Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB5715 Project Name Cambodia Agribusiness SME Access to Finance Project Region EAST ASIA AND PACIFIC Sector Agro-industry (50%); Micro- and SME finance (50%) Project ID P121809 Borrower(s) ROYAL GOVERNMENT OF CAMBODIA Implementing Agency Ministry of Economy and Finance Environment Category [ ] A [ ] B [X] C [ ] FI [ ] TBD (to be determined) Date PID Prepared May 4, 2010 Estimated Date of September 7, 2010 Appraisal Authorization Estimated Date of Board December 16, 2010 Approval 1. Key development issues and rationale for Bank involvement Cambodia has experienced strong economic growth along with significant poverty reduction over the past decade. The average annual gross domestic product (GDP) growth rate was 9.8 percent between 1998 and 2007, compared to 1.8 percent of population growth rate during the same period. The country has achieved macroeconomic stability and put in place open trade regime, which has led to significant inflow of FDIs. The latter has been the primary contribution to the explosion of non-traditional exports (largely textiles and garments), which together with tourism and construction sectors have been the main drivers of growth and non-farm employment. Agriculture sector, which makes up about 1/3 of GDP and provides employment to 70 percent of labor force, expanded at the annual rate of 4.2 during 1998 to 2007 period. Although lower than GDP growth rate, it has nevertheless been impressive when compared to agricultural GDP growth rates of the East Asia and Pacific (EAP) region (3.6 percent). Economic growth, however, has proven fragile to global economic and financial crises due to its narrow base. The slowdown in garment exports and tourism arrivals has reduced the GDP growth rate in 2008 to 6.7 percent, and the economy contracted by 1.5 percent in 2009, its worst performance in the post-conflict period. Exports, which accounted for 42 percent of GDP in 2008, dropped by 12 percent at year-to-year basis during the first half of 2009. The decline was led by garments (more than half of all exports), which contracted by almost ¼ during the first half of 2009, due to lack of orders and difficulty in remaining competitive vis-à-vis other lowcost producers in the region. It is expected that the economy would register marginally positive growth rates in 2010 and 2011, provided that there will be a recovery in exports. Agriculture has remained the only bright spot in this generally negative economic outlook, with the sector expanding at the rate of about 5 percent in 2009. However, the sector mirrors the overall narrow structure of the economy which is characterized by lack of diversification. Rice is a dominant crop, making up about ¼ of agriculture GDP and about ½ of crop value added. It is grown on 84 percent of cultivated land by some 4/5 of farmers. The production of paddy is
expected to reach 7.25 million tons during 2009/10 growing season. With a population of just under 13.8 million, domestic food consumption requirements are around 1.97 million tons of rice, leaving about 2 million tons of rice for exports (or about 3.1 million tons in paddy equivalent). Other emerging and traditional agricultural sub-sectors with a good potential for increased domestic value added processing and exports include maize, cassava and rubber. Yet, little agro-processing and value addition takes currently place in Cambodia. Most agriculture raw materials are currently exported in unprocessed form (and informally) to neighboring Vietnam and Thailand where it is processed and exported to international markets, including some back to Cambodia. This represents a potential income opportunity for the country. The global economic crisis has led to increased attention to agriculture and agro-business sectors by the Royal Government of Cambodia (RGC), both as an additional source of exports and as a creator of jobs. It is expected that international prices for food cereals and other agricultural raw materials would remain above its historic averages over coming years. With its abundant land and water resources, Cambodia has a considerable potential to take advantage of these price trends. For example, based on the current growth rates of 5.5 percent per annum, the country would be able to potentially export some 3 million tons of milled rice by 2016 and solid 4 million tons by 2020 making is potentially the fifth largest rice exporter in the world. Realizing this potential, however, would require concerted efforts from the RGC and private sector to address various constraints for the development of the sector. The fastest way to increase Cambodia agriculture exports is to redirect informal unprocessed raw material trade to formal processed agro-produce exports, given long-term production and infrastructure constraints. This, however, requires finding a way of urgently solving issues related to lack of finance. Agro-businesses need access to capital (both working and term) to purchase raw materials during harvest times and upgrade their processing equipment to reduce production costs and meet quality standards, while traders and wholesalers need money to meet on-going transport and inventory costs. Cambodia has relatively liquid commercial banking sector and the availability of funds and cost of finance is not a constraint per se. There seems to be sufficient capital available within financial sector to fund investments in agriculture, agro-industry and rural Small and Medium Size Enterprises (SMEs). Yet, the current bank lending to agriculture represents only 4.7 percent of all lending over the last 3 years. The problem lies largely in intermediation failures and the perceived risks versus returns to investment as banks perceive agriculture, agro-businesses and rural SMEs to be more risky and less profitable compared to other sectors. World Bank Group Strategy. The World Bank s Country Assistance Strategy (CAS, 2005) emphasizes improved public financial management, public administration, decentralization and trade facilitation improvement -- all which have indirect linkages to private sector development. The proposed Project is consistent with the Pillar 1 of the CAS, which aims to support the private sector to generate incremental and sustainable employment and diversify sources of economic growth. In line with the CAS, the International Finance Corporation s (IFC) strategy in Cambodia focuses on developing local financial sector to expand access to finance. An efficient and stable
financial sector capable of effectively supporting local businesses is a key to the continued growth and development of Cambodia s economy. Although the country has a large number of commercial banks and micro finance institutions, most of them are small and not very effective in terms of financial capacity and service delivery and only 6 percent of the population has access to formal financial services. The quality and range of financial services offered by the local financial institutions does not adequately meet market needs. The IFC s financial sector strategy therefore focuses on improving the quality and availability of financial services to commercial and retail customers in Cambodia by supporting the development and growth of financial institutions that have the potential to provide such services. With regards to the agriculture sector, IFC s strategy is to focus on the strengthening of the value chains of main agricultural crops as well as providing support to agriculture-based processors to improve their efficiency and product quality, in order to be able to access higher value export markets. Rationale for the IFC/IDA intervention. Risk Sharing Facilities (RSFs) are an effective way to leverage public resources through private sector investment, hence maximizing the reach and effectiveness of IFC and Development Partner funds. For example, the IFC s experience shows that more than $6 of financing is made available for every $1 of IFC/Development Partner funds pledged. The IFC and IDA have collaborated on a number of similar programs elsewhere. Using IDA credits, RSFs have been set up between IDA, IFC and the Governments of Madagascar, Mali and Ghana as part of the IDA/IFC Pilot Program in Sub-Saharan Africa. The IDA-IFC Secretariat has recently reviewed the lessons learned and experiences from these joint IDA-IFC RSFs 1. The review of the on-going pilots provides the following additional rationale for IDA/IFC RSFs: (i) the use of small amounts of IDA resources (i.e. US$1 to 5 million per country) could help achieve important public policy goals by leveraging IFC and private funds to increase lending to SMEs sustainably, as opposed to the large amounts of resources that have been required for other programs with a similar access to finance objective (i.e. lines of credits); and (ii) subsidy provided by such IDA/IFS RSFs, when properly designed, is justified based on the argument of addressing market failures that limit achievement of important public policy goals of promoting economic development and generating employment. The review also highlight that while the early outcomes from the small sample of pilot IDA/IFC RSFs in Africa are encouraging and consistent with the outcomes of global best practice, there is a need to extend the pilot to additional IDA countries and for specific sectors (e.g. agriculture, energy efficiency facilities), in order to provide a broader evidence base. Bank and IFC are supporting the Government through a number of technical assistance programs in trade facilitation, financial sector and agro-business development. Specifically, the IFC has partnered with the European Union to provide the trust fund (up to EUR 10 million) to support the development of agriculture and agrobusiness SMEs in Cambodia. The program includes: (a) the access to finance component which provides technical assistance to local banks to cater to agribusines; and (b) corporate advice component to help SMEs to adopt new technology and 1 IFC-IDA. TASK FORCE REPORT: Review on the Use of IDA funds for Risk Sharing Facilities and Partial Credit Guarantee Projects. July, 2009.
gain efficiency. This TA program will be linked to the proposed RSF as it aims to raise the standard for both the supply side and the demand side of agro SME finance. Lessons learned. The lessons learned from IFC RSFs show that well designed RSFs, which build on private sector participation and supportive business environment, can accomplish important public policy objectives of financial sector deepening, while the poorly designed RSFs with weak risk assessment, loan recovery and corporate governance, which has been often the case with state-owned financial institutions, can distort markets and/or encourage inappropriate risk taking; well designed PCGs with government involvement in funding and regulatory reform. Finally, lessons learned show that building technical and processing capacity of financial institutions to better ensure future sustainability of the business area is a critical part of the success of such RSFs. 2. Proposed objective(s) The preliminary development objective of the proposed project is to: (a) increase the flow of sustainable credit to agribusiness SMEs; and (b) increase the numbers of active labor force employed in the agribusiness sector. Proposed outcome indicators would be: (i) Per annum increase in incremental agribusiness lending portfolio size (number and volume) and quality; and (ii) Numbers of permanent and seasonal jobs created by agro-processing sub-projects. The project development (PDO) and indicators will be revised after the technical preparation as more information about expected outcomes will become available. Target Group. The primary project target groups are the investors receiving credit, in this case agriculture (i.e. production), agribusiness (i.e. processing) and rural SMEs in Cambodia, referred together as agribusiness SMEs. The criteria for the target group of SMEs who would be eligible for accessing financing from the participating financial intermediaries (PFIs) include: (i) minimum of 10 employees and maximum of 300 employees; (ii) Total assets of at least US$100,000 and maximum of US$15 million; (iii) annual business turnover of at least US$100,000 and maximum of US$15 million; and (iv) is not a wholly owned subsidiary of a larger corporate entity. The secondary project target groups are the financial institutions providing credit, in this case be PFIs who meet the selection criteria agreed by the IDA/RGC and IFC. The proposed selection criteria for the PFIs are presented in Anne 2. It is expected that no more than 2-3 PFIs would meet the proposed eligibility criteria in Cambodia. 3. Preliminary description The proposed project will be a pilot under Phase II of IDA/IFC Pilot Program for Risk Sharing Facilities, which includes a number of countries globally. As such, the proposed design parameters of the RSF follow the general structure of the previous pilots, and should be considered therefore as indicative. These parameters (i.e. risk share, fees, etc.) are subject to change based on the technical analysis which will be carried out by IFC/IDA teams during the project preparation. Furthermore, the proposed agriculture/agribusiness SME RSF is a pilot of such financial instrument also in Cambodia context. If successful, it could be scaled up in the future to include other sectors.
The project would demonstrate an effective method to leverage private sector funding to enhance agriculture sector contribution to Cambodia s economy. It is expected that the knowledge the PFIs gain during the program will allow them to develop their own procedures and criteria for lending to the sector in a long term in a sustainable manner. The 50 percent loss sharing provides participating banks with the credit protection needed to mitigate the perceived high risk of agribusiness lending. It incentivizes participating banks to conduct proper borrower credit appraisal and apply strict loan underwriting criteria (including taking proper security) in establishing the loan portfolio. Project Components. The proposed project would have the following component, which will be linked with the TA to PFIs and SMEs which is currently implemented by IFC through EU trust fund (see project rationale): a) Agribusiness SME finance Risk Sharing Facility (RSF) (US$3 million IDA). The agribusiness RSF would provide resources for a loss sharing, in order to mobilize capital from IFC and participating bank(s) to lend to agri-businesses. It is expected that the $3 million IDA financing would leverage about US$30 million of commercial lending to SMEs in agribusiness sector (i.e. 10 times), which would finance at least 60 and up to 120 borrowers engaged in agribusiness, trading or rural SMEs with loan sizes in the range of $250,000 to $1 million. It is assumed that a conservative estimate of financing needs for agribusiness SME sector is in the range of $200m over the coming 3 years. Project Costs and Financing. The IDA funding (50/50 credit and grant) for the proposed RSF will be $3 million, which will share 50 percent of the first loss with the PFIs (corresponding to 10 percent of the total portfolio). The IFC will share 50 percent of subsequent losses with the participating banks, up to a total amount of US$ 12 million (corresponding to 40 percent of the total portfolio). The IDA credit and grant would be used up equally when risk-sharing payments are called by PFIs. The proposed breakdown of the investment structure and cost is summarized below: Participating Bank: 50% (US$15 million) IFC: 40% (US$ 12 million) 2 nd loss IDA: 10% (US$ 3 million) 50 % 50 % 1 st loss
Indicative financing arrangements would be as follows: Participating private sector banks: International Finance Corporation (IFC): International Development Association (IDA): Total: $15.0 million $12.0 million $3.0 million $30.0 million It is proposed that during up to 2 years after signing, the participating banks will be allowed to ramp up the agribusiness portfolio up to the maximum portfolio balance which is predetermined for each bank (e.g. $30 million for the pilot program). The participating bank will no longer be able to ramp up the portfolio prior to the 2 year anniversary if: (i) the portfolio balance reaches the size of the facility; or (ii) the non-performing or rescheduled loans account for more than 20 percent of the portfolio balance, or if the aggregate net loss amount of the portfolio exceeds 10 percent. It is possible for the cumulative default rate of the portfolio to exceed 20% and thus the first loss to be used up fully. However, the trigger mechanism described above would mitigate such a risk. At the end of the program (e.g. 5 years), the remaining first loss amount would be returned or would be applied for the subsequent program. Proposed Implementation Arrangements. The main implementation principles of the IFC-IDA RSF model include the following key steps: (i) RGC will be the recipient of the IDA credit/grant funds; (ii) the RGC will transfer the IDA funds to a Trust Fund managed by IFC. RGC will be consulted on the selection of participating banks. The IFC-IDA team would review a number of PFIs during the project preparation and assess them against eligibility criteria which will be agreed with the RGC; and (iii) IFC will monitor the utilization of the RSF by PFIs. On the latter, the IFC will verify that calls on first loss by the PFIs are legitimate. PFIs can call on the first loss for risk-sharing payments only if certain strict conditions are met including: (i) The loan has become overdue, and bank has demanded payment of all outstanding amounts under the Loan and under all other loans to the same Borrower, and bank has initiated all appropriate legal proceedings to enforce collection; (ii) the amount due has not been repaid in full within 360 days after due date; (iii) the loan must have been classified as Loss according to the Regulator and fully provisioned according to such classification after taking into account the estimated value of the security; and (iv) the loan meets certain additional payment conditions. The portion of IDA financing that has not be called during the project lifetime would be cancelled and made available to Cambodia for its overall IDA program (including for a possible follow-up operation should the Government and the World Bank Group (WBG) agree).
Under the project, the IFC is acting both as an investor in providing credit coverage through RSF, and as a liaison between the PFIs and the RGC during the project preparation and implementation. It also plays a catalytic role in the development of the agribusiness SME sector in Cambodia through a demonstration effect for the rest of the banks in the country. In order to address potential conflicts of interest arising from its roles as investor and advisor, IFC will have two separate teams, in line with WBG s Conflict of Interests Guidelines for IDA-IFC joint projects, to work on this initiative. 4. Safeguard policies that might apply N/A 5. Tentative financing Source: ($m.) BORROWER/RECIPIENT 0 International Development Association (IDA) 3 Total 3 6. Contact point Contact: Paavo Eliste Title: Senior Economist The World Bank Group 1818 H Street, N.W. Washington, DC 20433 Tel: (202) 458-8925 Fax: 202) 522-1560/1557 Email: Peliste@worldbank.org