World Bank Documentdocuments.worldbank.org/curated/en/300931468103483824/... · 2016-07-13 · THE WORLD BANK FOR OMCIAL USE ONLY Washington. D.C 20433 U.S.A. Office o Diectetw-Gewal

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The World Bank

FOR OMFCIAL USE ONLY

MICROFICHE COPY

Report No. 10325-CE Type: (PCR) ReportNo. 10325ANDERSON, / X31676 / T9 111/ OEDD2

PROJECT COMPLMTION REPORT

SRI LANKA

SECOND SMALL AND MEDIUM INDUSTRIES PROJECT(CREDIT 1182-CE)

FEBRUARY 11, 1992

Industry & Energy Operation DivisionCountry Department ISouth Asia

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

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PROjECT CCWST!E ME=T

SECOND SMALL AND HEDIUM IN_USTRIES PROJECT

(CREDIT 1182-CE)

CURRENCY EQUIVALENTS(Annual Average.)

Sri Lanka RARepe Oer USS100

1981 - Rs. 19.251992 - Rs. 20.811983 - Rs. 23.531984 - Rs. 25.441985 - Re. 27.161986 - Rs. 28.021987 - Re. 29.441988 - Re. 31.811989 - Re. 36.051990 - Rs. 40.06

ABBREVIATIONS AND ACRONYMS

BOC - Bank of CeylonCBOC - Commercial Bank of CeylonCITI - Clothing Industry Training InstituteIDB - Export Development BoardGDP - Gross Domestic ProductGOSL - Government of Sri LankaHNB - Hatton National BankIDB - Industrial Development BoardNDB - National Development BankPB - People's BankSAR - Staff Appraisal ReportSMI - Small and Medium Industries

FISCAL YEARS

Government of Sri Lanka - January 1 to December 31Commercial Banks - January 1 to December 31NDB - January 1 to December 31

THE WORLD BANK FOR OMCIAL USE ONLYWashington. D.C 20433

U.S.A.

Office o Diectetw-GewalOpefatbws Evaluttt

February 11, 1992

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Completion Report on Sri Lanka -Second Small and Medium Industries Proiect (Credit 1182-CE)

Attached, fnr information, is a copy of a report entitled "ProjectCompletion Report on Sri Lanka - Second Small and Medium Industries Project(Credit 1182-CE)" jointly prepared by the Industry and Energy Division and theResident Mission in Sri Lanka of Country Department I of Asia Region with PartII contributed by the Borrower.

Attachment

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

FOR OFFICIAL USE ONLY

PROJECT CO*fPLETIOI REpoRj

SECOtD SHALL AND HEDIMN £IDUSMES PRO-jCT(CREDIT 1182-CE)

TABIE OP CONTENTS

Pee No.

Preface ... ..... . . . . . . . . . . . . . . . . (1)

Evaluation Sutary .... ... . . .... . ...... . . . . (iii)

PR I: PROJECT REVIEW FROM IDA'S PERSPECTIVE . . . 1

1. Project Identity . . . . . . . 1 . . . . . . . . . .

2. Baekgro-xnd and sectoral context . . . . . . . . . . .- Policy Context . ... 1- The Industrial Sector . . . . . . 1

3. Project Objectives and Description . . . . . . . 2Project Objectives. . 2

- Project Description... 2-rTechnical Assistance . 2

4. Project Design and Organization. 2

5. Project Implemencation. . . 3- Sub Project Operations. .. . 3- Sectoral Classification . 3- Geographical Dispersion . . . . . . . 3- The Role of NDB and PCIs . . 4- Technical Assistance Component . . . S . 5- Adequacy of Interest Rates . 5

6. Project Results . . 6- Credit Component . . . . ..... 6- Technical Assistane ...... . . . . . . . 6

7. Project Sustainability . . . . . . . . . . . . . 7- General .... . * .. .. . . . . . . .. . 7- TA Component . . . . . . .. . . . . . . . . . 7- Credit Component .... . . . . . 7

8. TDA's Performance . . . . . . . . 8

9. Borrower's Performance . . . . . . . 8

10. Project Relationships . . . .. . . . . . . . . 8

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

Tables of Content - continued

1I. Consulting Services . . . . . * . . . . . * . . . . . 9

12. Project Documentation and Data . . . . . . . . . . 9

13. Conclusions and Lessons Learned . . . . . . . . . g

PART II: PROJECT REVIEW FROM BORROWER'S PERSPECIIVE l.

PART III:STATISTICAL INFORMATION . . . . . . . . . . . . . . . 12-16

1. - Related Bank Loans . . . . . .... ........ 12

2. Project Time Table . . . . . . . . 13,

3. Credit Disbursement . . .. a. .. 13

4. Project Implementation ..... ... 13

5. Project Costs and Financing..... . . . . . . 14A. Project Costs . . . . . . . . . . * . . * * 14B. Project Financing . . . . . . . . . . . . 15

6. Project Results ..... 15A. Direct Benefits.. l.... . *.*.15

B. Economic Impact . .l.5.. . .

C. Financial Impact . . .15

7. Status of Covenants . . . . ... . . . . . . . 15

8. Use of Bank Resources i . 15A. Staff inputs . . . 15B. Missions . . . . . . . . . . . 16

ANNEXS

I. Sub Sectoral Distribution of Sub-Loans . . . . . . . 171I. Size Distribution of Sub-Loans . . . . . . . . . . .III. Analysis of Arrears . ..... . ........ 19

IV. Annual Collection Performance . . . . . . . . . . 21V. Present Statur of Projects Financed and 2

Reasons for Trojects in Default . . . . . . . . . .VI. Net Re-financing Approvals by PCIs . . . . . . . . . 23

- i -

PROJECT COMPLETION REPORT

SRI LANKA

SECOND SMALL AND MEDIUM INDUSTRIES PROJECT

(CREDIT 1182-CE)

PREFACE

This is the Project Completion Report (PCR) for the Second Smalland Medium Industries Project in Sri Lanka, for which Credit 1182-CE in theamount of SDR 26.7 million (US$30.0 million equivalent) was approved onOctober 13, 1981. The cred_i._ was closed on December 31, 1987, atter two oneyear extensions. It was disbursed to the extent of SDR equivalent of US$32.31million; the undisbursed amount of US$210,000 was canceled. The lastdisbursement was on April 14, 1988.

The PCR (Preface, Evaluation Summary, Parts I and III) was jointlyprepared by the Industry and Energy Division and the Resident Mission in SriLanka of Country Department I of Asia Region, and Part II by the NationalDevelopment Bank (the apex institution) on behalf of the Borrower.

Preparation of this PCR was started in January 1991 and is based,inter alia, on the Staff Appraisal Report; the Development Credit and ProjectAgreements; supervision reports; correspondence between IDA and the borrower;and internal Bank memoranda.

- iii. -


SRI AA


(CREDIT 1182-CE)

EVALUATION SUMMARY

Objectives

(M) The major project objectives were to increase output, employmentand exports through financial assistance to Small and Medium Industries (SMI)and by addressing constraints hindering their growth, productivity, andtechnological improvements, particularly in sub-sectors with significantexport potential.

ImDlementation Experience

(ii) The project had two components: (a) a credit component of US$28million on-lent by the Government of Sri Lanka (GOSL) to the NationalDevelopment Bank (NDB), the apex institution, for refinancing loans to SMIsmade by four commercial banks and the Development Finance Corporation ofCeylon (DFCC); and (b) a technical assistance component of US$2 million tostrengthen capabilities of institutions assisting the private industrialsector.

(iii) The project became effective on May 5, 1982. The credit componentwas fully committed by December 1987 and disbursed by April 1988 as againstthe appraisal estimates of 1984 and 1986, respectively. Initially, the rateof commitment and disbursement was slower than estimated at appraisal due toover-optimistic assessment of effective loan demand, adverse reaction by SMIborrowers to the perceived high rates of interest and ethnic disturbances inparts of the country. To expedite commitment and disbursement, the scope andsize of projects and amount of loans eligible fox refinancing were enlargedand interest rates reduced (Paras. 5.01-5.02).

(iv) The TA component provided funding for assistance to: (a) NDB andthe Participating Credit Institutions (PCIs) to upgrade their capabilities;(b) Industrial Development Board (IDB) to stzengthen its extension program byproviding an advisor to coach regional extension officers, establish a SHIconsultancy fund to tap local private expertise and expand its engineeringservice facilities; and (cj the Export Development Board (EDB) to divelop itsprogram of export promotion and supply development in key light industrialproduct lines.

Results

(v) The credit component financed over 2,500 sub-projects, mostly forexn-r. Son, mal.-ly in traditional sectors and in urban areas. These sub-prr .s are eotimated to have created 25,000 jobs at an estimated investmentcost -r job of US$1,900. The financed sub-projects' export potential appearslimitud althouih the project imphasized export development. A limited surveyof 66 sub-projects carried out in 1989 indicated that about one-third werefinancially shaky because of cost overruns or poor sales (Para. 6.01). As ofDecember 31, 1990, the principal infection ratio (representing the portion ofthe portfolio uith arrears of six months or older) was 33Z. The averagecollection ratio-as of this date was 792 (Para. 6.02).

(vi) The TA program's performance was mixed. While the TA to NDB andPCIs for institution building waF effective, the impact of programs directedat building up IDB's extension centers/activities was modest. EDB's programs,particularly the Clothing Industry Training Institute (CITI) and the LapidaryTraining Center, were successful. The TA program's mixed performance was dueto the following factors: (a) the program was overly ambitious, going beyondthe management capabilities of implementing agencies; (b) some of theactivities were supply driven rather than based on an analysis of marketdemand; and (c) the implementing agencies were unable to retain qualified andtrained staff due to poor compensation policies. IDA had identified theseissues during project appraisal but was unable to closely monitor implemen-tation due -to the inappropriate skill mix of its supervision missions (Paras.5.08, 6.03-6.05). -

Sustainabilitv

(vii) On the basis of a limited survey of sub-project performance,including repayrent performance, the sustainability of a number of sub-projects, i.e. their ability to continue to generate expected benefits overtheir useful life, is doubtful (Para. 7.01).

(viii) Sustainability of the results of TA presents a mixed picture.While there were initial gains in the capacity of IDB to provide extensionservices, it failed to retain staff due to lack of adequate incentives. TAwas more succe3sful in providing training facilities by establishing LapidaryTraining Center, Jewelry Training School, Musnroom Development Center andClothing Industry Training Institute. EDB has grown into a large institutionand continues to have influence in improving export policies and procedures.

(ix) Project appraisal skills continue to improve in all PCIs, withconsequent beneficial effect for SMI III. In terms of financial viability oflending institutions, SMI II had little effect as this type of lendingremained a relatively small portion of the commercial activities for the PCIs.Although all PCIs have invested staff resources in building up their SMIdepartments, it remains to be seen whether all of them would continue toprovide financing to SMIs without refinancing facilities from the GOSLIIDA.

-V

In±ingas ond J.essons Learned

(x) The most important lesson is that only those institutions whichare prepared to make a long-term commitment to SKI development throughstaffing end appropriate lending policy and procedures should be eligible toparticipate in future operations. This cammitment should extend toestablishing an organization structure which would involve a decentralizationof decision making to major branches and their adequate staffing. Lending toSMIs should be a part of their long-term strategy and not a transientinvolvement due to the availability of World Bank Group credit lines.Allowing all banks to participacL on the grounds that greater coLpetitionwould improve the project impact does not seem to be borne out by results(Para. 5.10).

(xi) Another important lesson for future SMI projects is thatfinancial assistance alone cannot ensure successful implementation oroperation of an SMI; the latter needs business advisory services from thestage of project conception to commercial operation. Arrangements for such aaervice should be an integral part of the project (Para. 13.03).

(xii) TA programs under the project were rather ambitious and did notvisualize the organizational and management weaknesses of the implementingagencies. IDA staff should have devoted more supervision effort in monitoringthe implementation of these programs (Para. 13.04).


SRI LANKA


PART I: Proiect Review From IDA's Perspective

1. PSo1ect Identity

Project Name: Second Small and Medium Industries Project(SMI II)

Credit No. 1182-CERVP Unit AsiaCountry : Sri LankaSector Industry

2. Background and Sectoral Context

2.01 Policy Context. In 1977, Sri Lanka adopted a dynamicliberalization program after a long period of control and regulation. Thethrust of the reforms was to reorient the economy in an outward direction andto reverse the bias against the private sector. The main elements of thereform package were a large devaluation coupled with eliminaticr of the dualexchange rate system, elimination of a large number of import quotas and theirreplacement by tariffs, easing of exchange controls, decontrol of most productprices and recourse to interest rates to determine credit allocation. Amongother measures adopted to reorient the economy were: (i) the establishment ofan Export Development Board (EDB) to administer a wide variety of exportincentives aimed at encouraging non-traditional exports; (ii) creation of aFree Trade Zone and encouragement of foreign-owned export oriented enterprisesto locate there; and (iii) relaxation of the strict rules and regulations onprivate domestic investments.

2.02 The Industrial Sector. Sri Lanka has a limited industrial baseconsisting of 30 public manufacturing enterprises, 500 large scale privateregistered factories, 5000 small and medium scale registered factories,approximately 25,000 small cottage units concentrated in handicrafts andservices and an estimated 100,000 units employing less than 5 persons.

2.03 The manufacturing sector contributed 17Z of GDP and accounted for52Z of exports in 1990. The sector provided about 11.6% (1990) of totalemployment. The private sector was estimated to account for 60% of manu-facturing value added. Most SMIs are oriented towards the domestic marketwith the exception of firms in garments and gems and jewelry. The latterindustries have emerged as extremely successful exporters, accounting for 582of manufactured exports.

2.04 The gradual liberalization of the trade regime and deregulation ofinternal investment controls have in ressed competition putting pressure onSMI firms to improve quality and reduce cost. The number of SMI firms engagedin activities involving modern technology and high level skills is verylimited. Lack of linkages between small and large firms has been a criticalconstraint to SMI growth in sectors such as engineering where a large numberof SMIs can be found in many newly industrializing countrics.

3. Project Objectives and Descri

3.01 Proiect Obiectives The major project objectives were to increaseoutput, employment and exports through financial assistance to SMIs and byaddressing constraints hindering their growth, productivity and technologicalimprovements, particularly in sub-sectors with significant export potential.

3.02 Project Description. The project provided SDR 26.7 million(US$30.0 million) in IDA financing, of which US$28.0 million equivalent wasfor the credit component and US$2.0 million for technical assistance. Thecredit component was to be on-lent by the Government to the NationalDevelopment Bank (NDB) as an apex body under a subsidiary loan agreement forthe account of a separately managed SMI Refinancing Fund within NDB. The SMIFund would provide refinancing of sub-loans made by participating creditinstitutions (PCIs) to SMIs which met financial and economic eligibilitycriteria. Responsibility for sub-project appraisal, on-lending andsupervision was delegated to the five PCIs: two public commercial banks, theBank of Ceylon (BOO) and the Peoples Bank(PB); two locally controlled privatecommercial banks, the Hatton National Bank (HNB) and the Commercial Bank ofCeylon (CBOC); and the Development Finance Corporation of Ceylon (DFCC).

3.03 The technical assistance component of US$2.0 million was tosupport: (a) institutional strengthening of the NDB and of the PCIs; (b) TheIndustrial Development Board's promotion and extension services, expansion ofengineering and technical services centers and SMI Consultancy Fund to tapprivate sector know-how; (c) The Export Development Board's promotion andsupply development programs including pilot projects in key light ind"stries;and (d) an Expansion Fund to support sub-sector schemes.

4. Proiect DesiRn and Organization

4.01 The project was the second in a series of prnjects, apprcved byIDA with the objective of achieving broader policy reforms in the trade andindustrial sectors in addition to providing conventional lines of credit andtechnical assistance to small and medium scale industrial and service firms toexpand output, employment and exports. A modest start in this direction hadalready been made under the SMI I project and the Government was keen tocontinue the activities and programs supported thereunder. Although SMI I didnot meet its overly ambitious objectives, it focused the GOSL's attention tothe need for policy reforms in the trade and industrial sectors andhighlighted the demand for term credit for SMIs. It, therefore, appreciatedthe projects scope and scale and its timing.

- 3-

5. Proiect Imlementation

5.01 The credit component of US$28 million was fully committed byDecar.ber 1987, and the final disbursement was made in April 1988, as againstthe appraisal estimates of 1984 and 1986, respectively; US$0.2 million fromthe TA component was canceled. Initially, commitments and disbursements wereslower than estimated at appraisal due to over-optimistic assessment of loandemand, the PCIs' increasing awareness of SMI borrowers' poor repaymentrecord, borrower resistance to the high interest rates charged for SMI loansand ethnic disturbances. As some of these problems resulted from misjudgedparameters, GOSL and IDA agreed to review the sub-project eligibility criteriaand to make adjustments in the light of new information. The scope ofprojects eligible for refinancing was enlarged to include some commercialsectors because of the saturation of loan demand from the traditional sectors,and loans for permanent working capital requirements were made eligible. Atthe same time, the size of sub-projects and -he maximum sub-loan size eligiblewere increased, and rate of interest to SMI borrowers was reduced.

5.02 Sub-project operations. The number and amount of sub-loansfinanced under the credit by PCIs is given in Annex VI. The Bank of Ceylonaccounted for the largest number and amount financed, followed by Peoples Bankin number and the DFCC in amount. A breakdown of sub-loans approved by sizeis given in Annex II. About 49% of the loan amount went for sub-loans overRs.1 million; the average sub-loan size was over Re. 400,000 ($10,000)reflecting the larger proportion of expansion projects. According to theappraisal estimates about 602 of the credit component would hava gone to loansbelow Rs. 500,000; actually only 26% went to loans of that size, partly due tothe changes in sub-project eligibility criteria. The lending operations ofthe five institutions included in the SMI II as PCIs (four commercial banksand DFCC) also affect this statistics as these institutions are less suited toservice "cottage industry" end of the spectrum.

5.03 Sectoral Classification. The Project mainly financed enterprisesin traditional industries: food processing (27%), metal products (82),printingw & paper and construction material (7% each), garments and commercialtransport (6% each), and wood products (5%). The credit appears to have hadvery little impact on promoting new technological processes or products notcontributed significantly to export growth.

5.04 Geographical Dispersion. The major concentration of industrieswas in urban areas: Colombo (28%), Gampaha (13%), Galle (10), with 4%-5% eachin the smaller towns of Kurunegala, Matara, Ratnapura, Kandy and Kegalle. Nofinancing was provided in the North or East, which were affected by ethnicdisturbances. The sectoral composition and regional distribution of the sub-projects financed reflects the sectoral and regional distribution of existingSMI units, since most of the sub-projects were expansions of existing firms.The lack of effective programs of entrepreneurial development n-' supportinginfrastructure as well as the ethnic disturbances appear to be responsible forconcentration of industries in selected industries and regions.

5.05 The Role of NDB and the PCIs. NDB was the apex institution underthe project and used its SMI Departwent to administer the Project operations.The diŽpartment benefitted from technical assistance under the project tostrengthen its capabilities in this area. The main functions of thedepartment were to: (a) operate an SMI Fund and refinance 80Z of loan amountsdisbursed by PCIs to eligible SMIs; (b) recycle sub-loan repayment under thecredit; (c) monitor commitments and disbursements under the credit, includingsectoral exposure limits, and submit regular reports to IDA; (d) reviewappraisale above the free limit submitted by PCIs; (e) liaise with the CentralBank SMI Credit Guarantee Scheme; (f) train PCI staff on project appraisalprocedures; and (g) undertake sub-sectoral studies.

5.06 The SMI Department helped in upgrading PCI's project appraisalstandards by establishing norms for financial parameters and assisting some ofthem in identifying sourc;s of machinery, etc. The TA funds available underthe credit enabled NDB to undertake an extensive training program for PCIofficers which enabled them to improve appraisal standards. The department'sability to monitor sub-project appraisals also improved. With IDA'sassistance, it implemented a quarterly reporting system for PCIs whosebranches provided data directly to the Department relating to commitments,utilization, collections and arrears; the latter collated the data andsupplied summary information to PCI headquarters. NDB did not carry out anysub-sectoral studies.

5.07 A serious shortcoring of the monitoring system was the lack of anin-built mechanism to collect information on the financed sub-projects' ex-post economic and financial performance, which prevented the assessment of theeconomic benefits of the sub-projects or of the SMI II itself. Whilecollection of t;.is information in respect of thousands of sub-projectsfinanced under the credit would have been a difficult task, particularly forthe participating commercial banks' branches where most of the financingactivities took place and whose staff does not have the orientation orappreciation of economic benefit assessment, IDA should have used itsavailable remedies to require the PCIs to develop a mechanism under which theavailable information regarding SMIs' financial performance, employmentgeneration, export performance etc. could be collected.

5.08 The main reason for encouraging a number of commercial banks withbranch networks to provide term financing to SMIs was to encourage competitionand imprcve accessibility of term finance, particularly to small firms locatedin small towns and non-urban areas through bank branches. The competitionmaterialized mainly between the two large state-owned banks: the two smallerprivate banks with limited branch network, participated to a very small extent(combined total of 8Z) in refinancing under the project. The technicalassistance funded under the credit enabled the PCIs to improve theirinstitutional capabilities to appraise proposals for term financing and tosupervise projects. The two state-ownad banks (BOC and PB) set up their ownSKI departments and invested substantial effort in training staff on SNIlending, but because of transfers, promotions etc., these departmentscontinued to remain inadequately staffed, and lending decisions were highlycentralized. This situation is reported to have since improved, and some loanapproval powers have been delegated to branch managers. Furthermore, the

training programs were not rigorous enough, lasting only 3-4 days for bothappraisal and supervision training. According to available information, mostlending decisions by banks continue to be based on security considerationsrather than on project appraisal reports and cash flow criteria, because ofthe commercial banking culture engrained in the concerned staff which shortterm training in project appraisal could not modify. Another reason forcontinued emphasis on security-based lending was the requirement of theCentral Bank's Credit Guarantee Scheme, which turned down claims if adequatesecurity were not obtained. As regards supervision, the bank branches did notgenerally monitor performance except when the client was not current onpayments.

5.09 Since term lending to SMIs raises difficult and very differentissues than commercial lending to large firms, and since acquiring thisexpertise requires time, capability and on-the-job training, only thoseinstitutions which are prepared to make a long-term commitment to SMIdevelopment, through project lending rather than security-based lending,should be eligible to participate in such operations. Under this project, BOCand PB, whose market share of the banking business is estimated at over 60%,appear to have made such a commitment over the years. The other privatecommercial banks whose market share presently does not exceed 20%, appear tobe participating not because of their commitment to project lending butbecause long-term resources were not otherwise available. Although theyprepare appraisal reports to satisfy IDA's requirements, the main criteria fortheir SMI lending continues to be collateral and the entrepreneur's ability torepay. Since SMI lending constitutes a small percentage of their overalllending, and there is a shortage of alternative sources of term finance, itwould be unrealistic to expect them to make a long-term commitment to projectlending at this early stage of the development of financial markets in SriLanka.

5.10 Technical Assistance Component. In the course of projectimplementation, a number of changes took place in the allocation andutilization of amounts earmarked for various activities. Table 5 in Part IIIsummarizes the changes. Some of the programs originally intended to befinanced under SMI II were transferred to SMI I as the Technical Assistancecomponent of SMI I was under-utilized. The amount transferred to SMI I wasaround US$ 593,000. The transfer of some of the projects to SMI I and theunder-utilization of funds by the Export Development Board (EDB) enabled theaddition of technical assistance programs for the Clothing Industry TrainingInstitute (CITI) under SMI II, although at appraisal stage technicalassistance to CITI was not envisaged. This last program proved to be verysuccessful.

5.11 Adequacv of Interest Rates. Financial markets in Sri Lanka lackbenchmark rates for medium and long term lending. Also, a wide range ofgovernment administered deposit and lending rates create anomalies that makeit difficult to assess the adequacy of SMI II onlending rates. The systemadopted for setting interest rates for PCIs was based on a proxy rate for thecost of funds (average weighted prime lending rate) minus a spread of 6% tocompensate for the added cost of SMI lending provide a reasonable margin.While this system failed to directly take account of the actual cost of

- 6 -

mobilizing funds in the domestic market, it yielded a rate that did not priceout non-PCI commercial banks from SMI lending but still resulted inutilization of the credit component of the Project at a moderate pace. Themechanism for setting lending rates was not changed in SMI III but rates inSMI TV are based on average weighted cost of deposit plus a margin to directlyincorporate the cost of mobilizing funds in Sri Lanka.

6. Proiect Results

6.01 Credit Component. The credit component was fully disbursed to2,513 sub-projects in traditional sectors such as food processing, metalproducts, printing and paper products, construction materials, garments,commercial transport, etc. These sub-projects are estimated to have created25,000 jobs at an estimated investment cost per job of U$1,900. About 62% ofthe loans approved were for expansion projects. The export impact of most ofthese projects was minimal. The lack of reasonably accurate follow-up data onsub-project performance has made it difficult to carry out an objectiveanalysis of the projects' benefits. A sample survey of the actual performanceof 66 sub-projects, carried out by NDB in May 1989, produced the followinginformation: 33 sub-projects (50%) had cost overruns of between 5% to 200%; 9were completed below cost; and the remainder (24) were completed at cost. Interms of financial performance, 12 sub-projects (18%) were operating at a lossor were closed. Eleven sub-projects (17%) had annual net profits as apercentage of investment between 0% to 5Z, fifteen had between 5% to 15%,while the remainder 28 exceeded 15%. It appears that slightly over one-thirdof the sub-projects were financially shaky, primarily because of cost overrunsor poor sales performance. The percentage of project costs financed by loansappears high, with most cases falling between 60% and 90%. These figuresreflect inherent riskiness of SMI lending in an environment in which PCIs werestill building their project appraisal skills.

6.02 The repayment performance of the sub-loans under the credit showeda deterioration between 1986-89 but has since improved significantly. Theprincipal affected by arrears of over 6 months (Principal Infection Ratio)which was some 41Z of total principal outstanding as of December 31, 1989,improzed to 33% as of December 31, 1990. The average annual collection ratio,which was 62.5% as of December 31,1989, also improved to 79%. The collectionperformance of the PCIs as of December 31, 1990, was as follows: BOC 61.9%; PB77.1%; DFCC 78.9%; CBOC 78.4%; and HNB 99%. The affected PCIs are takingsteps to improve the effectiveness of their debt recovery procedures.

6.03 Technical Assistance. The TA programs funded under the projectwere implemented with mixed results. The programs focused on completion ofthe initiatives launched under SMI I. The allocation to the IndustrialDevelopment Board (IDB) emphasized building up on the extension activities atits regional branches through coaching of extension officers by specialists aswell as expanding the engineering services centers. This activity did improvethe extension officers' effectiveness but was only marginally successful asIDB was unable to retain its professional staff, trained at high cost, due toinadequate compensation and incentives. Most of the industrial extensioncenters established under the project were supply driven and not based on acareful analysis of demand. Furthermore, their ownership and management by

the public center very likely reduced their market effectiveness. The RubberProducts Development Center, although very active, also had a minimal impactbecause its services were not used by the large scale sector. The sub-contracting exchange was not very effective because of the small number oflarge engineering industries that require sub-contracting services coupledwith the small number of SMI engineering firms capable of doing precisionwork. The consultancy services provided to SMI firms also had limited impactexcept in the case of mushroom farming.

6.04 Compared to IDB, the Export Development Board (EDB) used TA fundswith greater success. The Clothing Industry Training Institute (CITI) was themcst successful training center assisted under the project, followed by theLapidary Training Center, the Jewelry Training School and the MushroomDevelopmen,; Center. These training centers had some success in transferringtechnology and export marketing skills to entrepreneurs and continue tofulfill a portion of training needs in the sub-sectors.

6.05 The program of TA to NDB for institution building was effective interms of building up systems and procedures and assisting management instrategic planning. Technical assistance to the SMI Fund was effective inbuilding up staff capability, particularly for reviewing sub-projects abovethe free limit and overall monitoring of credit utilization. TA to PCIs forimproving their staff capabilities also appears to have been effectively used.

7. Proiect Sustainabilitv

7.01 General. On the basis of the limited survey of sub-projectperformance, including repayment performance, the sustainability of a numberof sub-projects is doubtful. Sustainability in this context refers to theirability to continue to generate expected benefits over their useful life;these benefits include employment, output and profits. The project componentswere not designed to build a self-sustaining system to service the creditneeds of SMIs in Sri Lanka. While TA component assisted in strengthening thePCIs and NDB, the Project did not address the policy reforms required tomobilize long-term funds for SMI needs. A Banking Sector Adjustment Project,currently being prepared by IDA, is addressing the issues associated withBanking Sector reforms and mobilization of longer term funds.

7.02 The role and the strategy of both IDB and EDB are being evaluatedat present in order to reorganize and refocus their activities to enhanceeffectiveness. While the benefits of TA to IDB have been largely lost due tostaff turnover and the inflexibility of IDB in responding to the needs ofentrepreneurs, EDB's problems are different in nature and are a result ofattempting to fulfill too many different functions. PCIs and NDB strengthenedthrough the Project continue to service the SMIs, as do the vocationaltraining institutes supported with the Project TA component.

7.03 Credit ComDonent. With the exception of BOC and PB, the PCIs arefinancially viable institutions. The two state banks, BOC and PB, which arethe largest commercial banks in the country and account for utilization ofabout 66Z of the credit, have high levels of non-performing loans. However,

- 8 -

their operations, policies and strategies are presently being reviewed byinternational consultants with a view to restructuring and adopting strategiesto improve their performance iu the future. The major issve with SMI lendingconcern's PCIs' long-term commitment to SMI financing, i.e, whether theywould continue to finance SMIs without refinance facilities from theGovernment/IDA and credit gudrantees from the Central Bank. It will dependmostly on the interest rate policies and the pace of institutionalstrengthening, which are being addressed by IDA under SMI IV. The proposedBanking Sector Adjustment Credit will also seek a major reform of these twolarge state-owned banks.

8. IDA's Performance

8.01 Although the project followed closely the design of the first SMIproject, IDA staff spent considerable time in assessing the results of the TAprogram under the first SMI project and in developing TA components whichwould be complementary and improve the performance of the beneficiaryinstitutions. However, the effectiveness of IDA's supervision was less thansatisfactory because of frequent staff changes, long intervals betweensupervision missions during the latter stages of the project and inadequatemonitoring of the technical assistance component, given the ambitious scope ofthe TA programs and the weak management and organizational capabilities of theGovernment agencies responsible for implementation.

9. Borrower's Performance

9.01 NDB, which was the apex institution for the credit, generallymanaged the implementation of the project satisfactorily. However, because ofits own staffing constraints, it was unable to have an impact on improving thePCIs SMI lending operations. Another shortcoming was NDB's inability to builda mechanism to collect information on sub-projects' ex-post economic andfinancial performance which prevents an evaluation of their economic benefits.

10. Prolect Relationships

10.01 The overall relationship between GOSL, IDA, NDB and the PCIsremained very cordial all along. The supervision missions worked closely withthem particularly with regard to training of their staff. In the area of TA,the relationship between IDA and EDB and IDB was quite constructive. IDA tookinto account these agencies' recommendations in making or adjustingallocations for technical assistance programs in order to enhance theireffectiveness.

11. Consulting Services

11.01 The quality of work performed by consultants was gelierallysatisfactory. The consultants who helped in setting up the diamond industrywere very effective, as were the consultants who coached the IDB extensionstaff. However, the performance of the consultants who provided services toCITI was mixed. The trainers engaged to train the CITI staff were veryeffective but there were differences of opinion between CITI and theconsultancy firm that assisted it as to the direction of the training program.

-9-

12. Project Documentation and Data

12.01 For the preparation of the PCR, data with respect to the creditcomponent was available with NDB and the PCIs. The data and the informationrelating to technical assistance were not available in the required form. Itwas quite evident that the monitoring of programs funded under SNI II TAcomponent was not properly documented. The SAR was not used by the borrowerand its agencies to obtain guidance for implementation of the programs, andsome of the implementing officers were not even aware of the contents of thedocument. Legal documents between IDA, GOSL, NDB and PCIs were adequate forthe Project.

13. Conclusions and Lessons Learned

13.01 The project had two components: (a) the credit component, whichmet the objective of providing financial assistance for development of smalland medium scale industries; and (b) the technical assistance component, whichwas only par:tly successful in removing the constraints to their growth,productivity and technological improvements.

13.02 In respect of the credit component, even the large PCIs haddifficulties in consistently providing adequate staffing for their SMIdepartments because of administrative reasons. This contributed to slowcommitments and disbursements during the early years. Lending decisionsduring those years were highly centralized; this defeated an importantobjective of associating commercial banks with branch network to participatein channelling credit to SMIs in small towns. The position has sinceimproved. The second objective i.e., increasing competition among banks wasonly partially achieved because the two privately owned banks were relativelyvery small and their participation was not material (3Z-4%). An importantlesson that can be learned from this project is that only those institutionswhich are prepared to make a long term commitment to SKI development throughstaffing and appropriate lending policy and procedures should be eligible toparticipate in future operations. This commitment should extend toestablishing an organization structure which would involve a decentralizationof decision making to major branches and their adequate staffing. This wouldalso imply that the PCIs adopt lending to SKIs as part of their long-termstrategy and not as a transient involvement due to the availability of WorldBank Group credit lines.

13.03 Another important lesson for future SMI projects is that mereprovision of financing cannot ensure successful implementation or operation ofan SHI; it needs business advisory services from the stage of projectconception to commercial operation. Government commitment to support SKIs andresources for providing TA should be an integral part of the Project.

13.04 The technical assistance program was ambitious and did not takeinto account the organizational and management weaknesses of the implementingagencies. IDA did not provide the relatively large amount of resourcesrequired to supervise a complex project of this type and IDA supervisionmissions did not have the skill mix necessary to effectively monitor theimplementation of these programs.

- 10 -

13.05 The findings of the supervision missions for SMI II were actedupon in the design of SMI III, the subsequent operation. Also, the findingsnoted in paragraphs 13.02 to 13.04 above were reflected in the design of SMIIV.

- 11 -


SRI LANKA

SECOND SMALL & MEDIUM INDUSTRIES PROJECT

(CREDIT 1182-CE)

PART II: Proiect Review From Borrower's Perspective

The following comments on the Draft PPAR were submitted by theNational Development Bank which was the apex institution for SMI II.

Proiect Performance Audit ReDort on SMI I (0942-CESMI II (1182-CE) and IDP I (1401-CE)

Thank you for your letter dated 7 May 1991 and the enclosed Reporton above subject. Our comments on the above report are given below:

1. Lending under SMI I & II - Section IV

(a) We are in agreement with the comments made in the report with-regard to the shortcomings on SMI I due to weaknesses of PCIs inProject Appraisal and Supervision and the monitoring system.However, under SMI II & III, we were able to overcome most ofthese lapses through the improvements in the guidelines on projectAppraisal norms and supervision. Efficiency of SMI lendingoperations of PCIs also has been improved by training PCIs' staffin SMI lending. Steps are also being taken by the NDB to carryout sectoral studies to further improve the efficiency of SMILending operations.

(b) Weaknesses in monitoring systems due to lack of in-builtmechanisms to collect information has now been rectified bycollecting data on the total investment cost of sub-projects whichwill enable calculation of key economic ratings.

(c) With regard to additional functions that can be performed by theNDB, we are now in the process of:

(i) examining the potential use of some resources in equitysupport to SMI entrepreneurs, and

(ii) undertaking sample surveys of SNI sub-borrowers to assessthe actual economic impact of the sub-borrowers.

- 12 -


SRI LANKA


PART III: STATISTICAL INFORMATION

1. Related Bank Loans

Year ofCredit Title Purpose Approval Status

Small and Medium Industries Promote private Industrial development 1979 CompletedProject (SMI I) Credit 942- focusing on SMIs assistance to develop 12/80CE the NDB technical and marketing

services to key SMI sectors and policystudies limited to reforms in tariffsand Export incentives

Third Small and Medium Provide credit to SMIs, make further 1987 On-goingIndustries Project (SMI III) contribution to policy reforms in theCredit 1860-CE areas tariff administration, export

promotion and financial sectoroperations

Industrial Development Provide term credit through DPIs to 1983 CompletedProject (IDP I) Credit 1401- assist in strengthening the system of 09189CE industrial financing, assist in trade

& industrial reforms, and providetechnical assitance to improveselected PMEs

Second Industrial Provide term credit to finance 1986 On-goingDevelopment Project (IDP II) rehabilitation and expansion (BMRE) byCredit 1692-CE private firms and selected public

manufacturing enterprises and assistimplementation of policy reforms toimprove sectoral performance andinstitutional development

Third IndustrialDevelopment Complement previous and on-going 1989 1989 On-goingProject (IDP III) Credit industrial sector operations to1948-CE provide credit through banking system

to medium and large scale privateindustrial enterprises, supportimplementation of GOSL's policyreforms and institutionalstrengthening

Fourth Small and Medium Complement previous and on going 1991 Credit signedIndustries Project (SMI IV) industrial and financial sector b u t n o tCredit 2250-CE intermediation; to provide credit for effective yet

industrial development and to makefurther contributions to policy reformand institutional strengthening in thearea of trade policy administrationand financial sector operations

- 13 -


SRI LANKA



2. Prolact Time Table

Item Date Planned Date Revised Actual

Preparation 12/7/80 thru 1/30/81 12/7/80 thru 1/30/81

Appraisal Mission 1/30/81 1/30/81

Credit Negotia- 8/17/81 to 8/21/81 8/17/81 to 8/21/81tions

Board Approval 10/13/81 10/13/81

Credit Signature 2/2/82 2/2/82

Credit 2/--/82 5/5/82Effectiveness

Credit Closing 12/31/85 12/31/86 12/31/8712/31/87

Credit Completion 6/30/86 6/30/87 9/30/886/30/88

3. Credit Disbursement

Cumulative Estimated and Actual Disbursements(US$ Millions)

1982 1983 1984 1985 1986 1987 1988

Appraisal Estimate 1.9 8.7 18.7 27.7 30.0

Actual 0.1 0.6 1.7 6.11 14.1 27.5 29.8

Actual as Z of 5.3 6.9 9.1 27.1 47.0 91.6 99.3estimate

Date of final disbursement April 1988

4. Prolect Implementation

Indicator Appraisal Estimate Actual

1. No. of sub-projects financed 2,000 2,513

2. Average size of sub-loan 15,000 10,000

- 14 -


SRI LANKA

SECOND SMALL AND MEDIUM INDJSTRIES PROJECT(CREDIT 1182-CE)


S. Proiect Costs and Financina

A. Prolect Coats

SAR Transferred Revised ActualItem Estimate to SMI I Allocations Utilizations

(Foreign Exchanga Cost)

1. Term loan for SMIs 28,000 27,913 27,913

2. industrial Development Board

- SMI Consultancy 460 230 43 35- Facilities/Equipment 160 35 220 203- Training 97 94

620 265 360 331

3. Exvort Development Board

- Consultancy 290 24 S0 75- Facilities/Equipment 250 47 245 230- Training 260 17 163 114

800 88 48-8 419

4. NDB/PCIa

- Consultancy 260 195 113 113- Training 70 32 180 178- Equipment 29 26

33-0 r227 32_2 317

5. SMI Comiittee

- Contingency 250 13- Consultancy 55 38- Training 125 108- Facilities/Equipment 24 17

Y5-0 -13 70-4 T6-2

6. CITI

- Consultancy 517 516- Training 99 91- Equipment 84 52

- 70 659

SUBTOTAL 2,000 593 2,074 1,887

TOTAL 30.000 29.800

Note: I SDR a USS 1.1235

- 15 -


SRI LANKA



B. Project FinancinA

Source Planned(Credit

----------- Aareement) Final(USS '000) (USS '000)

1. IDA 30,000 30,0002. Government 500 NA3. PCIs 7,000 7,0004. SMIs 15,000 26,500

TOTAL 52,000 56,500

6. Project Results

A. Direct Benefits

Indicator Appraisal Estimate Actual

1. Employment generated 22,000-25,000 24,993

2. Incremental Cost/Job US $ 1,500 US $1,938

B. Economic Impact

Economic Rate of return Appraisal Estimate Actual

tJot Available

C. Financial Impact

Financial rate Without Proiect Future With Actualof return Pro1ect

Not Available.

7. Status of Covenants There were no known instances of non-compliance with covenants.

8. Use of Bank Resources

A. Staff Inputs

(Staff weeks)FY80 FY81 FY82 FY83 FY84 FY85 FY86 FY87 FY88 FY91 TOTAL

Pre-appraisal - 26.2 3.2 29.4Appraisal - 26.3 0.4 26.7Negotiation - 2.7 2.7Supervision - 17.5 6.2 17.1 18.7 12.3 15.2 1.5 0.1 88.6Other 0.1 2.5 6.1 8.7Total 0.1 55.0 30.0 6.2 17.1 18.7 12.3 15.2 1.5 0.1 156.1"a R t ^ X 1-t----=8 = =tsat= eaS = =:$s l$.>-$ 1----gtstsa

- 16 -

8. Use of Bank Resources

B. Missions

Stage of month/ no.of no.of manweeks date of ratingsproject cycle year weeks persons return

PreparationAppraisalSupervision 1 8/84Supervision 11 5/85 1.5 2 3 06/04/85 3Supervision III 11/85 2 1 2 12/12/85 2Supervision IV 7/86 2 2 4 08/86 2Supervision V 9/87 4 2 8 10/87 4Supervision VI 12/87 1 1 1 1/88 2Supervision VII 7/88 1 1 1 8/88

Record of supervision missions prior to 8/84 are not available.

- 17- ANNEX I


SRI LANKA


SUB-SECTORAL DISTRIBUTION OF SUB LOANS

SUB-SECTOR No Amount (Rs. Mn)Contracting 24 19.6Cons material 174 74.3Food Processing 674 296.7Garments 138 62.1Metal Products 214 90.1Other agro-industries 48 16.3Repair work shop 121 29.8Rubber products 74 43.9Textiles 56 39.9Wood products 174 49.0Animal husbandry & 159 59.2Chemical Products 8 2.3Commercial transport 210 60.4Leather & allied products 28 11.1plastic products 42 41.0Printing & paper products 138 75.0Others 231 122.1

2,513 1,092.8

- 18 -

ANNEX II


SRI LANKA


SIZE DISTRIBUTION OF SUB-LOANS

CATEGORY NO Z AMOUNT (Rs. Mn) Z

Rs 0 - Rs 50,000 307 12 8.1 1

Rs 50,000 - Rs 500,000 1,435 57 275.4 25Rs 500,000 - Rs 1,C00,000 442 17 275.8 25Rs 1,000,000 - Rs 2,000,000 237 9 305.7 28Rs 2,000,000 - Rs 4,000,000 92 4 227.8 21

Total 2,513 100 1,092.8 100

- 19 -ANNEX III

Page 1 of 2


SRI LANKA


(CREDIT 1182-CE)

ANALYSIS OF ARREARS

LOANS IN ARREARS Dec.1986 Dec.1987 Dec.1988 Dec.1989 Dec.1990 June 1991

1. Total no of loans 1488 2203 2295 2058 1383 1221

in portfolio

2. No. of loans in 363 503 1010 499 384 356

arreas with 6 or

less than 6 months

3. As a * of total loan 24.4% 23.0% 44.0% 24.2% 27.8% 29.1%portfolio

4. No. of loans in 163 316 550 737 327 304

arreas over 6 months

5. As a % of total 10.9% 14.3% 23.9% 35.8% 23.6% 24.9%

loan portfolio

6. Total No. of loans 526 824 1580 1238 711 660in arrears

7. As a % of total 35.3% 37.3% 67.9% 60.0% 51.4% 54.1%

loan portfolio

PRINCIPAL AFFECTED BY ARREARS

8. Total principal 625.4 959.2 970.3 761.1 460.0 392.0

outstanding (Rs. Mn)

9. Principal affected N/A N/A 232.8 311.3 151.7 145.3

by arrears (Rs.Mn)

with over 5 months

10. As a % of principal N/A N/A 24.0% 40.9% 33.0% 37.1%

- 20 -

ANNEX III

Page 2 of 2

ACTUAL AMOUNTS IN Dec.1986 Dec.1987 Dec.1988 Dec.1989 Dec.1990 June 1991

11. Arrears with 6 5.0 8.1 19.2 9.4 7.8 7.9or less than6 months (Rs. Mn)

12. As a % of 1.0% 1.0% 2.0% 1.2% 1.7% 2.0%principal

outstanding

13. Arrears between 3.9 1.07 15.7 16.5 7.0 8.67-12 months

14. As a % of 0.5% 1.0% 1.8% 2.2% 1.5% 2.2%principal

outstanding

15. Arrears over 9.3 22.0 54.9 92.7 52.7 57.412 months

16. As a % of 1.5% 2.3% 5.6% 12.1% 11.4% 14.6%principaloutstanding

17. Total Arrears 18.2 40.8 89.8 118.6 67.5 73.9

18. As a % of total 3.0% 4.3% 9.2% 15.5% 14.7% 18.8%

- 21 -ANNEX IV


SRI LANKA


ANNUAL COLLECTION PERFORMANCE BY PCIsAs at 30th June 1990

BOC PB CBOC HNB

(1) Opening arrears - Interest 18.2 15.5 4.3 1.3- Principal 55.0 26.6 2.4 2.0

(2) Current Dues - Interest 49.2 24.5 2.5 3.2- Principal 75.7 50.5 12.3 8.1

124.9 75.0 14.8 11.3

(3) Total Dues at - Interest 67.4 40.0 6.8 4.5the end of - Principal 130.7 77.1 14.7 10.1the Period

198.1 117.1 21.5 14.6

(4) Collection - Interest 33.8 23.9 3.4 2.6- Principal 65.4 37.8 9.3 7.1

99.2 61.5 12.7 9.7

(5) Rescheduling - Principal 0.2 - - -

(6) Closing balance due - Interest 33.6 16.1 3.4 1.9- Principal 65.1 39.5 5.4 3.0

98.2 55.6 8.8 4.9

(7)(4)/(3)*100 50.1% 52.5% 59.0% 68.4%(8)(5)/(3)*100 0.1% - - -

(9)(4)+(5)*100 50.2% 52.5% 59.0% 66.4%(3)

- 22 -

ANNEX V


SRI LANKA


PRESENT STATUS OF PROJECTS FINANCED

AND

REASONS FOR PROJECTS IN DEFAULT

NO AMOUNT( Rs.Mn)Installments in arrears

Below 6 installments 339 5.86-12 installments 176 11.313-24 installments 213 26.3Above 24 installments 286 69.5

1,014 112.9

Reasons for Default

Wilful 141Genuine difficulties 288Disinterest of the borrower 108Not indicated/Other 477

1,014

Implementation Status

Under Implementation 23Operation at the expected level 788Operating below the expected level 254Abandoned 133Temporally Stopped 72Fully Settled 491Not Indicated 405

2,166

- 23 -

ANNEX VI


SRI LANKA


NET REFINANCING APPROVALS BY PCIs

PCI No Z Amount(Rs. Mn) Z

Bank of Ceylon 1,319 52 470.8 43

Peoples's Bank 730 29 263.8 24

Commercial bank of Ceylon 90 4 49.5 5

Hatton National Bank Ltd. 76 3 38.2 3

Development Fin. Corpn. ofCeylon 298 12 270.5 25

TOTAL 2,513 100 1092.8 100

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