Document o f The WorldBank

FOR OFFICIAL USE ONLY

Report No: 30400-IN

PROJECT APPRAISAL DOCUMENT

ON A

PROPOSED LOAN .

IN THE AMOUNT OF US$120 MILLION

TO THE

SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA (SIDBI)

WITH A GURANTEE OF THE REPUBLIC OF INDIA

FOR A

SMALL AND MEDIUM ENTERPRISE FINANCING AND DEVELOPMENT PROJECT

October 27, 2004

Finance and Private Sector Development Unit South Asia Region

This document has a restricted distribution and may be used by recipients only in the performance o f their official duties. Its contents may not otherwise be disclosed without World Bank authorization.

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CURRENCY EQUIVALENTS (Exchange Rate Effective March 9,2004)

Currency Unit - - Indian Rupees

US$ l - RS 45.3 -

FISCAL YEAR

March 3 1 - April 1 -

ADB BDS CF CGTSI CIBIL DEA DFID FIL FMR FX KFW GO1 HSBC HFCs IBRD IFC JBIC MoF NGOs NBFIs N P L S PFIs PMD PRC RBI RSF RSGC

ABBREVlATIONS AND ACRONYMS

Asian Development Bank Business Development Services Credit Facility Credit Guarantee Fund Trust for Small Industry Credit Information Bureau o f India Ltd. Department o f Economic Affairs, Ministry o f Finance, Government o f India Department for International Development, UK Financial Intermediary Loan Financial Monitoring Report Foreign Exchange German Development Cooperation Government o f India Hong Kong and Shanghai Banking Corporation Housing Finance Corporations International Bank for Reconstruction and Development International Finance Corporation Japan Bank for International Cooperation Ministry o f Finance Non Government Organizations Non-bank Financial Institutions Non-Performing Loans Participating Financial Institutions Project Management Department Project Review Committee Reserve Bank o f India k s k Sharing Facility Risk Sharing Guarantee Company

SARFAESX Securitization and Reconstruction o f Financi 1 Assets and Enfor em SECO SICA SMEs SIDBI SOE SSI TA U N D O

State Secretariat for Economic Affairs, Government o f Switzerland Sick Industrial Company Act Small and Medium Enterprises Small Industries Development Bank o f India Statement o f Expenses Small Scale Industries Technical Assistance United Nations Industrial Development Organization

nt o f Security Interest

Vice President: Praful C. Pate1 Country Director: Michael F. Carter

Sector Manager: Joseph De l Mar Pernia Task Team Leader: Pnya Basu

INDIA SMALL AND MEDIUM ENTERPRISE FINANCING AND DEVELOPMENT PROJECT

TABLE OF CONTENTS

Page

A .

B .

C .

D .

STRATEGIC CONTEXT AND RATIONAL,E ........................................................................... 5 Country and sector issues ..................................................................................................................... 5 Rationale for Bank involvement ........................................................................................................... 7 Higher level objectives to which the project contributes ...................................................................... 8

PROJECT DESCRIPTION ........................................................................................................ 8 Lending instrument ............................................................................................................................... 8 Project development objective and key indicators ............................................................................... 9 Project components ............................................................................................................................. 10 Lessons leamed and reflected in the project design ........................................................................... 14 Altematives considered and reasons for rejection .............................................................................. 15

IMPLEMENTATION .............................................................................................................. 15 Partnership arrangements (if applicable) ............................................................................................ 15 Institutional and implementation arrangements .................................................................................. 15 Monitoring and evaluation of outcomes/results ................................................................................. 17 Sustainability ...................................................................................................................................... 18 Critical risks and possible controversial aspects ................................................................................ 18 Loan conditions and covenants ........................................................................................................... 20

APPRAISAL. SUMMARY ....................................................................................................... 2 1 Economic and financial analyses ........................................................................................................ 21 Technical ............................................................................................................................................ 21 Fiduciary ............ ................................................................................................................................ 21 Social .................................................................................................................................................. 22 Environment ....................................................................................................................................... 22 Safeguard policies ............................................................................................................................... 23 Policy Exceptions and Readiness ....................................................................................................... 23

1

Annex 1: Country and Sector or Program Background .............................................................................. 25 Annex 3: Results Framework and Monitoring ........................................................................................... 34 Annex 4: Detailed Project Description ....................................................................................................... 45 Annex 5: Project Costs ............................................................................................................................... 51 Annex 6: Implementation Arrangements ................................................................ 52 Annex 7: Financial Management and Disbursement Arrangements .......................................................... 57

.................................. -

This document has a restricted distribution and may be used by recipients only in the performance of their official duties . I t s contents may not be otherwise disclosed jwithout W o r l d Bank authorization .

Annex 8: Procurement ................................................................................................................................ 62 Annex 9: Economic and Financial Analysis .............................................................................................. 65 Annex 1 1 : Project Preparation and Supervision ......................................................................................... 71 Annex 12: Documents in the Project F i le ................................................................................................. 73 Annex 13: Statement o f Loans and Credits ................................................................................................ 74 Annex 14: Country at a Glance ................................................................................................................... 79

INDIA

S M A L L AND MEDIUM ENTERPRISE F INANCING AND DEVELOPMENT PROJECT

PROJECT APPRAISAL DOCUMENT

SOUTH A S I A

SASFP

Date: October 27,2004 Country Director: Michael F. Carter Sector Director: Joseph D e l Mar Pemia

Project ID: PO86518 Lending Instrument: Financial Intermediary

Team Leader: Priya Basu Sectors: Micro and SME finance (100percent) Themes: Small and medium enterprise support

Environmental screening category: FI Safeguard screening category: SF

(PI

Loan Project Financing Data

[ ] Credit [ x ] Grant (Donor funded) [ ] Other:

For Loans/Credits/Others: Total Bank financing (US$m.): 120.00

IBRD 120.0 120.0 DFID’ 37.0 37.0 SECO 5 .O 5.0 Counterparty funding 11.4 11.4

Total: 173.4 173.4 Notes: 1. GBP 20 million; Exchange rate: GBP/$=l.85 Borrower: Small Industries Development Bank o f India (SIDBI) Responsible Agency: Small Industries Development Bank o f India (SIDBI)

ExPected closing date: June 30.2008

Does the project depart from the CAS in content or other significant respects? Ref: PAD A.3 Does the project require any exceptions from Bank policies? Re$ PAD D. 7

I s approval for any policy exception sought from the Board?

[ ]Yes [XINO

[ ]Yes [XINO

[ ]Yes [ ] N o Have these been approved by Bank management? E ]Yes [ IN0

[ ]Yes [X ] N o

[XIYes [ ] N o

Does the project include any critical r isks rated “substantial” or “high”? Re$ PAD C5 Does the project meet the Regional criteria for readiness for implementation? Re$ PAD 0 7 Project development objective: Re$ PAD B2, Technical Annex 3 The objective o f th is project i s to improve S M E access to finance (including term finance) and business development services, thereby fostering S M E growth, competitiveness and employment creation, which are key to achieving the Government o f India’s (GoI) overall objectives o f economic growth and poverty reduction. The project i s designed to achieve this objective through a multi-pronged approach that will address key bottlenecks to S M E financing and development in India, by focusing on: (a) creating a more enabling policy/regulatory and institutional framework for S M E financing by banks (the primary target group for this project), (b) helping banks gain better access to longer term financing for lending to the S M E sector, thereby facilitating capital formation and technological up-gradation (c) mitigating banks’ risks related to S M E lending and reducing transactions costs o f such lending while, at the same time, ensuring that banks enhance the quality o f their S M E loan portfolios, and (d) strengthening business development services and market linkage programs for SMEs (the secondary target group), thereby helping them to improve profitability and competitiveness, and become more creditworthy. Project description Re$ PAD B3.a, Technical Annex 4 The project has three main components:

1.

2.

3.

Credit Facility (CF)--financed through IBRD US$lOO million, counterpart b d s o f US$lO.O million-which will address term financing constraints faced by banks in their S M E lending, and hence, enable SMEs to access longer term funds needed for capital formation and technological up-gradation;

R isk Sharing Facility (RSF)-financed through IBRD US$20 million, donor/SECO funds approximating US$5.0 million- designed to immediately accelerate commercial bank financing to SMEs, through the establishment o f a commercially viable, self-sustaining R isk Sharing Guarantee Company (RSGC) that will provide partial credit risk cover to banks for their S M E lending portfolios;

Policy and Institutional Development Technical Assistance (TA) program-financed through DFID US$37 mill ion equivalent and counterpart funding o f US$1.4 million- designed to address the Zonger term developmental challenges o f policy, regulatory and institutional reforms, and capacity building o f SIDBI and commercial banks, to support efficient S M E financing and business development services.

The three project components are closely tied to achieve the overall project objectives. The proceeds o f the proposed IBRD loan would be used to finance the Credit Facility and the Risk Sharing Facility Which safeguard policies are triggered, if any? Re$ PAD D6, Technical Annex 10 Environmental Assessment (OP/BP/GP 4.01) Significant, non-standard conditions, if any, for: Re$ PAD C6 Board presentation: None Loadcredit effectiveness: None

Project Implementation Covenants:

(a) SIDBI shall maintain the Project Management Department (PMD) and the Intemal Audit Department (IAD) with adequate powers, functions, staff and resources;

(b) SIDBI shall implement the Project in accordance with the Operations Manual (OM), agreed with the Bank, and carry out Intemal Audits in accordance with the OM;

(c) SIDBI shall carry out the Project in accordance with the agreed Environment and Social (EM) Management Framework as reflected in the OM;

(d) SIDBI shall maintain a Financial Management System, carry out audits and furnish Financial Monitoring Reports in the agreed formats and periodicity;

(e) The Mid-Term Review o f the project shall be carried out in June 2006; (f) Under the CF component, SIDBI wil l make sub-loans directly to SMEs and also lend

through PFIs and will carry out appraisal, supervision and monitoring in respect o f these activities;

(g) SIDBI shall implement the RSF component provided that it secures financing for such purpose from SECO. Disbursement o f project funds for the RSF component wil l be conditional upon financing from SECO being made available for the RSF component o f the Project and the implementation arrangements being finalized;

SIDBI within 7 days o f receipt by SIDBI. (h) Funds under the RSF component will be transferred to the RSGC’s bank account by

A. STRATEGIC CONTEXT AND RATIONALE 1. Country and sector issues

The Indian economy needs to grow at around 8 percent per annum over the next decade to reduce the poverty rate to 11 percent, as targeted by the Govemment o f India's (GoI) Tenth Five Year Plan (2003). The Plan also notes that achieving and sustaining such growth and higher employment will require a sharp step up in industrial and services growth, spurred by small and medium enterprises (SMEs) - w h c h have the greatest potential to provide high-wage employment for the 70 percent o f the labor force st i l l working in agriculture. Indeed, there i s now widespread recognition within India that vibrant SMEs are potentially a key engine o f economic growth, job creation and greater prosperity.'

India has intrinsic advantages - abundant raw materials and a large and relatively low-cost labor force - that should allow it to emerge as a major hub for labor-intensive businesses, spurred by SMEs. But SMEs in India, unlike their counterparts in many developed as well as some emerging economies, have been unable to achieve the competitiveness that would allow them to drive manufacturing sector and overall economic growth, employment and poverty reduction (Annex 1).

While several factors constrain the growth and competitiveness o f Indian SMEs, key among these constraints are the problems that SMEs face in accessing adequate, timely financing on competitive terms. This has held back the establishment o f small units, their graduation to medium enterprises, and the overall growth and development o f the SME sector. (Annex 1)

While absolute amounts o f lending to the Small Scale Industries (SSI) sector has been increasing over the years, as a percentage o f net bank credit, commercial bank credit to SMEs has

Figure 1 Credit to SSls as 9'0 of net bank credit

~

declined sharply since the late 1 9 9 0 ~ . ~ 1% 1888 1887 1oQ8 1888 xoo m1 2002 2w3

(Figure 1); Furthermore, whereas Year

Indian SMEs have a strong demand for - term-financing Of years++) 1 -+-Public sector banks -4- Pvl Banks --Foreign banks +All banks 1 to meet their capital formation and , I technological up-gradation needs, which would help them grow and become competitive, bank financing currently available to SMEs is o f a shorter tenor. This i s because banks face difficulty in raising longer-term resources. At present, more than 80 percent of the total deposits of India's commercial banks have a maturity o f less than 3 years (Annex 1 and4).

The financing constraint faced by Indian SMEs i s attributable to a combination o f factors that are rooted in: (a) a legalhegulatory framework that makes recovery o f bad loans to SMEs, bankruptcy and contract enforcement difficult for creditors; (b) institutional weaknesses, such as the absence o f good credit

' Go1 successive industrial policy statements (1956, 1977, 1985 and 1991) have emphasized the role o f small business in growth, employment (particularly for the 1 mill ion or so workers transitioning out of agriculture each year) and poverty reduction. ' Successive expert committees appointed by the Go1 have voiced concerns over the financing constraint faced by small business. See, for example, the Reports of the Abid Hussain Committee on Small Enterprises (1997), SL Kapur High Level Credit Committee on SMEs (1 998), and the SP Gupta Study Group on Development of Small Enterprises (2000).

In the past, non-bank finance institutions played an important role in SME financing, but this source of financing dried up after the collapse o f the sector in 1997.

An additional problem is that, with the shrinkage o f the NBFI sector in response to policy and regulatory changes since 1997, SMEs no longer have access to finance from this source.

5

appraisal and r isk managemendmonitoring tools, that increase banks’ transactions costs in dealing with SMEs; (c) absence o f reliable credit information on SMEs, and (d) lack o f sufficient market credibility o f the SME sector. Th is has made it difficult for lenders to assess risk premiums properly, creating differences in the perceived versus real r isk profiles o f SMEs and resulting in untapped lending opportunities to SMEs. Go1 has recently initiated certain policy measures to address some o f these issues, viz., setting-up o f an SME fund o f US$ 2.3 billion, repeal o f the Sick Industrial Company Act (SICA), passage o f the Securitization and Reconstruction o f Financial Assets and Enforcement o f Security Interest (SARFAESI) Act and adoption o f the Base1 11 norms (Annex 1).

A banker’s risk perception towards SMEs i s heightened by the poor historical performance o f SME loan portfolios, particularly loans made by the public sector banks, which account for more than 90 percent o f al l lending to SMEs. While these banks have large SME portfolios, some report non-performing loans (NPLs) o f more than 15 percent o f their total SSI loan portfolio, and are hence risk averse to expanding their SSI portfolios. The other group o f banks engaged in SME lending are the newer, private sector banks. These banks view SME lending as a profitable business (they lend to SMEs in order to cross-sell fee-based products, while taking advantage o f non-interest bearing deposits from SMEs). So far, their experience with SME lending has been quite good. A few o f the new banks report NPLs lower than 2percent o f their total SME portfolio. (It i s important to note that the N P L s o f the public and new private sector banks are not directly comparable as the private sector banks have newer portfolios and losses may not yet be recognizable). However, the NPL experience o f the public sector banks with SME lending has made the newer, private sector banks cautious and risk averse to scaling-up SME lending, and they have concentrated their SME business mainly on channel-financing and cluster financing.

In recent years, the Indian authorities have taken several steps to support SME financing and development. These steps, along with the key challenges that remain, are discussed below:

First, there has been a welcomed s k i ? in focus from “SSI” to “SME”, as reflected in the GoI’s recently announced RslOO bi l l ion (US$2.3 billion) SME fund operated by the Small Industries Development Bank o f India (SIDBI), which i s the apex bank for SMEs in India. The past approach based on preferential treatment o f SSIs and targeted loans at subsidized interest rates, i s being challenged by a realization that artificial barriers to entry and regulated credit markets are not suitable for optimal size and efficiency o f SSIs. Going forward, a key challenge i s to remove any policy distortions that create perverse incentives for small business to graduate into medium-sized f irms, reaping economies of scale and contributing to growth and employment. A positive signal has been that the Finance Minister, in his latest Union Budget Speech in July 2004, has stressed that equal emphasis needs to be given to the medium-sized enterprises and to encourage migration o f SSIs to SMEs. Another recent initiative has been the setting up o f the Aqun Sengupta Commission on the unorganizedinformal sector. Second, to strengthen the framework for tackling loan defaults and contract enforcement, India has enacted the SARFAESI Act (June 2002). The Act empowers secured creditors to foreclose and enforce securities in case o f default, without intervention o f a court or tribunal, and has also created an enabling framework for asset reconshction companies and securitization in general. A new bankruptcy legislation was enacted in end-2003 and the SICA has been repealed (though not yet notified). The challenge now i s to ensure the efficient implementatiodenforcement o f these laws as they apply to SMEs. Third, recognizing that better credit information can directly increase the amount o f financing for SMEs, by reducing the r isk and costs arising from information asymmetries: Go1 has recently

’ In developed markets, the process of establishing the credit history o f borrowers through credit information bureaus has been an effective (but not infallible) tool in reducing credit risk. Through keeping track o f those with a poor repayment record, willful defaults can be meaningfully reduced.

6

supported the creation o f the Credit Information Bureau of India Limited (CIBTL) as a public-private partnership. CIBIL i s mandated to collect and disseminate credit information on individuals and firms of al l sizes, The creation o f CIBIL i s an important step but the immediate challenge for CIBIL i s to collect data, including on SMEs, and this requires information sharing between banks and CIBIL. The problem i s that most Indian banks do not have the necessary credit information on SMEs in a format that can be easily transferred to CIBIL, nor in a format that would enable banks to use t h s data for their own credit decision.6 While no individual bank or i t s client may see the benefits o f data sharing, collectively, this would reap significant benefits to both the banks and their clients. Fourth, the Reserve Bank o f India (RBI) has issued a directive requiring all banks to introduce standardized credit appraisal systems and guidelines. Wh i le the majority o f banks do have such systems in place, i t i s understood that most banks have credit scored only a small proportion o f their accounts, and these are generally corporate rather than S M E accounts. Moreover, most public sector banks require up-gradation o f credit scoring tools for S M E loans, and neither public nor private banks have the credit information required to “populate” the credit scoring models with reliable data (data sharing and cooperation among all concerned parties i s critical to getting valid credit scores). The absence o f transparent appraisal tools such as credit scores increases transactions costs in assessing S M E credit r isk at the branch level (where S M E lending decisions are taken at the public sector banks), and impedes the ability o f branch managers to identify and eliminate those borrowers most l ikely to default. The latest credit scoring tools would help branch managers better understand, appreciate, and mitigate S M E credit risk, making them more confident in lending to the sector. Fifth, efforts have also been made in recent years by SIDBI and others to improve business development services (BDS) for SMEs and enhance market linkages, which are critical to ensuring the longer-term commercial viability and hence, bankability, o f SMEs. But important challenges remain in improving the quality and expanding the outreach o f such services. In particular, public- private partnerships among BDS providers i s necessary to enable private providers to emerge and public providers to move increasingly from direct BDS provisioning to a facilitating role, thus optimizing the use of subsidies. This requires a critical number o f pilot interventions that can create models for replication across India.

Growth in productivity and a higher capital-labor ratio will require even higher growth in the S M E sector to generate sufficient employment opportunities (Annex 1).

2. Rationale for Bank involvement

Against this background, GoI, SIDBI, and a number o f commercial banks, have requested the Bank to support efforts to remove the bottlenecks that constrain S M E access to finance (including term financing), and to foster S M E development. Over the medium to longer term, this requires addressing the remaining policy and regulatory issues, institutional weaknesses and capacity constraints that have hitherto distorted bankers’ risk-return signals in S M E financing and hampered the efficient functioning o f S M E credit markets. I t also requires improving business development services for SMEs so that they become more efficient, creditworthy and “bankable”. To this end, technical assistance (TA) has been sought. Over the short-term, measures are required to kick-start bank financing, particularly term loans, to commercially viable SMEs. To this end, SIDBI has sought a loan that would be used partly to provide term financing to banks for on-lending to SMEs, partly for direct term financing by SIDBI to SMEs, and partly to capitalize a credit guarantee (risk sharing) facility to stimulate a hgher volume o f commercial bank

The public sector banks have historic data on borrowers, but i t is not in a form that would enable banks to use this data easily for their own credit decisions. Collating this data in a form that would enable banks to use this data easily for their own credit decisions and share i t with the credit bureau, represents a significant technical challenge that could well take two to three years of intensive efforts. The private sector banks typically tend to have data in electronic form but many o f these banks do not currently have the systems in place that would enable using this data in the most effective manner.

7

lending (particularly term loans) to SMEs. The combined impact o f the TA and lending support would be to demonstrate that it i s possible to scale-up lending to SMEs, without compromising on loan quality.

The Bank project catalyzes support from IFC’, the private sector (e.g., in the delivery o f business development services and SME credit rating, and from selected donors. With respect to the latter, the Project complements grant funding from DFID and SECO. As per Management guidance received during concept review and at the Quality Enhancement Review, the division o f labor between the various agencies i s based on their respective institutional mandates, comparative advantages and core competencies: the Bank will focus on key policy, regulatory and institutional reforms, drawing on i ts knowledge o f international best practices in t h s area, and will finance activities which warrant public support, including support to mitigate r isk that has been caused partly as a result o f public policy; IFC assistance will encompass activities that fall within the private sector’s role; donor funds will be used to provide assistance in their core areas o f competency, with a special focus to ensure employment generation and poverty reduction impacts. (Annexes 2 and 4).

The Project dovetails GoI’s SME fund being implemented by SIDBI. I t i s expected that the institutional support provided to SIDBI under the Bank-led Project wil l have a wider benefit by strengthening SIDBI’s capacity, where necessary, to implement the larger SMEfund and facilitate sector reforms. The Project i s therefore expected to add significant value, beyond the financial resources and technical advice that i t will bring to the table, and to leverage policy, regulatory and institutional changes far beyond what the Bank would have been able to achieve on i ts own.

3. Higher level objectives to which the project contributes

By improving SME access to finance and business development services, the higher level objective o f the Project i s to foster SME growth and employment creation, which are key to achieving the GoI’s overall objectives o f spurring economic growth and poverty reduction. The Project’s objectives are consistent with the Bank Group’s India Country Assistance Strategy (CAS) 2004.

B. PROJECT DESCRIPTION 1. Lending instrument

The lending instrument to be used i s a Financial Intermediary Loan, or “FIL” (as per the World Bank Operations Policy directive OP8.30), using IBRD funds, with SIDBI (the Borrower) as the Tier-1 financial intermediary and implementing agency, and backed by a Go1 counter-guarantee. As per OP8.30, SIDBI will assume the credit r isk and investment risk related to the loan, which will be mitigated through a well-designed r isk management strategy (Annex 4)and the final beneficiaries (SMEs) will pay market rates o f interest. While adherence to OP 8.30 i s required as a minimum condition to proceed, the value addition created through this Project wil l go beyond a typical FIL: the Project will help strengthen the policy, regulatory and institutional framework required to improve SME access to finance, while also acting as a vehicle to demonstrate, through support to banks, that i t i s possible to step-up financing to SMEs while maintaininghmproving loan quality and reducing default rates.

The BRD financial product chosen for the Project i s a Fixed Spread Loan (FSL). T h i s product carries a variable lending rate that consists o f a six-month LlBOR and a spread that i s fixed over the l i fe o f the loan. The charges for FSLs include a front end fee and a commitment fee apart from the contractual spread. At present, after factoring in the benefits o f sub-LlBOR funding cost, current loan charge waivers, the expected disbursement profile for the Project, grace period o f five years and the final loan maturity o f

A meeting o f the IFC’s Corporate Investment Committee to determine IFC’s support to this project was held on July 6, 2004. The IFC has offered to participate in the RSF to provide second-loss cover on the portfolios on a case-by-case basis.

8

15 years, the all inclusive cost for th i s product i s estimated at around LIBOR+40 basis points. Borrowers choosing FSLs have the flexibility, over the l i f e o f the loan, to: (i) change the loan currency on disbursed and un-disbursed amounts; (ii) fix the interest rate on disbursed amounts; (iii) unfix or re-fix the interest rate on disbursed amounts; (iv) cap or collar the interest rate on disbursed amounts. Borrowers also have the flexibility during Project preparation to custom tailor the FSL’s repayment terms (i.e. grace period, repayment period and amortization structure). Two alternative repayment choices are available for FSLs - i) loans with grace period and repayment maturities that are fixed at loan commitment (commitment linked); and, ii) loans with repayment schedules linked to actual disbursements (disbursement linked).

SIDBI has chosen a commitment linked, Fixed Spread Loan (FSL) for a term o f 15 years, including a five year grace period. The repayment term chosen i s level repayments. The key factors guiding SIDBI’s decision to chose th i s product include the additional flexibility that it offers, and also that it enables SIDBI to undertake a full foreign exchange swap (inclusive o f the fixed spread, which i s not the case for Variable Spread Loans) (Annexes 4 and 9).

2. Project development objective and key indicators

The objective o f this Project i s to improve S M E access to finance (including term finance) and business development services, thereby fostering S M E growth, competitiveness and employment creation. The Project i s designed to achieve this objective through a multi-pronged approach that will that will address key bottlenecks to S M E financing and development in India, by focusing on: (a) improving the policy/regulatory and institutional framework for S M E financing to create a more conducive environment for market-based financing to SMEs by banks (the primary target group for this Project); (b) helping banks gain better access to longer term financing for lending to the SMEs sector, thereby facilitating capital formation and technological up-gradation; (c) mitigating banks’ risks related to S M E lending and reducing transactions costs o f such lending while, at the same time, ensuring that banks enhance the quality o f their S M E loan portfolios; and (d) strengthening business development services and market linkage programs for SMEs (the secondary target group), thereby helping them to improve profitability and competitiveness, and become more creditworthy (Annex 3).

On successful completion o f the Project, the principal outcomes will be as follows: (i) increased lending (including term lending) to SMEs by all participating financial institution (PFIs) on market-based terms; (ii) reduced NPL ratio on the S M E loan portfolios o f PFIs; (iii) improved credit information on SMEs, organized in a format that can provide the necessary guidance to banks in making credit decisions, and can be shared easily with the credit bureau; (iv) PFIs improve credit assessment as well as risk monitoring and management techniques and practices; (v) improved profitability o f S M E business in al l PFIs; (vi) a more efficient policy framework underpinning S M E financing i s developed (through such means as facilitating the better enforcement o f NPL recovery and bankruptcy, developing a more customer friendly mortgage registration system, addressing the problem o f delayed payments, streamlining the tax and accounting framework to foster the development o f leasing finance, establishing a supportive financial environment that can offer SMEs with better access to equity financing, etc.); (vii) improved access to demand-oriented financial and non-financial business services for SMEs; (viii) SMEs record growth in investment, productivity and turnover, as well as in employment, and become more creditworthy clients (Annex 3).

Progress towards achieving the principal Project outcomes will be measured through agreed project monitoring indicators (both quantitative and qualitative), for which data will be gathered through baseline studies/surveys, updated on a regular basis (Annex 3).

9

Definition ofSMEs. The Project proposes to cover SMEs in India, defined as follows: (i) small scale enterprises (SSIs, as per Go1 definition and related service sector and business enterprises)’ and (ii) medium-sized enterprises (recently approved by Go1 as an enterprise with investment in plant and machinery up to RslOO million). SMEs across all sectors would be eligible for support under the Project,with an emphasis on supporting commercially viable businesses including manufacturing, trade, exports, service sector entities etc.

3. Project components

The Project i s designed to address the key factors constraining SME access to finance and development, in the short term and over the medium/ longer term. The Project includes the following three components, are closely tied to achieve the Project objectives:

1- I I 5d I

I) Credit facility (CF) The credit facility (CF) will primarily address the term financing constraints faced by commercial banks, and hence, enable SME clients to access longer term funds needed for capital formation and technological up-gradation. The CF will be financed through funds from IBRD (US$lOO million). SIDBI/PFIs will provide a counterparty contribution (US$lO.O million). While 60percent o f the total funds allocated to the CF will be utilized by SIDBI for on-lending to “eligible” commercial banks (Tier 2 FIs) to refinance (new) te rm lending to commercially viable SMEs, an amount o f up to 40percent o f funds allocated to the CF will be used by SIDBI for direct financing o f commercially viable SMEs. T h i s upfront agreement mitigates any potential conflicts o f interest between SIDBI’s roles as direct financier o f SMEs and re- financier o f commercial banks; moreover, all lending to SMEs under the Project will be priced at market- determined interest rates. In the event o f non-availment of re-finance by banks, at any time during the currency o f the loan, SIDBI may directly employ these funds to finance SMEs. Funds will be provided to banks/SMEs in the form o f dollar and/or rupee credit. Dollar financing will be available only for SMEs with export-based businesses. As the funds provided by IBRD will be in U S Dollars, SIDBI will manage the foreign exchange r isk in line with the institutional policy o f managing the FX risk. Hedging arrangements will be decided by SIDBI on a case-by-case basis. SIDBI will mitigate the credit risk related to this Project component through a well-designed risk management strategy (Annex 4).

A due diligence exercise conducted by the Bank in accordance with OP8.30 and OP10.02 has confirmed: (a) SIDBI’s eligibility to act as the Tier 1 FI for the Project and (b) the robustness o f SIDBI’s SME loan appraisal criteria and procedures in providing direct financing to SMEs under the CF. For i t s direct financing to SMEs, SIDBI will use SME loan appraisal criteria and procedures agreed with the Bank and detailed in the Operations Manual (OM), a draft o f which has also been shared with GoI; these criteria are robust and mitigate SIDBI’s credit risk.

Commercial banks’ eligibility to receive refinancing support under the CF will be determined through a due diligence of each interested bank for which the refinancing i s requested. .The due diligence will be conducted according to a set of criteria and procedures that have been agreed by SIDBI and IBRD (Annex 4), and based on OP 8.30 and 10.02 (detailed in the OM). SIDBI will enter into a Participation Agreement with each eligble bank, an important condition for which will be an upfront commitment by

SSIs are defined as industrial firms with investment in plant and machinery not exceeding Rs 10,000,000 (in certain cases, Rs. 50,000,000) and related service sector and business enterprises.

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the bank to an action plan covering such areas as improved credit assessment, risk management and better credit information and i t s sharing, to be supported by the TA component. Where necessary, SIDBI has agreed to adopt, as required, improved procedures for bank appraisal and SME loan appraisal, supported by the TA program (Annexes 4, 6).

Discussions are ongoing between SIDBI and KW for additional funding support under the CF component o f the Project. SIDBI may continue to pursue discussions with KfW bilaterally, through the Bilateral Cooperation Division o f the Department o f Economic Affairs (DEA), Ministry o f Finance (MoF), to finalize the related arrangements.

11) Risk Sharing Facility (RSF) The objective o f the pilot risk sharing facility (RSF) i s to immediately accelerate commercial banks’ lending to SMEs. The RSF i s designed to achieve a maximum leverage impact: the RSF i s expected to guarantee liabilities amounting to at least eight times i t s net worth by the end o f the fifth year o f i t s operation; by sharing up to Sopercent o f the credit risk (principal only) with PFIs on a pari passu basis, the RSF will leverage lending from banks to SMEs amounting to at least 16 times the net worth o f the entity. The RSF will be created by SIDBI as an off-balance sheet, Limited Liabil ity Company (the Risk Sharing Guarantee Company, or RSGC). The RSGC will be capitalized using IBRD funds (up to US$20 million)/contributions from SIDBI/other financial institutions, and funds from SECO (approximately US$5.0 mill ion equivalent)’. The IBRD/donor funds, will be passed on by SIDBI to the RSGC and w i l l serve as guarantee reserves to underwrite partial credit guarantees issued by the RSGC for commercial bank loans to SMEs. The guarantees wil l be issued on a portfolio basis, and the loan portfolios eligible for guarantees will include commercial banks’ loans to viable SMEs across sectors.

The guiding principles underpinning the structure of the RSF component have been the need to avoid moral hazard (Le. the risk that through providing the guarantee could result in a deterioration in the quality o f bank loans to SMEs) and adverse selection (the risk that banks pass on their worst loans to the RSF). The moral hazard issue has been addressed by ensuring that at all times the participating commercial banks retain 5Opercent o f the risk related to any portfolio that i s transferred to the RSGC. To address the adverse selection risk, stringent criteria have been agreed on bank and portfolio selection. Each portfolio to be transferred will undergo a rigorous risk assessment by a third party (rating agency). Portfolio selection will be based on statistical principles aimed at avoiding adverse selection; any portfolio selected for risk sharing would need to have a risk profile no worse than the average SME portfolio o f the commercial bank or that o f the segmented (by product/sector/procedure) portfolio offered by the commercial bank to the RSGC. This avoids cherry picking, while, at the same time, ensuring that banks do not selectively transfer their worst loans to the RSGC.

The owners o f the RSCC have every incentive to ensure that it i s well run so as to preserve i t s capital. To th i s end the RSGC will be operated on a commercial basis aimed at controlling costs, charging appropriate fees, and maintaining prudent treasury management. I t will be a self-sustaining entity to be run by professional managers (the RSGC Management Group, or MG), selected through a competitive process. Through i t s income sources (investment income and income on guarantee business), the RSGC will be able to cover all costs of payouts on defaults, and operating and due diligence expenses. The RSGC will manage i t s own risks through a well developed risk management strategy. The RSGC will have a reasonable equity base in terms o f i ts capital structure, sound investment policies and a lean but ‘control and audit’ focused staffing policy. To further mitigate risk, on a case by case basis, and to help

Implementation o f the RSF will be subject to availability o f matching funds from SECO and/or other donor agencies for the initial tranche. Possibility o f providing TA separately to the RSF to support operating expenses and build institutional capacity would also be explored with other donors.

lower i t s r i s k exposure, the RSGC may also enter into counter-guarantee agreements with IFC and/or other such agencies on a pre-determined fee sharing basis, for covering all r isk assumed by the entity above a threshold level (“critical default rate”). The critical default rate will be defined separately for each loan portfolio guaranteed, based on expected losses. Also the RSGC will have intemal exposure limits such that it avoids exposure to portfolios with any loan that i s greater than 25 percent o f the paid up capital o f the RSGC (Annexes 4 and 6).

Capitalization o f the RSGC will require upfront disbursement o f the IBRD/donor proceeds allocated for the RSF component, into the RSGC’s guarantee reserve account, to enable the entity to underwrite guarantee transactions). In order to ensure the RSGC’s efficiency, cost effectiveness, responsiveness to market demands, and credibility, funds must be unencumbered and transparently available to back the guarantees that it issues. These funds would be later used against executed r i s k participation agreement(s) between the RSGC and the participating commercial banks. The IBRD proceeds (if required) used to capitalize the RSGC will be drawn down by the Borrower in three to four tranches, with each tranche provided on an upfront disbursement basis, and the initial tranche amounting to about US$5 million. Subsequent draw down would be linked to performance and based on demand which o f course reflects the program’s success. Th is should help further minimize r isks and ensure that amounts disbursed reflect market demand.

The proceeds o f IBRD/donor fund contribution to the RSGC will be retained in a separate account (the entity account) that i s managed, maintained and accounted for separately from SIDBI’s own accounts, subject to strict financial control mechanisms acceptable to the Bank, including independent financial audit, and restricted to passive, conservative and adequately liquid investments. Bank policies on audits and financial reporting will be observed.

The RSF i s open to participation by all commercial banks as long as these banks meet the eligibility criteria, which would include, among other criteria, the requirement that banks have a net NF’L level o f no more than 6 percent. Over time the eligibility criteria may be changed to incorporate lessons learnt from operational experience. Commercial banks’ el igbi l i ty to participate in the RSF, and the eligibility o f the loan portfolios submitted for guarantee cover, will be determined through a due diligence o f prospective PFIs (based on OP 8.30 and 10.02). The due diligence will be conducted according to a set o f agreed criteria and procedures (detailed in the OM). The RSGC (as Guarantor) will enter into a Guarantee Framework Agreement (GFA) with eligible PFIs; transaction-specific r isk sharing agreements will be annexed to the GFA. The GFA will guide the r isk sharing transaction (Annexes 4 and 6). Reporting arrangements will enable a regular monitoring o f the use o f funds by the RSGC so as to track aspects such as the quantum o f finance being extended to different sectors/regons and also map the size and profile o f SMEs being financed using the facility. SIDBI will certify that the PFIs meet the eligibility criteria throughout the guarantee period.

III) Policy and Institutional Development Technical Assistance (TA) Component The TA component i s a cornerstone o f the proposed Project. I t will help address the medium term policy, regulatory and institutional constraints that hamper the efficiency o f the SME credit market in India. The TA will be financed through proposed grants from DFID (total o f GBP 20 million, approximating U S $37 mil l ion equivalent), and cost sharing by local counterparties benefiting from the TA (US$1.4 million). The TA will be implemented over a period o f seven years and will cover the following:

0 Strengthening the policy/legal/regulatory framework: Assistance in promoting informed and evidence based dialogue in the public domain on key policy, legal and regulatory measures that are critical to establishing a more efficient framework underpinning SME financing and development, through support to the following areas: (i) adoption o f an SME definition by GoI; (ii) effective sectoral articulation for supportive policy through enabled industry associations; (iii) efforts to

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create a supportive financial environment that can offer SMEs better access to equity financing; (iv) streamlining o f tax and accounting framework to foster the development o f leasing finance; (v) efforts to address the problem o f delayed payments; (vi) development o f standards in sub-contracting involving SMEs; (vii) improved mortgage regstration system to make it more customer hendly; and (viii) improved loan restructuring and recovery framework. Improving credit information (positive and negative information) on SMEs: (i) assistance to SIDBI and the participating commercial banks to verify and collate historic data on SMEs, which would be made available to CIBIL and also retained for use under the Project (and potentially for use by other credit bureaus approved by RBI); (ii) building the capacity o f C I B L so that it can provide S M E credit histories and develop credit scoring products; (iii) support to C I B L to enable interface between the Consumer and Commercial bureaus; (iv) developing a dedicated rating agency for SMEs as well as a framework which encourages financial institutions to make use o f ratings, and which sets standards for rating agencies; and (v) developing data requirements for access to the lending component. Building institutional capacity within the participating banks to reduce banks’ transactions costs and reduce/manage risks related to SME lending: (i) assisting SIDBI and commercial banks to implement credit scoring systems and cluster financing approaches (the assistance would extend to establishing processes for the ongoing monitoring o f credits under the scoring system); (ii) training of bankers in using past data on SMEs and in using the credit scoringlappraisal systems and broad- basing knowledge; (iii) “train-the-trainer” facilities in the use o f credit scoringlappraisal systems; (iv) delivering a targeted study to augment the current understanding o f the PFIs with respect to SME clusters - including, defining parameters for an “attractive SME” within a cluster, cluster specific risk factors, prognosis on l ikely evolution o f clusters etc.; (v) a knowledge transfer program for PFIs with respect to global best-practices in servicing the SME segments on a commercial basis through lending, deposits and fee-based services, and the introduction o f new and innovative products and delivery mechanisms, so that the PFIs can increase the scale and profitability o f their overall business in the S M E segment. Business Development Sewices(BDs) for SMEs: Ths i s designed to strengthen SME access to BDS. The approach will encompass: (i) enabling policy makers to design and implement strategies to foster BDS market development; (ii) selecting 25-30 SME clusters, and strengthening BDS within these clusters, so as to create “model” clusters that can have a strong demonstration effect; and (iii) selecting a few SME sectors with strong employment creation and poverty reduction impacts, and then focusing on all it takes to strengthen BDS within these sectors. Th is cluster and sector focused TA will include: (i) building the capacity o f existing and potential BDS providers and financial institutions (lead banks) within each o f the selected clusters and sectors to serve the SME market more effectively; (ii) facilitating networkrng between S M E business associations and other BDS providers and similar associations in other countries; (iii) developing linkage programs between large corporations and SMEs, workmg through the major SME business associations; (iv) developing high quality, affordable management training for local SMEs; (v) entrepreneurshp training programs to create new entrepreneurs; (vi) providing SMEs with better access to technology, for example, through technology transfer agentshpporting dedicated institutions to facilitate dissemination o f information on technology transfer and match-making. Institutional support to SIDBI: The TA will provide focused support to SIDBI’s Project Management Department to build up i t s capacity in the areas o f project management, implementation, and monitoring and evaluation.

Discussions are ongoing between SIDBI and GTZ for additional funding support under the’ TA component o f the Project. These discussions may continue between SIDBI and GTZ, through the Bilateral Cooperation Division o f the DEA, MoF.

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The three components o f the Project will be closely tied together. A key condition for SIDBI and commercial banks to access Project funds under the CF and RSF will be an upfront commitment to a time-bound action plan to implement capacity improvements (e.g., in S M E credit appraisal, r isk managemendmonitoring, upgrading credit information and data sharing), which will be supported by the TA component and closely monitored. These banks will be required to submit annual performance reports on progress with the TA, as a condition for further funding under the CF. Based upon the experience gained during the draw-down period, SIDBI will have the option to alter the allocation amongst the Project components. (Annex 8, Table C).

4. Lessons learned and reflected in the project design

The project design fully reflects lessons from recent analytical work” on SMEs, ongoing and completed Bank Group and donor projects, and international best practice in the S M E finance area,” and past experience with (a) refinancing operations involving credit lines, (b) credit guarantee funds capitalized through BanWdonor funds (as i s being proposed under the RSF)”, and (c) TA programs. (Annex 2). While past experience with refinancing operations funded through IBRD credit lines to financial institutions has been mixed, recent evaluation^'^ indicate the problems have stemmed mainly from weak borrower accountability and management capacity, lack o f clearly defined and transparent indicators for monitoring the financial performance of the concerned financial intermediaries as well as poor monitoring o f the overall project impact, inadequate demand from ultimate beneficiariedlack o f bankable sub- projects, and inflexibilities in project design that make it difficult to adjust design to reflect changing ground realities. These lessons have been incorporated into the design o f the proposed project, notably: (i) SIDBI has been assigned clear responsibility and accountability for project implementation and reporting; SIDBI i s strongly committed to the Project and has good management capacity, which i s being supplemented with externally recruited experts; (ii) quantifiable financial indicators have been identified upfront to monitor the performance/ progress achieved by SIDBI and the PFIs (Annex 3); (iii) a detailed firm-level base line survey has been designed to monitor the final outcomes o f the Project in terms o f providing better financial access to SMEs and fostering S M E growth and employment creation; th is survey will be updated on a regular basis to monitor Project impact on SMEs; (iv) the subsidy element o f the Project wi l l be made transparent, so it can be monitored; (v) demand aspects have been thoroughly examined and banks have confirmed a pipeline o f “bankable” S M E sub-projects that would benefit from the Project; (vi) the Project design builds in flexibility to allow for reallocation o f IBRD Project funds across the CF and RSF components. The RSF design i s modeled on international best practice. Similar credit guarantee programs have been helpful in accelerating S M E financing in countries such as China, Philippines and South Afiica, and are also an important instrument in the Bank’s climate change/energy efficiency portfolio and in the GEF’s operational programs. (Annex 2). The RSF also incorporates lessons learned from past credit guarantee facilities in India. It i s designed to maximize leverage impact and will

lo SME Development in India, World Bank, 2004 (EW-P084703-ESW); Improving Access to Finance in India, World Bank, 2004 (EW-PO8 1829-ESW); Improving India’s Investment Climate, World Bank, 2002 and India’s Investment Climate, World Bank, 2004 (forthcoming).

initiatives sponsored by Hong Kong’s SMELOAN, Wells Fargo of the US, Citigroup’s Citibusiness Initiative, Standard Bank South Africa’s Scored Lending model, and SME Finance initiatives of MiBanco Peru); SME finance initiatives sponsored by governments and IFIs (e.g., the Small Business Guarantee Finance Corporation of the Philippines, US Department of Commerce Export Finance Matchmaker Initiative, an SME initiative in Ghana, and various IFC initiatives); and best practice in credit. ’’ Similar facilities have become an important instrument for accelerating SME financing, industrial development, export development and trade facilitation, and are also an important instrument in the Bank’s climate change and energy efficiency portfolio and in the GEF’s operational programs. See, for example: Bosnia and Herzegovina Export Enterprise Facility Project, Bosnia and Herzegovina Emergency Industrial Re-start Project, Regional Trade Facilitation Project - Africa Region, Yugoslavia Export Finance Facilitation Project, China Second Energy Conservation Project, Croatia Energy Efficiency Project, Poland Krakow Energy Efficiency Project and Philippines Electric Cooperative System Loss Reduction Project. j3 See, for example, a recent paper on Evaluation o f credit lines Jacob Yaron, World Bank, 2003 (draft).

The project draws on successful SME finance initiatives launched by financial institutions from across the world (e.g.,

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be operated on a commercial basis aimed at controlling costs, charging appropriate fees, and maintaining prudent treasury management. The TA component incorporates lessons from best practice. It involves cost-sharing with beneficiaries to ensure greater ownership. A robust framework for TA supervision has been put in place.

5. Alternatives considered and reasons for rejection

The Project team considered and rejected the alternative o f trying to meet Project objectives through the TA alone, on the grounds that banks urgently require term financing to kick start SME lending over the short-term, not only because banks have difficulty accessing term fmancing, but also, the lending component provides the necessary “hook” for banks to implement the much-needed improvements in credit appraisal, r isk management and credit information (to be supported by the TA). The team also considered the alternative o f limiting the lending components to the RSF alone, but found that, in the short term, the CF would help address the te rm financing constraint faced by public sector banks, which currently account for the bulk o f SME lending, in a more efficient manner than the RSF. On the RSF design, the team recognizes that thefirst best option may have been for the commercial banks to assume the “f irst loss”, with the IFC/private counter-guarantors sharing the remaining risk. However, such a structure was not possible owing to the absence o f firm commitments from potential second loss providers. Moreover, since the RSF has been designed to initially target only the better commercial banks, i t became clear during appraisal that such banks would not find it attractive to take on the first loss, given their low N P L s at present. Finally, the team also considered the relative merits o f including equity support as a part o f the Project. While improvements in the policy framework for equity financing will be addressed through the TA, at present, investors are reluctant to provide equity finance to SMEs, owing mainly to the weak bankruptcy framework which makes it difficult for equity investors in small f m s to exit. The TA will address this over the medium term.

C. IMPLEMENTATION 1. Partnership arrangements (if applicable)

The proposed Project involves a partnership between the Bank and bilateral donors, involving parallel financing agreed through bilateral agreements between each o f the donor agencies and SIDBI. There will be no pooling o f BRD funds with donor funds.

2. Institutional and implementation arrangements

The Financial Services Division, MoF (GoI) has been designated by DEA as the nodal agency for the overall project. The Borrower and implementing agency i s SIDBI, which will be responsible for coordinating and managing the overall project (all three components). SIDBI was selected as the implementing agency because it i s the designated apex-level financial institutional responsible for S M E financing and development, and i s best positioned to act as the financial intermediary between the Bank and the various PFIs. Such a project structure i s more efficient than a structure involving individual participation agreements with each participating bank, as it helps assign clear accountability and reporting duties to one institution, ensures better coordination during implementation, and facilitates project monitoring and supervision. An additional factor guiding the choice o f SIDBI as the implementing agency i s that it has been made responsible for the GoI’s own recently announced SME Fund, which the proposed Bank Project would be dovetailing. SIDBI i s highly committed to the Project, has assigned dedicated project staff, and has extensive experience with managing donor credit lines (e.g., from KfW and JBIC) as well as donor grants funds (e.g., fi-om DFID).

To coordinate project implementation, monitoring and supervision, SIDBI has established a Project Management Department (PMD) at New Delhi. The Head o f the PMD and three staff have already been

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put in place, with one additional SIDBI staf f due to come on board shortly. Additionally, the staffing structure, including an externally recruited team, has been agreed with the Bank and included in the OM. The staffing arrangements will help in project implementation and in building up the capacity o f SIDBI s ta f f on a sustainable basis (Annex 6)

A committee comprising all the partners in the Project--(the “Project Review Committee” (PRC)-- o f which IBRD i s a key member) has been established to review and guide the Project. Th is committee will comprise representatives from the Banking Division, IBRD, DFID, SECO, and SIDBI management. While there will be a reporting line from the PMD to IBRDPRC, the P M D will also report directly to SIDBI management, which will assume ultimate responsibility and accountability for the Project.

A Policy Advisory Group i s being set-up to deliberate the case for required policy changes in light o f the policy component of the TA. The Group will comprise the Chairman and Deputy Managing .Director /Executive Director o f SIDBI, the head o f the PMD, and one Member each, from the Banking Division, Ministry o f SSI and the RBI.

IBRD project funds will flow to SIDBI, with a guarantee from GOI. SIDBI has opted for reports-based disbursement based on advances. An option will be available to SIDBI to open a new bank account with the State Bank o f India, New York to receive the initial special account deposit (if required). Funds would be received in SIDBI’s main bank account in India. IBRD/donor funds for the CF will be disbursed by SIDBI to PFIs and/or directly to the SME borrowers by SIDBI in accordance with the eligibility criteria and procedures described above, and detailed in Annexes 4, 6 and 7, and the OM.

IBRD/donor contribution funds allocated to the RSF will be disbursed upfront to SIDBI’s main bank account and transferred by SIDBI to the RSGC’s bank account (“guarantee reserve account”) within seven days o f receipt (legal covenant), to serve as guarantee reserves to be later used against executed guarantee framework agreements between the RSF and PFIs, as detailed in Annexes 4, 6 and 7. The rationale for upfkont disbursement i s as follows: (a) as with any guarantee program, the financial intermediary serving as a guarantor must have sufficient market credibility in terms o f i t s available reserves for local banks to accept i t s loan guarantees; use of project funds to support the RSF component will help build such credibility; and, (b) the guarantees will be comprised of many small individual and diverse transactions and it will be critical for the RSGC to operate in an efficient and cost effective manner, be responsive to market demands, and achieve credibility; for commercial banks to accept the guarantees o f the new facility, funds must be unencumbered and transparently available to back the guarantees. Upfkont disbursement o f the project funds into the guarantee reserve account o f the RSGC i s the most effective way in which this facility can function.

The proceeds o f IBRD/donor fund contribution to the guarantee reserve funds will be subject to strict financial control mechanisms acceptable to the Bank, including independent financial audits, and invested according to i t s investment guidelines as detailed in the OM. Given the pilot nature of this facility, the RSGC will initially (in the first year) be capitalized using US$5 mil l ion o f the IBRD funds allocated for the facility, supplemented by donor funds, to be topped up, as and when needed, in subsequent years. SECO funds are likely to f low to the RSGC via the Bank. Exact modalities are to be confirmed. IFC i s expected to separately provide assistance in terms o f second loss cover under the r isk sharing facility on an individual client basis. Subsequent draw down o f funds by SIDBI for the RSGC will be based upon demand, as reflected in the amount o f guarantees issued.

An operational review will be conducted by the PRC in the third o f year o f the operation o f the RSGC. If the RSGC MG decides against further upscaling, the amount allocated to the RSF component that has not yet been drawn down by the Borrower could (a) either be cancelled, or (b) reallocated to the CF. For the amount that has been drawn down by the Borrower but against which no guarantees have been issued, the

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amount may either be refunded to the Bank or reallocated to the CF. The amount that has already been drawn down by the Borrower, and against which guarantees have been issued and are outstanding, would remain in the guarantee reserve account until such time as the outstanding guarantees expire. For any amount remaining in the guarantee reserve account after the guarantees expire, SIDBI would have the option to reallocate the amount as deemed fit by SIDBI. It may be noted that continuation o f the RSGC would be an acceptable route only if it has performed well during the initial years o f implementation and demand for i ts guarantees are st i l l needed. T h i s would be jointly determined by GoI, SIDBI, RSGC’s MG, the Bank and other donors involved. In any event, the exit strategy will be revisited and confirmed at the end o f year 3 o f the RSGC’s implementation, based on i ts operating history (Annexes 6,7 and 8).

DFID i s proposing to fund the TA by way o f a grant, for which SIDBI shall establish a separate bank account.

Project funds will be disbursed by IBRD on the basis of: 1) quarterly financial monitoring reports (FMRs); 2) appraisal reports, in the agreed formats, at the time o f initial participation o f the PFIs; and, 3) PFIs commitment to design and implement a time-bound TA action plan (subject to availability o f TA funds from DFID). All the above will be coordinated by the PMD, and reported to SIDBI management as well as to the PRC. On the RSF component, the RSGC’s MG will provide financial reports to the PMD, which PMD will pass on to SIDBI management and the PRC. While the initial tranche for the RSF, if required, will be disbursed upfi-ont, subsequent tranches will be disbursed linked to past performance and expected future demand for guarantees (Annexes 6 and 7).

SIDBI has adequate financial management systems and procedures to generate the quarterly FMRs in the agreed formats, detailed in the O M (also see Annex 7). Procurement under the Project i s limited to the TA component. The consultancy services under this component wil l be funded by a DFID grant, and will be procured using a set o f procurement guidelines prepared by SIDBI that are modeled on DFID’s procedures, which were reviewed and found acceptable by IBRD (Annex 8).

3. Monitoring and evaluation of outcomes/results

All data for the Project’s outcome and results indicators wil l be coordinated by the PMD and reported to IBRDFRC on a regular basis, as agreed. For the CF, data on project outcomes and results will be provided to the P M D by the PFIs on a regular basis, in an agreed format; th is will also include periodic performance reports - covering both credit information on SMEs as well as progress on specific TA to commercial banks, wherever applicable. For the RSF, data on project outcomes and results will be provided to the P M D (via the RSGC’s MG) by the PFIs, in an agreed format; this will also include periodic performance reports - covering credit information on SMEs. For the TA, data on the institutional development o f C I B L and the rating agency will be provided by those agencies to PMD. Data on the performance o f the SMEs benefiting under the CF, RSF and TA will be collected both from the banks (as part o f the data reported to PMD) as well as through a baseline survey o f sample SMEs, and updated on a regular basis; PMD will be responsible for overseeing and coordinating this process. Data on the key policy reforms supported under the Project will be provided to P M D by the concerned Go1 agencies. A portion o f the TA will be set aside to strengthen SIDBI’s capacity in project monitoring and evaluation (Annex 3).

To facilitate the use o f data in assessing the Project’s effectiveness during implementation and after Project completion, P M D will regularly disseminate project monitoring and evaluation data to the IBRD/ PRC/other concerned stakeholders through reports from P M D and stakeholder workshops. SIDBI management will assume overall responsibility and accountability for project monitoring and outcomes.

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4. Sustainability

A number o f recent reforms initiated by Go1 indicate their awareness o f market-based solutions to address problems in SME financing. As discussed above, several steps have already been taken towards improving SME access to finance, by efforts to improve the policy, 1egaVregulatory and institutional framework. The measures implemented so far are unlikely to be reversed. To ensure that critical policy and institutional measures affecting SME financing and development are implemented in an efficient manner, the project design includes comprehensive TA in these areas.

5. Critical risks and possible controversial aspects

Risks Risk Mitigation Meatures iUtk Rating With Mitigation

FX, Credit and Investment Risks: FX Risk Credit risk

Investment risWRSF risks

Risks to project development objecti SECO funds that are a prerequisite for the establishment o f the RSF do not materialize.

SIDBI will enter into hedging arrangements to mitigate the FX risk. SIDBI’s credit r isk unda-the CF (i%r i t s direct 1en;ding to SMEs and also for refinancing to commercial banks) financed through IBRD and SIDBI’s own counterpart funds, will be mitigated through: SIDBI’s use of the agreed SME loan appraisal and bank eligibility/appraisal criteria and procedures. SIDBI has agreed to adopt, as required, improved appraisal procedures supported by the TA program. (Annex 4). SIDBI’s investment risk in the RSF will be mitigated through: ensuring that the RSGC i s operated on a commercial basis, with a strong focus on bank and SME loan portfolio selection for partial guarantee cover, controlling costs, charging appropriate fees, and maintaining prudent treasury management, including investments in safe securities. (Annex 4). T h e risk management function for the RSF will be dealt with through reasonable equity base in terms of its capital structure, sound investment policies and a lean but ‘control and audit’ focused staffing. To further mitigate its risk, on a case by case basis, the RSF may enter into a Counter- Guarantee Agreement with IFC or other second loss providers for covering all risk above a threshold level (“critical default rate”). The critical default rate wil l be defined for each portfolio, based on the due diligence exercise. (Annex 4) The RSF wil l have internal exposure limits such that i t avoids ewosure to

M

M

M

portfolios with any loan that i s greater than 25percent of the paidup capital of the RSF. (Annex 4).

There i s a very strong likelihood that SECO funds will be made available for the RSF component. However, in the unlikely event these funds do not materialize, the funds allocated towards the RSF would be either reallocated to the CF or the RSF component cancelled. I t may be noted that in the event the RSF component does not materialize, the scope of the Project would be somewhat reduced, but the project development objectives would still be met through the other two components (CF and

M

T A \

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Risks

111

The CF and RSF could result in (a) noral hazard (the risk that through xoviding credit support the quality of lending actually deteriorates); (b) idverse selection (that the banks pass :he risk for poorer loans on to the +sk-sharing facility while keeping Jetter accounts to themselves)

Market distortion could result on account of selective access to long- term funds to some banks Policy, regulatory and institutional problems continues to create market failure problems in SME financing Risks to component results: 1) CF cower-than-expected appetite of PFIs for the credit facility

2) RSF (a) Complex Structure of the Project

may pose a significant challenge for Financial Management

(b) Lower-than-expected appetite of PFIs for RSF

3) TA (a) Policy/legal/regulatory reform

slower than expected

@) Failure of banks to provide requisite information to CIBIL

(c) Lower-than-expected take-up of TA, poor implementation o f TA

(d) BDS interventions are ineffective

Risk Mitigation Measures

The close linkage between the lending (CF and RSF) and TA components should minimize the r isk of moral hazard; a key condition for SIDBI and commercial banks to access project funds under the CF will be an upfront commitment to a time-bound action plan to implement improvements in SME credit appraisal and risk management/monitoring, and also to upgrade credit information and share the information with CIBIL; in turn, this will be supported by the TA program. Periodic progress reports on this front and on NPLs would help detect any deterioration of credit quality. The criteria for determining eligibility of banks and/or loans/portfolios would ensure that the RSF does not create opportunities for adverse selection. The TA being provided under the Project would also help participating banks to improve their portfolio quality so as to be able to meet the eligibility criteria for participation in the RSF. Pricing will have to be seen to be ‘fair’, based on rigorous risk-assessment, portfolio selection will be based on statistical principles aimed at avoiding adverse selection and PFIs would have to retain at least 50percent of the exposure at all times. The CF and RSF are open to banks that meet the transparent eligibility criteria and clear due diligence.

A well-designed TA component for improving the policy, regulatory and institutional framework.

Extensive consultations during project preparation to determine realistic amount for the credit facility, based on a carefd analysis of past and projected SME loan portfolios of the PFIs. Pricing of the SIDBI refinancing to the banks to be based on close consultations between SIDBI and the banks so as to ensure that i t i s commercially attractive.

Projects funds to RSF will flow from SIDBI’s bank account to a separate, RSGC account (guarantee reserve account) to ensure that fimds flowing to RSF are managed, maintained and accounted for separately from SIDBI’s own accounts. A detailed F M assessment of the RSGC, once i t i s established, will be undertaken prior to any fimds flowing for this component. A single comprehensive financial report, meeting requirements o f all donors, i s being agreed to under the Project. No pooling of IBRD funds with donor funds i s being envisaged. Funds flow arrangements for SECO funds will be detailed later on in consultation with the donor. Product offering and pricing of the RSF to be determined on the basis of commercial criteria and on continual feedback from potential PFIs throughout the design process Inclusive consultative dialogue will be undertaken involving all stakeholders from the outset. Suggestions for policy/regulatory/legal reform will be based on independent expert studies. A Policy Advisory Group i s being set-up to help the PMD pursue the required policy/legal/regulatory reforms. Making TA to banks conditional upon upgrading credit information systems and providing relevant information to CIBIL Periodic performance monitoring reports would help address the desigdimplementation problems to speed up TA implementation.

BDS interventions in clusters will draw upon best-practices and learning from similar work done by other institutions, such as UNIDO, that i s well

M

M

N

M

N

M

M

M

M

19

HlSliv Risk Mitigation Measures

I ~ .

Risk Ralitlg wltb Nlkigatioo

(e) SIDBI’s environmental and social safeguards (E&SS) capacity

6. Loan conditions and covenants

documented. Extensive BDS demand-supply mapping at the chosen cluster level will be undertaken to serve as an input to intervention design. An extemal consulting firm has been engaged to assess the existing EandSS systems in SIDBI and develop an ECSS framework to be implemented within SIDBI, taking into account the requirements of the WBG. A dedicated person in the PMD will work with the consultant to facilitate the development of the framework as well as coordinate its

Environmental and Social Covenants: (a) SIDBI shall carry out the Project in accordance with the agreed Environment and Social Management Framework and ensure that the environmental and social screening criteria are satisfactorily applied.

Overall risk rating

Project Implementation Covenants: (a) SIDBI shall maintain the P M D and the Internal Audit Department (IAD) with adequate powers, functions, staff and resources; (b) SIDBI shall implement the Project in accordance with the OM (draft reviewed and the final OM to be agreed upon prior to Board approval) agreed with IBRD, and except as IBRD shall otherwise agree, SIDBI shall not amend or waive any provision thereof if, in the opinion o f IBRD, such amendment or waiver may materially and adversely affect the implementation o f the Project. However routine and desired changes in OM, to incorporate changed business environment and strategy may be affected from time to time, with notification o f these changes provided to IBRDRRC as part of the quarterly reports; (c) SIDBI shall carry out the Internal Audits in accordance with the OM; (d) SIDBI shall maintain a Financial Management System (FMS), records and accounts and prepare financial statements using acceptable accounting standards so as to adequately reflect i t s operations and financial condition; (e) SIDBI shall: (i) no later than January 3 1 in each year, furnish IBRD, for i t s review and agreement, a draft annual plan o f Project activities, including a work program and proposed budget, for the next following Fiscal Year; and (ii) not later than March 3 I next following, finalize such plan based on the draft as so agreed by IBRD; (f) SIDBI shall no later than January 3 1 and July 3 1, in each year, furnish IBRD, for i ts review, detailed project monitoring reports, as agreed with IBRD; (g) SIDBI shall ensure that a base-line survey o f the Project i s completed by not later than March 31, 2005, and furnish IBRD the reports; (h) The Mid-Term Review o f the Project shall be carried out in June 2006; (i) Under the CF, SIDBI will make sub-loans directly to SMEs and also lend through PFIs and will cany out appraisal, supervision, monitoring and reporting in respect o f these activities; (i) SIDBI shall take such steps as shall be necessary to protect itself against risk o f loss resulting from changes in the rates o f exchange between the used in i t s operations, and shall assume the credit r i s k associated with lending to the PFIs and i t s direct SME financing; (k) Funds for RSF wil l be transferred to the RSGC’s Bank account by SIDBI within 7 days o f receipt by SIDBI.

M

Disbursement conditions: Disbursement to the RSF component i s contingent upon (i) financing from SECO being made available for implementing the RSF component o f the Project and agreement(s) relating thereto have been executed and made effective; (ii) the RSGC being established in a manner satisfactory to the Bank; (iii) the OM being adopted by the RSGC to the satisfaction o f the Bank, (iv) the Financing Agreement between SIDBI and the RSGC being executed; (v) the RSGC establishing a satisfactory FMS; (vi) the RSGC’s MG becoming fully functional and operational in a manner satisfactory to the Bank, and (vii) an opinion satisfactory to the Bank o f counsel acceptable to the Bank being furnished by the RSGC to the Bank setting out that the RSGC has been duly established in accordance with the applicable laws for the purposes o f implementing the RSF, the Financing Agreement

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has been duly executed on behalf o f SIDBI and the RSGC and i s legally valid and binding on the parties thereto in accordance with i ts terms, and such other matters as shall be reasonably requested by the Bank in connection therewith.

D. APPRAISAL SUMMARY 1. Economic and financial analyses

Significant economic benefit i s expected to be derived from the Project. The Project will help improve SME credit market efficiency; develop the ability o f banks to appraise and manage SME loans, thereby enhancing profitable lending to viable SMEs and reducing banks’ SME-related NPLs; and develop select SME clusters, with positive impacts on growth, development and employment creation for the benefiting SMEs. Ultimately, through i t s economy-wide demonstration effect, the Project i s l ikely to generate benefits for a much larger number o f banks and SMEs, with wider implications for growth and poverty reduction. The financial analysis, which included a financial review o f SIDBI and several commercial banks, indicated that these (potentially) PFIs met the eligibility criteria on profitability, capital adequacy, asset quality and liquidity, under OP 8.30. The reliability o f financial information reports i s high and the overall quality and independence o f banks’ and SIDBI’s management i s good. All institutions have well developed internal practices and overall performance i s in line with the requirements o f Bank lending. Being listed institutions, the banks report quarterly financial results apart from detailed annual audits. The quality o f audited statements i s good for all institutions. In terms o f financial reporting to the Project, no issues are foreseen though for some monitoring indicators, PFIs would need to develop/adapt their internal systems somewhat (Annexes 1 and 9).

2. Technical

The Project design involves addressing the SME financing and development problem from both the supply and demand sides. It tackles the short term challenge o f kick starting bank financing to SMEs Additionally, the Project addresses the longer term challenge o f improving the underlying policyh-egulatory and institutional framework (through the TA component). The approach i s comprehensive in i ts coverage. Different elements o f the multi-pronged approach o f this Project have been successfidly tested internationally in other projects to promote access to finance for SMEs. For example, the CF addresses a specific constraint faced by the banking system in improving te rm financing, drawing on experience from successful Bank Group projects. The TA for capacity building in banks and other financial intermediaries improves access to financial and non-financial services for SMEs, and such TA has been successfully provided by various projects in other countries to address the supply and demand side issues facing SME finance. The design o f the pilot RSF has been based on lessons learned from international best practice to maximize the leverage impact o f the guarantee facility while ensuring commercial viability o f the RSGC, and robust governance, management and reporting (Annex 2).

3. Fiduciary

SIDBI has an FMS which i s considered adequate to account and report for project resources and expenditures. A draft OM, which lays down in detail the financial policies and procedures for the Project and operation o f the Financial Management System, has been prepared by SIDBI and shared with IBRD and GoI. Project funds will be disbursed by IBRD on the basis o f quarterly FMRs, submitted by SIDBI. SIDBI’s FMS i s well-equipped to generate these FMRs, which will provide sufficient information to monitor the use o f funds and allow the provision o f funding on a timely basis to meet the needs o f the Project. The FMRs will incorporate financial reports in agreed formats, as detailed in the OM (also see Annex 7). There will be no pooling o f IBRD funds with donor funds.

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Audit arrangements : To meet the fiduciary requirements, the Bank will receive (i) a project audit report and (ii) an entity audit report o f SIDBI within 6 months o f the end o f the fiscal year. The Project will be audited by the Statutory Auditor appointed by the RBI for SIDBI, as long as the terms o f reference for the Statutory Auditor are found acceptable to the Bank. The RSF will also be audited by SIDBI’s Statutory Auditor. The audit reports shall serve the fiduciary requirement o f all the participating donors and the terms o f reference for audit have been drafted in consultation with the other donors. The internal audit department o f SIDBI will ensure that agreed operational, accounting, payment and procurement procedures are followed in implementation o f the Project. They will also make recommendations for improving any systemic issues, if identified.

Procurement issues relating to this Project relate only to the TA component. Th is will involve, almost entirely, the procurement o f services, with only a small procurement o f goods. Clause 1.8 o f the Bank’s Guidelines (incorporating the latest revision o f May 2004) indicates that when consulting services are to be procured for a project are not financed in whole or in part from Bank loans or grants or Trust Funds, then the borrower may adopt procurement procedures other than Bank procedures. In such cases, the Bank needs to be satisfied that a) the procedures will result in selection o f consultants with the necessary professional qualifications, b) the consultants will carry out the assignment within agreed timeframes, and c) the scope o f the services are consistent with the needs o f the project. Based on a review o f the Procurement Guidelines o f DFID the Bank’s Procurement team feels that the procedures essentially satisfy the above-mentioned requirements. Therefore, it has been agreed that SIDBI would follow procedures that are modeled on DFID’s procedures for the selection o f consultants under the TA to be exclusively provided by DFID.

4. Social

The proposed Project will not finance a pre-identified set o f sub-projects and no specific social safeguard issues have been identified at present. Sensitizing SIDBI and the PFIs on issues related to land acquisition and on methods for social screening of sub-projects (on aspects such as child labor, welfare support for workmg mothers and payment o f minimum wages) i s important. This will be achieved through training programs for the staff o f SIDBI and the commercial banks. Wherever appropriate, industry associations will be used to raise awareness on social safeguards issues. Studies as well as baseline and repeat surveys wil l be used as part o f the project monitoring and evaluation framework to monitor and assess the social impact o f the project, including on employment and poverty.

5. Environment

Since SME financing under the Project i s not limited to any specific sector, the environmental issues to be encountered are expected to be varied in nature with complexities o f such issues depending largely upon the specific sector. Generally SMEs tend to have a relatively lower level o f awareness, capacity and willingness to manage environmental concerns. Investment in pollution prevention and management i s often perceived as costly with no financial return. Banks and financial institutions involved in lending to SMEs need to understand such complexities and assess the risks. To help SIDBI and the PFIs in managing environmental r isks in financing to SMEs and to help improve environmental performance o f SMEs, a framework approach i s being adopted, encompassing: i) creating awareness and capacity within SIDBI and the PFIs on potential environmental issues related to the sub-projects and sectors; ii) development o f an environment management framework including simple screening and assessment templates to address environmental concerns in their financing operations; iii) assisting SIDBI and the PFIs in the assessment o f a few environmentally sensitive projects (to be defined in the framework to be developed). A sensitization training program (by IFC in collaboration with the Bank and project partners) was held during appraisal. Similar programs will be conducted during the project period through the TA component o f the Project. The required environmental risk management framework i s being developed by

22

SIDBI, with the help o f an external consultant, and will be included in the OM. There may be a need to build necessary capacity within SIDBI to implement the framework - this will be addressed by the Project. For both social and environmental safeguards, use o f appropriate interventions as part o f the TA to banks and to SMEs, would be used and wherever possible, involvement o f appropriate industry associations would be encouraged. Consultations have commenced with industry associations that are l ikely to be involved in the Project through the TA component.

6. Safeguard policies

Safeguard Policies Triggered by the Project Yes N o Environmental Assessment (OP/BP/GP 4.0 1) [XI [I Natural Habitats (OPBP 4.04) [I [XI * Pest Management (OP 4.09) [I [XI * Cultural Property (OPN 1 1.03, being revised as OP 4.11) [I 1x1 Involuntary Resettlement (OPBP 4.12) [I [XI Indigenous Peoples (OD 4.20, being revised as OP 4.10) [I [XI Forests (OPBP 4.36) [I 1x1 Safety o f Dams (OP/BP 4.37) [I [XI Projects in Disputed Areas (OPBP/GP 7.60)*# [I [XI Projects on International Waterways (OPBP/GP 7.50) [I [XI

* To be decided on a case-by-case basis during project implementation

The social safeguards screening category i s SF; the environmental category i s F1. Since the Project will not finance pre-identified sub-projects, no specific safeguard issues can be identified at this stage. The safeguards framework for the Project adapts the approach used by IFC for Financial Intermediary projects. The approach would include building the capacity o f SIDBI and the PFIs involved in the lending component and help establish processes to better screen sub-projects for social and environmental issues. Sample checks o f projects financed by either SIDBI or the PFIs towards the oversight function for environmental and social safeguards would be undertaken. The draft ISDS was passed on to the InfoShop on March 9,2004 (Annex 10). Once the framework documents are prepared the same would be disclosed at SIDBI's website.

7. Policy Exceptions and Readiness

Exceptions. N o exceptions are sought.

Readiness. The Project fully meets the Regional Criteria for readiness for implementation. Project concept and objectives are specific and t components have been well-defined. Project design fully reflects lessons from ongoing and completed Bank Group and donor projects and best practices in the SME finance area, worldwide. Implementation arrangements for the Project are in place. SIDBI i s highly committed to the Project. It has established a PMD, at New Delhi, to implement, monitor and supervise the Project; the P M D i s staffed with a manager and three dedicated staff with extensive experience in managing donor credit lines and grant funds. Terms of reference for additional s ta f f to be recruited to the P M D have been agreed and the selection process has commenced. Counterpart funds have been budgeted and released. Detailed arrangements for SIDBI's implementation o f the Project components have been agreed, to ensure adequate due diligence. Fiduciary arrangements for the Project are in place. On procurement, the issues relate only to the TA component and will involve, almost entirely, the procurement of services. Procurement guidelines, in l i ne with DFID guidelines, have been agreed between SIDBI and DFID, and have been reviewed and found acceptable by IBRD. The PRC for project

*# By supporting the proposed project, the Bank does not intend to prejudice the final determination of the parties' claims on disputed areas.

23

oversight has been established. The results assessment arrangements have been completed, M&E institutional obligations have been spelled out, Man& capacity i s in place within the PMD, indicators have been specified, and baseline data collection has commenced. Updated PID and ISDS have been sent to info shop and Loan Covenants drawn up.

24

Annex 1 : Country and Sector or Program Background INDIA: Small and Medium Enterprise Financing and Development Project

Introduction

The Indian economy needs to grow at around 8 percent per annum over the next decade to reduce the poverty rate to 11 percent, as targeted by the Government o f India’s (GoI) Tenth Five Year Plan (2003). The Plan also notes that achieving and sustaining such growth and higher employment will require a sharp step up in industrial and services growth, spurred by small businesses - which have the greatest potential to provide high-wage employment for the 70 percent o f the labor force s t i l l worlung in agriculture. Indeed, there i s now widespread recognition within India that vibrant small and medium enterprises (SMEs) are potentially a key engine o f economic growth, job creation and greater prosperity in India. The GoI’s successive industrial policy statement^'^ have emphasized the role that small business can play in spurring industrial and overall economic growth, providing the much-needed large-scale employment (particularly to the 1 mil l ion or so workers transitioning out o f agriculture each year), offering a method o f ensuring a more equitable distribution o f national income, and facilitating the effective mobilization of capital resources and sk i l ls which might otherwise remain unutilized.

India has intrinsic advantages - abundant raw materials and a large and relatively low-cost labor force - that should allow it to emerge as a major hub for labor-intensive businesses, spurred by SMEs. Despite this, SMEs in India, unlike their counterparts in many developed and some emerging economies, have been unable to achieve the competitiveness that would allow them to drive manufacturing sector and overall economic growth, employment and poverty reduction.

While several factors constrain the growth and competitiveness o f Indian SMEs (see Box l), key among these constraints are the problems that SMEs face in accessing adequate, timely finance on competitive terms. In recent years, the financing constraint faced by SMEs has become ever more severe, as noted by successive expert committees appointed by the GoI.” Diff iculty in financial access has held back the establishment o f small units, their graduation to medium enterprises, and the overall growth and development o f the SME sector.

The financing constraint faced by Indian SMEs

In most countries, small, young, high growth un i ts rely mainly on equity financing; as small businesses grow, there i s a natural progression from equity to debt financing, and from short-to long-term financing. However, Indian SMEs, even during their initial phase, have traditionally relied much more on debt financing - from banks and non-bank financial institutions (NBFIs) - than their counterparts elsewhere. Indian f i r m s employing less than 100 workers source more than 50 percent o f their financing from banks and other loans; the comparable f igure for Chinese f i r m s i s about 30 percent. But debt financing - from both NBFIs and banks - for Indian SMEs has dropped sharply in recent years, particularly since 1997. The shrinkage o f the NBFI sector in response to policy and regulatory changes since 1997 has meant that SMEs no longer have access to finance from this source. At the same time, bank credit to SMEs,as a proportion o f net bank credit, has also declined sharply since the late 1990s. Furthermore, while the banking system has adequate liquidity, most banks report they are unable to raise the longer term resources to match the te rm financing needs o f SMEs related to upgrading technological capabilities and skills.16 (Box 2 and Table A).

l4 Go1 Industrial policy statements issued in 1956, 1977, 1985 and 1991. l5 See, for example, the Reports of the Abid Hussain Committee on Small Enterprises (1997), S L Kapur High Level Credit Committee on SMEs (1 998), and the SP Gupta Study Group on Development o f Small Enterprises (2000). l6 The regulations of the Reserve Bank o f India preclude commercial banks from issuing bonds to raise financing.

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Box 1. Key Investment Climate Bottlenecks Facing Indian SMEs

Product market distortions. Product reservations. At present, over 700 items are reserved for exclusive production in the small-scale sector,

i.e., for these products, investment in plant and machinery in any individual unit cannot exceed R s l O million. Although larger firms can now obtain a license to produce products reserved for the small-scale sector, provided these products are manufactured for export, in practice, obtaining such licenses i s a cumbersome process. The policy o f product reservations has held back firms from achieving economies of scale and greater efficiency, by inhibiting smaller f i rms from expanding their operations in the domestic market, and then moving into exports. The recent budget proposed the de-reservation of 75 critical, labor intensive products, and if this proposal i s ratified, i t would mark a major step forward, allowing existing units and new entrants in those product areas to invest in appropriate size and technology to compete with imports in the coming years.

Tarifexemptions. At present, small-scale industry enjoys tariff exemptions that give a tax advantage to smaller Indian firms over larger Indian firms, and are intended to benefit small f i rms in competing with imports which pay the equivalent of the normal domestic excise tax o f 16 percent. However, these benefits have encouraged the survival of inefficient firms and discouraged smaller f i rms from graduating into mediudarger enterprises.

Regulatory burden Entry procedures for firms. While the “License Raj” has largely been eliminated at the center, i t still survives at

the state level, along with a pervasive “Inspector Raj”. Starting a business in India requires 10 permits compared to 6 in China, and the median time i s 90 days in India compared to 30 days in China. Complaints of delays, corruption and harassment are common. A recent World Bank survey found that managers o f SMEs in India spend 16 percent of their time dealing with bureaucracy, compared to 9 percent in China, 1 1 percent in Latin America, and 12 percent in the transitional economies o f Europe. The persistence of controls also opens the door to possibilities of corruption. The same survey found that the share o f firms making irregular payments in India i s about 90 percent, almost double that in Malaysia. To reduce the costs of investment related to delays and rent seeking, all procedures for entry of firms need to be simplified and expedited. This requires re-engineering the entire gamut o f regulatory processes, especially at the state and local levels, on the basis of clear principles o f transparency, absence of discretion, and accountability. A number of states have begun to take steps to simplify the entry procedure, and others must follow suit.

Outdated bankruptcy procedures make industrial restructuring almost impossible in India, and this i s especially a problem for SMEs, that typically have a shorter l i fe span.

Factor Market Inefficiencies Lack of access to adequate, timelyfinancing on affordable terms i s identified as one of the greatest challenges to

improving the performance and competitiveness of Indian SMEs (see main text). Inflexible labor markets. Restrictions on the hiring andfiring of workers act as another serious constraint to doing

business in India. Any registered firm wishing to retrench labor can only do so with the permission o f the state government, which i s rarely granted. The Contract Labor Act allows firms to hire contract labor only for temporary activities.

Problems in the use and transfer of land. Some 90 percent of land parcels in India are reportedly subject to disputes over ownership, which take decades to settle in court. Obsolete tenancy and rent control laws keep a large part of urban real estate off the market.

Infrastructure botuenecks Power. Problems in accessing adequate and reliable power on affordable terms i s a key constraint for Indian firms.

Not only does industry receive irregular and low quality power, but i t i s also charged tariffs much above the cost of supply. Much of this i s due to cross-subsidization of power tariffs by state govemments and widespread power theft. As a result, a large majority o f Indian firms operate their own (captive) generators. Th is switch to captive generators has further increased the cost o f power faced by industry, and reduced firm-level competitiveness. Whi le large firms can bear such costs, SMEs suffer severely. Power sector reforms are now widely accepted as fimdamental to improving industrial performance.

Transport. The absence of high-quality, reliable, door-to-door transport infrastructure and services acts as another serious constraint to the performance of the industrial sector, including SMEs.

Source: World Bank/CII Investment Climate Surveys for India (March 2002; July 2003).

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Box 2. Maturity Profile of Assets and Liabilities

Banks have traditionally been borrowing over the shorter term through deposits (savings, current, term deposits) and lending over the longer term (working capital and term loans) or investing in longer dated govemment securities. This exposes them to asset-liability maturity (ALM) mismatch. Most of the banks (though not SIDBI) are witnessing a negative asset-liability mismatch over the shorter term with liabilities exceeding assets. Th is has worked to their advantage in a declining interest rate regime as borrowing rates have been re-priced downwards enabling them to re-price assets faster (loan assets are usually linked to the Prime Lending Rate (PLR) and the maturity profile does not reflect the interest re-pricing profile) and maintain market share. The asset-liability mismatch position has also been impacted by the increasing exposure towards housing loans, which typically have a tenure o f five or more years. In addition, banks have been positioning themselves to take advantage o f the expected decline in interest rates by investing in longer-term securities.

Thus, the asset-liability mismatch maintained by the banks i s a potential source o f both liquidity and basis risk. However, considering the sufficient liquidity in the market, besides the good market image, the high credit ratings and the diversified branch network that the banks have, they believe that asset-liability mismatch i s not a cause for immediate concem as they would be able to continue raising fresh deposit, increase core deposits and renew term deposits. SIDBI has mainly longer-term sources o f funds and thus faces constraints in reducing its lending rates, given that i t i s unable to re-price its liabilities quickly.

In the scenario interest rates increase, the banks lending long term loans funded by short term liabilities are likely to get adversely affected. On a very simplistic assumption, other things remaining constant, an interest rate increase of 1 percent for a 5 year fixed loan financed by a short term liability will adversely impact the Net Economic Value by approx. 2-3 percent. ICRA opines that i t i s a good r isk management practice to keep the asset-liability mismatch to an acceptable level and a long term line o f credit to fund the long term assets will assist banks in achieving this objective.

Source: Summary extract from ICRA report; sample of six public sector banks

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Table B: SME Loans Tenures as in March 2003

PFIs e 1 year 1-3 years 3-5 years Bank o f Baroda n.a. n.a. n.a. Canara Bank 56 percent 8 percent 33 percent

5-7 years > 7 years n.a. n.a.

3 percent, Oriental Bank of Commerce Punjab National Bank State Bank o f India

Source: Information provided by PBs as reported in ICRA’s study report for the World Bank, 2004

n. a n. a n.a n. a n.a 75 percent 1 percent 3 percent 9 percent 12 percent 52 percent 8 percent 18 percent 22 percent

Also, while overall interest rates have been falling, this seems to have helped mainly the larger firms, for whom the cost o f borrowing i s now about 40 percent lower than three years ago. Competition i s forcing banks into new areas such as consumer credit and mortgage financing. Meanwhile, SMEs appear to have been bypassed by the banlung system. The limited debt financing that i s available to Indian SMEs i s o f a short maturity (less than one-year, Table B) and i s relatively costly in comparison to larger f irms. The cost o f one year loans even for the best SMEs i s around 8.5-9 percent (by way o f comparison, the interest rate on short-term government paper i s 4.7 percent - also refer Table C below for interest rates for SMEs based on a sample o f some banks, where typical interest rates could hover towards the upper l i m i t s in each bank’s case), and most SMEs face interest rates o f between 10 percent-15 percent on one year loans.

Benchmark

Table C

Small Medium

Small Industries Development Bank of India 10.0- 14 .O

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Annex 2: Major Related Projects Financed by the Bank and/or other Agencies

INDIA: Small and Medium Enterprise Financing and Development Project

Related Projects

World Bank Group SMEprojects/FILs Small Enterprises Project Country: Timor-Leste (P072654) - Three project components including a line o f credit, capacity building including BDS and market rehabilitation. Main objectives are to generate employment, accelerate economic growth and improve SME competitiveness. The last PSR rating of the project is satisfactory for both the I P and DO. Export finance project: Turkey (P082801) - Line o f credit targeted at SMEs (medium to long term credit) to facilitate private sector recovery and job creation; improve ability o f banks to provide credit to the export sector especially SMEs; PSR ratings are satisfactory for IP and DO. Micro, Small and Medium Enterprise Project: Nigeria (P083082) - (IDNIFC initiative) Help develop capacity o f financial intermediaries to lend to SMEs and help SMEs increase access to financial and non- financial services; PSR ratings are satisfactory for I P and DO. E-business for small business development project: Mexico (P068290) - Building e-business development services markets for SMEs through demand and supply interventions. PSR ratings are satisfactory for IP and DO. Export development project: Tunisia (P055814) - Promote access to export markets and increased access to finance for exporters, particularly small and medium sized firms. Facilitate the latter through an export finance guarantee arrangement and the former through a trade facilitation component. PSR ratings are satisfactory for IP and DO. Regional Trade Facilitation Project: Africa (P063683) - Improve access to financing for productive transactions and cross-border trade through promoting political r isk insurance facilities in seven A h c a n countries and providing financing for start-up operational costs. PSR ratings are satisfactory for IP and DO. Energy Efficiency Project: Croatia (P079978) - Increase the demand for and supply o f energy efficiency projects and services through: 1) creating a core developer o f energy efficiency projects to finance, develop and implement energy efficiency project; 2) provide a framework for emerging service providers to tap into new energy efficiency opportunities; 3) a partial credit guarantee facility. PSR ratings are satisfactory for I P and DO. Bosnia and Herzegovina: Export Enterprise Facility Project - (PO62936 - closed) - aims to support sustainable economic growth by facilitating and expanding viable export activity. There are three project components 1) a working capital facility, a revolving line o f credit that provides working capital loans to exporting enterprises having specific and signed export contracts, 2) a performance bond facility which allows companies to tender for major construction and supply export contracts by giving security to bond giving banks. This security i s provided by placing Intemational Development Association (IDA) funds on trust in an offshore bank account available to reimburse commercial insurance companies that will guarantee the bond givers and 3) technical assistance to strengthen the Investment Guarantee Agency (IGA) and exporters. PSR ratings are satisfactory for I P and DO. Serbia and Montenegro: Export Finance Facilitation Project (P074484) - through the creation of the Serbia and Montenegro Export Credit Agency (SMECA), the project supports import/export activities, as per the following project components: 1) the Political Risk Insurance Facility, implemented in partnership with the private sector insurance industry, to set insurance policies covering certain non-commercial r isks to be issued to foreigners with financial exposure in Serbia and Montenegro, 2) a working capital facility providing working capital to exporting enterprises, by providing loans, or guaranteeing loans provided by banks, 3) Export Performance Insurance Facility supporting contract bonds, or guarantees, such as guarantees covering tenders, advance payments, and perfonnance obligations by exporters, 4) the Credit

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Insurance Facility includes both an export, and an import credit insurance component, 5) medium term import credit insurance/guarantees permit SMECA to support the acquisition o f machinery for production of export goods, under payment terms not to exceed five years, and, 6) TA i s being provided for SMECA, to develop the resources and ski l ls necessary in the provision o f quality credit reports on the country’s enterprises and banks, and for i t s entering into partnership with international credit information corporations. PSR ratings are satisfactory for DO but Unsatisfactory for IP on account of dificulties in relationship between SMECA and MoF, Serbia on proceeds allocation and composition of Board Members. Enterprise development: Zimbabwe (P035628; closed) - The project consists o f the following: 1) a business services component, 2) a finance component containing: (a) SME finance facility; (b) S M E credit guarantee facility; (c) export finance facility; andand (d) export finance guarantee facility; and 3) an institutional development component. Rated unsatisfactory primarily due to non-availability o f funds for project implementation and adverse macro-economic conditions leading to increase in interest rates and weakening asset quality o f ultimate borrowers (SMEs). Redressal mechanisms included TA to financial intermediaries to assess credit risk and to SMEs to bolster performance. Financial Sector Development Project: India (P010563, closed) - Capital restructuring loan targeted at strengthening six commercial banks financially and institutionally, and also take concrete steps to reduce the Government’s direct involvement in the banking system through opening up the capital o f the six banks to outside shareholders. Insufficient progress on catalyzing progress in the larger banking sector, which remains largely in the public domain. PSR ratings were satisfactory for IP and unsatisfactory for DO.

IFCWmulti-donor Project Development Facilities: across regions -Training banks in appraisals, BDS for SMEs, building capacities o f industry associations, training o f trainers and linking SMEs with larger corporates. To help SMEs develop “bankable” businesses, facilitate access to finance for SMEs and assist SMEs in improving accounting, financial management, etc. Ratings of the projects listed are awaited. 0 South Asia Enterprise Development Facility (SEDF): Bangladesh, Bhutan, Nepal and North-east India 0 Africa Project Development Facility (APDF): Sub-Saharan Africa 0 China Project Development Facility (CPDF): Sichuan province. 0 Program for Eastern Indonesia SME Assistance(PENSA): East Indonesia 0 Mekong Project Development Facility(MPDF): Vietnam, Lao PDR, Cambodia 0 North Africa Enterprise Development Facility(NAED): Egypt, Morocco, Algeria 0 Pacific Enterprise Development FacilityPEDF): South Pacific regon 0 South-East Europe Enterprise Development (SEED): Bosnia and Herzegovina, Albania, FYR Macedonia

and Kosovo

Some Recent Risk sharing/credit guarantee facilities 0

0

0

China Second Energy Conservation Project (2002) Serbia and Montenegro: Export Finance Facilitation Project (2003) ADB’s SME Trade enhancement finance project: Pakistan - Project comprised a partial r isk sharing arrangement backed by ADB guarantee to help m e r the credibility o f S M E exporters. It also included a line of credit to help increase access to finance for SMEs and a TA component targeted at building the capacity o f the export-industry ’ s association. Chengdu SME Guarantee Fund (with support from DFID and SECO) 0

Lessons Learned

Some o f the key lessons learned from these projects, and incorporated into the project design, are as follows:

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Overall lessons To ensure sustainability o f project outcomes, the project design adopts a comprehensive approach covering key supply and demand side issues, as well as short te rm financing needs and longer term needs related to policy and institutional development.

Project institutional arrangements are best coordinated by a single intermediary (rather than multiple arrangements with participating financial institutions) and institutional arrangements should establish enduring capacity in the financial intermediary to monitor the project post-completion. T h i s i s being addressed by appointing SIDBI as the overall implementing agency, bringing in a professional, experts on a need basis to work with SIDBI staff in project implementation, and devoting additional TA to build SIDBI’s capacity in project implementation.

0 Clear and transparent project eligibility criteria should be established for the participating financial institutions, and this has been done.

Critical to the success o f FILS i s the need to identify quantifiable financial indicators to monitor progress achieved by each o f the participating financial institutions, and regular project monitoring through these indicators; the project includes indicators to track the performance o f PFIs’ S M E portfolios (e.g., NPLs, profitability, pricing, etc.), as well as other key financial ratios to monitor the overall performance o f the PFIs (e.g., overall NPLs, loan loss provisioning, adequacy o f equity, profitability, etc.). Project monitoring will also track the quantum o f financing extended to S M E s (how much additional financing has the project been able to leverage; size/profile of S M E s being financed by PFIs). The subsidy element o f the project will be made transparent, so it can be monitored.

0 Under no circumstances should the foreign exchange (FX) risk be passed on to ultimate borrowers (SMEs), because unless they are exporters, there i s a r i s k that FX devaluation could result in conversion o f FX loss to credit loss - eventually passed on to the participating financial institutions (and often from PFI to Government). This i s being addressed through SIDBI or the PFIs’ assuming the FX risk.

Maximum transparency in project implementation arrangements (e.g., through continuous dissemination o f project monitoring reports) will be used to ensure that the results monitoring i s incorporated into implementation adjustments on a continuous basis, and also to enhance ownership and reduce potential for capture o f decision-making and prioritization processes by elite groups.

Lessons for the RSF The RSF under the project draws from lessons on what not to do2’, as well as best practice lessons from similar facilities elsewhere that have played a useful role in mitigating banks’ short-term credit r i s k s caused by shortcomings in government policy and market failure21, and helped catalyze sizeable funding for SMEs. Based on best practices, the principles guiding the RSF design are:

2o To kick-start lending to small business, the Go1 in collaboration with SIDBI, established the Credit Guarantee Fund Trust for Small Industry (CGTSI) in June 2001. CGTSI shares risks with banks for new lending to small business. But effectiveness o f the CGFTSI i s limited by several factors: (i) the stipulation that banks can only avail the guarantee if they extend collateral free loans o f up to a maximum of Rs 2,500,000 (US%S4,000) to “small scale” units (as narrowly defined by the GoI) and in the manufacturing sector; (ii) the guarantee does not cover non-fund facilities such as letters o f credit; and (iii) the pricing o f the guarantee premium i s not risk differentiated, raising problems o f moral hazard. These lessons on what-not-to-do have been incorporated into the RSF.

21 For example: Bosnia and Herzegovina Export Enterprise Facility Project, Bosnia and Herzegovina Emergency Industrial Re-start Project, Regional Trade Facilitation Project - Africa Region, Yugoslavia Export Finance Facilitation Project,

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Capitalization o f the RSGC would require uufiont disbursement o f a portion o f the proposed IBRD loan and donor funds, allocated for the r isk sharing facility, to enable the RSGC to underwrite guarantee transactions. These funds would be later used against executed risk participation agreement(s) between the RSGC and the participating commercial banks. Upfront disbursement o f the project funds into the guarantee reserve account o f the RSGC i s the most effective way in which this program can function. As with any guarantee program, the financial intermediary serving as a guarantor must have sufficient market credibility in terms o f i t s available reserves for local banks to accept i ts loan guarantees. Use o f project funds to support a guarantee program can alleviate th i s problem. The guarantees will be comprised o f many small individual and diverse transactions. Therefore, the RSGC must be established as a financial entity entrusted to implement the program, i f it i s to be responsive to market demands, operating in an efficient and cost-effective manner. For commercial banks to accept the guarantees o f the new program, funds must be unencumbered and transparently available to back the guarantees.

Risk sharing facilities should be self-sustaining; through i t s income sources (investment income and income on guarantee business), able to cover all costs o f payouts on defaults, operating and due diligence expenses, and preserve i ts capital reserves. The entity should be operated on a commercial basis aimed at controlling costs, charging appropriate fees, and maintaining prudent treasury management.

The proceeds o f lBRD/donor fund contribution to the RSGC should be retained in a separate account (the entity account) that i s managed, maintained and accounted for separately from the Borrower’s own accounts, and subject to strict financial control mechanisms acceptable to the Bank, including independent financial audit. Bank policies on audits and financial reporting should be observed. The Bank would have a right to request audits o f the RSGC throughout the duration o f the Bank’s supervision o f the “-financed project; the guarantee fund would be subject to the Bank’s financial management guidelines throughout the duration o f the Bank’s supervision o f the project.

Stringent eligibility criteria are required to ensure that only banks that meet a set o f agreed financial and operational criteria (based on OP8.30 and 10.02) would be allowed to participate, and also to ensure the quality and viability o f the loan portfolios to be selected for partial guarantee cover.

The board and management o f the RSGC should be composed o f professionals with qualifications and experience satisfactory to the Bank; The RSGC should be managed in accordance with operational and financial policies acceptable to the Bank. The board and management o f the RSGC should exercise strong control over the use o f the funds.

The Bank should have the right to require the Borrower to repay the loan to the Bank, if the recipient breaches any o f the foregoing conditions, except for such amount o f the proceeds as i s needed to meet obligations under guarantees issued and existing prior to the Borrower receiving the Bank’s repayment notice.

The IBRD loan proceeds remaining in the guarantee account should be granted in perpetuity to the Borrower at project completion, for continuing the risk sharing program or for other SME financing activities consistent with the project’s objectives. An “Exit Strategy” should be agreed between the Bank and the Borrower, and be revised in year 3 based on the program’s operating history.

China Second Energy Conservation Project, Croatia Energy Efficiency Project, Poland Krakow Energy Efficiency Project and Philippines Electric Cooperative System Loss Reduction Project.

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TA Cost-sharing between the project and beneficiary groups will be used to ensure true ownership o f the TA component.

0 Private sector f i r m s and NGOs will be used (in preference to Government Departments) to deliver key elements o f the TA, including implementation, and monitoring and evaluation.

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Annex 3: Results Framework and Monitoring INDIA: Small and Medium Enterprise Financing and Development Project

The objective o f this project i s to improve S M E access to finance (including term finance) and business development services, thereby fostering S M E growth, competitiveness and employment creation. The project i s designed to achieve this objective through a multi-pronged approach that will address key bottlenecks to S M E financing and development in India, by focusing on: (a) enabling framework for S M E financing by banks (the primary target group for this project); (b) helping banks gain better access to longer term financing for lending to the SMEs sector, thereby facilitating capital formation and technological up- gradation (c) mitigating banks' risks related to S M E lending and reducing transactions costs of such lending while, at the same time, ensuring that banks enhance the quality of their S M E loan portfolios, and (d) strengthening business development services and market linkage programs for SMEs, thereby helping them to improve profitability and competitiveness, and

Component One: The credit facility: PFIs have better access to term financing and are able to increase longer term (3 year++) lending to SMEs for vertical expansion.

Component Two: The risk sharing facility (RSF): PFIs' lending to SMEs (including term lending) i s expanded, while ensuring low NPLs.

Outcome Indicators - Increased lending (including term lending) to SMEs by all PFIs. Reduced net NPL ratio on the S M E loan portfolios of all PFIs. Improved profitability of S M E business in all PFIs. Benefiting SMEs scale-up operations (as measured by investment in plant and machinery, turnover or employment).

-- Results Indicators for Each

Component Component One":

Increased term lending to SMEs by the PFIs on market-based interest rates.

Component Two: Increased term lending by PFIs to SMEs on commercial terms.

-__ llse of Outcome lnforniation --

YRsl-2 gauge compliance of PFls with the project requirements of putting in place the necessary technologies, systems and practices to deal with credit risk and transactions costs related to S M E lending. Make any adjustments to the project design, as necessary. YRs2-4 gauge whether PFIs manage to expand lending to SMEs while reducing NPLs and improving the profitability of their S M E business, and also gauge the behavior of benefiting SMEs against the outcome indicators. YR5 use the outcome information for for project evaluation.

-I----

llse of Results Monitoring

Component One: YRsl-2 persisting low level of lending by PFls to SMEs may signify continued risk aversion among bankers, reflecting slow progress with project implementation. Yrs2-5 results monitoring will be used to speed up project implementation. YR5 use the outcome information for project evaluation.

Component Two: YR1 persisting low level of lending by PFIs to SMEs may signify (a) continued risk aversion among bankers, reflecting slow progress with project implementation and/or design. YR2 improve project implementation and/or adjustment to project design. . YRs 3-5 results monitoring will be used to speed up project

22 Target values for maturity structure, increased lending to SMEs, NPL reduction and other key balance sheet and income statement indicators to be set on a bank-by-bank basis.

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Component Three: Policy and Institutional Development Technical Assistance: (a) Improved credit information on SMEs

@) Strengthened capacity within the PFIs to reduce banks' transactions costs, better manage risks related to SME lending and make SME financing a profitable venture

(c) Better access to capacity buildinghusiness development services for SMEs

(d) Enhanced policy/legal framework underpinning SME financing

Component Three: PFIs prepare a framework for transfer of SME credit data to CIBIL in the required format CIBIL develops a platform for interface with banks for capturing data on SMEs. A dedicated rating agency for SMEs i s established A framework which encourages financial institutions to make use of ratings i s facilitated.

PFIs introduce enhanced credit scoring techniques and practices for SME lending as agreed under the TA. PFIs introduce enhanced technologies, systems and processes for SME credit risk management. PFIs reduce net NPL ratio on their SME portfolio, and improved pr~fitability.'~

Improved access o f SMEs in selected clusters to comprehensive business development services Improved access of SMEs in selected sectors to business development services. Increased employment, output or productivity in selected SME clusters.24 Increase compliance by SMEs to environmental and social indicators

Adoption of an expanded definition o f SMEs Effective sectoral articulation for supportive policy through industry associations; Efforts to create a supportive financial environment that can offer SMEs better access to equity financing Efforts to address the problem of delayed payments Development of standards in sub- contracting involving SMEs Framework for improved mortgage registration system to make i t more

mplementation and make any tdjustments, as necessary, to project lesign. fR5 use the outcome information for br project evaluation. Component Three: Yrsl-2 slow progress with achieving my of the results indicators flags xoject design or implementation xoblems Yrs2-5 results monitoring will be used .o address the design andor implementation problems so as to speed up the implementation o f the xoject. YR5 use the outcome information for project evaluation.

23 Target values to be achieved over the l i f e o f the project to be set on a bank-by-bank basis, using key balance sheet

24 Target values will be established for each cluster separately based on an initial baseline. and income statement indicators.

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e) Strengthened institutional capacity o f SIDBI, through its Project Management Division

customer friendly 0 Improved loan restructuring and

recovery framework

Improved capacity in the areas of project management and implementations (including procurement, financial management, etc.), and the collection and analysis of relevant SME data (including data for project monitoring and project impact analysis). Increased capacity, exposure and sensitization to issues of credit scoring, new product development for SMEs, use of credit information, environmental assessment o f SME projects, etc.

project) to the SME sector will use improved credit appraisal, and risk monitoringhanagement systems and procedures, and also enhanced FM, procurement and environmental procedures.

Additional lending (beyond the

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I

i

r

0 d

P x - p

P x p

Annex 4: Detailed Project Description INDIA: Small and Medium Enterprise Financing and Development Project

The project includes three components: (i) a credit facility; (ii) a risk sharing facility; and (iii) TA for policy and institutional reform, which are closely linked. A key condition for banks to access project funds under the credit facility will be an upfront commitment to a time-bound action plan to implement improvements in areas such as S M E credit appraisal and r i s k managemedmonitoring, and also to upgrade credit information and share the information with CIBIL; in turn, this will be supported by the TA program. The credit facility to SIDBI will be financed using IBRD credit line and counterpart funds from SIDBI; the r isk sharing facility will be financed using ”/donor hnds, supported by a counter- guarantee cover to the facility from IFC and/or other institutions. The TA will be financed through grants from DFID and cost-sharing from local counterparties benefiting from the TA. Counterparty contribution, across project components, would be approximately U S $ l 1.4 mil l ion (including US$lO.O mil l ion from SIDBI towards the CF).

1. Credit Facility

The credit facility (CF) will primarily address the term financing constraints faced by commercial banks, and hence, enable SME clients to access longer-term funds needed for capital formation and technological up-gradation. The CF will be financed through funds from IBRD (US$lOO million). SIDBI/PFIs will provide a counterparty contribution (US$lO.O million). While 60 percent o f the total funds allocated to the CF will be utilized by SIDBI for on-lending to “eligible” commercial banks (Tier 2 FIs) to refinance (new) term lending to commercially viable SMEs, an amount o f up to 40 percent o f funds allocated to the CF will be used by SIDBI for direct financing of commercially viable SMEs. Th is upfront agreement mitigates any potential conflicts o f interest between SIDBI’s roles as direct financier o f SMEs and re- financier o f commercial banks; moreover, al l lending to SMEs under the project will be priced at market- determined interest rates. In the event o f non-availment o f re-finance by banks, at any time during the currency o f the loan, SIDBI may directly employ these funds to finance SMEs. Funds will be provided to banks/SMEs in the form o f a dollar and/or rupee credit. Dollar financing will be available only for SMEs with export-based businesses. As the funds provided by IBRD will be in U S Dollars, SIDBI will manage the foreign exchange risk in line with the institutional policy o f managing the FX risk. Hedging arrangements will be decided by SIDBI on a case-by-case basis. SIDBI will mitigate the credit r isk related to this project component through a well-designed r isk management strategy.

Criteria for SIDBI’s direct lending of the CF to SME: A due diligence exercise conducted by the Bank in accordance with OP8.30 and 10.02 has confirmed (a) SIDBI’s eligibility to act as the Tier 1 FI for the project; and (b) the robustness o f SIDBI’s SME loan appraisal criteria and procedures in providing direct financing to SMEs under the CF. For i ts direct financing to SMEs, SIDBI will use SME loan appraisal criteria and procedures agreed with the Bank and detailed in the Operations Manual (OM), a draft o f which has also been shared with GoI; these criteria are robust and mitigate SIDBI’s credit r isk .

Criteria for SIDBI s on-lending of the CF to commercial banks for rejinancing Commercial banks’ eligbility to receive refinancing support under the CF will be determined through a due diligence o f each interested bank for which the refinancing i s requested. The due diligence will be conducted according to a set o f criteria and procedures that have been agreed by SIDBI and IBRD (Annex 4), and based on OP 8.30 and 10.02 (detailed in the OM). SIDBI will enter into a Participation Agreement with each eligible bank, an important condition for which will be an upfront commitment by the bank to an action plan covering such areas as improved credit assessment, risk management and better credit information and i t s sharing, to be supported by the TA component. Where necessary, SIDBI has

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agreed to adopt, as required, improved procedures for bank appraisal and S M E loan appraisal supported by the TA program.

Implementation/Monitoring Reporting arrangements will enable a regular monitoring o f the use o f the CF so as to track aspects such as the quantum o f finance being extended to different sectors/regons, map the size and profile o f SMEs being financed by SIDBI and the commercial banks using the facility, and progress under the TA. SIDBI will monitor the performance o f the PFIs with respect to the eligibility criteria throughout the period for which the refinancing i s made available.

2. Risk Sharing Facility (RSF)

The objective o f the pilot risk sharing facility (RSF) i s to immediately accelerate commercial banks’ lending to SMEs. The RSF i s designed to achieve a maximum leverage impact: the entity i s expected to guarantee liabilities amounting to at least eight times i ts net worth by the end o f the fifth year o f i t s operation; by sharing up to 50 percent o f the credit r i s k (principal only) with PFIs on a pari passu basis, the RSF will leverage lending from banks to S M E s amounting to at least 16 times the net worth o f the entity. The RSGC, to be established under the RSF component, will be capitalized using IBRD funds (up to US$20 million)/contributions from SIDBI and other PFIs and funds from SECO (approximately US$5.0 mil l ion equivalent)”. The RSGC will be created by SIDBI as an off-balance sheet, Limited Liabil ity Company. The IBRD/donor funds, will be passed on by SIDBI to the RSGC and will serve as guarantee reserves to underwrite partial credit guarantees issued by the RSF for commercial bank loans to SMEs. The guarantees will be issued on a portfolio basis, and the loan portfolios eligible for guarantees will include commercial banks’ loans to viable SMEs across sectors.

The following benefits are foreseen for banks and SMEs: 0

0

0

0

Expands r isk frontier o f banks leading to growth in the SME portfolios and consequent positive impacts on employment. Freeing up of banks’ r isk capital from regulatory and internal standpoint (internal exposure limits); Lower provisioning requirements. Helps PFIs expand their fee and transaction based business with SMEs - can significantly boost fee income, that typically allows for greater margins that lending. Demonstration effect for the banlung sector.

Key design features The RSGC will be established by SIDBI as a Limited Liabil ity Company as a separate, off-balance sheet entity. The RSGC will be a self-sustaining entity that can provide considerable leverage impact. I t i s expected that the leverage (guaranteed liabilities to net worth) achieved will be around eight by the end o f year five.

The RSGC will provide partial credit guarantees, sharing up to 50 percent o f the credit r isk (principal only) on a pari passu basis, with PFIs. The r isk sharing will be undertaken on a portfolio basis. The loan portfolios eligible for RSF guarantees will include loans to SMEs (as defined in the project) across sectors, including manufacturing, trading, exports, service sector entities, etc. The RSGC could cover a variety o f loan types including workmg capital loans, factoring o f receivables, and term loans for plant and equipment investment, subject to its internal guidelines outlined below (which wi l l be updated from

27 Implementation o f the RSF will be subject to availability o f matching funds from SECO andor other donor agencies for the initial tranche. Possibility o f providing TA separately to the RSF to support operating expenses and build institutional capacity would also be explored with other donors.

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time to time depending on market conditions and performance o f the RSGC). Both retrospective and prospective loan portfolios will be eligible. Loan portfolio guaranteed would be al l Rupee denominated loans.

The RSGC will be self-sustaining; through i t s income sources (investment income and income on guarantee business), it will be able to cover all costs o f payouts on defaults, operating and due diligence expenses, and preserve i t s capital reserves. To this end, the RSGC will be operated on a commercial basis aimed at controlling costs, charging appropriate fees, and maintaining prudent treasury management.

The RSGC will charge a guarantee fee for i ts services. The level o f the guarantee fee will be a function o f the asset quality andor the spread eamed on the relevant portfolio and may therefore, vary from deal to deal. I t i s expected that the pricing will vary from a level o f 1.5-3percent o f the guaranteed liability [or 0.75-1.5 percent o f the loans outstanding. Fees will be payable on a quarterly basis and will be based on the average outstanding portfolio (and average guaranteed liability) for the quarter. In addition, a one- time, small upfront fee may be charged.

The guiding principles for the r i s k sharing will include: (i) Focus on the SME portfolios o f banks (SMEs as defined above); (ii) Emphasis on the te rm portfolio o f banks and on existing portfolios, though prospective portfolios will also be considered; (iii) The RSGC will seek to diversify i t s exposure into multiple sectors and regionsflocations (detailed exposure guidelines will be developed).

Eligibility criteria for RSF Participation in the RSF component o f the Project i s open to all commercial banks that meet the eligibility criteria. Commercial banks’ eligibility to participate in the RSF, and the eligibility o f the loan portfolios submitted for guarantee cover, will be determined through a due diligence o f prospective PFIs (based on OP 8.30 and 10.02). The due diligence will be conducted according to a set o f agreed criteria and procedures (detailed in the OM). The following criteria, to be detailed in the OM, will be used to determine commercial bank eligibility for participation in the RSF: (i) experience and interest in delivering financial services to the SME market; (ii) marketing plans and capabilities to develop new SME loans using use thts guarantee program; (iii) loan origination and administration capacities, sk i l ls and standards; (iv) overall financial standing as determined according to the Bank’s internal guidelines (OP8.30 - same benchmarks for capital adequacy and profitability as used for the CF will also apply here; and, OP10.02); and (v) asset quality on the SME portfolio (net NPL ratio o f no more than 6 percent). Once a commercial bank has been deemed eligible, a second-level filter will be used to determine whether a specific portfolio o f that commercial bank i s eligible for participation in the RSF: the portfolio selected for risk sharing would need to have a r isk profile no worse than the average SME portfolio o f the commercial bank or that of the segmented (by product/sector/procedure) portfolio offered by the commercial bank to the RSF.

Implementation The RSGC (as Guarantor) will enter into a Guarantee Framework Agreement (GFA) with eligible PFIs; transaction-specific risk sharing agreements wi l l be annexed to the GFA. The GFA will guide the r isk sharing transaction.

The availability period of the guarantee on any portfolio will be determined upfront and reflected in the GFA. I t i s expected that the period will be linked to the underlyng loan or cluster o f loans with the maximum remaining maturity period at the time o f the GFA. The RSF and the participating bank will agree on servicing procedures for performing, delinquent and defaulted assets, and on the selection criteria for the portfolio.

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Risk management of RSF The risk management function for the RSF will be dealt with through a counter guarantee arrangement (second loss cover) adequate equity base in terms o f i t s capital structure, sound investment policies and a lean but ‘control and audit’ focused staffing. On a case by case basis, the RSF may enter into a Counter- Guarantee Agreement with IFC or other such agencies on a pre-determined fee sharing basis, for covering al l r i s k above a threshold level (“critical default rate”). The critical default rate will be defined for each portfolio, based on the due diligence exercise; however, depending on the assessment o f expected loss, the RSF may seek to provide only enough first cover to ensure that the portfolio i s AAA rated for the second loss provider - this would lead to lower pricing for the second loss cover). Second loss participation will lead to lowering o f the contingent liabilitieshisk exposure o f the RSF. The facility would likely not have a critical default rate greater than lopercent. In cases where a counter guarantee agreement i s being reached between the RSF and the second loss provider (to be pre-determined based on the second loss provider listing a set o f banks where it would be potentially interested in taking a second loss position), the latter will participate in the due diligence exercise.

The RSF will invest i t s capital base in a portfolio in accordance with i t s investment guidelines. The exact level to be invested will be a function o f working capital requirements for operating expenses as well as making payouts for claims raised by PFIs. The investments will be structured so as to have a prudent mix in terms o f tenor as well as liquidity enabling the RSF to maximize returns on investment, while at the same time, providing it with sufficient liquidity.

Monitoring Reporting arrangements will enable a regular monitoring o f the use o f the RSF so as to track aspects such as the quantum o f finance being extended to different sectorshegions and also map the size and profile of SMEs being financed using the facility. SIDBI will monitor that the PFIs meet the eligibility criteria.

Exit strategy An operational review o f the RSF will be conducted by the PRC in the third o f year o f the operation o f the RSF. If a decision i s taken by the management o f the RSF not to further upscale the RSF, the amount allocated to the RSF that has not yet been drawn down by the Borrower could (a) either be cancelled, or (b) reallocated to the credit facility. For the amount that has been drawn down by the Borrower but against which no guarantees have been issued, the amount may either be refunded to the Bank or reallocated to the CF. The amount that has already been drawn down by the Borrower, and against which guarantees have been issued and are outstanding, would remain in the guarantee reserve account until such time as the outstanding guarantees expire. For any amount remaining in the guarantee reserve account after the guarantees expire, SIDBI would have the option to reallocate the amount as deemed fit by SIDBI. I t may be noted that continuation o f the RSF would be an acceptable route only if the RSF has performed well during the init ial years of implementation and demand for i t s guarantees are st i l l needed. This would be jointly determined by GoI, SIDBI, RSF management, the Bank and other donors involved. In any event, the exit strategy will be revisited and confirmed during year 3 o f the RSF’s implementation, based on the RSF programk operating history.

3. Policy and Institutional Development TA Component

The TA component i s a cornerstone o f the proposed project. I t will help address the medium term policy, regulatory and institutional constraints that hamper the efficiency o f the SME credit market in India. The TA will be funded by DFID ( U S 3 7 mil l ion equivalent) and counterparty (cost sharing) funds (US$1.4 million). The TA will cover the following:

(a) Strengthening the policy/legal/regulatoly framework: Assistance in promoting informed and evidence based dialogue in the public domain on key policy, legal and regulatory measures that are critical to

48

establishing a more efficient framework underpinning S M E financing and development, through support to the following areas: (i) adoption o f an S M E definition by Go1 (ii) effective sectoral articulation for supportive policy through enabled industry associations; (iii) efforts to create a supportive financial environment that can offer SMEs better access to equity financing; (iv) streamlining o f tax and accounting framework to foster the development o f leasing finance; (v) efforts to address the problem o f delayed payments; (vi) development o f standards in sub-contracting involving SMEs. (vii) improved mortgage registration system to make it more customer hendly; (viii) improved loan restructuring and recovery framework.

(6) Improving credit information (positive and negative information) on SMEs: (i) assistance to the PFIs to verify and collate historic data on SMEs, which would be made available to CIBIL and also retained for use under the project (and potentially for use by other credit bureaus approved by RBI); (ii) building the capacity o f CIBIL so that it can provide S M E credit histories and develop credit scoring products; (iii) support to CIBIL to enable interface between the Consumer and Commercial bureaus; (iv) developing a dedicated rating agency for SMEs as well as a regulatory framework which encourages financial institutions to make use o f ratings, and which sets standards for rating agencies; and (v) developing data requirements for access to the lending component.

(c) Building institutional capacity within the PFIs to reduce banb ’ transactions costs and reducehanage risks related to SME lending: (i) assisting PFIs (including SIDBI) in implementing credit scoring systems (that present a cost efficient tool for screening S M E loan applications, provide a simple and consistent approach for measuring relative default risk, and act as an effective guide on where the account officer should focus loan evaluation time and effort) and cluster approaches (the assistance would extend to establishing processes for the ongoing monitoring o f credits under the scoring system); (ii) training o f bankers in using past data on SMEs and in using the credit scoring/appraisal systems and broad-basing knowledge; (iii) “train-the-trainer” facilities in the use o f credit scoring/appraisal systems; (iv) delivering a targeted study to augment the current understanding o f the PFIs with respect to S M E clusters - including, defining parameters for an “attractive S M E ’ withn a cluster, cluster specific r isk factors, prognosis on likely evolution of cluster etc.; (v) a knowledge transfer program for the PFIs with respect to global best-practices in servicing the S M E segments on a commercial basis through lending, deposits and fee-based services, and the introduction o f new and innovative products and delivery mechanisms, so that the PFIs can increase their overall business in the S M E segment profitably.

(d) Business Development Sewices(BDS) for SMEs: This i s designed to strengthen S M E access to business development services. The approach will encompass: (i) Enabling policy makers design and implement strategies to foster BDS market development; (ii) selecting 25-30 SME clusters, and strengthening BDS within these clusters so as to create “model” clusters that can have a strong demonstration effect; and (iii) selecting a few S M E sectors with strong employment creation and poverty reduction impacts, and focus on all i t takes to strengthen BDS within these sectors. T h i s cluster and sector focused TA will include: (i) building the capacity o f existing and potential BDS providers and financial institutions (lead banks) within each o f the selected clusters and sectors to serve the S M E market more effectively; (ii) facilitating networking between S M E business associations and other BDS providers and similar associations in other countries; (iii) developing linkage programs between large corporations and SMEs, working through the major S M E business associations; (iv) developing high quality, affordable management training for local SMEs; (v) entrepreneurship training programs to create new entrepreneurs; (vi) providing SMEs with better access to technology, for example, through technology transfer agentshpporting dedicated institutions to facilitate dissemination o f information on technology transfer and match-making.

(e) Institutional support to SIDBI’s PMD: The TA will provide focused support to SIDBI to build up i t s capacity in the areas of project implementation, and monitoring and evaluation. SIDBI’s capacity in the

49

collection and analysis o f relevant SME data (including data for project monitoring and evaluation, and project impact analysis) will also be strengthened through TA.

DFID grant funds will be spread across all the above elements of the TA. The TA will involve some cost recovery in select areas through contributions from the recipients, to ensure ownership.

Banks participating in the CF will be required to agree upfront to an action plan covering such areas as improved credit assessment, risk management and better credit information and i t s sharing, which will be supported by the TA component, and monitored closely.28

Banks participating in the RSF will also be required to agree to action plans for specific improvements in these areas, but will not benefit from the TA, the assumption being that the institutional upgrading needs of these banks would be less pressing.

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Annex 5: Project Costs INDIA: Small and Medium Enterprise Financing and Development Project

Local Foreign Total

Project Cost By Component and/or Activity

Grant for RSF (SECO) TA

US$ mil l ion 120.0

5 .O Lending component (Credit Facility and RSF)

TA for Credit Information and Credit Rating Agency TA for Capacity building o f Banks

TA on BDS for SMEs

8.8 5 .O 2.0

16.7 TA on Policy, Legal and Regulatory issues

Project (TA) ManagerQerational Costs 3.5 Project Monitoring and Evaluation 1 .o

US$ mil l ion US$ mil l ion 0 120.0

5 .O

0

8.8 5 .O 2.0

16.7 3.5 1 .o

Counter party funding1 11.4 11.4 Total Baseline Cost 173.4 173.4 Physical Contingencies 0 0 0 Price Contingencies Total Project Costs2 173.4 173.4

Notes: 1. Includes SIDBI's counterparty contribution plus contributions by CIBIL, rating agency, PFIs. 2. Identifiable taxes and duties are US3.84 million, and the total project cost, net o f taxes, i s US$169.56 million. Therefore, the share o f project cost net o f taxes i s 97.8 percent. Total project costs also includes front-end fees o f US0.6 million. Assumptions: a. The on-lending of the Line o f Credit by SlDBI to PFIs and the sub-loans from the PFIs to the SMEs have been assumed to be in Indian Rupees. I t i s l ikely that some portion o f the on-lending and sub-loans to SMEs may eventually be in dollar terms. b. Exchange rates used for conversion into USD i s US$/GBP = 1.85

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Annex 6: Implementation Arrangements INDIA: SME Financing and Development

The Financial Services Division, MoF (GoI) has been designated by the Department o f Economic Affairs o f the Ministry o f Finance (GoI) to act as the nodaZ agency for the overall project, on the grounds that it i s the concemed unit within M o F responsible for all issues pertaining to banking and finance, including SME financing issues.

Institutional arrangements for project implementation

The Borrower and implementing agency i s SIDBI, which will be responsible for coordinating the three components o f the project and managing the project. SIDBI was set up as a wholly owned subsidiary o f the Industrial Development Bank o f India (IDBI) in April 1990 under an Act o f the Indian Parliament as the principal financial institution for: promotion; financing; development o f industry in small scale sector; and coordinating the functions o f other institutions engaged in similar activities. In order to provide greater operational flexibility, the SIDBI Act was amended in 2000 and the Bank was de-linked from IDBI with effect from March 27, 2000. SIDBI’s financial assistance to small scale sector has three major dimensions; indirect assistance to small units through primary lending institutions (PLIs), direct assistance to small units, and development and support services.

SIDBI was selected as the implementing agency because it i s the designated apex-level financial institutional responsible for SME financing and development, and i s best positioned to act as the financial intermediary between the Bank and the various PFIs. Such a project structure i s more efficient than a structure involving individual participation agreements with each participating bank, as it helps assign clear accountability and reporting duties to one institution, ensures better coordination during implementation, and facilitates project monitoring and supervision. An additional factor guiding the choice o f SIDBI as the implementing agency i s that i t has been made responsible for the GoI’s own recently announced SME fund, which the proposed B a r k project would be dovetailing. SIDBI i s highly committed to the project, has assigned dedicated project staff, and has extensive experience with managing donor credit l ines (e.g., from KfW and JBIC) as well as donor grants funds (e.g., from DFID).

To coordinate project implementation, SIDBI has established a Project Management Department (PMD) at New Delhi. The Head o f the P M D and three s ta f f have already been put in place, with one additional SIDBI staff due to come on board shortly. Additionally, terms o f reference have been agreed with the Bank for an externally recruited team, comprising some 2/3 staff from PFIs (on deputation to the P M D for a period o f up to three years to assist in specific components o f the project) and at least two external experts, including (but not limited to) a financial management and procurement specialist (to be selected based on the procurement guidelines laid out in the OM). The externally recruited team will be put in place on a need basis.

A committee comprising all the partners in the project (the “Project Review Committee” o f which IBRD i s a key member) has been established to oversee the project; SIDBI management will be accountable to IBRD and al l other members o f the Project Review Committee. A Policy Advisory Group i s also being set-up to guide and assist the PMD in mahng the case for the required policy changes, identified as part o f the policy component o f the TA.

Flow of Funds

The Credit Facility IBRD project funds will f low to SIDBI, with a guarantee from GOI. SIDBI has disbursement based on advances. An option will be available to SIDBI to open

opted for reports based a new bank account in

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State Bank o f India, New York to receive the initial special account deposit, if required. Funds would be received in SIDBI’s main bank account in India.

RSF The RSF will be established by SIDBI as a Limited Liability Company as a separate, off-balance sheet entity, henceforth referred to as the “RSGC”. IBRD project funds, icrequired, allocated to the RSF will f low to SIDBI’s main bank account, and from there, to a separate account (the entity account) within seven days o f receipt. These funds will be treated as SIDBI’s contribution to the RSGC and will serve as guarantee reserves to be later used against executed guarantee framework agreements between the RSF and PFIs.

Technical Assistance For the DFID grant that will finance the bulk o f the TA, SIDBI will establish a separate bank account. The TA program will be managed and administered by the PMD, using the agreed procurement guidelines that are in line with DFID’s guidelines and have been reviewed and accepted by IBRD. For the policy elements o f the TA, a Policy Advisory Group i s also being set-up to assist the P M D in makmg the case for the required policy changes, identified as part o f the policy component o f the TA.

Banks participating in the CF will be required to agree upfront to an action plan covering such areas as improved credit assessment, r isk management and better credit information and i ts sharing, which will be supported by the TA component, and monitored closely.

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Credit Facility (CF)

Project Review Committee

Credit facility

Financial Services Division

Nodal agency; MoF counter guarantees CF

lmplementing agency

~ SIDBI

Refinancing Loans to SMEs

- Funds flow + Reportingflow ........................................

Note: Counterparty (SIDBI) contribution o f US$lO.Omn i s not shown in the diagram

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Risk Sharing Facility (RSF)

VIA IBRD TRUST

US$S.Omn up to US$2Omn

I I I I I

I TAsupport

I I I

I GO1 - Ministry o f Finance (MoF) - ................................ I 1 Financial Services Division I I I , I I

I I I I I I

SIDBI //.’ . _.-

Nodal agency

.--- _-.- ._*e A*.-

....................................... RSF [Company] Other donors/PFIs

Banks

Loans to SMEs

SME S M E S M E - Fundsflow

....................................... + Reportingflow

-b TAf low -.-.-.-.-.

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Technical Assistance

Project Review Committee DFID grant Funds

Loans to SMEs N

Financial Services Division

- Fundsflow

+ Reportingflow ........................ ................

-b TAf low _._._.---.

US$37mn

PFIs (CIBIL, Credit Rating Agency), BDS, Policy reform

Note: Counterparty contributions of US$ I .4mn are not shown in the diagram

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Annex 7: Financial Management and Disbursement Arrangements INDIA: Small and Medium Enterprise Financing and Development Project

Summary of Financial Management (FM) Assessment

This project will be implemented by a Financial Intermediary (FI): the Small Industries Development Bank o f India (SIDBI). SIDBI has an adequate financial management (FM) system which would be able to account and report for project resources and expenditures.

FM Strengths, Weaknesses and Mitigating Arrangements The project has the following strengths in the area of financial management: (i) a reporting and budgeting system i s already operational for the entire entity w h c h will be used for accounting and generating the required financial reports under the project; (ii) SIDBI has an adequate financial management system and framework for carrying out the functions assigned to it under the project; (iii) SIDBI has a well laid out appraisal criteria for refinancing and direct financing; and (iv) SIDBI has prior experience o f dealing with external financiers l ike KFW, JBIC and DFID. While the project structure i s complex, with involvement o f several donors, the flow of funds and disbursement arrangements have been designed to minimize complexity; there will be no pooling or co-mingling o f funds with IFC and bilateral donor agencies who are project partners.

Arrangements for oversight and accountability SIDBI will be the main implementing agency o f the project and will be responsible for handling the FM arrangements o f the project. A Project Management Department (PMD) has been established within SIDBI, at New Delhi, to implement the project (Annex 6). A Project Review Committee, comprising IBRD and the other, partners involved in the project, has been established for project oversight. SIDBI’s main responsibilities/accountabilities will include: financial management functions; managing the finances in respect o f technical assistance component o f the project; accounting for the various activities; and providing financial reports in the formats agreed. SIDBI shall also provide the fiduciary assurance to IBRD over proper and efficient use o f grant proceeds. It i s proposed to use the current mainstream FM systems o f SIDBI (housed as a part o f their accounts, finance and resource management department) to generate the financial and other progress reports under the project.

Financial Reporting and Monitoring The reporting framework for the project will include a quarterly financial monitoring report prepared by SIDBI, in a format which would give up to date details on the project expenditure incurred along with projection in respect o f funds utilization in the coming 2 quarters, distinguishing the requirement in respect o f the PFIs, sub-loans, technical assistance and other project components. SIDBI has adequate FM systems and capacity to prepare these FMRs, which will be prepared (on cash basis with separate details o f accrued expenditure) for the project every quarter and forward it to the Bank within 45 days o f the end o f the quarter. The FMRs will include, at a minimum, the following aspects:

0 Comparison o f projectedhudgeted and actual expenditures and analysis o f major variances, including aspects such as sources of funds and application o f funds (classified by donors, components, sub- components and summarized expenditure categories); Comparison o f budgeted and actual physical progress under the project and analysis o f major variances on key physical/performance monitoring parameters; Forecast for next two quarters; and Schedules for withdrawal fi-om credit account.

0

0

0

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FMRs will be prepared from information generated from SIDBI’s mainstream FM and MIS systems. These then would be consolidated and a single report will be prepared for submission to the Project Review Committee including IBRD. The annual project financial statements, which would be similar to the format o f the quarterly FMRs, would also be submitted under the project.

Quarterly FMRs will also be required on the funds balance remaining in the RSF guarantee reserve account. The I B R D k o j e c t Review Committee will also review periohc reports on use o f funds from the RSF to monitor that the r i sk assumptions o f the RSF fall within the critical default range established and that the payments from this account are only for eligible expenditures.

Accounting Policies and Procedures The formats o f balance sheet and the profit and loss accounts o f SIDBI are prescribed by the SIDBI Regulations, issued under the SIDBI Act. SIDBI has implemented accrual system o f accounting and i s required to follow the accounting standards as issued by the Insti tute o f Chartered Accountants o f India mandated under clause No. 23 o f the listing agreement that SIDBI has signed.

SIDBI has well defined policies in place for revenue recognition including interest income and other income generated from i t s business as a developmental fmancial intermediary; valuation o f investments and recognition o f income from investments; foreign currency transactions; provisions for loans and advances; presentation and disclosure o f financial statements and fured assets and depreciation. In addition, SIDBI, being a financial institution, i s also statutorily required to make the following disclosures as per the RBI guidelines: relating to capital adequacy, classification o f the Loan Assets; asset quality and credit concentration including information relating to N P L s and their provisions and movement; diminution in investments; restructuring of loan assets; credit exposures as percentage o f capital funds and as percentage o f total assets; liquidity; operating results; and forward rate agreements and forward rate swaps. SIDBI also prepares consolidated financial statements along with i t s various subsidiaries as required under Accounting Standard 21 issued by ICAI.

All project costs and expenditures, including those related to the TA component, will be paid for and recorded in the books o f SIDBI in accordance with i ts accounting policies and procedures detailed in the OM. Each credit l ine o f SIDBI i s allocated a separate general ledger code within the books o f accounts which helps in keeping track of progress under each credit line o f both resources raised from various sources (liabilities) and assets (sub-borrowers, loans and advances) created there under. The credit facility under the proposed project would be allocated a separate account code which will help in distinguishing transactions under this l ine with those under other existing credit lines. The technical assistance will be handled by PMD and the required book keeping and accounting records would be maintained in this respect. The proceeds of IBRD/donor fund contribution to the RSGC will be retained in a separate account (the entity account) that i s managed, maintained and accounted for separately from SIDBI’s own accounts, subject to strict financial control mechanisms acceptable to the Bank, including independent financial audit. The Bank would receive audited accounts o f the RSGC throughout the duration of the Bank’s supervision o f the IBRD-financed project; the guarantee fund would be compliant to the Bank’s financial management guidelines throughout the duration o f the Bank’s supervision o f the project. These arrangements are detailed in the O M and will be refined after the FM assessment o f the RSGC has been undertaken.

FM and other Information Systems The IT architecture of SIDBI i s evolving and i s based on an ORACLE environment. SIDBI i s assisted by a consultant to manage i t s database which has relevant security features. All the applications (business software developed on different platforms over a period time) have been deployed centrally and accessed over the Wide Area Network using Citrix Metaframe presentation server which i s housed in Mumbai. The server located in Mumbai forms the central server and connects all the offices on a real time basis

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using leased lines, ISDN and VSAT. Currently SIDBI i s in the process o f integrating the various application packages into consolidated single software which will help in removing any duplication o f work and data redundancies. T h i s will also help augment an IT driven internal control atmosphere within the corporation. SIDBI’s accounting system i s computerized and this helps in facilitating the finalization o f quarterly accounts by 15th o f the next month. SIDBI i s currently using different accounting packages for different business areas like direct credit; refinance; bills discounting, etc.

Policy and Manuals The operational framework o f SIDBI i s captured in the various policy documents and manuals which are revised from time to time to capture the evolving needs o f the business and also to meet the regulatory framework, including RBI guidelines as applicable to the Financial Institution. Loan Policy (revised in 2004) of SIDBI sets the exposure limits according to sectordindustries and group o f borrowers. FX manual lays the basis for managing the FX exposures and the risk limits within which operations are conducted. The business and accounting procedure manual (BAPM) i s hosted on the intranet to facilitate usage. The internal audit manual lays down the procedures for conducting and reporting on internal audit o f various departments and the follow up procedures thereafter. Some o f these manuals are currently under revision to capture the evolving business needs o f the corporation.

Readiness Fiduciary arrangements for the project are in place. The Project Review Committee for project oversight has been established and monitoring arrangements agreed. The PMD, responsible for project implementation, monitoring and supervision, and reporting, has been established. The PMD has an FM expert (reassigned from within SIDBI); to bolster SIDBI’s overall capacity for project financial management, an externally recruited senior financial management specialist (consultant) may be appointed to the PMD, to lead the FM functions within the overall project. Th is person will be familiar with SIDBI’s internal systems and processes and will also preferably have experience o f worlung with external financiers and will be responsible for establishment o f the agreed financial management arrangements under the project. The senior FM specialist would also coordinate with other departments/ functionaries with SIDBI to ensure smooth and timely operations. The TORS for the specialist have been agreed, and hehhe will shortly be appointed to the PMD. Counterpart funds have been budgeted and released.

Audit Arrangements

External audit SIDBI’s statutory auditor i s appointed at the Annual General Meeting (AGM) o f i t s shareholders under Section 30(1) o f the SIDBI Act 1989 (as amended in 2000). The auditor i s selected by the Reserve Bank o f India (RBI) and approved by SIDBI’s Board. An auditor i s usually appointed for a period o f three years and i s rotated thereafter as per the directives o f RBI. SIDBI i s also covered by RBI inspection which involves an evaluation o f various capital adequacy and other related disclosures that SIDBI i s required to make as a financial institution.

I t i s proposed that the project will be audited by the Statutory Auditor appointed by the RBI. The RSGC, however will also be audited by an independent firm o f chartered accountants, acceptable to the Bank, under agreed terms o f reference. These audit reports shall serve the fiduciary requirement o f all the participating donors and the terms of reference for audit have been drafted in consultation with the other donors. The annual audit report would be accompanied by a project financial statement which would separately identify each component under the project, i t s progress and the funding sources for each o f the components. SIDBI, in turn, would receive entity audits o f the banks participating under CF and RSF. SIDBI would make these reports available to the Bank supervision missions. For the RSGC, an audit report o f the proposed off-balance sheet entity (Limited Liabil ity Company) would be received by the

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Bank. This would be in such format and details as identified and agreed during proposed FM assessment o f the RSGC (disbursement condition for this component).

I Agency Audit Report

SIDBI Annual Entity audit report

SIDBI Project audit (including audit o f special Account and the FMRs submitted for disbursement and)

RSF Annual Entity audit report

The audit o f the project accounts would also include an assessment o f (a) the adequacy o f the accounting and internal control systems, (b) the ability to maintain adequate documentation for transactions and (c) the eligibility o f incurred expenditures for Bank financing. Thus the following audit reports will be monitored in Audit Reports Compliance System (ARCS):

Audited by Due Date

Statutory Auditors 30th September appointed by SIDBI’s board

Statutory Auditors 30th September

SIDBI’s Statutory 30th September Auditors

Internal control and Corporate Governance

SIDBI’s intemal control framework i s considered adequate for a financial corporation o f i t s size, and i s currently in the process o f being upgraded through several measures (IT consolidation, Risk Management Department, Business process re-engineering). The internal control framework includes an audit committee constituted by three independent members o f the board. The audit committee o f the board provides direction and oversees the working o f the internal audit and interacts with the statutory auditors during the year to resolve any issues and take corrective action on systemic issues brought to i t s notice. In addition to the audit committee, there i s another committee o f the board, executive committee which i s empowered to sanction financial assistance and deal with operational matters as delegated by the Board. There are other committees within the Bank formed by officials o f the Bank l ike the Central and Regional Credit Committees to look into credit proposals as per the authorization levels established with in the organization.. In order to manage the market r isks associated with assets/liabilities, there i s an Asset Liability Management (ALM) committee, headed by the CMD, which meets regularly to monitor and review the business strategy as well as managing Financial intermediary r isks (like Liquidity risk, ALM risk, interest rate risks, credit risks). SIDBI has also set up an exclusive Risk Management Department (RMD) to supervise and manage the credit and other related r i s k s associated with business lending o f SIDBI.

Internal audit department: SIDBI has a full fledged Internal Audit Department (IAD) at the Head Office directly reporting to the Deputy Managing Director o f the corporation. IAD takes up operationay financial audit o f HO departments and Branch offices. IAD ensures that operations are carried out in accordance with the policies and procedures laid down and also makes suggestions for streamlining the operations and malung suitable modifications in the procedures. Under the corporate govemance framework, the audit sub-committee of the board oversees the functionalities o f the IAD. The intemal audit department would also audit the project and i ts report would be available to the donors, on request.

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Disbursement Arrangements

Project funds will be disbursed by IBRD on the basis o f periodic financial monitoring reports (FMR), incorporating financial and performance reports in agreed formats, submitted by SIDBI on a quarterly basis. Supporting documentation, including completion reports, certificates and other documentation, will be retained by SIDBI and made available to the Bank during project supervision.

- CF: IBRD/donor funds for the CF will be disbursed by SIDBI to participating commercial banks and to the SME borrowers in accordance with the eligibility criteria and procedures described in Annex 4 above, and detailed in the OM. The CF will be financed using an IBRD credit line and SIDBI’s counterparty contribution (US$lO.Omillion).

m: IBRD/donor contribution hnds allocated to the RSF will be disbursed, if required, to SIDBI’s main bank account and transferred by SIDBI from the main bank account to a separate RSF bank account (“guarantee reserve account”) o f the Limited Liability Company within seven days o f receipt (legal covenant). These funds will serve as guarantee reserves to be later used against executed guarantee framework agreements between the RSF and PFIs. It i s being stipulated that an FM assessment o f RSGC would be undertaken before the Funds begin to flow under the RSF component.

The rationale for upfront disbursement into the guarantee reserve account i s that this will entrust SIDBI (i) to implement the RSF program, which comprises small individual and diverse transactions, and (ii) to be responsive to market demands, efficiently and cost effectively. For PFIs to accept the guarantees o f the new RSF program, funds must be unencumbered and transparently available to back the guarantees.

Init ial upfront disbursement o f the IBRD/donor funds for the RSF will be conditional upon SIDBI completing al l the formalities associated with legal establishment o f the Company, including obtaining al l the necessary approvals and exemptions, and a financial management assessment o f the RSF. Subsequent draw down o f funds, by SIDBI, for the RSF will be based upon demand as reflected in amount o f guarantees issued.

The proceeds o f IBRD/donor fund contribution to the guarantee reserve funds wil l be subject to satisfactory financial control mechanisms, including independent financial audits, which will be determined and agreed as a part o f the proposed Financial Management Assessment (disbursement condition) after creation o f the RSGC.

- TA: DFID i s proposing to fund the TA by way o f a grant, for which SIDBI shall establish a separate bank account.

No pooling arrangements are envisaged with other donors under the project.

Retroactive Financing:

No Retroactive financing i s envisaged under the project.

Supervision Plan

The project would require a high degree of supervision in the initial stages especially for ensuring effective implementation o f RSF component. The other focus areas during the supervision will be on meeting the training needs of the project finance personnel (disbursement and FM related trainings). A detailed supervision plan i s included in the OM.

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Annex 8: Procurement INDIA: Small and Medium Enterprise Financing and Development Project

Procurement Arrangement

IBRD funding will be used for financing the Credit Facility and Risk Sharing Facility and hence does not entail any direct procurement o f goods, works or services by SIDBI. All procurement o f goods and services to be undertaken by SIDBI under the Technical Assistance (TA) component shall be financed through DFID.

For procuring the goods and services under DFID financing, SIDBI has drafted internal procurement guidelines modeled after, and in line with, DFID procedures. These guidelines were reviewed by IBRD and found acceptable. Hence, procurement review under the TA will be conducted by DFID.

Implementation Arrangements

Procurement at SIDBI i s limited to very small goods procurement related to office consumables and printing, and the institution does not have experience o f procuring large value consultant assignments as will be required under the TA. Hence, in order to enable the critical procurement component to be carried out efficiently and in time, SIDBI shall appoint a Senior Procurement Consultant, selected through competitive bidding, to be part o f the Project Management team. As part o f the team, the Senior Procurement Consultant shall prepare an overall procurement plan detailing the various TA Consultant contracts required for the project duration, and a summary plan for their proposed goods procurement requirements, if any.

Procurement Methods

1. Procurement by SIDBI:

The project does not involve any Works procurement. All Goods (US$0.3 million) and Services (US$38.1 million) will be procured following SIDBI’s internal procurement guidelines, modeled on DFID procurement procedures.

2. Procurement by Beneficiaries or Sub-Borrowers:

In the case o f procurement undertaken by beneficiarieshb-borrowers utilizing the proceeds o f IBRD loan on-lent by SIDBI or a Financial Intermediary under the Credit Facility, the procedures shall be in accordance with accepted and prevalent commercial practices in accordance with the provisions o f clause 3.14 o f the Bank’s Guidelines.

Prior review, Thresholds and Frequency of Supervision

There will be no prior review o f Consultant contracts funded solely out o f the proceeds o f the DFID grant. Thresholds have not been specified since the entire TA component, for w h c h procurement issues are relevant, i s being financed solely by DFID grant funds and will be procured in line with the procurement guidelines prepared by SIDBI.

The project elements, their estimated costs, and proposed methods o f procurement are summarized in Table A.

62

Table A: Project Costs by Procurement Arrangements (US$ mill ion equivalent)

Procurement Method'

Expenditure Category ICB NCB Othe? N.B.F. Total Cost

- .

1. Works 0.00 0.00 0.00 0.00 0.00 (0.00) (0.00) (0.00) (0.00) (0.00)

2. Goods 0.00 0.00 0.30 0.00 0.30 (0.00) (0.00) (0.00) (0.00) (0.00)

3. Services 0.00 0.00 38.10 0.00 38.10 (0.00) (0.00) (0.00) (0.00) (0.00)

4. Credit and 0.00 0.00 135.00 0.00 135.00 Risk Sharing facilities

(0.00) (0.00) (120.00) (0.00) (120.00)

(0.00) (0.00) (120.00) (0.00) (120.00) Total 0.00 0.00 173.40 0.00 173.40

'Figures in parentheses are the amounts to be financed by theJBRD loan. All costs include contingencies.

'Refers to procurement o f TA according to procurement guidelines prepared by SIDBI and for sub-loandborrowers (under the CF and RSF components) to be governed by provisions under clause 3.14 of the Bank's guidelines. The project costs include 1) T A o f US$37 mil l ion equivalent from DFID, counter-party funding o f US$1.4 mil l ion and 2) Credit Facility: US$lOO mi l l ion from IBRD, US$lO.O mil l ion from counter-party funding and 3) RSF - up to US$20 mi l l ion if required from IBRD and US$5.0 mil l ion potential grant f rom SECO

Total value o f contracts subject to prior review: not applicable

Overall Procurement Risk Assessment: Not Applicable since IBRD funding i s not being used for the TA

Frequency o f procurement supervision missions proposed: One every Twelve months (as part o f joint review mission).

63

Table C: Allocation of Tota l Project Proceeds

Project costs Expenditure Category Amount in

US$ mill ion Of which IBRD in

US$ mil l ion FINANCING

PERCENTAGE

Technical Assistance 38.40 Opercent( *) NIL

Lending: a) Credit Facility 90.87 percent o f the sub-

loans29 disbursed by SIDBI 109.5 99.5**

b) Risk Sharing Facility 5 .O# UP TO 50 percent o f the first

tranche, if required

14.9** c) Unallocated 14.9

Total Project Costs 172.2 119.4 --I---- Interest during construction

Front-end Fee 0.6 100 percent 0.6

Total 173.4 120.0 66.89 percent

* NBF- to befinanced by DFID * * Front end fee has been deducted proportionately from the CF (amounting to US$0.5 million) and the unallocated portion (amounting to US$O. 1 million) # The RSF wil l be capitalized using IBRD funddcontributions from SIDBI and other PFIs

64

Annex 9: Economic and Financial Analysis INDIA: Small and Medium Enterprise Financing and Development Project

Economic Analysis

The S M E Financing and Development project aims to increase bank financing to SMEs while also improving tEe quality o f banks’ S M E lending. Through a combination of financing instruments and technical assistance (TA) to financial institutions and SMEs, the project seeks to address both supply and demand side issues constraining SMEs’ access to finance, with an expected positive impact on the overall growth o f the S M E sector, employment and a reduction in poverty. Discussions with banks and other stakeholders have indicated high levels o f interest and demand for all the project components.

Significant economic benefit i s expected to be derived from the project. Broadly, the project will help improve S M E credit market efficiency, strengthen banks’ S M E loan appraisal systems and practices, and improve risk management o f their S M E loan portfolios. This should help enhance profitable bank lending to viable SMEs, reduce banks’ NPLs. Ultimately, through i ts economy-wide demonstration effect, the project i s l ikely to generate benefits for a much larger number o f banks and SMEs, with wider implications for S M E growth, job creation and poverty reduction. Expected project benefits are as follows:

a) The CF will provide banks with access to longer term resources for on-lending to SMEs. This will help SMEs access term lending (3 years++) that i s required for capital formation and technological upgradation, thereby facilitating the growth, productivity and competitiveness o f SMEs.

b) The RSF, by sharing credit risk, will help step up lending to SMEs in the near term. The leverage per rupee o f funds invested into the RSF i s expected to be significant; i.e. each rupee invested as capital in the RSF, will enable the RSF to share risk on an S M E loan portfolio 16 times as much as the capital invested. Moreover, the RSF will help the PFIs free up r i s k capital and build up a track record o f good S M E lending, giving them the much-needed confidence and encouragement to scale-up lending to SMEs.

The TA intervention targeted at banks i s expected to lead to improved efficiencies in loan appraisal quality and processes, better designed products for SMEs, improved quality of lending to SMEs and higher profitability growtldmargins for banks from lending to SMEs. Through the BDS TA to selected S M E clusters, improved productivity, management quality and competitiveness o f SMEs i s foreseen as an impact o f the project. The technical assistance on credit information will address the critical issue o f lack o f credit information on SMEs that tends to constrain bank lending to this sector and will have a significant role as a ‘public good’ while the policy focused TA will help develop a more efficient policy framework underpinning S M E financing, including greater ease in enforcing NPL recovery and bankruptcy.

Being dovetailed as part of a larger govemment initiative focused on encouragmg f low o f funds to SMEs through SLDBI, the project intervention i s l ikely to enhance SIDBI’s capacity for undertaking this larger initiative more effectively.

65

Financial analysis

SIDBI and commercial banks A financial review o f SIDBI and several commercial banks that are potential candidates for participation in the CF and RSF, was undertaken to determine compliance with the eligibility criteria under OP8.30 (SIDBI has also been separately assessed with respect to OP10.02 - refer to Annex 7 for this).

The eligibility criteria under OP8.30 are as follows: 0

0

0

0

0

Adequate profitability, capital adequacy, asset quality and liquidity in accordance with accounting and auditing principles acceptable to the Bank Acceptable levels o f loan collections Appropriate capacity including staffing for sub-project appraisal and implementation Adequate managerial autonomy and commercially oriented governance Appropriate prudential policies, administrative structure and business procedures.

The result o f the review showed that all institutions reviewed meet the basic eligibility criteria. Select key financial parameters are displayed in the Table below.

Financial data of reviewed institutions*

Source RepodonTmndand?mgmseofBan~g~nIndia,RessneBa~~indla1001&2003, D~af013131(03aiebasedonbarda audlted$tale"nb ' Units USD in milltons uniafs obenwsa $Wed rr ForSIDRI,Me~ureintiudermarketbomrmngs

R e l u m o n s s s e ~ a n d n ~ ~ c a ~ u s i n g a r m u a t , ~ p a l n l i n e r a g e s o ~ ~ s s P s a n d n e ~ u s i n g s u d ~ ~ b a n k 6 ~

The returns on assets for the institutions stood in excess o f 0.9 percent, while capital adequacy position i s strong and typically stands well above the 9 percent prudential requirement. On asset quality, while overall quality i s in acceptable limits, the public sector banks' portfolios need improvements; however, by and large, banks have undertaken adequate provisioning cover for th is portfolio.

Liquidity positions for all banks are sustained on account o f a steady growth in short term deposits and high levels o f te rm deposit renewals; thus, banks' are effectively borrowing short to lend longer term. Given the very stable deposit growth rates banks over long periods o f time, banks regard this to effectively mean that deposits are in practice long term and stable sources o f funds for them. Adequate liquidity and ability to raise resources in the short term money markets, deposit guarantee cover and strong balance sheets, provide an overall comfortable position for the banks on liquidity aspects. Nonetheless, gwen the present strategy o f borrowing short to lend longer te rm (with a significant part at fixed rates), in the event o f a hardening o f interest rates, banks would need to reconsider their financing strategy and move towards raising longer term debt to sustain the longer term asset deployment objectives. SIDBI, however, has a comfortable, matched position in all time brackets and has a sound position on liquidity.

66

Specifically looking at SIDBI, i t ’s overall position with respect to the financial parameters in OP8-30, was found to be sound. A recent update using end-March 2004 figures on SIDBI’s financial performance showed that SIDBI i s a viable financial institution (a) with good performance on profitability (return on assets, 2 percent), (b) strong capital adequacy (52 percent), (c) has acceptable credit quality (gross N P L s at 8 percent), (d) has the capacity to mobilize domestic resources, and, (e) has adequate institutional capacity and systems and thus i s qualified to act as conduit for on-lending the World Bank’s funds to the SME sector as required under OP8.30. SIDBI’s capital adequacy position i s very strong (>5Opercent) and it enjoys the support o f Government o f India.

Operating Expenses -0.02percent -0.1 lpercent Provisions -0.30percent +0.55percent Net improvement +O.O3percent -0.22percent

But the possible impact o f the poor performance o f State FinanciaVIndustrial Development Corporations on i t s asset quality continue to be areas that merit attention. SIDBI i s aware o f the challenges and i s paying increased attention to direct financing. On the qualitative criteria specified in OP8.30, information from SIDBI (as also other banks) was found to be reliable and the overall quality and independence o f S IDBI ’s management, acceptable. SIDBI (and other reviewed banks) has well developed practices related to internal controls, lending and investment policies, human resource management and overall operations - performance on. these fronts i s acceptable and in line with the basic requirements o f Bank lending. SIDBI will report progress and provide accounting and monitoring information according to the financial reporting arrangements described in Annex 7.

Overall, the financial review showed that, prima facie, despite challenges for improvements facing al l the institutions reviewed and scope for improvement, al l these institutions meet the basic eligibility parameters specified in OP8.30.

The RSF The RSF has been designed as a self-sustaining, profitable and capital adequate institution that can provide considerable leverage impact. Through i ts income sources (investment income and income on guarantee business), it will be able to cover all costs o f payouts on defaults, operating and due diligence expenses and meet i t s liabilities.

67

Fiscal impact

The l ine o f credit will not be a direct borrowing for the Government of India and will reflect as a contingent liability (counter guarantee provided for SIDBI’s borrowing from IBRD). Moreover, through the project’s blend o f financing and technical assistance interventions the project i s l ikely to have a significant impact on strengthening the financial and operational performance o f banks participating in the project, thereby reducing potential fiscal costs related to demands for Government-supported recapitalization support.

68

Annex 10: Safeguard Policy Issues INDIA: Small and Medium Enterprise Financing and Development Project

Social and Environmental Safeguard Issues

The proposed project will not finance a pre-identified set o f sub-loans and no specific social safeguard issues have been identified at present. Sensitizing banks and SIDBI on issues related to land acquisition and on methods for social screening o f sub-loans i s seen as important. Th is would help banks identify social safeguard issues related to sub-loans - such as child labor, welfare support for working mothers and payment o f minimum wages. Apart from training these institutions on such issues, wherever appropriate, industry associations will be used to help increase awareness on such social safeguards issues. Studies as well as baseline and repeat surveys will be used as part o f the project monitoring and evaluation framework to monitor and assess the social impact o f the project, including on employment and poverty. These impacts can be assessed based on the sample o f clusters o f SMEs, which are a focal point for project TA interventions on the business development services side. Coordination with other project partners on social safeguards issues would be undertaken.

For similar reasons stated above, the environmental issues associated with the sub-loans are expected to be varied in nature with complexities o f such issues largely depending upon the specific sector. I t i s expected that there will be no issues related to cultural property, involuntary resettlement, indigenous peoples, forests, safety o f dams, projects in disputed areas, project in international waterways. On natural habitats and pest management, while no significant issues are foreseen, the possibility o f they being applicable at a sub-loan level cannot be totally ruled out.

The environmental and social screening tool being designed in collaboration with SIDBI as part o f the Environmental and Social Risk Management Framework i s expected to capture such issues in such a manner so as to provide indicative guidelines for action that will take into account the environmental concerns related to the projecthector and also factor in the project size and what type o f safeguard actions are practical to take.

Proposed approach

Since the project will not finance a pre-identified sub-loans, no specific safeguard issues identified at th is stage. The social safeguards screening category i s SF; while the environmental category i s F 1.

Social The social safeguards framework for the project would center around adapting the approach used by IFC for Financial Intermediary projects. This would include supervision and traininghapacity building o f SIDBI, the implementing agency and o f the PFIs, using the training approach used by IFC. This would be undertaken in collaboration with the Bank and other project partners. Involvement o f those SME industry associations in helping build awareness on social safeguard issues will be considered. The cornerstone o f the social safeguards framework for this project would be through the training and supervision o f the implementing agency. Related issues will be incorporated into legal agreements and Operating Guidelines for the project. The guidelines related to these will be a part o f the Project’s Social and Environmental Framework.

Environment To help SIDBI and the PFIs manage environmental r isks in their lending operations, a framework approach i s being used, encompassing: i) creating awareness and capacity withm SIDBI and the PFIs on potential environmental issues related to the sub-projects and sectors; ii) development o f an environment

69

management framework including simple screening and assessment templates to address environmental concerns in their financing operations; iii) assisting SIDBI and the PFIs in the assessment o f a few environmentally sensitive projects (to be defined in the framework to be developed). To begin, a sensitization training program (by IFC in collaboration with the Bank and project partners) was held during appraisal. Similar such programs will be conducted through the TA component o f the project. The required environmental risk management framework i s being developed by SIDBI. For both social and environmental safeguards, use of appropriate interventions as part o f the TA to banks and to SMEs, would be used and wherever possible, involvement of appropriate industry associations would be encouraged. Consultations have commenced with industry associations that are l ikely to be involved in the project through the TA component.

In summary, the safeguards framework for the project adapts the approach used by IFC for Financial Intermediary projects. The approach includes building the capacity o f SIDBI and the PFIs involved in the lending component and help establish processes to better screen sub-projects for social and environmental issues. Further, the BDS component of the project would also address these issues with select S M E clusters and industry associations and would seek to sensitize the SMEs on social and environmental issues.

70

Annex 11: Project Preparation and Supervision INDIA: Small and Medium Enterprise Financing and Development Project

Planned Actual PCN review 09/22/2003 09/25/2003 Init ial PID to PIC 03/09/2004 03/09/2004 Init ial ISDS to PIC 03/09/2004 03/09/2004 Appraisal 031 1512004 061 1512004 Negotiations 09/27/2004 091 3 012004 BoardlRVP approval 11/23/2004 Planned date o f effectiveness 01/01/2005 Planned date o f mid-term review 06/30/2006 Planned closing date 061 3 012008

Key institutions responsible for preparation o f the project:

World Bank, SIDBI, DFID

Bank staf f and consultants who worked on the project included:

Name Title Unit Priya Basu Senior Financial Economist SASFO Niraj Verma Financial Specialist SASFP Inderbir S. Dhingra Private Sector Specialist SASFP C. Juan Costain Lead Financial Specialist SASFP Anita D’Souza Program Assistant SASFP Heather Sophia Fernandes Program Assistant SASFP Maria Marjorie Espiritu Program Assistant SASFP Manoj Jain Senior Fin. Mgmt Specialist SARFM Hyacinth Brown Senior Finance Officer LOAG2 Sanjay Rastogi Consultant SARFM Kirtan Sahoo Environmental Specialist SASE1 Samuel Thangaraj Senior Social Dev. Specialist SASES

Syed I. Ahmed Senior Counsel LEGMS Shellka Arora Legal Assistant LEGMS Robert Keppler Senior Adviser FSOPD Jose F. Molinha Senior Financial Officer BCFBD Nicholas Vickery Investment Officer IFC Nathalie Louat Investment Officer IFC Richard English Senior Environmental Specialist IFC Rita Bhagwati Investment Officer IFC Ani1 Sinha General Manager CSADP John Maclean Consultant Sumant Batra Consultant K R Ramamoorthy Consultant Monitor Group Consultant

K i ran Baral Senior Procurement Specialist SARPS

71

Bank funds expended to date on project preparation: 1. Bank resources: US$201,370 (at May 3 1,2004) 2. Trust funds: 3. Total: US$201,370

Estimated Approval and Supervision costs: 1. Remaining costs to approval: Commitments o f US$47,960 + additional costs o f US$20,000

approx. 2. Estimated annual supervision cost: US$120,000 in Yr-1; US$100,000 in Year-2 and Year-3;

thereafter US$80,000 p.a.

72

Annex 12: Documents in the Project Fi le INDIA: Small and Medium Enterprise Financing and Development Project

1. Beck, Thorsten, Asli Demirguc-Kunt, and Ross Levine, Small and Medium Enterprises, Economic Growth and Development (Draft, 2002)

2. Government o f India (GoI), Planning Commission a. Interim Report o f the Study Group on Development o f Small Enterprises, chaired by SP

Gupta (2000) b. Report o f the Committee on Small and Medium Enterprises, chaired by Abid Hussain

(1 997) c. Go1 Industrial policy statements issued in 1956, 1977, 1985 and 199 1

3, Government o f India, Ministry o f Finance a. Economic Survey (2002-03)

4. Monitor Group Report on Scoping the TA Needs o f Commercial Banks in the S M E area

5. Reserve Bank o f India a. Report of the High-level Credit Committee, chaired by SL Kapur (1998) b. Report of the Committee on SSI Credit Policy, chaired by P.R. Nayak (1991)

6. Steel, Will iam and V. Desai, Proposal on an SME Investment Fund (2003)

7. World Bank Group a. World BanWCII Study on Improving India’s Investment Climate (2002) b. Board Paper on SMEs: Strategy, Business Plan and Budget (IFC 2000). c. SME Strategy (2000) d. India: Addressing the SME Financing Constraint (World Bank Policy Note: P084703-

ESW, Report) (July 2003) e. Policy Note (May 2003) f. Project Concept Note (Sept 2003)

8. Term FinancindTerm Transformation constraints in the SME lending operations faced by select PFIs in India, ICRA, Feb 2004

73

Annex 13: Statement of Loans and Credits INDIA: Small and Medium Enterprise Financing and Development Project

~~ ~~

Difference between expected and actual

disbursements Original Amount in US$ Millions

Project I D FY Purpose IBRD IDA SF GEF Cancel. Undisb. Orig. Fm. Rev’d

PO73370 2005

PO73651 2005

PO77977 2005 PO84632 2005

PO73776 2004

PO73369 2004

PO55459 2004

PO50655 2004

PO82510 2004

PO79865 2004

PO78550 2004

PO75056 2003

PO71272 2003

PO50649 2003

PO67606 2003

PO72123 2003

PO76467 2003

PO73094 2003 PO69889 2002

PO40610 2002

PO50668 2002

PO71033 2002

PO72539 2002

PO50647 2002

PO50653 2002

PO74018 2002

PO67216 2001

PO38334 2001

PO67543 2001

PO71244 2001

PO70421 2001

PO50658 2001

PO55454 2001

PO55455 2001

PO35173 2001

PO59242 2001

PO10566 2001

Madhya Pradesh Water Sector Restructurin

DISEASE SURVEILLANCE

Rural Roads Project

Hydrology I1

ALLAHABAD BYPASS

MAHAR RWSS

ELEMENTARY EDUCATION PROJECT (SSA)

RAJASTHAN HEALTH SYSTEMS DEVELOPMENT

Kamataka UWS Improvement Project

GEF Biosafety Project

Uttar Wtrshed

Food and Drugs Capacity Building Project AP RURAL POV REDUCTION

TN ROADS

UP ROADS

TecWEngg Quality Improvement Project

Chatt DRPP

AP Comm Forest Mgmt

MIZORAM ROADS

RAJ WSRP

MUMBAI URBAN TRANSPORT PROJECT KARN Tank Mgmt

KERALA STATE TRANSPORT

UP wsw KARNATAKA RWSS I1

Gujarat Emergency Earthquake Reconstruct

KAR WSHD DEVELOPMENT

Rkl POWER I LEPROSY I1

Grand Trunk Road Improvement Project

KARN HWYS

TECHN EDUC 111 KERALA RWSS

RAJ DPEP I1

POWERGRID I1 MP DPIP

GUJARAT HWYS

396.00

0.00

99.50 105.51

240.00

0.00 0.00

0.00

39.50

0.00 0.00

0.00

0.00 348.00

488.00

0.00

0.00 0.00

0.00

0.00

463.00

0.00 255.00

0.00 0.00 0.00

0.00 180.00

0.00

589.00

360.00

0.00 0.00

0.00 450.00

0.00

381.00

0.00

68.00

300.00

0.00 0.00

181.00

500.00

89.00

0.00 0.00

69.62

54.03

150.03

0.00 0.00

250.00

112.56

108.00

60.00

140.00

79.00

98.90

0.00

149.20

151.60

442180

100.40

0.00 30.00

0.00 0.00

64.90 65.50

74.40

0.00 110.10

0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00

0.00

0.00

0.00 0.00

0.00

0.00

0.00 0.00 0.00

0.00 0.00

0.00

0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00

0.00 0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00 0.00

0.00

0.00

1 .oo 0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00

0.00 394.02

0.00 68.81

0.00 401.75

0.00 104.98

0.00 227.60

0.00 178.89

0.00 415.20

0.00 85.19

0.00 39.50

0.00 0.90

0.00 69.53

0.00 55.59

0.00 138.11

0.00 332.99

0.00 433.14

0.00 270.53

0.00 117.10

0.00 100.31

0.00 53.82

0.00 141.66

0.00 480.27

0.00 109.41

0.00 207.90

0.00 160.49

0.00 162.25

0.00 326.64

0.00 104.56

2.02 78.22

0.00 3.01

0.00 422.63

0.00 262.13

0.00 43.46

10.00 44.24

0.00 50.06

0.00 166.15

0.00 87.50

0.00 237.42

0.00

0.00 0.00 0.00

18.80

1.32

66.09

9.20

6.70

0.13

0.00 9.32

47.87

21.89

76.93

33.39

-0.45

0.70

6.00

55.97

85.71

25.56

9.90

92.32

45.22

343.04

66.96

74.73

9.63

265.63

104.13

21.46

19.89

10.14

104.15

36.06

167.42

0.00

0.00

0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00

-0.75

1.51

0.00

-6.16

7.67

44.64

74

PO09972 PO49770 PO10505

PO35172

PO45049 PO50657 PO55456

PO59501 PO50667 PO67330

PO4 1264

PO45050 PO45051

PO50651 PO50646

PO50637 PO38021 PO10496 PO10561

PO49385 PO35827

PO 10473 PO44449 PO10511

2000 2000 2000 2000

2000 2000

2000

2000 2000 2000

1999 1999 1999 1999 1999 1999 1998

1998 1998 1998

1998 1997 1997

1997

NATIONAL HIGHWAYS I11 PROJECT REN EGY I1 RAJASTHAN DPIP

UP POWER SECTOR RESTRUCTURING PROJECT AP DPIP UP Health Systems Development Project

IN-Telecommunications Sector Reform TA IN-TA for Econ Reform Project UP DPEP 111 IMMUNIZATION STRENGTHENING PROJECT Wtrshd Mgmt Hills I1 RAJASTHAN DPEP 2ND NATL HIVIAIDS CO MAHARASH HEALTH SYS UP Sodic Lands I1

TN URBAN DEV I1 DPEP 111 (BIHAR)

ORISSA HEALTH SYS Natl Agr Technology AP ECON RESTRUCTURIN

WOMEN and CHILD DEVLPM TUBERCULOSIS CONTROL RURAL WOMEN'S DEVELOPMENT

MALARIA CONTROL

516.00 80.00 0.00

150.00

0.00 0.00

62.00

0.00 0.00 0.00

85.00 0.00 0.00 0.00

0.00 105.00

0.00 0.00

96.80 301.30

0.00

0.00 0.00

0.00

0.00 50.00

100.48 0.00

111.00 110.00

0.00

45.00 182.40 142.60

50.00 85.70

191.00 134.00 194.10

0.00 152.00 76.40

100.00 241.90 300.00

142.40

19.50 164.80

0.00 0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00

0.00 0.00 0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00

20.00

0.00

0.00 0.00

0.00 0.00 0.00

16.96

0.00

0.00 0.00 0.00

18.00 0.00

0.00 13.04 6.72

46.50

314.00 86.83 73.56

10.56

49.34 87.10 13.18

40.07

49.06 12.11

20.50

28.30 58.88

49.25 73.89

15.97 79.62 48.99 37.28 97.95

178.01

47.93

5.74 40.46

237.35 53.26 69.90

10.56

8.48

46.78 33.18

9.90

50.12 -75.97

23.03 25.93 56.69 61.63 63.41 15.97

71.59 44.67

60.30 95.77

168.71 65.97 13.44 87.12

-6.00

10.63 29.29

0.00

0.00 0.00 1.07

5.07 11.69

0.00

0.00 13.68 0.00

-1.56 0.00

10.32 18.23 -2.52

32.60 13.80 4.15

19.57 4.81

40.73

Total: 5,790.61 6,042.32 0.00 1.00 133.24 8,094.54 3.133.60 252.47

75

INDIA STATEMENT OF IFC’s

Held and Disbursed Portfolio In Mill ions o f U S Dollars

Committed Disbursed

IFC IFC

FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic.

2005 2002103 2003

1994 1992193

2003 200 1 I04 200 1

2003 2001 198419 1

2001103 1997 1990192

2004 2004

2002 2004 1995 2003 2003 1997

1995 200 1 1994 1994198100 1994 2003 2001 1998 1995100 1998 200 1 1990193198 1992195

2000 1996 1985190194

AP Paper Mills

ATL

Alok

Ambuja Cement

Arvind Mills BHF

BILT

BTVL

Balrampur

Basix Ltd.

Bihar Sponge

CCIL

CEAT

CESC

CGL

CMScomputers

COSMO

Caim Energy

Centurion Bank

DQEL

Dewan

EEPL

EXB-STG

GE Capital

GTF Fact

GVK

Global Trust

Gujarat Ambuja

HDFC

HIWEL

IAAF

ICICI-SPIC Fine

IDFC

IIEL

IL and FS

ILandFS VC

IndAsia Fund

India Direct Fnd

India Lease

35.00 1 .oo 17.50 0.00 0.00

10.37 0.00

0.00

15.12 0.00

0.00

1.50 8.50

16.36 15.00

10.00 7.50 40.00 0.00

0.00 12.23 0.00 0.31 0.00

0.00 0.00

0.00 0.00

100.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00 0.00 0.00

0.00

0.00 0.00

0.00

4.94 3.33

0.00 0.00

10.00

0.00 0.98

0.05 0.00

0.00

0.00 0.00

10.00 0.00 0.00

0.77 1.50 0.00

0.03 0.00

4.39 2.39 7.45

0.36 4.88

0.00 1.64 1.45

2.79 15.46 3.13 3.12 0.60

14.39 6.33 0.30

0.00 0.00 0.00 0.00

0.00 10.37 15.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00

0.00 2.50 0.00 0.00 0.00 1.50

0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00 0.00

0.00

0.00

0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00 0.00

36.48 0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00 ’

100.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.68 0.00 0.00

0.00 2.16 0.00

0.00 15.12 0.00

0.00 0.59 8.50

16.36 0.00 5.00

7.50

0.00 0.00

0.00 12.23 0.00 0.31 0.00

0.00 0.00

0.00 0.00

100.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00 4.94

3.33 0.00 0.00

10.00 0.00

0.98

0.05 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.77

1.50 0.00

0.03 0.00

4.39 2.39

7.45

0.36 4.88 0.00

1.64

1.29 2.79

15.46

2.06 3.12 0.60

0.00 5.84

0.30

0.00 0.00 0.00 0.00

0.00 2.16

15.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 1.50 0.00 0.00

0.00

0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00

0.00

0.00

36.48 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

100.00 0.00

0.00

0.00

0.00

0.00

0.00 0.00 0.00 0.00

0.00

76

2001

1993

1996

1992

1992

1992194

2001

2003

1990193

2002

2003

2001

2003

1996/99/00

I992196197

2001

2003104

2003

2001

1997 2004

1995

2004

1995104

1997

2001

1997100

1995

200 1/03

2004

2000/02

1998

2002

1989

2004

1996

2002

2001

1997

1997

Indian Seamless

Indo Ram Indo Ram (IRTL)

Indus I1

Indus VC Mgt Co

Info Tech Fund

Ispat Industries

Jetair

LandT

MandM

MMFSL

MSSL MahInfra

Max Healthcare

Moser Baer

NICCO-UCO

NIIT-SLP ,

NewPath

Niko Resources

Orchid

Owens Coming

Powerlinks

Prism Cement

RAK India

Rain Calcining

SAPL

SBI SREI

Sara Fund

Spryance

Sundaram Finance

Sundaram Home

TCWIICICI

Th4L

UCAL

UPL

United Riceland

Usha Martin

Vysya Bank

W N

Walden-Mgt India

10.50 7.86

0.00 0.00 0.00

0.00 7.50

0.00 50.00

0.00 10.05

0.00

0.00 19.44

24.20

1.88

6.05

0.00 30.00

0.00 11.56

73.43

11.25

20.00

10.00 0.00

50.00 8.50

0.00 0.00

43.19

10.35

0.00

50.00

0.00 17.50

8.13

21.00

0.00

0.00 0.00

0.00

0.00

0.71

1.88

0.01

0.60

0.00 0.00 0.00

0.03

0.00

2.29

10.00

0.00 9.68

0.13

0.00 3.00

0.00 4.27

0.00 0.00 5.02

0.00

0.00 0.07

0.00 0.00

5.94

1 .oo 0.00 0.00 3.92

0.00

0.03

0.00

0.00 3.60

3.66

1.97

0.02

0.00 0.00

0.00

0.00

0.00 0.00

0.00 15.00 0.00 0.00 7.56

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00

0.00

0.00

0.00 0.00

0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00

6.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00

0.00 0.00 0.00 0.00

0.00

0.00

6.00

7.86

0.00 0.00

0.00 0.00

7.50

0.00 50.00

0.00 10.05

0.00

0.00 0.00

24.20

1.88

0.04

0.00 20.00

0.00

11.56

3.56

11.25

0.00 0.00

0.00 0.00 8.50

0.00 0.00

43.19

10.35

0.00 50.00

0.00 17.50

8.13

21.00

0.00 0.00

0.00

0.00 0.00

0.71

1.88

0.01

0.60

0.00 0.00

0.00 0.03

0.00 2.20

0.70

0.00 9.68

0.13

0.00 2.03

0.00 4.27

0.00

0.00

5.02

0.00 0.00

0.07

0.00 0.00

5.94

1 .oo 0.00 0.00

3.92

0.00

0.03

0.00 0.00 3.60

3.66

1.97

0.02

0.00

0.00 0.00

0.00 0.00

0.00 0.00

15.00

0.00 0.00 7.56

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00

0.00 0.00

0.00 0.00 0.00 0.00

0:oo 0.00

0.00

0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00 0.00 0.00 0.00 0.00 6.00

0.00 0.00 0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00

0.00 0.00

0.00 Total portfolio: 792.78 158.11 51.93 142.48 481.02 121.64 41.22 142.48

77

Approvals Pending Commitment

FY Approval Company Loan Equity Quasi Partic.

2005 2000

2004 2004 2001 2005

2003 2004 2005

2004 2002

2001

AP Paper Mills

APCL

CGL

CIFCO

GI Wind Farms H and R Johnson

Niko Resources

Ocean Sparkle

SRF Ltd.

Sealion Sparkle

TML

Vmva Bank

0.00 0.01

0.01 0.00 0.01

0.03 0.01

0.00 0.02 0.01 0.02 0.00

0.01

0.00

0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00

0.00 0.00 0.00 0.02

0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00

0.00

0.00 0.00 0.00 0.00

0.00 0.00

0.00 0.00 0.00 0.00 0.00

~ ~ ~~

Total pending commitment: 0.12 0.01 0.02 0.00

78

Annex 14: Country at a Glance INDIA: Small and Medium Enterprise Financing and Development Project

- 3 0

POVERTY and SOCIAL

2003 Populatron, midyear (miuionr) GNI per capita (Atlas method, US$) GNI (Atlas method, US$ billrons) Average annual growth, 199703

Population ( % j Labor fone (%I Most recant estimate Wtea year available, 1997.03)

Povertv f% of poPu/afton below natmnal Dove& /ineJ Utban wpulation 4 of fotafpopu/dionj Life exwctancy at birth (years) Infant martalltv Iwr 1,OOO live brrths) Child IlWhMtfZIoil(% ofchildren under 51 Access to an improved water source I% Ofwpu/aOon) Illiteracy (% ofpopulation age ?5+) Gross pnrnary enrullment /% of school-age populationj

Male Female

KEY ECONOMIC RAllOS and LONG-TERM TRENDS 1983

GDP (US$ bllions) 212 3 Gross domestic investmenVGDP 19 7 Expats of goods and ~#rv~csslGDP 6 0 Gross dwnestic savingslGDP 17 6 Gross natimaf savingdGDP 16 4

I

Current amount balcmce/ODP interest paVmenZslGDP ldal debt/GDP Total debt SeNiCe/eXpOftS Present value of debffGDP Preseni value of debffexports

1983-93 lgg303 ZOO2 2003

Agnculture 3 1 2 4 -5 2 9 1

Manufactunng 6 1 6 0 6 2 7 3 Services 6 7 8 1 7 1 8 7

General govemment consumption 5 6 7 1 3 1 9 9 Gross domestic investment 5 3 7 5 9 5 120 Imports of goods and services 6 3 106 8 1 111

(average annual growth)

industry 6 4 5 9 6 4 6 7

Pnvate consumption 5 2 4 5 -08 7 6

-1.7 0 4

15 1 16.5

p 20

lo

-,J sa 99 w 01 m m

__ii* Exports -imports L

1983-93 199303 (average annuai growul) GDP 5 4 5 9 GDP Der caoita 3 3 4 2

lndia

t,W 4 540

569 8

1 6 2 1

29 28 63 65 47 84 39 99

207 90

1 9 s

273 9 21 3 10 0 22 5 23 1

-06 1 3

34 4 25 2

2002

4 6

South Asla

1,425 510 726

1 8 2 3

28 63 68 48 a4 41 95

103 88

2002

510 2 22 8 15 2 24 2 263

0 7 0 7

20 6 13 9

2003

8 3

Low. income

2,310 450

1.038

1 9 2 3

30 58 82 44 75 39 92 99 85

2003

603 3 23 8 14 5 22 2 24 4

1 4 18 3 19 6 18 3

2003.07

6 0 6,7 4.6

-1 -- Development diamond"

Life expectancy

T GNI Gross per + pnmary capita enrollment

1

Access to improved water source

lndia Lowincome group ----a>

Indebtedness

lndia Lowincome group " *z_-,

79

India PRICES and GOVERNMENT FINANCE

Domestic prices (% change) Consumer prices Implicit GDP deflator

Government finance 1% of GDP, indudes current grants) Current revenue Current budget balance Overall sumluddeficit

TRADE

(US$ millions) Total exports (fob)

Tea Iron Manufactures

Total imports (cif) Food Fuel and energy Capital goods

Export price index (1995=100j Import price index (1995=100) Terms of trade (1995=100)

BALANCE of PAYMENTS

(US$ millionsf Exports of goods and services Imports of goods and services Resource balance

Net income Net cumnt transfers

Current account balance

Financing items (net) Changes in net reserves

Memo: Reserves including gold (US$ mi//ions) Conversion rate (DEC, local/US$j

EXTERNAL DEBT and RESOURCE FLOWS

(US$ mi///ons) Total debt outstanding and disbursed

IBRD IDA

Total debt service IBRD IDA

Composition of net r e s " flows Official grants Official creditors Private creditors Foreign direct investment Portfolio equity

World Bank program Commitments Disbursements Principal repayments Net Rows Interest payments Net transfers

1983 1993

14.4 5.0 8.9 9.5

.. 17.5

.. 4.3

.. -8.3

1983 I993

9,861 22,683 348 814 434 888

5,234 16,657 16,575 26,739 1,694 327 4,703 5.754 3,069 6,243

101 104 106 96 96 109

1983 1993

13,141 27,947 18,767 31,468 -5,626 -3,521

-527 -3,270 2,558 5,265

-3,595 -1,526

2,777 10,160 818 -8,634

5,649 19,254 10.3 31.4

1983 1993

32,139 94,342 1,779 10,123 7,820 16,192

2,618 8.345 246 1,509 91 294

380 368 1,360 1,754 1,318 2,634

0 668 0 3.567

1,072 929 1,345 1,716

120 964 1,225 753

216 838 1,009 -86

2002

4.1 3.5

17.5 -6.0

-10.2

2002

52,512 1,432 1,996

40,245 65,422 2,411

17.640 13,498

88 96 92

2002

77,475 83,620 -6,145

4,935 14.807

3,727

13,253 -16,980

75.428 48.4

2002

105,210 5,141

21,642

13,042 3,029

637

410 -3,657 -1.861 3,611

944

1,523 1,465 3,196

-1,730 470

-2,200

2003

3.7 3.7

18.7 4 .9 -9.3

2003

62,952 1,321 2.341

47,616 79,658 3,059

20,570 17,132

93 100 94

2003

90.568 96,590 6,022

4,703 18,885

8,160

8,820 -16,980

111,648 46.0

2003

118,075 4.128

22,632

20,545 2,048

693

559 -2,765 -1,983 3,137

1 1,355

1,169 1,557 2,403 846 338

-1.184

15

10

5

0 98 69 w 01 02 03

&-'GDP deflator I -O-CPI I Export and Import levels (US$ mill.)

Current account balance to GDP (%) 7 01 02 03 1

1.2 1

Composition of 2003 debt (US$ mill.)

9,472 A: 4.128

F 57.72

E - Bilateral

G - Short-term

A - IBRD B - IDA 0 -Other multilateral F - Private C ~ IMF

ueveiopment tconomics

80