Technical Assistance Consultant’s Report · cluster-based approach to SME development should be explored. The cluster-based approach has various advantages. SME clusters can achieve

Technical Assistance Consultant’s Report

This consultant’s report does not necessarily reflect the views of ADB or the Government concerned, and ADB and the Government cannot be held liable for its contents. (For project preparatory technical assistance: All the views expressed herein may not be incorporated into the proposed project’s design.

Project Number: 49273 May 2017

Sri Lanka: Small and Medium-Sized Enterprises Line of Credit Project (Financed by the Japan Fund for Poverty Reduction)

Prepared by

Pricewaterhousecoopers – Sri Lanka

Colombo, Sri Lanka

For Ministry of Finance’s Department of Development Finance

Cluster Finance in Sri Lanka GAP Report

May 2017

Cluster Finance in Sri Lanka May 2017

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Table of Contents

Executive Summary .................................................................................................................. 3

1. Rationale for SME cluster development ................................................................................ 5

2. International Precedence for Clusters ................................................................................. 6

2.1. International Precedence ........................................................................................................................... 6

2.1.1. Processed food cluster, UK ............................................................................................................... 6

2.1.2. Fruit Clusters in Latin American Countries .................................................................................... 6

2.1.3. Chilean Salmon Cluster .................................................................................................................... 7

2.1.4. Afghanistan Carpet Weaver Cluster ................................................................................................. 7

2.1.5. Rice Cluster, Kerala, India ................................................................................................................ 8

2.1.6. Beverage Cluster, Andhra Pradesh, India........................................................................................ 9

2.1.7. Rubber Cluster at Kottayam, Kerala, India ..................................................................................... 9

2.1.8. The Grape Cluster, Maharashtra, India ......................................................................................... 10

2.2. Lessons Learned ........................................................................................................................................ 11

2.2.1. Types of Clusters .............................................................................................................................. 11

2.2.2. Success factors for cluster financing .............................................................................................. 11

3. Gap Analysis for Cluster Finance in Sri Lankan Market .......................................................13

3.1. SMEs’ capacity to structure cluster financing .......................................................................................... 13

3.2. Leadership role of industrial associations ............................................................................................... 13

3.3. Bank’s expertise in non-collateralized lending ........................................................................................ 13

3.4. Government support ................................................................................................................................. 14

4. Next steps ............................................................................................................................. 15

Appendix A. - Appendices ....................................................................................................... 16

A.1. Appendix –Lack of pure cash flow based by Banks ................................................................................. 16

A.2. Appendix –Documentary information normally requested by lenders for SME loans ....................... 18

A.3. Appendix – Cluster Development Agent ................................................................................................. 19


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Executive Summary

Clusters worldwide are being acknowledged as a strategic mechanism, through which a group of SMEs can have

access to finance or technology that individual SMEs cannot have, especially when SMEs face the same or a

similar set of threats (e.g. product obsolescence, lack of markets, etc.) and opportunities (e.g. increasing

turnover through quality up-gradation or introduction of new products or markets, etc).

The cluster approach is not new to Sri Lanka. Several business clusters are well established among larger

enterprises in Sri Lanka. In 2001, USAID’s competitiveness program supported SME cluster development

activities in the top export sectors such as tea, rubber, gems & jewelry, tourism, spices, ICT, coir and ceramics.

However, the enthusiasm among the cluster members has faded. In addition, there is no cluster finance product

available, in which a Special Purpose Vehicle (SPV) can be formed as an entity to borrow on behalf of a group of

SMEs.

International Precedence and Lessons Learned

SPVs for SME cluster in both developed and developing countries like UK, Latin America, Afghanistan and

India have done remarkably well in sectors such as food & beverage, fruits and vegetables, and rubber. All these

SPVs were formed to increase the competitive advantage of individual SMEs by addressing common issues

ranging from sourcing raw material at a lower cost, access to new customers and markets, access to more labour

force, having common facility centres, common warehouses, technology upgradation, cost sharing, joint

selling/exporting, etc.

A successful cluster/SPV has the following key attributes. First, government interventions, including initiating a

cluster formation, establishing network with existing support institutions, providing technical assistance for

member SMEs, providing financial support for constructing common facilities, are effectively made to ensure

the sustainable operation of a cluster/SPV. Second, SPVs should be formed by a group of SMEs with the similar

mindset, which results in robust decision-making and efficient cluster management for its sustainable

operation. Therefore, identification of potential cluster members is key for the success of cluster during

implementation. Third, an independent professional manager (Cluster Development Executive/Agent) plays a

critical role to ensure long-term sustainability of the Cluster/SPV. Lastly, independent professional managers

assist potential cluster members in identifying common objectives and partners, guide the cluster members in

the cluster formation process, give advice on various tasks/choices (i.e. legal form; funding; business plan, etc.),

establish links with support institutions, support the recruitment of personnel for the cluster’s SPV, and resolve

conflicts amongst cluster members.

Gap Analysis for Cluster Finance in Sri Lanka

Several gaps were identified in Sri Lanka to develop cluster-based lending for SMEs. First, SMEs cannot

prepare bankable loan proposals due to their lack of technical and financial capabilities. The strong leadership

of SMEs with technical capabilities is imperative to drive the SPV and to keep it alive and sustainable. Second,

SMEs lack the motivation to form an SPV because they don’t want to reveal their confidential business

information. Although there are various associations in all the four target sectors under the ADB’s technical

assistance (Fruits & Vegetables, Food and Beverages, Rubber and ICT/BPO) in Sri Lanka, their major role is to

diagnose various business & technical issues in the value chain and facilitate advocacy campaign to the

government. These industrial associations could support SMEs to make a consensus to form an SPV. Further,

The Industrial Development Board and Export Development Board (EDB) could be the key stakeholders to

anchor the formation of clusters and revive the inactive SPVs in rubber and Food processing sectors. Third,

banking sector is not ready for promoting cluster-based loan. SME finance in Sri Lanka is characterized as lack

of cash-flow based lending and high interest rates. Some financial incentives are recommended to be in place,

such as government special finance schemes to SMEs or credit guarantee schemes, to structure cluster-based

loans at affordable rates.


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Next Steps

The team has been conducting multiple workshops and individual in-depth meetings with SMEs in the food and

rubber production sectors in March-April 2017 to disseminate international success stories in cluster

development and understand their current status, specific issues and challenges to obtain bank finance, their

business model and short-term and medium-term capital needs; their ability to prepare loan proposals. Then,

the team will shortlist the best potential cluster-based on key filters, which include stage of cluster

development, strong leadership, geographic spread, size and density of cluster, linkages with large

corporates/exporters (in case of cooperatives and small enterprises), existing/potential markets or product

demand, technical and financial capacity, size and scale of activity reflected by turnover and profitability,

documentation level, manpower availability, competition, government support, sustainability factor,

banks/financial institutions interest in financing. In parallel, the team will also identify the bank/financial

institutions that will finance the identified cluster. The final output of the technical assistance (TA) is to prepare

a loan proposal for the short-listed cluster. For a loan proposal, the effective use of ADB’s credit line, a newly

established credit guarantee scheme or government financial schemes to SMEs will be considered.

To mainstream the cluster-based lending practice in the long-term, other components of the ADB’s TA will also

address the key gaps. For example, the TA may support financial literacy trainings for SMEs to make use of a

credit guarantee scheme.


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1. Rationale for SME cluster development

Small and Medium-sized Enterprises (SMEs) are recognized as a driver for economic growth and diversification

in Sri Lanka. However, since many SMEs in Sri Lanka are isolated and had to work independently along the

value chain, SMEs, individually, cannot develop its capacity to continuously respond to competitive pressure

and to mobilize factors, such as finance or technology, for expansion and innovation. To overcome this issue,

cluster-based approach to SME development should be explored.

The cluster-based approach has various advantages. SME clusters can achieve economies of scale for better

bargaining position and more cost-effective procurement, facilitate training and technological innovation,

easier access to finance and greater institutional support. It also becomes more cost- effective for the

government, large enterprises, universities and other supporting agencies to provide business development

services (BDS) to a whole cluster of enterprises, rather than to individual enterprises in several locations.

The cluster approach is not new to Sri Lanka. Several business clusters were well established among larger

enterprises in Sri Lanka. However, these cluster-based approaches have been rarely seen at the SME level. In

2001, USAID’s competitiveness program supported SME cluster development activities in the top export

sectors such as tea, rubber, gems & jewelry, tourism, spices, ICT, coir and ceramics. However, the enthusiasm

among the cluster members has faded. Also, a GIZ funded project supported a rubber SPV to be formed by a

group of 20 SMEs, but the SPV became inactive when the project funding was over.

The government has supported the SME cluster development by strengthening subcontracting linkages

between large enterprises and SMEs to enhance technological, marketing and production improvements,

reduce information and transaction costs, improve the productivity of SMEs and ensure stable orders and

favorable payment conditions. For example, several programs such as the National Agribusiness Development

Programme (NADeP) were launched, in which several industrial bodies such as the Institute of Post-Harvest

technology in Sri Lanka are working towards linking farmers/microenterprises to large corporations such as

Cargills, Hayleys, Sunforest, HJS Condiments, and Nelna Group. However, most of these programs target at the

domestic value chain, and there have been limited interventions for developing a global value chain.

Recently, the government has expressed strong ownership to promote the cluster-based approach. In Budget

Speech 2017, the Finance Minister announced the formation of a textile cluster where the Government of Sri

Lanka will also invest in this venture by providing adequate space, to save close to $2,000 million per annum.

The Industrial Development Board (IDB) has been requested to provide the necessary infrastructure and

training for cluster development and increase support for SMEs to enhance knowledge transfer and upgrade the

industrial estates.

The formation of SME cluster can enhance the borrowing capacity of SMEs. Individual SMEs faces the issue of

limited access to finance because they do not have sufficient collateral for bank lending. Sri Lankan banks rarely

extend cash flow based lending to individual SMEs (Appendix A.1) because of its relatively large transaction

cost and banks’ limited capacity to manage risks of SME loans. To overcome this issue, SMEs can utilize

cluster finance model, in which a group of SMEs form an SPV to borrow under a single contract with banks. 1 The cluster finance is attractive for banks because its large scale can justify the bank’s transaction cost. The

cluster finance is also attractive for SMEs because each SME’s liability is limited to their equity investment in SPV. The cluster finance model can effectively work if different risks are appropriately distributed to different

stakeholders and risk mitigation measures, such as credit guarantee, are available at affordable price.

1 The cluster finance model is different from microfinance model. In the microfinance model, a group of microenterprises

approaches the bank to obtain loans on individual basis where the microenterprises provide personal guarantees to each other. Although

microenterprises negotiate with financial institutions as a group, loan contracts are prepared for individual microenterprises.


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2. International Precedence for Clusters

SME cluster development has been demonstrated as a workable business model in several countries. This

section provides an overview of international precedence for SME cluster development and summarize the best

practices that can be replicated for Sri Lanka. The international precedence includes cluster developments in (i)

fruit and vegetable sector, (ii) processed food and beverage sector, and (iii) rubber production sector.

2.1. International Precedence

2.1.1. Processed food cluster, UK

BioVale Limited, was formed in 2014 by 40 members (16 SMEs, 5 large companies, 7 research institutions

and 12 ecosystem actors) across the value chain in food processing cluster in Yorkshire, UK. The industry

needed to be competitive by exploring revenue from converting bio-wastes into high value products.

The total funding requirement of the SPV was USD 5.12 million, out of which contribution from Government

was USD 2.19 million and contribution from donor agencies was USD 2.93 million. Management decisions were

jointly undertaken by the cluster members and government given its substantial financial contribution.

The cluster member SMEs were provided institutional support by the government, including overseas

marketing and networking with investors. The cluster member SMEs also received support from technology

research institutes for technical capacity building to acquire latest technical knowhow and improve their

current practices. BioVale helps cluster member SMEs to (i) access the latest research and world-class expertise

in the bio economy; (ii) facilitating networking, dialogue, partnerships & collaboration in the bio-based value

chain; (iii) find funding for members for expansion and R&D; (iv) having their bio-based business promoted to

investors; (v) finding overseas markets for products and services; and (vi) getting training specially designed for

the bio economy workforce.

Biovale has successfully expanded its outreach and facilitated information flows on technology or market

development by establishing a partnership with other clusters. Furthermore, over 30 bio economy businesses,

and academic and public sector organizations have engaged with BioVale through its industry association,

MOUs or BioVale membership. Over 400 subscribers regularly get the latest bio economy developments and

opportunities via the BioVale newsletter. Biovale helped secure funding of USD 22 mn for the BioVale Project at

the University of York. Through this funding, the university will develop the Yorkshire and the Humber as a

world-leading region for innovation in the bio economy by facilitating networking and dialogue, building

international collaboration, encouraging trade and investment and coordinating specialized training.

2.1.2. Fruit Clusters in Latin American Countries3

Several fruit clusters in Latin American Countries were successful to cater to the domestic and the export

markets. Famous examples include:

Brazil: the mango and grape clusters of Petrolina Juazeiro, the apple cluster in Santa Catarina, and the

melon cluster in Rio Grande do Norte

Chile: the raspberry cluster

Mexico: the pineapple, avocado and lemon clusters

Post cluster formation, these small and medium enterprises contributed around 30 – 60% of the nation’s production volume. Various reasons were cited for the success of the fruit clusters in Latin American region.

First, the formation of a cluster by these farmers could support establishing a long term contract between SMEs

3 FAO United Nations 2020 Report on Agro-based clusters in developing countries: Staying competitive in a globalized economy.


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and a large buyer. For example, about 2000 smallholder raspberry producers (less than 2 ha), established long-

term supply agreements with larger firms that pack/process and export raspberries.

Second, these farmers took joint action to meet market based threats and challenges collectively. For instance,

the Brazilian Apple Producer Association fostered the development of a so-called apple integrated production

system and introduced a quality and grading system, which contributed to the establishment of a public

competitive grant programme to finance training and laboratory equipment for research on Brazilian fruit

exports. Another example is VALEXPORT, a Brazilian association that represents the fruit and vegetable

growers and exporters of Petrolina-Juazeiro. The association signed cooperation agreements with public and

private entities, nationally and internationally for the production, handling, shipping, warehouse services, trade

and promotion. They are actively involved in organizing the cluster participation in fairs and expositions.

Third, strong institutional support from government was provided to aid cluster members. For instance, the

Government of Santa Catarina provided extension services to smallholder producers of apples and other

temperate fruits and facilitated their access to credit, marketing, research and training. The state’s research experimental stations also maintained very strong ties with small growers. Public-sector research agencies

explicitly included small growers in their research projects to make the technology and research relevant to the

small grower and to disseminate findings to small-scale producers.

2.1.3. Chilean Salmon Cluster4

Chile’s global export market share in production of cultivated salmon and trout was 38.2 and 39.7 percent

respectively in 2006. Chilean exports of these products experienced a giant leap from USD 668 million in 1997

to USD 2,207 million in 2006.

The salmon sector had to develop a quality seal to meet stringent quality requirements from the overseas

markets. They formed a cluster for (i) the establishment of geographic and good management practices tools;

(ii) the development of a labour-competency certification system for various subsectors of the salmon cluster;

and (iii) the implementation of a “Clean Production Agreement” for the salmon industry and a Vigilance and Management Model that serves the principal producers and suppliers in the industry.

The Chilean Government played an important role as a facilitator and catalyzed promotions and took joint

actions to building trust among the cluster stakeholders which includes salmon hatcheries, feed producers,

transport suppliers, pharmaceutical labs, equipment producers, fish net manufacturers, logistics and

equipment service providers, packaging and veterinary service providers, environmental and fish health service

providers.

Along these lines, various public agencies collaborated amongst each other to solve key issues for upgradation

of the salmon cluster such as registration procedures concerning vaccines; the use of the coastal zones

enforcement of regulations; and the mitigation of environmental impacts.

2.1.4. Afghanistan Carpet Weaver Cluster

Primary issues faced by this cluster was, direct access to markets and better price realization. Since Afghanistan

is a land-locked nation all shipments were routed through the Karachi port in Pakistan. The afghan traders

were received USD 90 per sq. meter from the Pakistan based traders. The latter would then re-brand and

export it at USD 160 per sq. meter with minimal value addition to USA and Germany.

To collectively mitigate the above challenges, the carpet weavers formed 3 SPVs/consortia, (i) Kabul Carpet

Consortia of Afghanistan (KCCA),(ii) Aqcha Carpet Consortia of Afghanistan (ACCA), (iii) Northern Afghan

4 ibid


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Carpet Consortia (NACC). These 3 SPV’s jointly set up a dyeing and finishing facility. The project cost was

financed through equity contribution from members and debt finance by banks.

These 3 consortia were established after brainstorming sessions & negotiations on composition of consortia,

constitution of consortia , methodology of working, democracy of decision making process, rules of operations,

order sharing format, investment structure, staffing manager issues, listing of activities etc. An independent

manager (a champion) was appointed by all 3 consortia to essentially manage the marketing, branding and,

pricing and production aspects.

Joint international marketing/Distribution channel. To bypass the traditional land routes through

Pakistan, the consortia decided to explore an air route from Kabul to Hanover for “Domotex 2006”, one of largest carpet weaver delegation in Germany. As a result, the consortia could exhibit and sell their carpets at

USD 150 per sq. meter directly to importers in Germany under their own. The consortia continue to jointly

participate in such exhibitions in other countries and promote their products that are transported via air. They

sell carpets online and have common warehouses and showrooms in USA, Germany and India. This SPV is

currently active and is working towards addressing other common issues among the consortium members, such

as technology upgradation, quality standards etc.

2.1.5. Rice Cluster, Kerala, India

The Industries Department of the Government of Kerala in India took lead in promoting proactivity in the rice

milling cluster of Kalady. 5 39 rice mill units established the Kalady Rice Millers Consortium Private limited.

With the support of the state government, the followings were identified as major common challenges:

High cost of inputs in terms of raw material price fluctuation, very high cost of procuring consumables and

spares because of low quantity requirements and high packaging costs.

Skewed demand affected utilisation of the installed capacities month on month leading to lower economies

of scale.

Inadequate value addition and realisation of potential for by-products, such as rice bran: Enterprises offer

products like bran to middlemen who in turn, invariably, sell the same to bran oil refineries in other states.

Inadequate common facilities for testing and R&D within the cluster: The charges of private laboratories

located in the region were too expensive and lead times in testing products too long.

To collectively mitigate the above challenges, the rice millers came together and formed an SPV. The total

project cost was around USD 0.96 million, of which equity contribution by cluster members was USD0.21

million, equity contribution from Government was USD 0.20 million, and bank loan was USD 0.56 million at

12% with a payback period of 7.7 years.

The cluster SPV currently runs, assists and manages production centers, research and development centers,

factories, common effluent treatment plants, exclusively for the benefit of rice mill owners. It includes scientific

and technical research of extraction of edible oil from rice bran and other agro products. Further it provides

assistance in raw material procurement, common warehousing, standardized quality control, and marketing

facilities in India and abroad. The consortium is now sustaining the interventions and is looking for further

growth by exploring innovative schemes such as bio-gas operated gen-sets. A refinery project and registration

under Geographical Indication Act for high value rice 6 are also in the pipeline. Various training programmes

including a 3-month long growth programme to promote exports, sponsored by SIDBI and implemented by the

Entrepreneurship Development Institute of India (EDI), are also under progress.

5 Kalady is situated in district Ernakulam in the State of Kerala. The initiative for development at the rice milling cluster of Kalady was started in the year 2003 by the Industries Department of the Government of Kerala. The Project is under implementation 6 The Kalady rice cluster plans to get registration of its high value rice under the Geographical Indications of Goods (Registration and Protection) Act, 1999 (GI Act) Act of the Parliament of India for protection of geographical indications in India. The GI tag ensures that none other than those registered as authorised users (or at least those residing inside the geographic territory) are allowed to use the popular product name.


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Further, this SPV operates a mutual guarantee fund to meet emergency fund requirements of members.

Members pay USD 150 per month into the fund. About 50 members, in turn, contribute to a pool of USD 7,500.

On an average, about USD 230,000 is the fund availed of per annum by different members from this financing

operation. The mutual guarantee fund can provide emergency financial assistance to members who may find it

difficult to borrow from banks.

It should be noted that the cluster was evolved autonomously. To ensure the sustainability of intervention, the

independent manager (Cluster Development Agent / Executive)7 played a critical role in coordinating the

stakeholders and developing a strong governance system among SMEs.

2.1.6. Beverage Cluster, Andhra Pradesh, India

Gaia Packaged Beverages Cluster was incorporated in 2012 as an SPV to collect, purify and distribute packaged

water and other beverages in the Guntur District of Andhra Pradesh. The cluster was formed by 676 micro and

55 small enterprises. These SMEs commonly faced challenges, such as limited market access, high production

cost, old technology and no quality packaging facility. The government supported these SMEs to form an SPV to

operate out of single-room work-space/sheds. Significant changes were required in production, processing and

packing technology to become a partner of large export-oriented firms.

The SPV prepared a loan proposal for setting up a common facility center to: (i) ensure quality packaging for

cluster products; (ii) ensure higher value-accrued to cluster firms by setting up common facility center8 and

contribute to enhanced capacity utilization; and (iii) develop the mindset of member SMEs to become more

competitive in premium-markets.

The total project cost was about USD 2.31 million, of which contribution by cluster members was about

$US0.46 million, the government contribution was about USD0.46 million and bank loan was about USD 1.39

million at 12% with a payback period of 3.75 years. Cluster turnover more than doubled from USD 48 million to

USD 119 million in a period of 3 years. Profit margin of cluster firms was increased by 100%. At least 2,000 new

employment were generated.

2.1.7. Rubber Cluster at Kottayam, Kerala, India

The Kottayam Rubber Cluster consists of about 516 enterprises from various product groups, like. footwear

(186), adhesives and rubber cements and solutions (39), latex foam (25), rubber bands, latex thread and gloves

(100), thread rubber (51), rice polishers, rubber sheets, mats, tyre flaps, etc. (77) and other molded products

(38).

A Cluster Development Co-ordination Committee (CDCC) was formed with the involvement of key stakeholders

and support institutions. CDCC identified several critical gaps on various fronts, such as high cost of production

due to sub-optimal procurement and weak linkages with financial institutions; poor physical infrastructure

(roads, overhead power cables, water supply distribution etc.) within the industrial estates; inefficient

manufacturing process (of the ‘mixing mills’ vis-à-vis the ‘press’); poor entrepreneurial initiatives and

inadequate marketing and market development efforts; and inadequate R&D base and initiatives for product

development, quality, product-mix and design of moulds for manufacture of floor coverings. Throughout this

process, the State Government took special interest in promoting supportive policy framework.

An SPV was formed to address the identified challenges. Over seventy enterprises were working together in the

form of networks within the SPV9. An independent manager was appointed to manage the cluster and played a

key role in enhancing awareness and providing capacity building training programs to the SPV members. SMEs

7 The details of role played by the Cluster Development Executive/Agent in the Cluster is provided in Appendix 3 8 It resulted in increased production output, enhanced processing capability and improved packaging quality which meant higher price

realization for cluster members. 9 Similar product group members (footwear, adhesives and rubber cements and solutions, latex foam, rubber bands, latex thread and gloves) were working in the form of networks within the SPV.


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utilized the services of private BDS providers extensively for management training and in preparation of

common project proposals.

One of the networks (NRFPMC Pvt. Ltd.) within the SPV have benefited in reducting input costs by 20-30 per

cent due to savings of about Rs. 2 million (US $46,000) from the common purchase program. The consortium

company secured a profit of Rs. 1 million (USD23,000) in the last 15 months of operation. Direct export

turnover of network members increased by about Rs.100 million (USD2,273,000) over the intervention period.

2.1.8. The Grape Cluster, Maharashtra, India10

During 1961, an industrial association named Maharashtra State Grape Growers' Association (MRDBS) was

formed by a group of 25 grape producers from across the state. The primary aim of the association was to

improve cultivation practices. Though it helped in increasing access to the domestic market, access to export

market was still an issue due to the low quality of the grapes. Against this backdrop, Mahagrapes cluster was

formed under Public-Private-Partnership route. It is owned and governed by its members (grape cooperatives)

but with considerable State Government financial support, such as subsides for the salaries of the governing

body for the first three years and consultancy services.

Mahagrapes undertook a number of activities. It received a credit line (mostly from the NCDC11 and state

government) to build pre-cooling and cold storage facilities for each cooperative. Additionally, it supported

marketing of all grapes under one brand name to establish an international reputation for the produce and

improve forward and backward linkages of the value chain. The most important contributions by Mahagrapes

were (i) creating knowledge base and (ii) facilitating the implementation and application of new knowledge.

Mahagrapes helped to overcome the information barrier on GLOBALGAP quality requirements by

disseminating it free of cost to its member farmers. It continually updated lists of pesticides and fertilizers that

were approved or banned by the standards and distributed them to farmers in a yearly handbook. Through

workshops and field demonstrations, farmers and grape handlers/sorters were informed about the latest

methods.

Mahagrapes also helped farmers in the implementation and application of this new knowledge. It provides

materials, such as imported packaging materials that comply with international norms. It purchases inputs,

such as bio-fertilizers in bulk to help producers economically meet GLOBALGAP requirements. In all these

ways, the collective action facilitated by Mahagrapes enabled grape producers in Maharashtra to overcome the

challenges for export.

As a result, the performance of the cluster was improved. In 2013, it was observed that Mahagrapes members

had more income (USD 20,500 per member per annum) than independent farmers (USD 18,500 per annum).

Further the productivity of grapes per member was over 10% higher than the individual farmers outside

Mahagrapes. Productivity and export increased by over 10%. In the early years of exports, consignment

rejection at times was as high as 80%. At present the Mahagrapes claims a negligible rate of rejection (less than

1% after 2001 from 10% in 1995).

10 Agro-based clusters in developing countries: staying competitive in a globalized economy, FAO report 11 National Cooperative Development Corporation (India)


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2.2. Lessons Learned

2.2.1. Types of Clusters

The international precedence can be categorized into the following two types depending on its scope. The

categorization helps to address not only why the clusters were formed in the first place but also how they

overcame / sought to address the underlying issues.

One way is to develop product-based clusters encompassing the entire value chain. By forming a cluster,

actors within the value chain can be more focused in improving product quality, developing and sharing

information on best practices, product needs and technology development will more efficiently flow from the

exporters/processors to growers, thereby increasing the market competitiveness of the product. The Chilean

Salmon cluster showed how successfully it strengthened its competitiveness by setting up quality standards

and norms. Further, the product cluster can set up multipurpose common processing facilities where the latest

technologies are adopted on a cost sharing basis (preferably on a PPP mode) as seen in the example of the rice

cluster of Kalady in Kerala, India, where the cluster has built a multipurpose facility for testing and R&D

of various variants of rice based products. The Grape Cluster, Maharashtra, India also (i) supported

improving product quality to meet the requirements of GLOBALGAP, which is necessary for export to EU

countries, through providing technical assistance to farmers on cultivation method, strengthening backward

linkage with research institutions to develop grape plants, and (ii) facilitated farmers in the cluster to obtain

certification as a group. The formation of this type of cluster can be led by an industry association or

government. For example, to address the primary issue for the fruits sector in Sri Lanka to comply with

“International Quality Standards”, product-based clusters could be formed under a strong leadership of the

relevant industry association such as Lanka Fruit & Vegetables Producers, Processors and Exporters

Association.

Another way is to develop issue-based clusters that are intended to address core business issues for export

growth. Issues may include non/lower-availability of cold chain facilities, transportation & logistics costs in the

outbound value chain due to inherent/traditional channels adopted. Afghan dry fruits & nuts consortia

sets up a brilliant example as to how cluster members could avail air transport (through cost sharing)

eliminating various middlemen in Pakistan. The Andhra Pradesh beverage cluster is another example of

the issue-based cluster. SMEs were unable to penetrate both domestic and international market due to lack of

desired standards, technology, financing and competition with already established brands of large players. The

common working facility was established by SPV for SMEs to improve capacity utilization and ensure quality

packaging. The common issues brought SMEs together to form an issue-based SPV with support from state

government. To structure an effective cluster, cluster member SMEs need to proactively study the cost incurred

in various stages of product value chains and mutually agree to select the convenient solution with a strong

support from the government.

It should be noted that these two types are not mutually exclusive and sometimes a product-based cluster

transforms to issue-based cluster as its scope is expanded. In the Sri Lankan Context, where the SPV model had

limited success and is yet to be proven, it is suggested that the issue-based clusters should be explored initially

to kick start the SPV concept and then gradually explore product-based clusters to expand the scope of the SPV.

2.2.2. Success factors for cluster financing

Based on the international precedence above, the key success factors for SPV formation in the Sri Lankan

context are described below.

a. Government support. The involvement of the Government in soft and hard interventions for cluster

development is crucial. The soft interventions could be capacity building of cluster actors, exploring

new markets, improving infrastructure product diversification and developing institutional linkages,

etc. In terms of hard interventions, government can partly invest in setting up common facility centers,

processing facilities, mini tool rooms, design centers, testing facilities, training centers, R&D centers,

common raw material bank /sales depot, etc.


PwC DC02 12

Government institutions should catalyze trust building among cluster members, provide adequate

support in establishing strong market linkages, etc. As captured in the Mahagrapes cluster, state

government proactively supported the Mahagrapes members to develop backward linkages with

scientists from NRC grapes, government officials, consultants, private input dealers, private nurseries

etc. and forward linkages with private traders and private companies like Mahindra etc. Institutional

support should also be extended to banks and other financial institutions such that clusters formed are

financed through development of a cluster-based loan, establish a credit guarantee scheme and other

innovative financing products.

b. Selection of Cluster Members. It has been observed that the success factor for any SPV depends on

the similarity in mindset of the cluster members which results in benevolent decision making and

management of the cluster. Thus, similar minded cluster members take proactive measures to address

various gaps which are hindering the performance of the value chain. To form a sustainable SPV, some

of the key measures that needs to be undertaken are identifying potential cluster members through soft

interventions like workshops, organizing regular meetings with potential cluster members, finding a

common solution for the issues to be addressed through cluster formation, and undertaking a feasibility

study and drafting a business plan with detailed financial outlays.

c. Independent Professional Manager. The independent professional manager (champion

promoter) plays a critical role in ensuring long term sustainability of the SPV formed as seen in the

rice cluster of Kalady in Kerala, India. The major role played by them are (i) assisting firms in

identifying common objectives and partners, (ii) guiding firms in the cluster formation process, (iii)

giving advice on various tasks/choices (i.e. legal form; funding; business plan, etc.), (iv) establishing

links with support institutions, (v) supporting the recruitment of personnel for the cluster’s SPV, (vi)

resolving conflicts amongst cluster’s SPV members, and (vii) accompanying cluster’s SPV members in their first collective activities.


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3. Gap Analysis for Cluster Finance in Sri Lankan Market

As explained in the last section, there are several successful factors for cluster financing. This section analyzes

the gap in Sri Lankan Markets to accomplish these successful factors. The following gaps will be addressed

when the team will support structuring cluster financing for a selected SME clusters.

3.1. SMEs’ capacity to structure cluster financing

During the in-depth discussions with existing inactive SME-SPVs, such as the ones developed under the GIZ-

funded project, it was observed that SMEs were not competent enough to prepare bankable loan proposals due

to their lack of technical and financial capacity. Additionally it was also found that SME’s had issues related to trust and transparency. Most SMEs lacked the motivation to form an SPV because they presumed that their

trade secrets would be revealed once they partake in SPV formation. Thus a need for a strong and independent

leader (Cluster Development Executive/Agent) with technical & managerial capabilities is necessary to drive an

SPV forward and ensure its sustainability. The independent professional manager would play a key role in

developing trust & transparency amongst the cluster members.

Further, various fruits & vegetable, food & beverage associations and rubber product based enterprises have

expressed their interest in forming/reviving the cluster/SPV, if the following handholding services are provided

for at least 8-12 months:

Operations Management: procurement planning, transport & logistics planning, scale and scope

economics (fixed asset efficiency)

Financial Management & Planning: Preparing investment plan, loan proposals to access finance

Export & Marketing Strategy: Preparing a branding plan, pricing plan, market expansion strategy,

mapping export market in terms of potential and quality standard requirements,

Human Resource Strategy: Drafting organizational structure, preparing schedule of powers,

recruitment planning

3.2. Leadership role of industrial associations

Industrial associations can play a leadership role in making consensus among SMEs to form an SPV. In Sri

Lanka, there are various associations in all the four target sectors under the ADB’s TA (Fruits & Vegetables,

Food and Beverages, Rubber and ICT/BPO). The major focus of these associations is to diagnose business and

technical issues in the value chain through training, facilitating advocacy campaign to the Government, market

development, export promotion etc. However, most associations are not proactive in encouraging SMEs to

move up the value chain by forming a cluster or an SPV. This is because these associations are represented by a

diverse set of members, representing firms of different sizes, distinct products and different levels of maturity,

and they find it difficult to build a consensus among these different association members on several key aspects

such as investments to be made, facilities to be built etc. In addition, some industry associations are not well

informed about the merits of cluster-based financing.

3.3. Bank’s expertise in non-collateralized lending

Some active Sri Lankan SME clusters in areas of food processing, fruits and vegetables and rubber could enable

member firms to seek finance together under an SPV, and they can provide collective guarantees or even set up

their own financial body. The threat of expulsion from the cluster SPV ensures that obligations are followed.

However, since a new SPV/Cluster will not have credit history and may not have physical collateral to show in

the beginning, and the concept of cluster is new in Sri Lanka, the lending agencies may get extra cautious when

it comes to cluster-based lending.


PwC DC02 14

Non-collateralized lending. To structure cluster-based loans to SMEs at affordable rates, financial

institutions in Sri Lanka should have expertise in non-collateralized lending to properly assess the credit risk of

a borrowing cluster as observed in middle-income Asian countries. In fact, several financial institutions in India

have an institutional mechanism to promote cluster-based lending. The Small Industries Development Bank of

India (SIDBI) tried to improve the flow of credit to SMEs by using the cluster approach. SIDBI also initiated the

establishment of small enterprise financial centres in selected clusters. Similarly, ICICI Bank of India divides

SME clients into three groups, namely (i) corporate-linked businesses, (ii) the cluster-banking group and (iii)

business-banking group. This kind of segmentation of SME clients into clusters may also help banks to address

challenges such as risk management and knowledge development. Some Sri Lankan banks are recommended to

follow this Indian precedence in the long-term.

Risk mitigation measures. Also, some risk mitigation measure should be introduced to structure non-

collateralized lending practice. For example, Government of India and Small Industries Development Bank of

India (SIDBI), established a Trust named Credit Guarantee Fund Trust for Micro and Small Enterprises

(CGTMSE) to implement the credit guarantee scheme for SMEs. ADB is currently working with the Sri Lankan

Government to establish an SME credit guarantee institution with a size of $100 million as in the recent Budget

Speech. During the TA implementation to structure cluster-based loans, the effective use of the new credit

guarantee scheme should be explored. Also, the effective use of government loan schemes could improve

bankability of the SME cluster project. A $100 million ADB’s credit line to SMEs through 10 participating banks

was launched in 2016, and the banks can utilize this credit line for structuring cluster-based loans.

3.4. Government support

The Industrial Development Board, could be one of the key stakeholders to anchor the formation of clusters and

revive the inactive SPVs in rubber and food processing sectors. The other key stakeholders could be the Export

Development Board, Board of Investment, Ministry of Industries, Urban Development Authority and private

sector. The Ministry of Finance can request financial institutions to implement the ‘cluster’ approach to SME lending. The government can request banks to establish specialized SME branches in identified clusters to

enable enterprises to have easy access to finance.


PwC DC02 15

4. Next steps

Stakeholder consultation. During the meetings with various fruits & vegetable and food and beverage

associations and the rubber product-based enterprises, some SMEs have expressed their interest in

forming/reviving the cluster/SPV, if they are provided with market assistance and business development

services on a continuous basis (for at least 6-8 months). Also, many SMEs wanted to understand how a business

model of the SPV will be developed and what kind of innovative financing products will be used for an SPV.

They also wanted to clearly understand how cash flow projections could be developed for an SPV; how the SPV

structure will operate (i.e. management structure); and how to retain individual competitive edge despite being

part of an SPV (for e.g. they were keen to understand how sharing of crucial financial information with other

SPV members affect firm competitiveness). Financial institutions, industry experts, EDB and other key

stakeholders confirmed that the cluster finance model is prevalent, at either micro or large corporate level, in

Sri Lanka.

Shortlisting. As a next step, it is critical for the team to short list best potential SME clusters (either in a

cooperative form, farmer producer organization or SPV form or any other collaboration). As a preliminary

exercise, the team held workshops with EDB for SMEs in food and rubber sectors in March 2o17. As captured

earlier in the Chapter 1, there are already existing clusters at micro/farmer level in the fruits & vegetables sector

and medium enterprises in the rubber product sector. Further, the various food associations and an inactive

rubber SPV have expressed their interest in restructuring into clusters or active SPVs.

Multiple workshops and group meetings are under progress to shortlistthe best potential clusters for financing.

Based on the discussion in the workshops and group meetings, the team will apply key filters to shortlist the

best potential cluster as per lessons learned from the international precedence (section 2.2.2.).

These filters shall include (but not limited to) –

Stage of cluster development

Strong Leadership

Geographic Spread, Size and density of cluster

Linkages with large corporates/exporters (in case of cooperatives and small enterprises)

Existing/potential markets or product demand

Distribution of cluster units

Technical and financial capacity

Size and scale of activity reflected by turnover and Profitability

Documentation level - audited balance sheets, incorporation certificates, existing orders etc.

Manpower availability

Competition

Government Support

Sustainability factor

Banks/Financial institutions interest in financing

Access to R&D, technology etc.

Loan Proposal. After shortlisting, the loan proposal shall be prepared in consultation with all key

stakeholders including cluster members, bank/financial institution, EDB and ADB. In parallel, the team will

identify the financial institutions’ willingness to lend to an identified cluster.


PwC DC02 16

Appendix A. - Appendices

A.1. Appendix –Lack of pure cash flow based by Banks

Through primary interactions with banks, it was observed that the credit culture in the Sri Lankan banking

industry shows that banks predicate their decisions not so much on cash flows but on physical collateral such as

land. Further, lack of proper title for the land in Sri Lanka prevents SMEs from offering them as collateral at the

time of applying for loans. Most private land records take the form of deed registrations that record

transactions. Each time a piece of land is used as collateral, a lengthy search for all deeds recorded during the

last 30 years must be undertaken to provide title to land. Records are often poor, and this results in frequent

disputes.

Further, despite the existing of legal framework for secured transactions (lending) based on moveable assets,

credit secured on movable assets is severely underutilized, in large part due to high risks and transaction costs.

Lenders when financing against movables need to account for significant default and enforcement risks. Double

collateralization of the same asset to different lenders – due to weaknesses in the movables registration system

is a common feature. The ability of debtors to impose delays through court action adversely affect the interests

of creditors. These factors combined with the transaction costs, drive up the cost of credit and constrain its

availability against movables.

Another reason for lack of cash flow or project based lending from the Bank’s side is that about 50-80% of

entrepreneurs in Sri Lanka often operate as unregistered sole proprietors/partnerships. Further, many of them

do not maintain proper books. For instance, due to the lack of proper books, banks seek high collateral

requirements for loan approval. Further, without proper legal standing, SMEs may not be able to get the

necessary certifications/approvals to access export markets, resulting in very poor SME participation in exports

(81% of exports are accounted for by less than 250 SMEs in the country)12.

At the least, the short-term lending to SMEs in Sri Lanka can improve, if the financial institutions in Sri Lanka

can consistently utilize the movable asset mechanism for SME lending and consider reputational collaterals

such as project cash flows, utility bills, enterprise rating and buyer(s)/exporter(s) endorsement etc. Although

Credit Information Bureau of Sri Lanka is working in this direction, the outcome and impact is yet to be seen.

Additionally, the culture of encouraging the SME ratings through credit rating agencies (Lanka Rating, ICRA,

Fitch etc.) should be promoted on a large scale to assist SMEs avail collateral free loans.

Domestic as well as overseas warehouses formed through cluster SPVs can guarantee warehouse receipt

financing loan on agricultural stock specifically in agriculture SME cluster. Other financial instruments, such as

leasing and factoring, can reduce risk effectively for credit institutions. But such facilities are not readily used by

the SME sector in Sri Lanka.

12 ADB report on Sri Lanka: Mobilizing Finance for Sri Lanka


PwC DC02 17

Example of Warehouse Receipt Financing in India13

In agri sector related lending for farmers, Sri Lanka is moving towards collateral free loans by initiating

domestic warehouse receipt based financing. It has been recently initiated by the Regional Development Bank

(RDB) of Sri Lanka with World Bank assistance. The pilot project started in August 2015 by building a spacious

26000 sq ft warehouse in Anuradhapura. The cost for infrastructure development of the warehouse in

Anuradhapura was $ 6.5 million. The purpose of the project was to help those farmers who are unable to show

physical collateral as security and to increase farmers’ profits by providing storage facilities for their crops at warehouses until off seasonal demand rises and creates good price by releasing them to market at the proper

time.

Currently these farmers are engaged in farming paddy, corn, maize, soya bean, green gram, black gram and

other crops. The bank is disbursing the loans to farmers considering the receipts issued by warehouse officials.

A warehouse receipt is like a Treasury bill. The face value of the receipt will be considered as the current price of

the crops. Therefore, farmers could apply for a loan up to 50% of the face value of the receipt of any time. With

success of Anuradhapura, RDB will construct three other similar warehouses in Monaragala, Mannar, and

Ampara.

During the discussions with RDB, it was suggested that the current domestic warehouse receipt financing

model could explore the possibility of moving up the value chain in future by having overseas warehouse based

financing.

13 http://www.businesstoday.in/opinion/columns/warehouse-receipt-finance-a-game-changer-in-agri-finance/story/230003.html

Post harvest, due to lack of liquidity, a farmer is compelled to sell hisproduce immediately, sometimes within days of harvest. Due to a supplyglut in the market, the farmer is not able to realise the best price for hisproduce.

So, instead of selling, the farmer deposits his produce in a WDRAaccredited warehouse, which issues him a warehouse receipt.

Farmer takes the receipt, which has all the necessary details likequality and quantity of the produce, to the bank. Bank offers creditfacility against that receipt up to 70 per cent of the value of thecollateral with the warehouse.

The farmer can use the fund for his consumption needs and inputs forthe next season.

Meanwhile, farmer keeps an eye on the price, and sells the produce,wholly or partly for a price that he thinks is right, and repays the bank.

http://www.businesstoday.in/opinion/columns/warehouse-receipt-finance-a-game-changer-in-agri-finance/story/230003.html


PwC DC02 18

A.2. Appendix –Documentary information normally

requested by lenders for SME loans

1. Duly completed loan application

2. Business Plan/Feasibility Report/Project Report/ information that includes the product, process,

market, people, cost, forecasts, modes of funding, forecasts etc. (as applicable)

3. Company/Business profile

4. Sponsors past track record/other business interests etc.

5. Copies of NIC/DL/Passport (only one) of Sponsors/Directors

6. Business Registration/ Certificate of Incorporation

7. Documents proofing permanent address of the business/individual

8. Statements of other banks (Generally for past 6 months)

9. Audited / Management accounts of the business (Audited accounts for past 3 years. Management

accounts for the current year). If audited accounts not available constructed accounts.

10. Documentary evidence for all necessary approvals (internal and external) Eg: EIA/EPL/Board

Resolutions/BOI Approvals/ etc.

11. Proof of confirmed orders, guarantees, sales agreements, contracts signed/to be signed with principles

etc.

12. Details of proposed funding with supporting documents

13. Details of security offered with supporting documents Eg: deeds/plans/right of way/land registry

extracts/street line certificates/guarantors statements/valuations etc

14. Income tax receipts/Assessment notices etc.

15. Certified copy of Articles of Association

16. Details of all borrowings/facilities from financial institutions

17. Forcasted P&L/Cashflow statements

18. Building Plans/BOQ/Engineering Drawings/Pro-forma Invoice/Valuation reports for reconditioned

items/Competitive Quotes etc for proposed project assets

19. Market information (share/competitors/delivery/pricing/growth rate/target market/entry barriers etc)

Note:

• All these information are not mandatory. Depending on the type of product/proposal requirements

may differ

• Also the requirements for a new customer may differ from an existing customer

• Depending on the customer type (proprietorship/partnership/PLC) some items may not be applicable

Source: Published information by local banks.


PwC DC02 19

A.3. Appendix – Cluster Development Agent14

Cluster Development Agents (CDAs) were recruited for the Rice Cluster and Rubber Cluster in Kerala, India.

Selection of the CDA

An officer/executive of the cluster-based SPV or the implementing agency (other than the SPV) was selected

and trained to act as the Cluster Development Agent (CDA). CDA should be selected based on their

organizational and managerial skills. The CDA’s were appointed right from the inception of the SPV and continue to deliver their services.

The CDA conducted the Diagnostic Study, prepared the Action Plan based on the former and implemented the

Plan implemented with full participation of the Cluster members, to build up the collective capacity of the units

in the Cluster to continue to carry on the promotional as well as commercial activities in the long run even after

the project comes to an end.

Role and Function of the CDA demonstrated in the Indian SME Clusters

The initial task of the CDA was identification of the cluster viability and sustainability. This was mainly done

through a detailed diagnostic study that carefully puts together the important general characteristics of the

cluster such as its dispersion, size and the resulting density, the scale of operations among the constituent units,

the nature of the cluster, the markets it caters to, and the various inputs that it requires. This diagnostic study

comprehensively assesses the existing externalities, the market prospects over the medium and long term as

well as the constraints and bottlenecks both contemporary and anticipated. Based on the findings in the

diagnostic study, a strategic plan for cluster development was prepared, and the selection of appropriate

interventions as well as the prioritization of these interventions were carried out. The followings were summary

of interventions by the CDA:

Soft Interventions

Prepare a Diagnostic Study

Trust Building among Units and Strengthening of Associational activities in the Cluster

Organizing Exposure Visit

Conduct of Training Programmes /Seminars on Capacity Building

Development of Information Bank and Common Website for Cluster

Development of Product Brochures and Information CDs for Cluster Products and Prices

Organizing Industrial Promotion Activities and Participation in Industrial Fairs

Organizing Financial Assistance/Credit Facilities

Awareness Creation and Introduction of New Technology and Technology upgradation

Development of New Products, Market tie-ups and tie ups with Technical Institutions and BDS

providers

Creation of Raw Material Bank and Spares through Collective Procurement

Hard interventions

Formation of Special Purpose Vehicle (SPV)

Preparation of Detailed Project Report (for developing facilities of the SPV) and following up on its

timely approval by concerned authorities.

Setting up of the facilities of the SPV and its testing and commissioning.

14 MSE Evaluation Study of Indian Clusters, January 2009


PwC DC02 20

This report contains information derived or obtained from a variety of sources (as indicated in the report). PwC has not verified the accuracy of this information and accepts no liability or responsibility for any error or omission. The evidence presented in this report are based on information obtained from various publicly available information and discussions held with stakeholders and industry experts, and does not necessarily reflect any views or opinions of PwC. The report is based on information collected during the period from June 2016 to January 2017. Economic conditions, political conditions, legislative factors, market factors and performance change may result in the report becoming quickly outdated and may require updating from time to time.

This report is not intended to constitute investment advice. Readers should not rely on this report in making investment decisions. PwC accepts no liability or responsibility to the contents of this report or any reliance placed on it.