use of fixed assets (e.g. land and buildings) as collateral to secure loans, placing SMEs generally at a disadvantage in accessing credit. Another critical constraint is limited credit information on customers that allow banks to assess credit risk. Until recently, requests by banks for such information are processed by the central bank's credit information bureau (CIB) using an inefficient manual paper-based system that can often take up to a week to generate responses. Upgrading the system to one based on a centralized database that allows commercial banks to search for as well as update customer credit information in real time can significantly reduce the time and costs involved in credit assessment. To address this concern, government adopted a two pronged strategy starting from SP1. First, developed and launched a web based credit information system (CIB online) and second approved the implementing decree of the Secured Transaction Law. During SP2, the CIB-online has been made fully operational. All banks are required to provide credit information of customers to the online

6 Kip 000s per employee 6 system and all queries for credit information now utilize the online system. As of March 2013, CIB online receives an average of over 3,000 queries per month. In addition all new loans above 50 million Kip require credit reports. Government is committed to make the credit report a requirement for smaller amount of loans. Government has also continued to make progress with the secured transaction registry. After careful deliberation, Ministry of Finance (MOF) agreed to host the secured transaction registry and has assigned a team to work on the registry. Currently the software of the system of the registry is going through beta testing, and awareness on the facility is being raised. Figure 1: Lao PDR: Cost of Red Tape (a) Distribution of Business Compliance Costs Facilitation fees 7% (b) Compliance Costs per Employee by Firm Size ($/employee) Official fees 32% Enterprises' staff Time Costs 61% Microennterprises Small enterprises Medium enterprises Large enterprises Source: ADB red tape survey. 14. Cost of Red Tape. The 2009 ADB Options for A Regulatory Review Program and Office of Best Regulatory Practice (red tape study), using the standard cost model, 5 estimated that firms on average incur $483 annually to comply with the three most common licenses the enterprise registration certificate, the sector operational license and the tax certificate. These costs comprise of wage costs and overhead costs incurred in preparing applications for licenses and permits, the waiting time for the firm in obtaining the license or permit and any official and unofficial costs in the application process. These costs are much more burdensome on small enterprises than for medium and large ones (Figure 2). At the time of the survey, it costs the business community (those complying) $36 million to comply with the three licenses. The study reported that depending on the sector, firms will require additional licenses and a realistic estimate of the average business compliance costs amounted to $1,071 per firm each year (approximately 1.5% to 3.0% of GDP in 2008). The cost of red tape has deterred entrepreneurs 5 The standard cost model simply estimates the costs incurred by the firm to comply with and obtain a license to operate in a sector. It comprises of estimates of staff time involved in preparing for the application, company overhead costs, any legal fees, and official/unofficial fees to obtain the license. Some estimates also include the waiting costs. These costs are estimated in different ways estimated as staff and overhead costs incurred by the firm while waiting for the license to operate, or could be the cost of capital incurred while waiting to operate. This model is commonly used to assess licensing reforms. See for example, Environment Protection Agency, State Government of Victoria (2010) Corporate Licensing Standard Cost Model Assessment. EPA Victoria, Australia.

7 7 from formalizing their businesses. For example, according to the 2006 industrial census, only about 40,000 out of 126,000 enterprises were registered. Until recently, there was no systematic process within government that mandated regulators to carry out proper regulatory impact assessments (RIA) on new regulatory proposals to ensure costs to the business community in complying with them are not excessive. In 2012, the Government mandated RIA requirement with capacity development support coming from ADB technical assistance. 15. Trade policy and SME growth. A recent ADB study on enterprise utilization of preferences under AFTA and other preferential trade agreements in ASEAN found that SMEs utilization rates were low compared to larger firms. It identified three factors for low utilization among SMEs that are relevant in the Lao context. One key reason identified is SMEs lack of information on ways to benefit from preferential trade agreements. The GIZ Enterprise Survey reports that firms have little to no knowledge of upcoming trade integration and upcoming trade agreements. Firms in the sample, for instance, know less about AFTA and the WTO than they did in 2009, with less than 30% of the firms aware of each respective agreement. In view of Lao s accession to the WTO in February 2013, information dissemination becomes more critical so that SMEs can compete within Lao s more open economy. The recent GTZ enterprise survey also found limited awareness among SMEs of AFTA and the Government s WTO accession efforts. Recent developments in protection of regional trademarks such as geographical indication (GI) show promise in promoting SME exports and increasing value added on GI protected products. 16. PSME2 will support the Government s key reform priorities aimed at promoting SME development and growth. It is aligned to the NSEDP7 ( ). The reform priorities include efforts to: (i) enhance SME policy development; (ii) promote increased SME legal formality, improve SME access to business development services and greater access to finance; (iii) support establishment of structured and systematic regulatory review processes within the national government; and (iv) make trade policy better support SME growth. A. Impact and Outcome 17. The impact of the PSME-2 cluster is an increased formalized SME sector. By the end of 2015, the PSME-2 program is expected to have increased the number of enterprises formally registered by 100% over the 2009 baseline of 45,000 registered firms. The outcome of the PSME-2 cluster will be an improved business environment where the private sector operates efficiently and effectively. B. Options 18. In formulating the PSME2 and implementing both SP1 and SP2, several options were considered in addressing the key impediments to SME growth and development. Consequently, the PSME2 draws on international best practices in microeconomic reforms and input from stakeholders. These include measures that: (i) promote good SME policy development, effective coordination among line ministries, stakeholder participation (demand for good governance), and effective gender mainstreaming of the SME development plan and sufficient national budget funding for SME development plan; (ii) address demand-side impediments to SME access to finance through improving rates of SME formality, improving credit information and providing for secured transactions; (iii) address supply-side impediments to access to business development services (BDS) through initiatives to develop the private market for BDS; (iv) supply side capacity development assistance and institutional reforms for better regulatory practice; (v) supply-side incentives through improving trade policy related to

8 8 international norms and development of a geographic indication framework and registry; and (vi) supply side capacity development assistance to address information gap on trade rules and ways for SMEs to improve utilization rates under AFTA and other agreements. A mix of legislative, regulatory and non-regulatory instruments is adopted to achieve the program approach and goals. This includes capacity development TA loan to support regulatory reform, SME access to trade information and support for property rights to support trade. For example: Legislative and regulatory initiatives. The Program supports several major legislative and regulatory initiatives to improve access to finance, improve trade policy for SME growth, improved SME policy development, and better regulatory practices. These include the SME Law, the Law in Making Legislation which mandates RIA across government, Intellectual Property Law, Prime Minister s decree on Implementation of the Secured Transactions Law, Prime Minister s decree on Implementation of the Investment Promotion Law, Bank of Lao PDR Governor circulars on implementing the new web-based credit information bureau, Minister of Commerce decisions on creating the technical barriers to trade (TBT) and sanitary and phyto-sanitary standards (SPS) Notification Unit and creating the RIA Unit, and Geographical Indication Regulations among others. Initiatives for institutional development. The Program supports major institutional and capacity development efforts for SME growth and development. First, the Program supports and assists with the completion of the national rollout of the new enterprise registry system. The target is to have 90,000 enterprises registered by 2015, double the benchmark numbers for in By the end of 2012, this target has been met with number of registered enterprises having increased to 91,077. The next step for the government in particular the Department of Enterprise Registry and Management (DERM) is to review their systems and find solutions to make it more efficient including the possibility of online registration. In the meantime, government is committed to decentralize enterprise registry offices into all districts. Second, the Program supports deregulation effort in the business environment through the institutionalization of the regulatory impact assessment (RIA) process. The RIA reform program includes developing a national RIA strategy, RIA pilots at key line ministries, capacity building with line ministries to implement RIA guidelines and practices, and advocacy programs. Third, the Program through past technical assistance in collaboration with the EC and IFC developed a web-based, modern credit information bureau that will provide real time credit information on loan applicants. Individuals will also be able to self search credit information on themselves. Eventually credit rating facility will be provided by the CIB. Fourth, the Program supports the government to establish a secured transaction registry for removable assets as one modality for improving SME access to finance. Initiatives to develop markets for the provisioning of business development support (BDS) and technology. Several initiatives to improve SME access to BDS and technology were considered. The first option was the government provides BDS services to SMEs, either through government technical providers or through development partner projects. However past direct interventions by government and development partners have produced mix results and DOSMEP has refocused its approach to public support for market development of commercial private BDS providers and not public provisioning of BDS services. This option was therefore rejected by the EA during program formulation. A second option and preferred one by the EA and ADB is to facilitate a network of private sector providers for SMEs to

9 9 access. This approach addresses the deficiency among SMEs on the types of BDS providers available. This option is also considered the lowest cost option for the Government. Thus, under the PSME-2, assistance was provided to launch a pilot network of BDS providers. Policy work was also carried out to find ways to develop the market for basic technology providers and management services such as the accounting profession. A third option that was recently considered is a matching grants scheme to partially fund SMEs efforts to upgrade management and technology adoption. This option would complement interventions under the preferred option. There is broad support for this option and this will be further developed in consultations with government and stakeholders in future PSME programs. The Program supports new innovative initiatives to increase benefits to SMEs from Lao PDR s increased international market integration. Several interventions are developed to support SME access to international markets. First, supply side incentives for business through trade policy reforms in line with international norms. Second, simplifying the application process for certificates of rules of origin. Third, development of information systems for dissemination of information on trade rules and ways for SMEs to utilize preferences under AFTA. Forth, establishment of the framework for trademark protection over geographical products (Geographic Indication), among others measures. Fifth, development of a SME buyer and seller information technology portal linked to ASEAN and East Asia s chambers of commerce. The portal would allow members of chambers to search for buyers and sellers of products within the region and provide information on accessing preferential markets within the region. This trade portal is a new innovation in the ASEAN region that will be supported by the PSME 2 capacity development loan project under subprogram Second National SME Development Plan ( ). SMEPDO has developed the National SME Development Plan ( ) and this plan has been approved through the NSEDP7. The plan incorporates many of the lessons learned from the first strategy. In particular, it will be fully aligned to the 7 th National Socio and Economic Development Plan (NSEDP7). The approval of the plan as part of NSEDP7 instead of a standalone document further enhances coordination of SME sector with government overall priorities. The SME monitoring unit will continue to monitor measurable performance targets and expected results for the SME development plan and these will be reported on a bi-annual basis. The government has also approved the SME Law. The law changed the office of SMEPDO to a department under MOIC s structure with enhanced responsibilities including supporting and facilitating development of women entrepreneurs. The Government has established provincial privatepublic dialogue forums (P3D). Two has been fully institutionalized in Champasak and Luang Prabang provinces, and the Ministry of Planning and Investment (MPI) initiated phase 3 by expanding into Xiengkhouang. This forum is coordinated through the Lao Chamber of Commerce and Industry (LNCCI). Key issues discussed and resolved by the P3Ds related to local taxes and levies and land usage rights. 6 C. Impact Analysis 20. This section presents estimates of the potential benefits and costs to Government and SMEs of the PSME-2. For this purpose we combine quantitative estimates with a qualitative assessment of potential benefits and costs to SMEs from key reforms and innovations under the 6

10 10 three program outputs: (i) enhance SME policy development; (ii) promote increased SME legal formality, improve SME access to business development services and greater access to finance; (iii) support establishment of structured and systematic regulatory review processes within the national government; and (iv) make trade policy better support SME growth Potential benefits. The PSME 2 addresses the key impediments that constrains SME growth, supports measures to promote greater SME competitiveness, and introduces innovations to assist SMEs increase benefits from improved market access. Hence, the potential benefits from these reforms are the cost savings to enterprises from lower registration costs and other business compliance costs, lower cost of capital from improved credit information and secured transactions, cost savings from lower search costs in finding quality BDS providers, increase export revenues to SMEs from their better utilization of preferential trade agreements, and potential increase in SMEs product value added from GI registration. 22. The costs of reforms. The costs of the reforms estimated are primarily the short to medium term costs of government administering and enforcing reforms, the direct fiscal costs of selected reforms, and costs to businesses (primarily SMEs) in complying with reforms. There are permanent administration cost increases in the national budget from establishing new government institutions under the reform program (i.e., CIB online, secured transaction registry, GI registry, RIA units, enterprise registry offices, information systems to disseminate trade information to SMEs, funding of SME strategy). Potential Benefits to SMEs from Reform under the PSME Distortions in the incentives framework impose several types of costs on the economy that impedes growth in the private sector. The first cost arises from allocative inefficiency misallocation of resources across the economy. Major inefficiencies arise if there are restrictions on entry, domestic competition through tariff protection at the border, technical barriers to trade, restrictions on investment in sectors or price controls that affect price signals thereby leading to over-investment or under-investment in the sectors. 24. The second is high transaction costs that arise from poorly designed policies and regulations. While societies require regulations to address market failures or minimize negative externalities, or influence community behavior for the public good, they do impose compliance costs on businesses and the wider community. Other regulations may be outdated and essentially tax businesses and consumers. These compliance costs can be broken into three categories: i) business administrative costs in complying with regulations and obtaining licenses (staff time, overhead costs, official and unofficial fees to obtain licenses); ii) commercial delay costs in waiting for licenses etc (loss profits etc); and iii) adjustment costs related to changing product and or management processes to comply with the regulation. The government also incurs monitoring and enforcement costs related to regulation. Excessive business compliance costs raises industry-wide costs, of which some proportion is passed on to consumers through higher prices hurting low income households the most. Overall, high compliance costs reduce investment and longer term economic growth. According to the 2009 ADB Options for A Regulatory Review Program and Office of Best Regulatory Practice (red tape study), ADB staff estimates that business compliance costs in Lao PDR amount to 1.5%-3.0% of GDP (or about $ million). The compliance costs are most burdensome on micro, small and mediumsized enterprises (Figure 1a). About 60.0% of total compliance costs arise from internal business costs such staff time involved in obtaining licenses. (Figure 1b).

11 A third cost is the inefficiencies in the banking sector that have led to relatively high interest rate margins in the range of 6-7 percentage points or more. SMEs carry higher risk of default on loans compared to larger firms and this explains part of the higher cost of capital faced by SMEs. Improvement in credit information on SMEs and new financial instruments such as secured transactions can help lower risk of default and therefore the cost of capital to SMEs. 26. Improving intellectual property (IP) rights can protect benefits to SMEs arising from innovations. A new promising discipline of IP is Geographic Indication (GI), or trademarks for products uniquely originating from a region. GI can provide price premium on sales in the domestic and international markets. Most recently Cambodia has GI registered black pepper from the province of Kompok. ADB staff analysis shows that prices of Kompok pepper doubled after the registration. Export volumes have also increased tenfold (albeit from a low base). Lao PDR has identified some products that could be eligible for GI protection including coffee, tea, and silk. GI registration combined with technical assistance to improve quality, standards and lower production costs of these products can substantially increase value added and volume of exports. SMEs along the whole value chain are likely to benefit the most. 27. Table 1 presents some potential benefits to SMEs from the reforms. These benefits are non-exhaustive and indicative only. The potential gain comprises of efficiency gains to the private sector SMEs and exporters from reduced transaction costs in trade and lower business compliance costs with regulations and lower enterprise registration costs. There would be potential gains to SMEs from improved access to finance from reduced interest margins from improvements in financial sector efficiency. There would be potential gains to SMEs from GI registration of key products. Not all benefits can be estimated due to unavailable data for statistical analysis. Instead we use qualitative assessment drawing on experiences with other countries that have implemented similar interventions. The second round effects of incremental investment and lower consumer prices from reduced transaction costs have not been calculated. 28. Regulatory reform could save businesses between $11.5 million and $16.5 million annually in lower regulatory compliance costs. The improvement in the quality of regulations and lower compliance costs with regulations through the regulatory impact assessment program could save businesses in the range of $9.7 million and 14.7 million annually. The rollout of the lower cost enterprise registry system could save new businesses up to $1.8 million per year in registration costs. There are also second round effects of higher profits, investments, and lower final consumer prices. To calculate the cost savings from better regulations and licenses under the RIA reform we use estimates from the 2009 ADB red tape study. The study estimated that it costs on average approximately $1,071 per firm annually to apply for annual licenses and permits. We assume that over the program period the compliance costs are reduced by between 10.0% and 15.0% or approximately $107 to $161 per firm annually. With 91,000 firms currently registered and therefore in compliance with main licenses and permits, we estimate that total cost savings to the business community of between $9.7 million and $14.7 million annually. 29. The rollout of the enterprise registry system and offices (including upgrading software, installation of hardware and web-linked based enterprise registry system) to the remaining 10 provinces and selected districts will also save business costs in registration. The rollout provides efficiency gains in registration as the number of documents and time taken to register are reduced. The 2009 ADB red tape study estimated the new registration system reduces business costs by 35% per year as registration is no longer required annually. According to the ADB red tape study, this saving amounts to about $40 per firm per year. With the rollout, the Program

12 12 estimates this will benefit an additional 46,000 newly registered firms over the program medium term period (base line figure of 45,000 in 2009). Thus, savings to these firms could be a total of $1.8 million annually. Table 1: Lao PDR: Potential Gains to SMEs from PSME-2 Program 1. Reduced business compliance costs with enterprise registration from rollout of the lower cost registry system (enterprise registry rollout to all provinces and selected districts) 2. Reduced business compliance costs of 15% with lower cost licensing requirements (RIA program) 3. Lower capital costs faced by SMEs from modern CIB. 4. Lower trade facilitation costs facing SMEs from reforming trade regulations and establishing the IT trade portal for SMEs 5. Increase value added of commodities GI registered (coffee) Quantitative % of GDP Gains $1.8 million 0.02% $9.7 million to 14.7 million Estimates not available Estimates not available % Na Na $15-20 million % Source: ADB Staff estimates. 30. Improved financial sector efficiency should reduce costs of capital to SMEs. The improvements in credit information form the new CIB-online and the secured transaction registry that provides for collateral over movable assets, among other initiatives, will improve financial sector efficiency and lower credit risk through the provisioning of real time credit information on potential borrowers and securities on removable assets and therefore enhanced and expanded collateral for debt. These improvements would be reflected in both SME credit growth rate and the narrowing of the spread between domestic lending and deposit rates. Quantitative estimates are not available. 31. Improved trade facilitation would reduce transaction costs to SME exporters. According to World Bank logistics study, the total cost of exporting and importing goods almost three times higher in Lao compared to Thailand. The reforms under the Program focus on cutting back red tape to exporters and establishing an IT portal to link Lao SME exporters and importers with buyers and sellers in ASEAN, Japan and Korea, Rep. It is expected that these reforms will lower trade facilitation costs to SMEs resulting in increased export sales. Quantitative estimates are not available. 32. Implementing GI policy and registration could increase value added of Lao PDR s key commodities. Cambodia s experience show that the right product can have substantial value added gain from GI protection. Kompok pepper for example saw a doubling in export price as a result of the GI registration. In Lao PDR the development of the GI framework will come in stages. First, a local registry system will be implemented and then followed by international registration after Lao PDR acceded to the WTO in Several products have been identified for possible GI protection chicken sticky rice, coffee, silk and tea. According to a recent assessment funded by the French Development Agency (AFD), Bolavin coffee provides the most promise for GI registration. Processed Bolavin coffee is almost entirely produced by SMEs. It is believed that a premium to the international price of Bolavin coffee will be created

13 13 once it becomes GI registered. Current Bolavin coffee exports amount to $40 million, thus the creation of a price premium on coffee exports will transfer significant benefits to SMEs producing processed Bolavin coffee estimated $15-20 million a year. This is based on increased in price of products that have seen price premium from GI registration in neighboring countries such as Kampot Pepper in Cambodia. Estimating the costs from the PSME2 33. The Government and relevant agencies and private sector enterprises are likely to bear most of the PSME 2 costs. These costs are identified as follows: Government and statutory agencies. Government administrative costs in implementing the PSME 2 including investment costs in setting up the CIB-online at the Bank of Lao PDR, secured transaction registry at the Ministry of Finance, one stop centers at the Ministry of Planning and Investment, RIA units at participating line ministries, rollout of the enterprise registry system in the 10 provinces, launching and maintenance of the network of service providers, TBT/SPS Notification Units, the IT portal linking Lao exporters and importers with buyers and sellers in region, and other initiatives under the SME Development Plan. Government will also incur current and future stream of operating costs for CIB-online, RIA units (including carrying out RIA work plan), secured transaction registry, and network of service providers, and costs involved in monitoring implementation of the SME Development Plan. Public sector will also incur costs associated with carrying out stakeholder consultations through the provincial public-private dialogue forums, disseminating trade related information and implementing of its communication strategy, and advocacy of RIA through the RIA interagency taskforce. Some costs will be recovered through user charges and fees. The CIB-online and the secured transaction registry will charge users access fees. Borrowers will also be charged fees for depositing securities over movables. Private Sector. Private sector enterprises (primarily SMEs) will also incur private costs where adjustments need to be made to comply with new regulations such as the PM decree on Implementation of the Investment Promotion Law, the PM Decree on Implementation of the Secured Transaction Law, among others. 34. Table 2 highlights the key costs with quantitative estimates where possible. The estimates are based on discussions with stakeholders, project design costs and assessments made under ADB technical assistance. These costs are not exhaustive and indicative only.

14 14 Types of Adjustment Costs 1. Administrative costs Table 2: Lao PDR: Potential Costs to Government and Stakeholders from the PSME2 Government and Statutory Agencies (i) Costs incurred in legislative and regulatory initiatives estimated $600,000 (staff time and overheads used for drafting new legislations, prime ministers decree and ministerial decisions); a/ (ii) Administrative and investment costs in improving access to finance such as developing and launching the CIB-online and the secured transaction registry estimated project costs at $500,000; (iii) Administrative and investment costs in improving regulation review systems and reducing red tape such as establishing the RIA units, RIA learning center, advocacy of RIA, rollout of the enterprise registration system to 10 provinces, establishment of one stop licensing centers, and greater stakeholder participation in policy development (P3Ds) estimated at $3,350,000; b/ (iv) Administrative and investment costs in improving transparency in trade policy and initiatives to support SME growth through trade such as establishment of the TBT/SP Notification Unit, GI Registry, trade-related information systems and dissemination estimated at $330,000; c/ (v) Launching of the network of service providers estimated at $25,000.c/ (vi) Establishment of the IT portal for SMEs to access buyers and sellers in the region. The portal will be housed at the Lao Chamber of Commerce and Industry estimated at $500,000 c/ Stakeholders (including SMEs and households) 2. Fiscal costs (i) Implementation of activities under the SME Development Plan $4 million as budgeted by National Assembly and earmarked under the SME Fund. (ii) The permanent budget operating costs of secured transaction registry, RIA units, TBT/SPS Notification Unit, GI Registry, Enterprise Registry Offices, one stop licensing centers, and trade-related information systems estimates not available. (iii) Maintenance costs of the network of service providers over the program period, costs involved in monitoring implementation of the Development Plan implementation over the program period, and the P3Ds estimates not available. 4. Business compliance costs Payment of approximately $250,000 for registration, maintenance and inquiry fees to CIB online (assumed 36,000 transactions per year from 30 registered members) d/ Total estimates At least $9.3 million $0.25 million Source: ADB staff estimates. a/ The estimates based on number of persons and time involved in drafting and advocating new legislations and decrees issued under the program. Under the program there are three laws, three Prime Minister Decrees and several ministerial decrees issued. It took between two years and five years to draft, enact or issue the laws or decrees under the program. b/ The Government has agreed to the ADB TA loan to support the rollout of the enterprise system at the district level and establishment of RIA system (learning center and rollout to other lone ministries) amounting to investment costs and administration costs of $1.8 million. Additional project costs of approximately $300,000 were incurred in the rollout of enterprise system to several provinces during subprogram 1 of PSEM-2. Additional project costs involved in RIA capacity development amounting to $750,000 under ADB RIA TA. c/ Estimates based on the ADB TA loan project costs and previous technical assistance. d/ estimates based on Lao PDR s Decision on Fee for Membership and Credit Information Services.

15 15 V. Program Financing 35. The government has requested a $15 million loan equivalent for the policy based loan from ADB s Special Fund resources to finance subprogram 2 of the PSME2 and $4.378 million loan equivalent for the TA loan from ADB s Special Fund resources to institutionalize the completed reforms and make them sustainable. The size of the loans is based on a number of factors. The key considerations include: (i) (ii) (iii) (iv) The relative importance of the sector to the economy. The private sector and SME sector accounts for a sizeable proportion of employment and its development is critical to support Lao PDR s economic transformation, growth and poverty reduction. ADB staff have assessed over the period ( ) substantial benefits of the reform program with savings to the business community estimated between $11.5 and $16.5 million annually from the RIA and enterprise registration reforms alone. There is also potential benefit of approximately $15-20 million from the export of products that may benefit from geographical indication registration. Other benefits, while not quantifiable due to lack of data, are expected to also be substantial from improved access to finance for SMEs and reduced trade facilitation costs. The longer term benefits and the second affects of increased investment and lower consumer prices will be much larger. The program costs. The policy adjustment costs to the Government, relevant agencies and private sector are assessed to be substantial. Direct quantifiable costs from the program reforms are at least $9.3 million coming from government staff time and overheads involved in completing the legislative agenda, project costs for implementing RIA, GI, the IT portal for trade information, rolling out the enterprise registration system, and implementing activities the SME strategy. The annual administrative and operating costs of new systems supporting reforms are not estimated. Cost will also be incurred by the private sector for registration, maintenance and enquiries to CIB online, estimated at $0.25 million The reform program includes several politically sensitive policy and institutional reforms that have are likely to be resisted such as the RIA reforms. To support the reforms, the program amount loan provides leverage to the executing and implementing agencies to support implementation; and The program loan also reflects the government s development financing needs as well as the need to conform to the overall financing requirement from the country partnership strategy period. The government produced a deficit of 1.9% of gross domestic product in 2011 (subprogram 1), deficit of 1.5% for 2012 and a deficit of between 3.5 to 5.0% for 2013 taking into account the need to increase social sector spending and maintenance of new infrastructure critical to long term development goals. 7 7 Budget deficit includes grants.