ASIAN DEVELOPMENT BANK RRP: BAN 35225

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON

PROPOSED LOANS AND TECHNICAL ASSISTANCE GRANT

TO THE

PEOPLE’S REPUBLIC OF BANGLADESH

FOR THE

SMALL AND MEDIUM ENTERPRISE SECTOR DEVELOPMENT PROGRAM

November 2004

CURRENCY EQUIVALENTS (as of 15 November 2004)

Currency Unit – taka (Tk)

Tk1.00 = $0.0168 $1.00 = Tk59.375

ABBREVIATIONS

ADB – Asian Development Bank ACC – Anti-Corruption Commission BB – Bangladesh Bank BBS – Bangladesh Bureau of Statistics BDS – business development services BSCIC – Bangladesh Small and Cottage Industries Corporation BSTI – Bangladesh Standards and Testing Institution CPCU – central program coordination unit DFID – Department for International Development EA – executing agency EGBM – Enterprise Growth and Bank Modernization FBCCI – Federation of Bangladesh Chambers of Commerce and Industry FI – financial institution FIL – financial intermediary loan GDP – gross domestic product IA – implementing agency IDLC – Industrial Development Leasing Company of Bangladesh Ltd. IFC – International Finance Corporation IMF – International Monetary Fund IPDC – Industrial Promotion & Development Company of Bangladesh Ltd. I-PRSP – interim poverty reduction strategy paper MFA – Multi-Fibre Arrangement MIDAS – Micro Industries Development Assistance and Services MOF – Ministry of Finance MOF-FD – Ministry of Finance, Finance Division MOI – Ministry of Industries MSME – micro, small, and medium enterprises NASCIB – National Association of Small and Cottage Industries of Bangladesh NBFI – nonbank financial institution NBR – National Board of Revenue NCB – nationalized commercial bank NCID – National Council for Industrial Development NPL – nonperforming loan OECD – Organisation for Economic Co-operation and Development PCB – private commercial bank PFI – participating financial institution PRGF – Poverty Reduction and Growth Facility RJSC – Registrar of Joint Stock Companies RMG – readymade garment SCI – small and cottage industry SCITI – Small and Cottage Industries Training Institute SEDF – SouthAsia Enterprise Development Facility

SEF – Small Enterprise Fund SME – small and medium enterprise SMESDP – SME Sector Development Program TA – technical assistance USAID – United States Agency for International Development WB – World Bank

NOTES

(i) The fiscal year (FY) of the Government ends on 30 June. FY before a calendar year denotes the year in which the fiscal year ends.

(ii) In this report, “$” refers to US dollars. This report was prepared by a team consisting of H. Y. Hong, R. M. Limjoco, S. N. Oh, S. Thongplengsri, V. T. Velasco, and V. L. You.

CONTENTS Page

LOAN AND PROGRAM SUMMARY i I. THE PROPOSAL 1 II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES 1

A. Sector Description and Performance 1 B. Issues and Opportunities 4

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM 11 A. Objectives and Scope 11 B. Important Features 11 C. The Program Loan 12 D. The Project Loan 19 E. The Technical Assistance Loan 25 F. Implementation Arrangements for the Sector Development Program 28

IV. TECHNICAL ASSISTANCE 30 V. PROGRAM BENEFITS, IMPACTS, AND RISKS 30

A. Benefits and Impacts 30 B. Risks 32

VI. ASSURANCES 32 VII. RECOMMENDATION 34 APPENDIXES 1. Program Framework 35 2. Development Policy Letter and Policy Matrix 40 3. Sector Analysis and Framework for Small and Medium Enterprise Development 47 4. List of Ineligible Items 56 5. Small Enterprise Fund 57 6. Summary of Due Diligence of Preidentified Participating Financial Institutions (Deleted – Confidential) 58 7. Technical Assistance Loan Components 60 8. Technical Assistance Loan Cost Estimates and Financing Plan 64 9. Program Implementation Schedule 67 10. Technical Assistance Grant to Support Program Implementation and Coordination of SMESDP 68 11. Summary Poverty Reduction and Social Strategy 71 SUPPLEMENTARY APPENDIXES (available on request) 1. Gender Action Plan 2. Environmental Assessment of Policy Matrix 3. Bangladesh Bank Circular on Refinance Scheme for Small Enterprises Sector 4. Program Organization Chart 5. Terms of Reference for Technical Assistance Loan Components 6. Selected Public Institutions Supporting Small and Medium Enterprises

LOAN AND PROGRAM SUMMARY Borrower People’s Republic of Bangladesh Classification Targeting Classification:

General intervention (GI)

Sector: Industry and trade Subsector: Small and medium-scale

enterprises Themes: Sustainable economic growth,

private sector development Subthemes: Promoting economic efficiency

and enabling markets, policy/institutional/legal/ regulatory reforms, private sector investment

Environment Assessment Category FI.

Rationale The national poverty reduction strategy of Bangladesh

recognizes that reducing income poverty will require more concerted and intensified effort. To meet its goal of halving the income poverty level by 2015 will require more than doubling the rate of poverty reduction from the 1.5% per year experienced during the 1990s. Accordingly, the Government’s priority is to accelerate and expand the scope for pro-poor economic growth by raising the rate of economic growth quickly and sustainably, with an emphasis on generating productive employment. The promotion and development of small and medium enterprises (SMEs) will take center stage for raising pro-poor economic growth that, being generally labor intensive, utilizes Bangladesh’s factor endowments to their competitive advantage in the local and global markets. Recent analysis confirms the important role that the SME sector plays in reducing poverty in Bangladesh. The more rapid growth of the economy in the 1990s has been accompanied by a faster rate of poverty reduction than in the 1980s. Significantly, this growth can be traced to nontradable activities (services, construction, and small-scale industry) that accounted for about 70% of the incremental growth of the past decade relative to the earlier decade. Unlike the 1980s, when the rapid shift of labor into the rural nonfarm sector was largely in the form of self-employment, the 1990s reflected the absorption of wage labor in greater numbers by enterprises that were relatively larger scale and more productive. It is, thus, of critical importance to the poverty reduction effort to build on this growth momentum by developing an enabling environment conducive to the accelerated growth of the SME sector over the medium to long term and to adopt policies that enable the poor to find gainful employment in this sector.

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SMEs account for about 40% of gross manufacturing output, about 80% of industrial employment, and about 25% of the total labor force in Bangladesh. However, they have not been able to realize their full potential due to various constraints: (i) dearth of medium to long-term credit; (ii) limited access to market opportunities, technology, expertise, and information, relative to larger enterprises; (iii) lack of suitable incentives; (iv) inefficient and limited outreach of government services; and (v) weak capacity among SME entrepreneurs in managing functional areas of business.

Recognizing the role of SMEs in economic development and the fight against poverty, the Government formed a national Task Force to recommend SME policy guidelines and implementation strategies, provide the necessary underpinnings for public support to the sector, and specify targeted assistance and a dedicated institutional setup for SME development. The SME Sector Development Program (SMESDP, the Program) supports the Government’s initiative in addressing SME constraints and providing promotional support to facilitate their accelerated growth and development. SMESDP is fully consistent with the strategic priorities of the Government and of the Asian Development Bank (ADB) country strategy, and is supported by other development partners. SMESDP also complements the Government’s agenda of developing the country’s private sector as the engine of growth for the economy, and helps facilitate the flow of private investments into the SME sector in parallel with ADB’s interventions to promote good governance and the development of the financial sector, particularly rural credit.

Objectives The goal of SMESDP is to support government efforts to

foster development of the SME sector and enable the sector to attain its full potential for contributing to sustainable economic growth and poverty reduction. SMESDP will support strengthening the policy environment for SMEs, and improving access by SMEs to credit and related support services. SMESDP consists of four parts: (i) a program loan of SDR9.954 million ($15 million equivalent) supporting policy reforms, (ii) a project loan of SDR19.908 million ($30 million equivalent) for extending credit to small enterprises, (iii) a technical assistance (TA) loan of SDR3.318 million ($5 million equivalent) for improving the effectiveness of government assistance to the SME sector and facilitating SMEs’ access to various support services including capacity building and support for infrastructure development for SMEs, and (iv) a TA grant of $600,000 equivalent for assisting the Government to implement and coordinate the Program and for benefit monitoring.

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Program Loan

SMESDP supports three program outcomes. The first is to establish an SME policy and development framework to provide impetus and guidance to the development of the sector. The second is to establish an institutional structure and necessary mechanisms to support SME development. The third is to define government support to SMEs and facilitate SME access to various services. The latter entails (i) rationalization of government assistance to the SME sector, including credit directly administered by government agencies and public financial institutions; (ii) provision of tax incentives; (iii) enhancement of SME access to market, government services, capacity building, and product certification, including upgrading of the current product certification system to international standard; and (iv) development of an integrated SME database for improved targeting of assistance.

Cost Estimates The costs of adjustment (excluding the project and TA costs) are estimated at $33.4 million equivalent over the period FY2005–FY2008, reflecting the costs for development and implementation of the SME policy and development framework, tax incentives, establishment of SME support infrastructure, and restructuring of concerned agencies under the Ministry of Industries (MOI) providing services to SMEs.

Financing Plan ADB will provide a program loan of SDR9.954 million ($15 million equivalent) from its Special Funds resources with a term of 24 years, including a grace period of 8 years, and with an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter. The loan closing date is expected to be 31 December 2007.

Tranching The program loan will be released in two tranches subject to compliance with agreed conditions. The first tranche, in the amount of $5 million equivalent, will be released upon effectiveness of the loan and fulfillment of the first tranche release conditions. The second tranche of $10 million equivalent is expected to be released by end-June 2007, upon fulfillment of the second tranche release conditions.

Implementation Arrangements

The executing agency (EA) for the program loan will be the Ministry of Finance, Finance Division (MOF-FD). The EA will constitute a central program coordination unit (CPCU) in charge of program monitoring and coordination. The implementing agency (IA) for the program loan will be the MOI, except for the tax incentive measures, which MOF-FD will coordinate with the National Board of Revenue.

Procurement and Disbursement

The program loan will finance the full foreign exchange costs (excluding local duties and taxes) of imports procured in and from ADB’s member countries, other than those specified in the list of ineligible items and those items financed by other

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multilateral and bilateral official sources. Disbursements under the program loan will be made in line with ADB’s simplified disbursement procedures and audit requirements. The Borrower will certify that the value of eligible imports exceeds the amount of ADB’s projected disbursements under the program loan in a given period. ADB will have the right to audit the use of loan proceeds and to verify the accuracy of the Borrower’s certification.

Project Loan The project loan will be provided to enhance access to credit

by SMEs, especially small enterprises referred to in Bangladesh as the “missing middle.” These enterprises are too large to qualify for microcredit assistance programs of the Government but too small to be within the scope of current bank lending. The loan proceeds will be used as contribution to the Small Enterprise Fund (SEF), which was set up by Bangladesh Bank (BB) as a credit facility available to small enterprises with fixed assets of less than Tk10 million. The World Bank has also contributed to the SEF. SEF will be administered by BB for channeling credit through participating financial institutions (PFIs) to these small enterprises.

Cost Estimates The total project cost including contribution from SME beneficiaries and PFIs is estimated at $257.8 million equivalent, while the fund size of SEF is $56.7 million equivalent. In addition to the project loan of $30 million equivalent, SEF will comprise $10 million equivalent from the World Bank and $16.7 million equivalent (Tk1 billion) from the Government through BB. The Government can increase its contribution to SEF if there is sufficient demand. The project loan will be provided in foreign exchange but re-lent by BB to PFIs in local currency at the BB rate.

Financing Plan ADB will provide a project loan of SDR19.908 million ($30 million equivalent) from its Special Funds resources with a term of 32 years, including a grace period of 8 years, and with an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter. The commitment period for the project loan is 5 years and the completion date is expected to be 30 June 2010.

Executing and Implementing Agencies

The EA for the project loan will be MOF-FD and the IA will be BB.

Procurement and Disbursement

PFIs will onlend the funds from SEF in taka as subloans/subleases to their SME clients at their prevailing pricing. Activities to be financed through subloans/subleases will be carried out in accordance with ADB’s procurement requirements and environmental and other safeguard policies. An imprest account procedure will be used for the disbursement of the project loan.

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Technical Assistance Loan

ADB will provide a TA loan of SDR3.318 million ($5 million equivalent) for (i) the conduct of studies to rationalize government assistance to the SME sector including the restructuring, phaseout, or strategic reorientation of concerned agencies under MOI providing services to SMEs, and to review and rationalize credit assistance directly administered by government agencies and public financial institutions; (ii) SME web portal/virtual front office design and development; (iii) establishment and operation of helpline outreach centers; (iv) capacity building for SME entrepreneurs, particularly in rural areas, and for women entrepreneurs, displaced workers, and credit staff of PFIs dealing with the SME sector; (v) upgrading of the product certification system; (vi) integrated SME database development; and (vii) environmental assessment and monitoring.

Cost Estimate The total TA loan project cost is estimated at $8.46 million equivalent, of which $5.00 million equivalent will be funded by ADB. The Government will finance $1.84 million equivalent through budgetary support, and the remainder of the cost will be borne by the private business sector through the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI) and other chamber bodies and industry associations, SMEs, and PFIs, by payment of fees and cost-sharing arrangements.

Financing Plan ADB will provide the TA loan from its Special Funds resources, with a term of 32 years, including a grace period of 8 years, and with an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter. The TA loan completion date is expected to be 31 December 2007.

Executing and Implementing Agencies

The EA for the TA loan will be MOF-FD and the IA will be MOI.

Procurement and Consulting Services

Procurement of goods and services will be in accordance with ADB's Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. All consulting services that are to be financed from the proceeds of the TA loan will be engaged in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements for the engagement of domestic consultants satisfactory to ADB.

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Safeguard Policies

As IA for the credit facility, BB will monitor compliance of PFIs with ADB’s Environmental Policy (2002) and Environmental Assessment Guidelines, and ADB’s policies on involuntary resettlement (1995) and indigenous peoples (1998). PFIs in turn will monitor compliance by subborrowers with ADB policies and government regulations.

Technical Assistance Grant

The TA grant will support program implementation and coordination to ensure timely compliance with policy conditions and other deliverables to achieve the stated outcomes. The main tasks under the TA are to assist in setting up and operationalizing the institutional body for SME policy and development framework implementation, strengthen monitoring and reporting, help oversee the implementation of various components under SMESDP to enable timely corrective action if needed, build up capacity of the EA and IAs in implementing the activities and monitoring benefits of SMESDP, and provide administrative support to the EA and IAs. The total cost of the TA is estimated to be $750,000 equivalent. ADB will provide $600,000 equivalent on a grant basis from the ADB-funded TA program. The Government will contribute $150,000 equivalent. The TA will be implemented over the implementation period of SMESDP. Consultants will be recruited in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements for the engagement of domestic consultants satisfactory to ADB.

Executing and Implementing Agencies

The EA for the TA grant will be MOF-FD and the IA will be MOI.

Benefits and Impact

Policy SMESDP is central to the formulation and implementation of public policy that focuses on SME development. The SME policy and development framework will make government commitments to the sector explicit, and lay out targeted SME policy measures and institutional structure to guide the concerned government agencies in providing support to the SME sector. The policy measures will rationalize government assistance to SMEs and facilitate SME access to credit, business support services, product certification, and capacity building.

Institutional Development SMESDP will help mobilize high-level public policy support for SME development. At the highest level, the National Council for Industrial Development (NCID), chaired by the prime minister, will take responsibility for SME policy and development. The NCID will be assisted at the ministerial level by the Guidance Committee headed by the minister, MOI. At the implementation level, the SME Cell set up in MOI will

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implement the action program to be developed by the SME Advisory Panel to support implementation of the SME policy and development framework. Subsequently, over the medium term, SMESDP will assist in establishing and operationalizing the SME Foundation in the form of a public-private partnership to be a dedicated agency responsible for SME development on a sustainable basis. Further, the Program will support studies for improving the effectiveness, restructuring, and strategic reorientation of concerned agencies under MOI that interface with and provide services to SMEs.

SME Financing Small enterprises will have better access to credit through SEF. The Program will also enhance capabilities of PFIs in extending credit to SMEs by assisting PFIs in establishing or strengthening their SME financing operations and training about 1,000 SME credit staff of PFIs as well as other financial institutions intending to engage in lending to SMEs, on SME financing, project appraisal and supervision, and credit and portfolio administration of small loans. Capacity building of SME credit staff will strengthen their abilities to assess SME credit applications as well as facilitate provision of business development services (BDS) to SMEs. PFIs are expected to have more focus on the SME business segment, strengthen their SME unit, and expand their SME loan portfolio. PFI financial assistance will allow the SMEs to strengthen their competitiveness and to be commercially viable. It is estimated that there will be about 10,000 subloans/subleases that will be made out of SEF. In addition, lending to SMEs will have a strong linkage impact on BDS providers who would be responding to generated demand for their services and PFI referrals.

Beneficiaries SMESDP will contribute to the country’s goal of raising real economic growth, generate employment, and thereby contribute to reducing poverty incidence. Overall, during the program period FY2005–FY2007, employment in the SME sector is expected to rise by at least 8% per annum.

It is estimated that during the TA loan implementation period, over 8,000 participants from SMEs, including about 2,000 women, will undergo training to be conducted by the Small and Cottage Industries Training Institute in collaboration with FBCCI, and its district chambers and line associations. Over 12,000 displaced workers are expected to undergo retraining programs and at least 50% are projected to be re-employed during the program period. It is also expected that about 150,000 entrepreneurs or individuals interested in setting up an enterprise will take advantage of the services of the helpline outreach centers established as public-private partnerships under the Program. SMESDP will address

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gender concerns of women entrepreneurs and businesswomen managing SMEs. SMESDP will enable them to have greater participation in the formulation of SME-related polices and action plans, and better access to information, credit, and BDS.

Development Partner Coordination

SMESDP complements ongoing and planned activities of other development partners, in particular as regards BDS and private sector development. The interventions under SMESDP were closely coordinated with the Local Consultative Group composed of all development partners active in the SME sector in Bangladesh.

Risks and Safeguards Drawing from past experience, despite possible changes in the Government, it is presumed that Bangladesh will pursue the required reforms, based on high-level government commitment.

The program implementation risks have been addressed through institutional mechanisms that involve all tiers in the Government, including the NCID at the top policy level, the Guidance Committee at the ministerial level, and the dedicated SME Cell (over the medium term, the SME Foundation) at the implementation level. Direct oversight of specific program, project, and TA components will be provided through the CPCU organized under the EA. The TA grant will provide capacity-building assistance to strengthen the capabilities of counterpart staff to implement the policy measures, and support the EA and IAs in terms of program coordination and monitoring activities, as well as PFIs in monitoring benefits from subloans/subleases financed under SEF. On the project loan, both ADB and World Bank staff based in Dhaka will be closely involved in monitoring utilization of SEF and adherence to relevant policies, and take corrective measures where needed.

The Program also reduces risk and institutes checks and balances through the use of participatory consultation mechanisms and public-private partnerships. The SME policy and development framework will be developed through consultation and participation of various stakeholders and information disseminated to the public through publication in newspapers of nationwide circulation. The SME Foundation will have private sector representatives on its board. The private sector through FBCCI, chambers, and associations will be involved in program implementation and make a substantial contribution to the total resources, in addition to their business network, practical knowledge and skills, and linkages to sources of market information and technology.

I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on proposed loans to the People’s Republic of Bangladesh for the Small and Medium Enterprise Sector Development Program (SMESDP, the Program) consisting of (i) a program loan supporting policy reforms; (ii) a project loan for extending credit to small enterprises; and (iii) a technical assistance (TA) loan for improving the effectiveness of government assistance for the small and medium enterprise (SME) sector and facilitating SMEs’ access to various support services, including capacity building and support of infrastructure development for SMEs. The report also describes a proposed TA for Supporting Program Implementation and Coordination of SMESDP, and if the Board approves the proposed loans, I, acting under the authority delegated to me by the Board, will approve the proposed TA.

II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Sector Description and Performance

1. Macroeconomic Performance 2. Bangladesh achieved a steady 5% growth rate of real gross domestic product (GDP) during the 1990s, as compared with 4% in the 1980s. The growth of per capita real GDP accelerated from 1.7% per annum in the 1980s to 3.1% in the 1990s. The growth in the 1990s was attributable to the reforms to move Bangladesh toward an open economy, such as making the currency convertible on the current account, reducing import duties, removing controls on the movements of foreign private capital, and introducing value-added tax. The Bangladesh economy became more closely integrated with the global economy, with its trade doubling over the 1990s to reach 31% of GDP by 2001. The industry and services sectors each contributed about 41%, and agriculture about 18%, to incremental GDP growth in the 1990s compared with the 1980s. Unlike the 1980s, when the rapid shift of labor into the rural nonfarm sector was largely in the form of self-employment, the 1990s witnessed the absorption of wage labor in greater numbers by relatively larger-scale enterprises. These enterprises were at the higher end of the productivity scale compared with the self-employed form of enterprises in the earlier years.1 Reflecting higher economic growth and increased employment generation, the poverty rate declined from 59% to 50% between 1991 and 2000. 3. The Government has progressively moved away from administered interest rates toward market-based rates. The disproportionately high interest rates offered by the National Savings Certificates2 that crowded out long-term borrowing by financial institutions (FIs) and private sector borrowers have been reduced toward closer alignment with comparable market rates. Despite these efforts, spreads between lending and deposit rates remain high due to the nonperforming loan (NPL) problem in the banking system, which is being addressed by the Government. The Government is also developing a market for government securities and significantly reduced the withholding tax on income from securities and bonds.3 On the foreign exchange market, the taka was floated in May 2003 and the exchange rate is managed flexibly, with interventions confined to countering disorderly conditions. 1 Osmani, S. R., Wahiduddin Mahmud, Binayek Sen, Hulya Dagdeviren, and Anuradha Seth. 2003. The

Macroeconomics of Poverty Reduction: The Case Study of Bangladesh. Dhaka: United Nations Development Programme.

2 National Savings Certificates are offered to small savers at administered rates, currently in the range of 7.5–11% for 1–5 years tenor.

3 Reduced from a range of 25–45% to a unified rate of 25%, in the current year’s budget.

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4. To maintain macroeconomic stability and implement structural reforms that will contribute to improving the investment climate, promoting economic growth, and reducing poverty, the Government has prepared the National Strategy for Economic Growth, Poverty Reduction, and Social Development, the Government’s interim poverty reduction strategy paper (I-PRSP), dated March 2003,4 which forms the basis for a 3-year arrangement with the International Monetary Fund (IMF) under the Poverty Reduction and Growth Facility (PRGF) originally approved for SDR347 million (about $505 million). The Government will have to accelerate economic growth to about 7% per year over the next decade to reduce poverty in half by 2015 in accordance with the Millennium Development Goals.5 In comparison, annual GDP growth was 5.3% in FY2003, 5.5% in FY 2004, and is projected at 5% for FY2005. The IMF PRGF target is 6% for FY2006–FY2008. The IMF PRGF together with the Development Support Credit I and II projects of the World Bank (WB) also provide policy support in the financial sector, including preparation for privatization of and management support for the nationalized commercial banks (NCBs) and issuance of prudential regulations. In July 2004, IMF completed the second review of Bangladesh’s economic performance under PRGF and approved a release of SDR49.5 million (about $72 million) as well as an augmentation of the PRGF, amounting to SDR53.33 million (about $78 million), for the Trade Integration Mechanism.6

2. Business Environment and Private Sector Development 5. Despite higher economic growth during the 1990s, Bangladesh still lagged behind other countries in the region such as India, Pakistan, and Sri Lanka. Various studies carried out under Asian Development Bank (ADB) TA in 20027 and 2003,8 an investment climate assessment by the WB,9 the 2003 National Private Sector Survey of Enterprises in Bangladesh (the 2003 Private Sector Survey),10 and surveys by the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI) have identified major impediments to the country’s competitiveness and economic growth, including inadequacies in infrastructure facilities (particularly power, gas, and port facilities), corruption and “invisible” costs, deficiencies in the legal and regulatory framework, and lack of access to finance by businesses. 6. Nevertheless, the Government has taken several policy initiatives to improve the investment climate. The I-PRSP recognizes the private sector as the engine of economic growth. The 1999 Industrial Policy eliminated restrictions on private sector participation in all

4 The full poverty reduction strategy paper is currently being prepared; its completion is expected by end-2004. 5 Poverty reduction targets are set at 35% in 2010 and 25% in 2015 with 2000 as the base year. 6 The IMF Trade Integration Mechanism was introduced in April 2004 to assist member countries to meet balance of

payments shortfalls that might result from multilateral trade liberalization. It is not a special lending facility, but rather a policy designed to make resources more predictably available under existing IMF facilities.

7 “Strategic Issues and Potential Response in the Enterprise Sector: Small and Medium Enterprise Development and Export Expansion,” November 2002, a report under TA 3698 (ADB. 2002. Technical Assistance to the People’s Republic of Bangladesh for Review of Finance, Industry and Trade Sectors and Strategy Formulation. Manila).

8 “Report on the SME Enabling Environment,” June 2003, prepared under TA 3879 (ADB. 2003. Technical Assistance to the People’s Republic of Bangladesh for Preparing Small and Medium Enterprise Development and Export Expansion Program. Manila.)

9 World Bank and the Bangladesh Enterprise Institute. June 2003. Improving the Investment Climate in Bangladesh. Washington, District of Columbia. The report was based on an enterprise survey funded by the WB and the Department for International Development (DFID) of the United Kingdom.

10 Lisa Daniels, International Consulting Group. September 2003. Report on the National Private Sector Survey of Enterprises in Bangladesh. Melbourne. The report was funded by DFID, United States Agency for International Development (USAID), Swiss Agency for Development and Cooperation, and Swedish International Development Cooperation Agency.

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sectors except defense, nuclear energy, forest plantation, and mechanized extraction of reserved forests. The foreign direct investment regime is also liberal, although the bulk of direct investment from abroad has been in the gas and power subsectors. With regard to trade reform, the Government has introduced a three-tier tariff structure with the maximum rate having been reduced from 30% to 25%. The average tariff and the number of products subject to quantitative restrictions have also been reduced. Import-licensing requirements have been streamlined. The Government has introduced export promotion measures and at the same time developed a comprehensive plan to cope with the phaseout of the Multi-Fibre Arrangement (MFA) at end-2004, which will adversely affect textiles and garments, the strategic exports of Bangladesh. 7. Reforms are also under way to create an enabling environment for private sector development and development partners, including ADB, are providing continuing support for infrastructure development.11 To tackle the issue of corruption and rent-seeking behavior of public officials, the Government set up the Anti-Corruption Commission (ACC) under the ACC Act passed in February 2004. The WB’s Development Support Credit I and II projects as well as the ADB’s ongoing TA12 provide support for the establishment of the ACC. In addition, the Government is promoting e-governance and introducing the use of computers and web sites in all ministries and sector corporations to enhance transparency and expedite administrative processes.

3. Role and Characteristics of the Small and Medium Enterprise Sector 8. It is generally recognized that SMEs have a significant role in generating growth and employment. SMEs account for about 40% of gross manufacturing output, about 80% of industrial employment, and about 25% of the total labor force in Bangladesh. Preliminary figures based on the 2001–2003 Census of Non-Farm Economic Activities (Urban and Rural) [the Economic Census], which excludes agriculture, fisheries, and forestry, estimate the number of persons employed by SMEs at 1.72 million, which is about 45% of the total number employed in nonfarm small, medium, and large establishments. The 2003 Private Sector Survey estimated that micro, small, and medium enterprises contributed around 20–25% of GDP. Given the critical role of SMEs in economic growth and poverty reduction, it is imperative that the Government develop and implement targeted policy measures to address specific constraints to SMEs to enable them to realize their full potential and contribute more effectively to economic growth and employment generation. 9. Definition of SMEs. The Industrial Policy 1999 defines SMEs as enterprises employing fewer than 99 workers and/or with a fixed capital investment under Tk300 million. “Small industry” refers to enterprises (excluding cottage units) employing fewer than 50 workers and/or with a fixed capital investment of less than Tk100 million while “medium industry” covers enterprises employing between 50 to 99 workers and/or with a fixed capital investment of between Tk100 million and Tk300 million. However, this definition has the second highest upper limit on fixed assets for SMEs in South Asia and Southeast Asia, after Singapore, and does not accurately reflect the size of SMEs. The Bangladesh Bureau of Statistics (BBS) classifies enterprises solely according to total persons employed or “engaged” (including proprietor) in the Economic Census. Development partners involved in the SME sector have different definitions of SMEs. The major commercial banks follow the Industrial Policy definition in terms of 11 ADB’s projects include among others, construction of roads and transport infrastructure, development of the power

and gas sector, and improvement in efficiency of Chittagong Port. 12 ADB. 2003. Technical Assistance to the People’s Republic of Bangladesh for Supporting Good Governance

Initiatives. Manila. The TA is progressing well and the Government has requested ADB’s assistance in the development of an implementation plan for the ACC.

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investment capital for lending purposes. The lack of any single standard definition makes it difficult to interpret data on SMEs and target assistance for SME sector development. 10. Population of SMEs. There are varying estimates of the SME population in line with different definitions of SMEs. Based on the Economic Census, the total number of SMEs13 is estimated at 79,754 establishments, of which 93.6% are small and 6.4% are medium. The 2003 Private Sector Survey estimated about 6 million micro, small, and medium enterprises defined as enterprises with fewer than 100 employees. B. Issues and Opportunities 11. Most of the key impediments to the development of the SME sector are linked to structural problems in the business environment. ADB and other development partners are addressing issues in private sector and financial sector development. While these problems affect all enterprises irrespective of size, SMEs are disproportionately affected due to their small scale of operations and more limited resources to address the problems. Complementary to the government initiatives and other development partner programs, the proposed SMESDP aims at introducing policy reforms and creating support infrastructure targeted at SMEs to enhance their capabilities and facilitate their access to the necessary resources to deal with the regulatory, credit, capacity, and other key issues that they are facing owing to policy and market failures. Sector analysis and framework for SME development, including government initiatives and development agency-funded programs, are summarized below with details included in Appendix 3.

1. Present Challenges for Small and Medium Enterprises a. Access to Credit 12. Lack of SME Access to Credit. Financial constraint was cited most frequently as a key problem during startup and operations as reflected in the 2003 Private Sector Survey. Problems are more pronounced for small enterprises predominantly in the informal sector that are in the so-called “missing middle.” These enterprises, some of which have graduated from microcredit programs, are no longer considered microenterprises and are ineligible for financing from nongovernment organizations and microcredit institutions or from government special assistance programs. On the other hand, they are not large enough to fall within the scope of current bank lending. Banks view SMEs as relatively higher credit risks, and expected returns do not justify the high administrative and servicing costs of small loans. SMEs are normally required to assign real or other immovable properties as collateral to secure their obligation, a condition that most SMEs find difficult to comply with. Further, lack of suitable lending modalities, and limited capability of SME credit staff to appraise SMEs’ cash-flow-generating capacity is another reason for the predominance of collateral-based lending. 13. Secured Financing. Lack of ownership of land or immovable property as collateral for bank financing poses a constraint to SME access to credit. Secured financing backed by movable property (e.g., equipment, vehicles, and other non-land assets) as security would generally be preferred by SMEs, as they typically own movable property. However, the secured financing sector in Bangladesh covering leasing companies is quite small with limited growth potential due to lack of a legal and institutional framework for secured transactions. Currently,

13 In the Economic Census, microenterprises are defined as those with total number of persons employed of less

than 10, small enterprises with 10 to 49, medium enterprises with 50 to 99, and large enterprises with 100 or more.

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there is no law specifically providing for taking movable property as security for a loan. Security interests in movable property are created by contract, creating unnecessary litigation and delay. The current law does not provide for priority of creditor interests; thus, loan recovery typically involves long and costly litigation to determine interests of creditors. Moreover, there is no comprehensive registry system in Bangladesh. Not all security interests can be registered, posing a limitation on secured lending. Coverage of the current registry system at the Registrar of Joint Stock Companies (RJSC), restricted to limited companies, excludes from secured financing SMEs that are not in corporate form, although these constitute the majority of enterprises. The manual registration system results in excessive delay and creates opportunities for corrupt practices. 14. Market Failures in SME Financing. In the absence of a long-term market for debt funds, availability of medium- to long-term credit is limited. Although there is excess liquidity in the market, a significant portion is lodged with NCBs that are facing chronic NPL problems and have been restricted by Bangladesh Bank (BB) to limit their credit portfolio growth to 5% annually in order to contain their losses. In the absence of an effective interbank market, this excess liquidity in NCBs does not readily flow to the private commercial banks (PCBs) or nonbank financial institutions (NBFIs). Moreover, NBFIs are limited in their scope for accepting deposits while PCBs and leasing companies have limited term funds due to an inability to engage in asset/liability mismatches by using short-term deposits for medium- to long-term lending in the absence of liquidity support from BB and without a repo market. In addition, cash reserves are required to be met on a daily basis while the inefficient payments system makes monitoring and adjusting liquidity positions highly cumbersome and difficult. Furthermore, even if many NBFIs are keen to engage in SME financing, loans from NCBs are available at rates that, owing to the high NPL level, make SME financing unprofitable or marginally profitable. Their relatively high costs of capital limit the expansion of their SME loan portfolio.

b. Need to Rationalize Present Government Support for Small and Medium Enterprises

15. Although SME development has been included in the Industrial Policy, there are neither significant specific policy measures nor specific institutional support to establish an enabling framework at a policy level, resulting in costly and inefficient implementation of SME development initiatives. SMEs are typically in a disadvantaged position to benefit from neutral business-friendly policies compared with large enterprises. Targeted policy interventions are necessary to improve access of SMEs to market opportunities, financing, technology, expertise, and information. There is also an evident need to create an institutional mechanism that can effectively coordinate and implement SME-related policies. 16. The Government provides business support and capacity-building assistance as well as infrastructure facilities to SMEs, mainly through the Bangladesh Small and Cottage Industries Corporation (BSCIC). Founded in 1957 by legislation as the principal government organization mandated to promote the development of countrywide small and cottage industries (SCIs), BSCIC is responsible for (i) allotment of developed industrial estates in 64 districts in Bangladesh; (ii) entrepreneurship development training programs conducted by its training arm, Small and Cottage Industries Training Institute (SCITI); (iii) credit arrangement and end-use supervision; (iv) design, development, and distribution of prototypes through its design center; (v) research and development activities; (vi) management and skills development; and (vii) market study and marketing assistance (e.g., trade fairs).

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17. However, BSCIC has failed to fulfill its mandate due mainly to lack of a clear focus, burden of managing many nonperforming industrial estates, weak management deputed from the civil service system with lack of understanding of SMEs, and shortage of well-trained professionals. Currently, there is no cost recovery in the use of public resources in the estates or in almost all of the services provided by BSCIC, while training participants pay only a nominal fee for its training programs. BSCIC is overstaffed with 3,244 people. In FY2004, the revenue budget of BSCIC was Tk248 million. Low revenues coupled with high operating costs have resulted in substantial accumulated operating losses of Tk660 million or about $10.1 million over the past 10 years. A parliamentary subcommittee was formed to address the issue of operating losses while the Ministry of Industries (MOI) has set up a committee to study human resource restructuring at BSCIC. To move BSCIC toward a leaner and more effective organization, the committee proposed human resource rationalization, including downsizing field offices and the head office. 18. Since its establishment in 1985, SCITI has conducted training courses for over 24,000 participants, mostly existing and potential entrepreneurs and managers of SCI enterprises. However, SCITI has very limited outreach with more than two thirds of its training programs conducted at its premises in Dhaka. Although SCITI has carried out training programs in other parts of the country in collaboration with BSCIC’s respective local offices and industrial service centers, the implementation of these programs was ineffective due to a meager budget, lack of qualified faculty members and trainers, and lack of training facilities. There is a need to strengthen SCITI’s capacity to deliver its training services to SMEs on a sustained basis. (Profiles of BSCIC and other public institutions serving SMEs are in Supplementary Appendix 6.) 19. Public institutions including BB, NCBs, and specialized financial institutions, engaged in extending loans to the agriculture and industry sectors, currently have financing facilities for SMEs, the performance and effectiveness of which have been uneven. These facilities have varying features and terms. Some are targeted at certain industries or subject to limited geographic coverage. BB’s Rural-based Agro-Processing Industries Refinancing Facility, originally set up for Tk1.5 billion, had a low utilization rate owing mainly to the restriction on use of funds to agro-processing industries located outside the major cities; consequently, the size of the facility was later reduced to Tk0.5 billion and Tk1 billion was reallocated to set up the Small Enterprise Fund (SEF). The Entrepreneurship Enterprise Fund was set up by BB in FY2001 as a venture capital fund to co-invest in projects in software, food processing, and agro-based industries. Since its establishment, the utilization rate has averaged about one fourth of the budget allocated in each fiscal year. The Government is exploring an exit strategy for its equity shareholding in the enterprises cofinanced under the Entrepreneurship Enterprise Fund. Some credit facilities provided by NCBs and specialized financial institutions impose ceiling on loans to subborrowers in certain sectors, such as agricultural credit, thus distorting interest rates and further exacerbating the vulnerable financial position of these entities. There is no indicator to measure the effectiveness, outreach, or impact of these facilities. Thus, a study needs to be conducted to identify ways to rationalize the existing government assistance and to ensure efficient and effective delivery mechanisms.

c. Incentives 20. The tax system in Bangladesh provides incentives to promote exports. For example, a special income tax rate of 10% is provided for the readymade garment (RMG) industry and 15% for textile and jute industries up to June 2006, compared with a normal rate of 37.5%. With the

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exception of very small enterprises classified as “cottage industries,”14 which are exempted from value-added tax on an extensive list of items, no special tax treatment is given to SMEs. To relieve the tax burden of newly established enterprises, the Government has provided tax holidays for all manufacturing or service enterprises, irrespective of size, if they are established before June 2005. These enterprises can register with the National Board of Revenue (NBR) to be exempted from income tax for 5 years if they are located in major cities such as Dhaka and Chittagong and for 7 years for those located in other cities. The abolition of the tax holiday scheme, which is expected to be approved by the Government in the next fiscal year, will adversely affect small enterprises to a greater extent than larger enterprises because of their limited income-generating capacity to absorb high startup costs. Tax and customs procedures are also cumbersome and involve high informal payments, reflecting additional compliance costs and posing a barrier for SME entry into the formal sector.

d. Registration, Licensing, Tax, and Other Requirements 21. The establishment of an enterprise in general requires a trade license from local government bodies, registration under the Factories Act with the Department of Inspection of Factories and Establishments of the Ministry of Labor, registration for value-added tax and a tax identification number with NBR, and environmental clearance from the Department of Environment of the Ministry of Environment and Forest. Compliance complexity increases as the business becomes a legal entity and seeks registration for access to government incentives. If an enterprise is to be incorporated as a company, registration with RJSC is required. Investment registration with the Board of Investments will be required for access to capital machinery import incentives in the form of import duty and tax exemptions, and to infrastructure facilities such as utility (water, electricity, and telecommunications) and land (e.g., industrial estates managed by BSCIC or Bangladesh Export Processing Zone Authority). The processes to meet these requirements usually involve unnecessary delays, harassment, and side payments. The information gap has been identified as the key constraint in obtaining certificates or licenses from any of these regulatory agencies. Awareness and understanding of documentation requirements, steps to be followed, and fees to be paid will help entrepreneurs to be prepared and make it more difficult for officials or brokers to take advantage of the entrepreneurs’ lack of knowledge. The delays in the processes are also caused by manual systems at many of these public service institutions and duplication of procedures.

e. Market for Business Development Services 22. SMEs operating outside the urban centers do not have ready access to business development services (BDS) providers. BDS are generally regarded as unaffordable by this subsector. The BDS market is still fragmented and unorganized with few privately owned organizations providing BDS. Some started as projects funded by development partners.15 Many of the training and capacity-building programs are neither demand-driven nor specifically targeted at certain groups of SMEs that are disadvantaged, such as those in rural areas and those headed by women entrepreneurs. Moreover, retraining programs are also needed for the displaced RMG workers due to the phaseout of the MFA by end-2004. It is estimated that at

14 Cottage industries in this context are defined by the NBR as enterprises that have (i) investments in capital

machinery of less than Tk500,000, (ii) annual turnover of less than Tk2 million, and (iii) no production in the name of any brand belonging to others.

15 These include Micro Industries Development Assistance and Services (MIDAS), the Bangladesh Advisory Services Center funded by USAID, and the Business Advisory Services training center at the Dhaka Chamber of Commerce and Industry supported by the German Agency for Technical Cooperation with funding from the German Government.

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least 200,000 RMG workers, over 85% of whom are women, need retraining to be able to reenter the gainfully employed labor pool. Further, Bangladesh needs to diversify its know-how and technology away from core garment industries to lessen external shocks and better equip the country to cope with the changing market environment. 23. Some FIs provide basic advisory services to their clients, or make BDS arrangements with service providers to assist enterprises that they finance.16 Generic training courses on credit management and core banking and on finance subjects are conducted at the training center of BB and the Bangladesh Institute of Bank Management. However, to extend FIs’ lending to the SME sector, there is a need to build up capacity of SME credit staff to provide in-house basic advisory services and “handholding” assistance to SMEs, including preparation of business plan and bankable proposals.

f. Product Certification System 24. The Bangladesh Standards and Testing Institution (BSTI), an autonomous organization under MOI, is responsible for setting national standards for industrial, food, and chemical products; conducting product testing; and issuing product certification. BSTI’s certification mark is mandatory for an extensive list of items to assure quality of products and to protect consumers. There is no accreditation system to allow for services of private sector accreditation bodies. BSTI’s monopoly and lengthy procedures led to the practice of side payments to obtain certificates. Thus, BSTI’s seal of quality has not gained credibility either at home or abroad, impeding the ability of exporters to market their products. To meet importers’ requirements, enterprises have to go through expensive and time-consuming processes to seek certificates from foreign certification bodies. Many SMEs do not comply with product certification requirements due to their ignorance and weak enforcement capacity of BSTI. This limits their potential to broaden their client base to overseas markets.

2. Government Policy Support for Small and Medium Enterprise Sector Development

25. Industrial Policy. The promotion of pro-poor growth propelled by the private sector as stated under the I-PRSP will have to be supported by appropriate macroeconomic and sector policies. The new Industrial Policy, in its final draft form, covers (i) roles of MOI and other relevant agencies including BSCIC, Board of Investments, and Bangladesh Export Processing Zone Authority, in promoting the development of industries, particularly those with strong growth potential; (ii) promotion of exports and foreign direct investment; and (iii) privatization of state-owned enterprises. With renewed interest in SME development, it now highlights the priority given to the development of the SME sector, and, drawing upon the recommendations of the national Task Force on Development of SMEs [the SME Task Force] (para. 27), outlines the Government’s development strategy for the SME sector. Key elements of the strategy cover, among other things, (i) strengthening the role of public agencies to ensure proper industrialization of SMEs; (ii) providing tax incentives to SMEs; (iii) simplifying laws and regulations; (iv) using e-commerce to develop production and marketing; (v) establishing an information bank to provide market opportunities and trade information; (vi) improving supply chain management to foster subcontracting and linkages between SMEs and larger enterprises;

16 BRAC Bank, a PCB, has its own field staff trained to provide advice to its borrowers on basic business plan

development and has a partnership with the Job Opportunities and Business Support program of USAID for provision of BDS, while MIDAS Financing, an NBFI, taps the resources of its parent company, MIDAS, for delivery of BDS.

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and (vii) conducting a survey to analyze and identify industries with growth potential. The new Industrial Policy does not provide details for this SME development strategy but refers instead to the SME policy and development framework. However, the revised definition of SMEs has been incorporated. According to this definition, to be made generally applicable, (i) for manufacturing, small enterprises are those with fixed investment less than or equal to Tk15 million and medium enterprises with fixed investment greater than Tk15 million and less than or equal to Tk100 million,17 while (ii) for nonmanufacturing, small enterprises are those with fewer than 25 full-time employees, and medium enterprises with between 25 and 100 full-time employees. 26. Preparation of SME Policy and Development Framework. There is global consensus recognizing the role of SMEs as engines for growth, employment, and poverty reduction, and the need to design SME policies in the context of a coherent and integrated approach to economic growth and social development.18 SME development requires a crosscutting strategy that touches on such areas as macroeconomic policies, business environment, legal framework, and finance, and that is integrated into the broader national development and poverty reduction strategy. 27. In line with such a consensus and to prioritize specific elements of SME policies from the Bangladesh perspective, the Government established the SME Task Force on 5 November 2003. The SME Task Force—comprising 16 members from the Government, academia, and the private sector, and chaired by the principal secretary, Prime Minister’s Office—held a national workshop on 20 February 2004 and prepared the Report on Development of SMEs.19 The Report, endorsed by the prime minister and submitted to the Economic Affairs Committee of the Cabinet in October 2004, contains policy recommendations with timeframe to create an enabling environment conducive to SME development. Key components are declaration of SMEs as a priority sector, an institutional framework, various incentives, and capacity building and human resource development measures. These recommendations will form the basis for framing the Government’s policy vis-à-vis the SME sector, which will be completed in 2005 and implemented by an action program (paras. 39–40).

3. Development Agency-Funded Programs that Impact on the Small and Medium Enterprise Sector

a. Financial Market Development

28. Reforms in the Banking Sector. The ongoing reforms will help address market failures in SME financing. The restructuring of NCBs has been initiated and will be supported by the WB’s Enterprise Growth and Bank Modernization (EGBM) project, which will assist in preparing strategies for resolution of problems of NCBs, improve governance arrangements, and divest the Government’s shares in the NCBs. Amendments of relevant laws have been made to strengthen BB’s oversight of the banking sector and ensure its autonomy over monetary and

17 Fixed capital assets, valued at replacement cost based on current market prices, include plant, machinery,

building, and structures. Land is excluded primarily because in Bangladesh, land values in urban areas are disproportionately high relative to the other productive assets of enterprises and distort their balance sheet.

18 Organisation for Economic Co-operation and Development (OECD). 2000. The Bologna Charter on SME Policies. Bologna; and OECD. 2004. Istanbul Ministerial Declaration: Fostering the Growth of Innovative and Internationally Competitive SMEs. Istanbul.

19 ADB funded the national workshop in February 2004 where over 100 participants from the public and private sectors participated. ADB and other development partners participated and provided comments on the draft report.

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exchange rate policies. Stricter prudential regulations have been introduced, including increased capital adequacy requirements and revisions to loan classification and provisioning guidelines. 29. Development of Capital Market. ADB has provided assistance to strengthen the legal and regulatory framework as well as oversight of the securities markets. It has also been closely involved in reforming the Bangladesh domestic capital market and in enhancing the role of the Securities and Exchange Commission as a regulator.20 Further, the WB’s Financial Institutions Development project, which includes a component to facilitate FIs’ issuance of securities and securitization of their loan/lease portfolios, has achieved some progress.21 30. Secured Financing. To support secured financing as part of good governance initiatives as well as SME development, ADB is providing assistance for legal and registry reforms to facilitate secured transactions. 22 The draft secured transaction law is being prepared and has been discussed among stakeholders, while the registry reform will cover development of an overall architecture for a transparent, electronic registration system. 31. Financial Reporting. The Government has acknowledged that in the long term it has to implement recommendations identified in the Report on the Observance of Standards and Codes23 including simplification of financial reporting standards for SMEs. WB is providing assistance in strengthening accounting and auditing practices in the corporate sector under an economic management TA program.

b. Registration, Licensing, and Tax Requirements 32. To facilitate issuance of trade license in Dhaka, Dhaka City Corporation set up a help desk at FBCCI and has been working toward developing a simple form of application with fewer certifications required for issuing a trade license. It has introduced automatic annual renewal of trade license up to 5 years through payment in designated banks. The automation project of RJSC is ongoing and supported by the Australian Agency for International Development and SouthAsia Enterprise Development Facility (SEDF).24 Further, SEDF also assisted RJSC in preparing a registration toolkit and an animated television film on how to register a business, and established knowledge centers in Dhaka and Chittagong chambers of commerce and industry, which maintain a library of SME information and resources including SME toolkits offering business software. The development of mechanisms and policies to streamline

20 ADB. 1997. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and

Technical Assistance Grants to the People’s Republic of Bangladesh for the Capital Market Development Program. Manila; ADB. 2000. Technical Assistance to the People’s Republic of Bangladesh for Capacity Building of the Securities and Exchange Commission and Selected Capital Market Institutions. Manila; ADB. 2003: Technical Assistance to the People’s Republic of Bangladesh for Financial Markets Governance Program. Manila.

21 The Industrial Promotion and Development Company of Bangladesh Ltd. (IPDC) is the first to launch a securitization transaction involving private placement of zero coupon bonds for collateralization of its loan portfolio. The Industrial Development Leasing Company of Bangladesh Ltd. (IDLC) and the United Leasing Company Ltd. are preparing to issue their own asset-backed debt securities.

22 ADB. 2003. Technical Assistance to the People’s Republic of Bangladesh for Supporting Good Governance Initiatives. Manila.

23 The report provides detailed assessment of regulatory and supervisory practices for the Bangladesh financial system prepared jointly by the IMF and WB and issued in 2003.

24 SEDF was established in 2002 as a subregional project facility funded by WB, International Finance Corporation (IFC), DFID, European Commission, Canadian International Development Agency, Norwegian Agency for Development Cooperation, and The Royal Netherlands Government, to provide broad-ranging assistance to SMEs in the areas of regulatory environment, BDS, and training and capacity building. SEDF is also the executing agency for ADB. 2002. Regional Technical Assistance for Small- and Medium-Sized Enterprise Growth and Development in the South Asia Region. Manila.

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regulatory constraints on company registration, inspections, and export and import clearances could be covered under the Regulatory and Investment Systems Improvements for Enterprise Growth program of the Department for International Development (DFID) scheduled for 2005. In addition, DFID is also providing assistance under its Revenues Administration Reforms project to streamline and increase transparency in tax procedures by supporting the reform of administrative procedures and computerization at NBR and taxpayer education activities, including tax information leaflets in Bangla and English and a web site containing tax information and forms.

c. Business Development Services and Training 33. Under the EGBM project approved in June 2004, WB will provide training on automation applications to BSCIC and training of trainers to SCITI.25 SEDF provides (i) local service providers and training institutions with the tools and training to develop their capacity to provide BDS, and (ii) SME entrepreneurs and staff with training programs in target subsectors, i.e., garments, agribusiness, information technology, software, and light engineering.

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM A. Objectives and Scope 34. The objective of SMESDP is to support government efforts to foster development of the SME sector by strengthening the policy environment for SMEs and improving SMEs’ access to credit and related services. This will enable the sector to attain its full potential for contributing to sustainable economic growth and, through generation of employment, the reduction in poverty. 35. SMESDP consists of: (i) a program loan of SDR9.954 million ($15 million equivalent) supporting policy reforms; (ii) a project loan of SDR19.908 million ($30 million equivalent) for extending credit to small enterprises; (iii) a TA loan of SDR3.318 million ($5 million equivalent) for improving the effectiveness of government assistance to the SME sector and facilitating SMEs’ access to various support services including capacity building and support for infrastructure development for SMEs; and (iv) a TA grant of $600,000 equivalent for assisting the Government to implement and coordinate the Program and for benefit monitoring. The program framework is in Appendix 1. The development policy letter and the policy matrix are in Appendix 2. B. Important Features 36. Rationale for Sector Development Program Modality. The sector development program modality will enable ADB to apply a holistic approach to SME development. Due to market failures, targeted policy interventions are necessary to create an enabling environment for SME development. The SMESDP policy actions will represent the key and core measures under the SME policy and development framework that will provide justification for the government interventions in the sector and help relevant agencies focus on SME development in an integrated fashion as opposed to past ad hoc interventions. Moreover, the program loan component will provide budgetary support for the establishment of an institutional framework dedicated to SME development on a sustainable basis and support infrastructure to facilitate SME access to market opportunities, technology, business support services, government

25 In addition, the EGBM project also covers additional facilities to modernize BSCIC’s design center and institutional

capacity building of the Board of Investments and Bangladesh Export Processing Zone Authority.

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services, and capacity building. The project loan that provides funds for SEF will improve SME access to credit and will be complementary to the ongoing projects of ADB and other development partners in the financial sector. The TA loan will support implementation of policy actions, and help carry out the needed assessments, capacity building, and development of infrastructure for SMEs. 37. Complementarities to Government Initiatives and Development Agency Interventions. SMESDP underpins the Government’s agenda of developing the country’s private sector, particularly the SME sector, which is accorded high priority to serve as the engine of pro-poor economic growth. The interventions under SMESDP will be targeted at removing obstacles to SME growth and facilitating the flow of private investments into the SME sector and will complement existing government reform measures and other ADB and development agency assistance programs in private and financial sector development. Moreover, SMESDP is fully consistent with ADB’s country strategy and is complementary to ADB’s interventions in Bangladesh in rural and microfinance and in financial market development, which helps improve resource mobilization and access to credit by SMEs. C. The Program Loan

1. Components and Outputs 38. The Program is designed to have three policy outcomes:

(i) Outcome 1: Establish SME Policy and Development Framework (a) Declare SMEs as a priority sector under government policy (b) Formulate an SME policy and development strategy

(ii) Outcome 2: Establish Institutional Structure and Mechanisms to Support SME

Development (a) Set up an institutional structure and mechanisms to implement the SME

policy and development framework (b) Prepare an action program to support the SME development strategy

(iii) Outcome 3: Define Government Support to SMEs, and Improve SME Access to Various Services (a) Rationalize government assistance to the SME sector including the

restructuring of BSCIC and other concerned agencies under MOI involved in the sector and rationalization of government direct credit assistance currently provided

(b) Rationalize incentive and tax structure for SMEs (c) Enhance SME access to market and government services (d) Enhance SME access to capacity building (e) Enhance SME access to product certification and upgrade product

certification system to international standard (f) Develop an integrated SME database

a. Establish SME Policy and Development Framework 39. Drawing upon the work of the SME Task Force, the Government will, as part of the Program, formulate an appropriate SME policy and development framework in consultation with

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various stakeholders including SMEs and development partners. The Government will adopt the SME policy and development framework that will, in particular, (i) provide the justification for government assistance to the sector; (ii) map out a government development strategy to support the SME sector over the short, medium, and long term; (iii) adopt a single uniform definition of SMEs; (iv) identify areas of assistance to SMEs to enhance their access to capital, business support services, capacity building, and technology to improve their product marketability and competitiveness; (v) delineate the institutional setup to take responsibility for SME sector development; and (vi) incorporate internationally accepted market-based principles for SME development. Summary of the SME policy and development framework will be disseminated to the public through publication in newspapers of nationwide circulation. Further, the development of the SME sector as a priority will be stated in the Industrial Policy and the Poverty Reduction Strategy Paper.

b. Establish Institutional Structure and Mechanisms to Support SME Development

40. The National Council for Industrial Development (NCID), which is chaired by the prime minister and charged with making policy decisions under the umbrella of the Industrial Policy, will take responsibility for SME development. The Government will constitute an SME Advisory Panel mandated to develop an action program to support the SME development strategy. The Panel will consist of representatives from MOI and other concerned ministries, industry associations, and representatives from the private sector and academia, and report to the Guidance Committee,26 set up under the Industrial Policy and chaired by the Minister, MOI. MOI will be the designated agency for implementation of the Government’s SME development strategy and has set up an SME Cell to facilitate operationalization. Over the medium term, the Government will draft and approve the memorandum and articles of association that will provide the organizational and operational framework for setting up an SME Foundation, which will have at least 50% private sector representation on the board and a chief executive officer recruited from the private sector, to assume the responsibilities for implementing the SME development strategy and action program from the SME Cell and to take over, in a phased manner, management of SME credit facilities currently directly administered by the Government.

c. Define Government Support to SMEs, and Improve SME Access to Various Services

41. Rationalize Government Assistance to the SME Sector including the Restructuring of BSCIC and Other Concerned Agencies under MOI involved in the sector and Rationalization of Government Direct Credit Assistance Currently Provided. The Government will review the effectiveness of existing government assistance to the SME sector and the efficiency of delivery of such assistance covering various public sector agencies, particularly those under the supervision of MOI including BSCIC, SCITI, and BSTI, as well as various forms of credit assistance now being provided to the sector. The study will undertake detailed diagnostic analysis of the selected agencies’ activities in terms of need, coverage and scale, impact, cost-effectiveness and sustainability, identification of restructuring alternatives, and preparation of a restructuring plan or a phaseout plan, depending on the study’s findings.

26 The Guidance Committee has 22 members including the Minister of Industries as chairperson; chairman, Board of

Investments; governor, BB; secretary, MOI; secretary, Finance Division, MOF; secretaries of other ministries; chairman, BSCIC; representatives of other agencies; and presidents, FBCCI, Metropolitan Chamber of Commerce and Industry, and the major district chambers of commerce and industry.

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42. It is envisaged that BSCIC, SCITI, and BSTI will be restructured, or replaced by more responsive institutions. In any event, restructuring or setting up an alternative institution is to be guided by (i) a strengthened governance structure that will introduce public-private partnership with private sector representation on the board of the organization; (ii) recruitment of professionals from the private sector, particularly for key positions; (iii) commercialization of the operations by charging fees at least for cost recovery; (iv) a strengthened performance evaluation and incentive system; (v) drawing up of a strategic plan with a time-bound road map for each product or service group, e.g., market-oriented development and management of industrial estates and parks, customer-responsive training, and capacity-building services to SMEs; and (vi) strengthened transparency and accountability, based on defined performance indicators. 43. The rationalization of concerned agencies under MOI is moving forward. Staff rationalization is currently ongoing at BSCIC as part of human resource restructuring. Staff strength of BSCIC is 3,244, comprising 1,644 officers (436 in the head office and 1,208 in field offices) and 1,600 employees. It is planned to significantly reduce their strength. The number of head office officers will be reduced by half. Staff reduction in the field offices is being worked out. Voluntary retirement will be offered to regular officers and employees. Staff who do not have properly approved appointments (about 300 persons) will be considered for termination. For improved productivity, training/retraining will be provided. Regardless of whether BSCIC is restructured or phased out, the Government will have to replenish the employees’ provident fund and cover special deposit accounts for withdrawals made to bridge BSCIC’s accumulated losses (para. 17). SCITI has been upgraded from a development project to a regular agency of BSCIC,27 and is recruiting experienced staff and faculty members. SCITI will be restructured to strengthen its capacity to deliver training and capacity building services to SMEs. In light of the expected passage of the Accreditation Law that will set up the Accreditation Board, which will accredit calibration and testing laboratories and certification bodies including those in the private sector, there is a need to assess BSTI’s role in conducting product testing and in certification, and to carry out a study for its strategic reorientation. The Program seeks to resolve these issues based on the findings of the study. 44. Rationalization of credit assistance will be based on an analytical review of all government-assisted credit programs and facilities for SMEs, including their scope, interest rates, terms and conditions, and implementation arrangements. These include credit programs of government ministries, agencies, and public sector banking institutions funded from the national budget, refinancing facilities of the BB, and credit programs of NCBs and specialized financial institutions funded from their own resources. The issues of directed lending and political considerations, subsidy, and moral hazard will be examined, and, drawing on findings of the analytical review and considering international best practices, specific recommendations to make credit delivery mechanisms more effective and sustainable will be prepared. These studies will be financed by the TA loan (para. 83). 45. Rationalize Incentive and Tax Structure for SMEs. The SME policy and development strategy will include the Government’s plan to provide for a suitable incentive and tax structure for SMEs. To enhance viability of these small enterprises, tax incentives should be given during their initial stage of operations. If the Government abolishes the tax holiday scheme in the next fiscal year, a 75% income tax rebate and accelerated depreciation allowance for plant and machinery will be given as a substitute to newly established small enterprises with fixed

27 Previously SCITI was a project funded from the annual development program. SCITI is now a permanent

government body with budgetary allocation from the annual revenue budget.

15

investments excluding land and building of less than Tk3 million. However, these tax incentives will not be provided to those enterprises that already take advantage of tax incentives under existing export incentive schemes. The Government will implement the tax incentives agreed upon to take effect from assessment year FY2006, as provided for in the Finance Act 2005 or other appropriate legislation. The impact of these tax incentives will be minimal initially because these enterprises are very small. However, in the long run, these measures are expected to facilitate the expansion of SMEs and consequently enhance revenue to the Government as they come out of the informal sector and are captured in the tax net. As stated in the Industrial Policy, to encourage the establishment of small firms, assistance will be given by way of rearranging the tax structure such that taxes and duties are fixed at the lowest level that can be justified. 46. Enhance SME Access to Market and Government Services. MOI has a program to implement e-governance, which will involve the development and maintenance of a web site to be linked to the web sites of other line ministries, and has constituted an e-governance committee to spearhead and coordinate this program. The e-governance program is important for access and dissemination of information, and enhanced transparency, particularly in crucial areas where corrupt practices prevail, such as procurement and business registration. The Program will incorporate the development of an SME web portal/virtual front office and the establishment of SME helpline outreach centers to provide (i) assistance for facilitating access to government services; (ii) guidance to comply with government requirements including registration, product testing and certification; and (iii) dissemination of information about SMEs, market opportunities, and linkages to international markets. The extensive geographic presence of BSCIC and FBCCI and its member associations could be used to further extend the outreach of government services to SMEs countrywide. MOI, in partnership with FBCCI and its district chambers and line associations, will establish helpline outreach centers at selected district offices of BSCIC, and knowledge centers at the Dhaka and Chittagong chambers of commerce and industry. The helpline and knowledge centers will utilize the SME web portal to provide access to information by SMEs in various parts of the country and through the Internet. Assistance for the development of the SME web portal and helpline outreach centers will be financed under the TA loan (paras. 84 and 85). 47. Enhance SME Access to Capacity Building. Under SMESDP, SCITI will undertake a training needs assessment and develop appropriate training programs under a public-private partnership with FBCCI, district chambers and line associations of FBCCI, accredited women entrepreneurs’ associations, and the National Association of Small and Cottage Industries of Bangladesh. The Government has committed to support targeted SME training, particularly for (i) SMEs in rural areas, (ii) women entrepreneurs, (iii) displaced workers in the RMG industry, and (iv) SME credit staff of participating financial institutions (PFIs) under SEF. MOI will present a plan to restructure SCITI to strengthen its capacity to deliver training services to SMEs. SCITI will charge for at least cost recovery for those who can afford to pay for the services. The TA loan will provide assistance to SCITI in implementing these training and capacity-building programs (para. 86). 48. Enhance SME Access to Product Certification and Upgrade Product Certification System to International Standard. To meet SMEs’ need for credible certification bodies where they can obtain a technical evaluation of the quality of their products, BSTI will be strengthened in conducting product testing and certification. The Program will also support enactment of the draft Accreditation Law, establishment of the Accreditation Board, and an application by the Accreditation Board for membership of the International Accreditation Forum to ensure worldwide acceptance of certificates issued by accredited certification bodies in Bangladesh. To

16

facilitate SME access, a special window for certifying SME products will be set up at BSTI. Assistance in upgrading the product certification system and in promoting product certification among SMEs will be provided under the TA loan (para. 87). 49. Develop an Integrated SME Database. For monitoring SME performance and development, and for targeting assistance, it is essential to have a database that indicates, among other things, the number of SMEs, their characteristics and economic activities, and type and number of employees. An initial listing of SMEs will be generated from the Economic Census supplemented by other sources. This will serve as a sampling frame for large-scale nationwide sample surveys on attributes of SMEs such as employment (with gender breakdown) and output. Such data will be captured in an integrated SME database that will facilitate assessment, particularly as regards impact and effectiveness of government policies. The BBS is completing the processing of the Economic Census and will be publishing a preliminary report by end-2004. It is envisaged that the creation of the SME database will be a collaborative effort with BBS. While BBS continues to prepare the basic statistics regarding the enterprise sector, it is important to have a dedicated unit or institution focusing on information gathering for SMEs. The SME Cell will assume this function. The TA loan will provide assistance in the development of the database (para. 88).

2. Important Features 50. Internationally Accepted Principles. Policy actions under SMESDP incorporate key principles28 as discussed in paras. 51–58. 51. Public-Private Partnerships. To ensure ownership and credibility of policy reforms, the development of the SME policy and ensuing action program to support the SME development strategy will be a participatory process involving consultation with all concerned stakeholders. The proposed SME Foundation that will eventually take over functions to support SME development within the Government will have private sector representation on its board. The training service delivery will be implemented by SCITI in collaboration with FBCCI, chambers, and associations. The Government will provide, with development agency support, initial investments in public goods (e.g., SME database) for the benefit of SMEs, and the associated services to maintain such public goods will be contracted to private sector organizations, or run as a joint public-private undertaking. The Government will focus on promoting the development of markets for the delivery of BDS by private sector providers. The Government and public service institutions will continue to provide services where gaps exist due to market failures, and will withdraw when markets for these services develop. 52. Demand-Driven Interventions. Training provided under SMESDP will be demand-driven and based on training needs assessment, avoiding duplication with existing training programs. 53. Principles of Cost Recovery. The principle of cost recovery will guide the planning and implementation of the targeted training programs. There could be exceptions to the principle of cost recovery in cases that involve very small rural participants who do not have immediate capacity to pay regular training fees but could influence the direction and pace of SME development in their communities. Similarly, employers hiring displaced RMG workers will pay

28 These are based on the OECD’s Bologna Charter on SME Policies, the Istanbul Ministerial Declaration: Fostering

the Growth of Innovative and Internationally Competitive SMEs, and current SME policies and legal framework of ADB developing member countries. Market-based principles in finance are discussed in the Project Loan section.

17

for their training, but fees will be waived if workers with no ability to pay do not have immediate employment prospects. 54. Coordination of Government Efforts. The institutional framework for SME development will involve all tiers of the Government, including high-level support from the interministerial committee to be chaired by the prime minister. Moreover, the SME Foundation, a dedicated institution, will be set up to promote SME development on a sustainable basis. 55. Efficient Resources Utilization and Outreach of SME Programs. Efficiency of resource use will be maximized by working with SME groups or cells within chambers and business associations, which will coordinate with helpline outreach centers to ensure efficient service delivery to SMEs nationwide. 56. Use of Information Technology and E-Commerce. The SME web site/virtual front office under SMESDP that will contain information of SMEs and market opportunities will reduce barriers to SME access to global markets, and will be complementary to the Government’s e-governance program. 57. Development of Evaluation Culture and Statistical Database for SME Development. An evaluation culture will be promoted in ministries and agencies responsible for SME policies and programs to ensure cost-effectiveness and outreach of benefits of the programs. The SME database will help identify population of SMEs and facilitate implementation of SME-targeted interventions and studies of the SME sector, while the TA grant will support the development of benefit monitoring systems. 58. Empowerment of Women Entrepreneurs. To target women entrepreneurship development, a gender action plan has been prepared, specifying women-targeted activities to be conducted under SMESDP. First, women entrepreneurs will be involved in the preparation and implementation of the SME policy and development framework. The composition of the SME Task Force includes a representative from the Women Entrepreneurs’ Association of Bangladesh. Women entrepreneurs will also have a representative in NCID. Second, targeted women’s training programs will be conducted in collaboration with women entrepreneurs’ associations. Third, a portion of funds under SEF will be allocated to women entrepreneurs (para. 71). Lastly, gender-disaggregated data will be included in the SME database and the monitoring system of SMESDP to facilitate gender-targeted interventions and to keep track of women beneficiaries, including trained participants under the targeted women entrepreneurship training programs. (The gender action plan is in Supplementary Appendix 1.)

3. Financing Plan 59. Adjustment Costs. The total adjustment costs estimated at $33.4 million equivalent comprise (i) the development of SME policy and development framework and institutional setup for policy implementation; (ii) loss of revenues from tax incentives to small enterprises; (iii) establishment and operation of SME support infrastructure including the integrated database, web portal, helpline outreach centers, and e-governance infrastructure; and (iv) rationalization and improvement of government assistance to SMEs including restructuring of SCITI, restructuring of BSCIC, and upgrading of facilities and capacity building of BSTI. Under restructuring of BSCIC or its replacement, the Program will provide budgetary support for financial restructuring costs to cover its accumulated operating losses (paras. 17 and 43), staff rationalization, voluntary retirement, termination of excess personnel (particularly those not

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authorized to be in the employee roster), and recruitment of qualified professionals for specific important positions. The breakdown of adjustment costs is in Table 1.

Table 1: Estimate of Adjustment Costs ($ million)

Item FY2005 FY2006 FY2007 FY2008 Total SME Policy Development and Implementation 0.6 0.4 0.8 0.5 2.3

Tax Incentives 0.4 0.8 1.2 1.8 4.2

SME Support Infrastructure and E-Governance 1.7 2.2 1.3 1.2 6.4

Restructuring of Concerned Agencies under MOI Involved in the SME Sector

15.1 3.9 0.8 0.7 20.5

Total 17.8 7.3 4.1 4.2 33.4 FY = fiscal year, MOI = Ministry of Industries, SME = small and medium enterprise. Source: Asian Development Bank staff estimates.

60. Financing and Tranching. The program loan of SDR9.954 million ($15 million equivalent) will be from ADB’s Special Funds resources, with an amortization period of 24 years, including a grace period of 8 years, and with an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter. The loan closing date is expected to be 31 December 2007. Other terms and conditions are set out in the Program Loan Agreement. The loan proceeds will be available for withdrawal upon satisfactory compliance with the agreed conditions. The first tranche of $5 million equivalent will be released upon effectiveness of the loan and fulfillment of the first tranche release conditions. The second tranche of $10 million equivalent is expected to be released by end-June 2007, upon fulfillment of the second tranche release conditions.

4. Procurement and Disbursement 61. The program loan will follow ADB standard procedures for procurement and disbursement. Proceeds of the loan will be utilized to finance the full foreign exchange costs, excluding local duties and taxes, of imports produced in and procured from ADB’s member countries, other than those specified in the list of ineligible items and those items financed by other multilateral and bilateral official sources. (The list of ineligible items is in Appendix 4.) All procurement under the program loan will be in accordance with ADB’s Guidelines for Procurement and undertaken through normal commercial practices for the private sector or the Government’s prescribed procurement procedures acceptable to ADB, with due consideration to economy and efficiency. Disbursements under the program loan will be made in line with ADB’s simplified disbursement procedures and audit requirements. To withdraw the proceeds of the loan, the Borrower will certify that the value of eligible imports exceeds the amount of ADB’s projected disbursements under the program loan in a given period. ADB will have the right to audit the use of loan proceeds and to verify the accuracy of the Borrower’s certification.

5. Environmental Assessment of Policy Matrix 62. The assessment has been carried out. No specific environmental mitigation or monitoring requirement was identified (Supplementary Appendix 2).

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D. The Project Loan

1. Components and Outputs 63. Small Enterprise Fund. Market and policy failures in the financial sector are being addressed through various loan and TA projects on the reform of the Bangladesh financial sector funded by ADB and other development partners (paras. 28-31). However, the development of an appropriate legal framework as well as capacity building of the regulator and market players will take time. The Bangladesh credit market suffers from a dearth of medium- to long-term funds and does not allocate funds efficiently. Some FIs, which are keen to lend to SMEs, are constrained by the limited availability of term funds at reasonable costs while others are reluctant to expand their SME loan portfolio due to perceived higher credit risk and administrative costs of dealing with small borrowers. To encourage FIs to extend credit to SMEs, the Government has allocated Tk1 billion from the Rural-based Agro Processing Industries Refinancing Facility to establish SEF as a credit facility to be managed by BB for refinancing loans to small enterprises lent by banks and NBFIs (see summary of SEF terms and conditions in Appendix 5 and BB’s circular of 2 May 2004 on the Refinance Scheme for Small Enterprises Sector in Supplementary Appendix 3). 64. To support the government initiative in this regard, the project loan of SDR19.908 million ($30 million equivalent) will be used as a contribution to SEF. WB has contributed $10 million equivalent to SEF under its EGBM project.29 SEF will enhance access to credit by small enterprises in the “missing middle” between micro- and medium enterprises. Eligible enterprises will have fixed assets of not more than Tk10 million and will not be in the exclusion list that covers tobacco, alcoholic drinks, armaments, and other ineligible items. While the overall financing gap of the SME sector is large, the problem of lack of access to credit is more pronounced for this segment of SMEs. Under SEF, these enterprises can apply for loans in the range of Tk0.2 million–5 million. In addition, the TA loan component will provide capacity-building assistance to PFIs to strengthen their systems and procedures for SME lending, and train the SME credit staff to better understand and guide SMEs in their operations.

a. Participating Financial Institutions 65. Preidentification of PFIs. Under ADB’s financial intermediary loan (FIL) modality, PFIs are preidentified based on due diligence conducted not only to analyze their financial aspects but also to determine their ability to handle social and environmental issues. Six PFIs, namely, Prime Bank, Eastern Bank, Basic Bank, Industrial Development Leasing Company of Bangladesh, Industrial Promotion & Development Company of Bangladesh, and United Leasing Company, for which due diligence has been carried out, have been preidentified to participate under SEF (see summary of due diligence report in Appendix 6). However, since the facility is aimed at improving access to credit by SMEs, it was deemed appropriate to make the facility available to as wide a number of eligible FIs as possible. Moreover, the current approach is aimed at mainstreaming SME lending in the financial sector as opposed to the previous practice of relying on specialized FIs such as development finance institutions to deliver the credit. Consequently, BB in its capacity as administrator of SEF could accredit additional PFIs provided they meet eligibility criteria as agreed between BB, WB, and ADB (see also para. 77). BB will

29 Concerns about large-scale terminations of workers under the EGBM project led the Government to find ways to

reabsorb excess workers from state-owned enterprises and banks and provide gainful employment. Consequently, supporting the more rapid expansion of the SME sector was considered a viable way of addressing the problem.

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provide relevant information to ADB regarding accreditation of additional PFIs, which would enable ADB to conduct due diligence as necessary. 66. PFI Eligibility Criteria. Eligible PFIs must have no more than 10% classified loans on portfolios up to Tk5 million. Being under the supervision of BB, PFIs must also fully comply with BB’s prudential regulations which include, among other things, (i) minimum capital of 9% on a risk-weighted basis, up from 8% previously; (ii) exposure limit to a particular customer or group; (iii) loan classification and loan loss provisioning;30 (iv) internal control system; (v) risk management and antimoney-laundering procedures; and (vi) early warning system. In addition, under the Project Agreement between ADB and BB, each participation agreement between BB and the PFI will contain provisions that require the PFI to maintain financial soundness; conduct its operations in accordance with sound financial principles and practices; maintain a lending and investment policy acceptable to ADB and BB to enable it to effectively appraise the financial, technical, environmental, and economic feasibility of investment projects; and supervise and monitor the implementation of investment projects by beneficiaries. BB’s prudential regulations as well as the WB’s criteria conform to the eligibility criteria of PFIs under ADB’s FIL policy that have been reflected in the Project Agreement between ADB and BB. Moreover, the TA loan will provide assistance to PFIs to strengthen their systems and procedures for SME lending to ensure compliance with ADB’s FIL policy. 67. Safeguard Policies. BB will ensure that PFIs adhere to ADB’s safeguard policies on environment and resettlement. It is expected that many PFIs will not have systematic procedures for monitoring and assessment. ADB will assist PFIs through the TA loan to establish environmental management and monitoring systems appropriate for the targeted small enterprise clientele. 68. Environmental Due Diligence of the PFIs. The six PFIs include environmental risk analysis during their appraisal of loans, which involves as a minimum, checking if the borrower has an environmental clearance certificate. The PFIs do not finance projects that are hazardous or environmentally risky.31 All FIs have a designated officer responsible for environmental issues, but none has formal training and only a few have attended development agency-sponsored seminars on the environment. All FIs expressed need for further assistance and training. 69. BDS Offered by PFI. ADB, under the TA loan, will provide assistance to build up the capacity of PFIs to improve their SME lending capabilities, systems, and procedures; and to provide in-house advisory services for their SME clients. For more in-depth and sophisticated BDS, PFIs will refer SMEs to external BDS providers.

30 BB is bringing loan classification in line with international standards, i.e., currently, "substandard" if arrears are

more than 6 months but less than 9 months, "doubtful" if more than 9 months but less than 12 months, and as "bad debt" if more than 12 months (as compared with limits of 3, 6, and 12 months respectively under international standards). The Cabinet has approved amendments to allow BB to make the necessary changes to loan classification standards. BB is receiving assistance under the WB’s Central Bank Strengthening Project for $37 million to ensure banks' compliance with international standards.

31 IPDC (which was formerly affiliated with IFC) and IDLC (in which IFC is a shareholder), both follow environmental guidelines prescribed by IFC/WB and they do not finance any project that is on the exclusion list of IFC/WB. They have incorporated in the loan agreement a provision requiring the borrower to obtain an environmental clearance certificate for setting up the project to be financed and to renew the certificate every year. United Leasing, in which ADB has a shareholding, and Basic Bank, which has received loans from ADB and several other funding agencies, have similar requirements. The two other banks, Prime Bank and Eastern Bank, are not as rigorous or regular in checking environmental compliance, and they do not have a formal environmental management system.

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b. Small and Medium Enterprise Beneficiaries 70. Scope. Taking into account the experience under the BB’s Rural-based Agro-processing Industries Refinancing Facility, which had a low utilization rate owing mainly to the geographic restriction on use of funds, SEF has no geographic, industrial, or sector restrictions. SEF will finance agro-based enterprises, but not crop, livestock, and fish production that are being financed already with agricultural loans. Furthermore, participation in SEF is not limited to scheduled banks and the facility can be used for financing leases. More importantly, SEF will be subject to periodic review. BB in consultation with WB and ADB, will take corrective measures to improve utilization, including raising the coverage to include SMEs beyond the strict definition of the “missing middle” if needed. 71. Allocation for Women Entrepreneurs. Women are normally given lower priority in allocation of credit due mainly to negative sociocultural perceptions of women in business. To facilitate access by women borrowers, a minimum of 10% of SEF will be earmarked for lending to women entrepreneurs. However, if the earmarked funds are not utilized within a period of 1.5 years, such funds will revert to the general pool.

c. Use of Asian Development Bank Loan Proceeds 72. The loan proceeds will be used to finance new loans advanced by PFIs under a participation agreement with BB for the purpose of using the SEF, and will not be used to refinance the portfolio of old loans in the existing portfolio of the PFIs. Loans approved by PFIs more than 180 days prior to the application date for reimbursement of first disbursement using ADB funds will not be allowed. 73. Use of ADB Loan Proceeds for Working Capital. SEF will be available for medium-term (1–3 years) and long-term (3–5 years) loans as well as for short-term working capital loans. ADB’s FIL policy states that ADB funds may be used by the financial intermediary recipient of the FIL to finance fixed capital requirements of subprojects as well as subprojects’ foreign exchange requirements for initial working capital (such as initial stock of spare parts, tools, and raw materials), but not for subsequent working capital requirements.32 The WB’s FIL policy allows for financing of working capital for expansion of business activities.33 Since ADB loan proceeds will be contributed with WB and BB funds to the same pool, it would be an administrative burden on BB to distinguish whether a subloan is for initial working capital or for expansion or simply for additional working capital. Such differentiation would be highly impractical given the small size of these loans. Further, it would be impractical and complicated for small enterprises to seek financing from other sources just for their working capital needs given their limited access to credit. In this case, the requirement in the FIL policy for the use of ADB loans to finance only initial working capital should be relaxed to allow the ADB loan to help meet credit demands and for harmonization with BB’s criteria and WB’s policy. 74. Taking into account the estimated contribution from PFIs and SME beneficiaries as well as WB and BB cofinancing, ADB’s share of the project cost is estimated at only 11.6% (Table 2). At the subproject level, however, there may be cases where ADB’s financing may exceed the 75% cost sharing limit for Bangladesh. Under ADB’s local cost financing policy, ADB allows financial intermediaries to use the foreign exchange provided under FILs, to finance local currency expenditures of subprojects within standard cost-sharing limits; it is estimated that

32 ADB Operations Manual, Section D6/BP, para. 14. 33 WB’s Operational Policies on Financial Intermediary Lending.

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direct and indirect foreign exchange costs at the Project level will be 16.6% and 7.2%, respectively.34 In this regard, the local cost financing limit of ADB for Bangladesh should not be applied at the subproject level for flexibility in meeting the financing needs of small enterprises.

d. Relending and Onlending Rates 75. SEF is available for PFIs in local currency (taka) at the BB rate, which is currently 5%,35 while PFIs will onlend the funds in taka to qualified SME borrowers at market rates. Currently, the average cost of funds (less than 1 year) is about 7–9% for PCBs and 11–13% for NBFIs. The average lending rate is 10–13% for banks and 14–15% for NBFIs (even as high as 17% for longer-term maturities). The 5% BB rate utilized as the basis for refinancing loans under SEF will be applied uniformly and in a nondiscriminatory fashion to all eligible PFIs under the SEF. The BB rate is also the reference rate for all of BB’s refinancing facilities. The use of this rate is justified on the basis of the 3.5–4% foreign exchange cover and credit risk premium over the Asian Development Fund rate of the project loan. The BB rate is viewed as the wholesale cost at which PFIs would be willing to borrow to finance the SEF end-users. The 2% differential between the BB rate and the bank deposit rate36 is also to compensate PFIs for the higher servicing and administrative costs of dealing with small SME borrowers. Moreover, PFIs need inducements to focus their lending on SMEs. The penetration into this segment of borrowers could create a demonstration effect among FIs. Given more familiarity with the SME sector and enhanced capabilities of their staff, PFIs are expected to establish or strengthen their SME units to provide SME financing on a sustainable basis even after the expiry of SEF. Notwithstanding the use of the BB rate as the basis for the refinance facility, the onlending rate of PFIs to subprojects will be on strictly market-determined terms. In view of this, and consistent with ADB’s FIL policy,37 the use of the BB rate at a level below bank deposit levels is justified. 76. There are differing viewpoints as to whether this could be considered an implicit subsidy. According to the ADB Board Information Paper Bank Criteria for Subsidies dated 30 October 1996, “the exceptions to the general rule of no subsidies for private provision include interest rate subsidies directed to SMEs or to exporters to compensate for other policy effects. In many developing member countries, there is no market for long-term capital. ADB, through its activities, can provide access to long-term capital and encourage the development of domestic capital markets for longer term funds. In seeking to establish and improve capital markets, ADB is justified in providing funds and encouraging the domestic development of investment funds at a price that does not fully reflect the risks being taken.” Thus, the relending rate in either case could be justified in the context of Bangladesh where the capital market has not effectively played its role in mobilizing and allocating long-term funds. Moreover, concerns about subsidies—including fiscal burden, altering market signals, and undesirable and unanticipated effects on income distribution—are not relevant in the case of SEF. 34 WB and Bangladesh Enterprise Institute. 2003. Improving the Investment Climate in Bangladesh. Washington,

District of Columbia. Table A3.2 of Appendix 3 of the WB report gives a breakdown of sources of inputs and supplies by firm size. For small enterprises, the breakdown is: 76.2% of inputs and supplies from domestic sources; 16.6%, imported directly; and 7.2% imported indirectly.

35 The BB rate is used as a reference rate for BB to signal an expansionary or contractionary monetary policy stance. It is also used uniformly as the refinance rate in various BB credit facilities. Repo rates derived from open market operations are used as a monetary policy tool.

36 Bank deposit rates are also influenced by the Government’s National Savings Certificates schemes. 37 ADB Operations Manual, Section D6/BP, issued on 15 December 2003. In exceptional and well-justified cases,

ADB, for a certain period, may accept relending rates that are below market, but not below ADB’s ordinary capital resources lending rates in the case of a foreign currency-denominated loan or the equivalent rate in the case of a local currency loan, which should reflect an adequate foreign exchange risk premium.

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e. Management of the Facility 77. Bangladesh Bank as Facility Manager. BB was deemed appropriate to administer SEF at this stage because of BB’s large contribution to SEF, its ready access to information in determining the financial soundness and capabilities of PFIs for providing credit to the SME sector, and its function as administrator of the Credit Information Bureau, which gathers information regarding borrowers.38 No feasible alternative for facility management could be found. Concerns about governance, conflict of interest, and lack of capacity of candidate facility managers earlier considered ruled them out. BB’s regulatory and supervisory capacity is being strengthened under the ongoing WB’s Central Bank Strengthening Project. Guidance and support are provided in designing new bank regulation policy and strengthening prudential regulations, reporting, and enforcement. BB has made progress in improving its financial reporting, auditing, and control systems, and has adopted the International Accounting Standards as its accounting basis. The Agriculture Credit and Special Programs Department of BB will take charge of administering SEF, and BB will ensure that there are well-qualified professionals for the management of SEF. Once the SME Foundation is established, the management of SEF will be transferred in a phased manner from BB to the SME Foundation to ensure a sustainable institutional structure with private sector participation.

2. Important Features 78. The ineffective allocation of credit is due to market failures resulting from NPL problems of NCBs and lack of effective long-term debt and interbank markets. ADB and other development partners have actively supported financial sector reform through various loan and TA projects to address market failures. However, measures aimed at creating an enabling environment will require continuous long-term commitment from the Government and will take time to bring about substantial development impact. Currently, some FIs that are keen to engage in SME lending are constrained by limited availability of term funds at reasonable cost while others need to be provided with incentives to expand their loan portfolio. The problem is more pronounced for SMEs in the “missing middle”. It is imperative that PFIs are provided with financing resources, especially term funds at reasonable rates, to induce them to focus on the SME sector, and trigger the expansion of their SME portfolio. SEF is formulated to mainstream SME lending in the financial system instead of just defining one or few PFIs. The project loan as contribution to SEF will also be complementary to the WB’s contribution under its EGBM project. BB, as the fund manager, will coordinate the utilization of the ADB and WB fund contributions and the Government’s own funds in SEF. Complementary to the project loan is the TA loan that will enhance understanding of the SME sector among PFIs. Once the legal and institutional infrastructure is developed, these FIs will be able to introduce diversified financing mechanisms and instruments for more appropriately meeting the needs of SMEs. SMESDP will help bridge the current gap and allow for policy measures on financial market development to bear fruit.39

38 A Credit Information Bureau has been set up in BB. Currently, it covers loan accounts of at least Tk50,000. BB

plans to put the Credit Information Bureau online by 2005 and further expand the coverage of credit information. This will enable enhanced transparency on the quality of loans by borrowers.

39 The Government was receptive to the possible introduction of partial credit guarantee as credit enhancement to mobilize resources for SMEs on a sustainable basis. During SMESDP implementation, the Government, in close collaboration with BB, will further assess the need and feasibility for alternative credit enhancement arrangements. Under the Trade Finance Facilitation Program launched in May 2004, ADB will issue partial credit guarantees to guarantee participating international and regional banks (confirming banks), for payment of trade credits issued by accredited local banks (issuing banks) in selected developing member countries, including Bangladesh. A trade facilitation agreement has been signed by ADB with Southeast Bank.

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3. Costs and Financing Plan 79. The fund size of SEF is $56.7 million equivalent consisting of $16.7 million equivalent from the Government, $10.0 million equivalent from WB, and $30.0 million equivalent from ADB. PFIs and SME beneficiaries will contribute to the costs of subprojects from their own resources. The total project cost is estimated at $257.8 million equivalent, including $201.1 million equivalent estimated to be financed by PFIs, other sources of credit, and SME beneficiaries’ equity in addition to SEF.40 ADB will provide the project loan of $30 million equivalent from its Special Funds resources for a term of 32 years, including a grace period of 8 years, and with an interest rate of 1.0% per annum during the grace period and 1.5% per annum thereafter. The project loan will be provided in foreign exchange. Interest during the implementation period will be capitalized. Cost estimates and the financing plan are in Table 2.

Table 2: Project Cost Estimates and Financing Plan ($ million)

Item Cost Estimates Financing Plan

Foreign Exchange

Local

Currency

Total Cost ADB

World Bank GOB PFI

Other Sources of Credit

SME

BeneficiaryA. Small

Enterprise Fund

12.9 41.5 54.4 28.8 9.6 16.0 0.0 0.0 0.0

B. Administrative Cost

0.0 0.7 0.7 0.0 0.0 0.7 0.0 0.0 0.0

C. Interest during Implementation Period

1.6 0.0 1.6 1.2 0.4 0.0 0.0 0.0 0.0

D. Project Costs Financed by Other Sources

47.9 153.2 201.1 0.0 0.0 0.0 30.9 85.1 85.1

Total 62.4 195.4 257.8 30.0 10.0 16.7 30.9 85.1 85.1Share of Total (%) 24.2 75.8 100.0 11.6 3.9 6.5 12.0 33.0 33.0

ADB = Asian Development Bank, GOB = Government of Bangladesh, PFI = participating financial institution, SME = small and medium enterprise. Source: Asian Development Bank staff estimates.

4. Disbursement

80. ADB will lend the SME credit funds in US dollars to the Government under a loan agreement. In turn, the Government will provide the taka proceeds to BB under an administrative agreement. As the apex institution, BB will lend the SME funds in taka to eligible PFIs at refinancing rate of interest equivalent to the prevailing BB rate. ADB financing will be available to PFIs on a refinancing basis (i.e., based on disbursement by PFIs to SME borrowers). In turn, PFIs will relend the SME credit funds in taka as subloans/subleases to their SME clients at market-determined rates. The SME clients will repay the principal amount of the subloans/subleases to PFIs, which are obligated to repay BB in full irrespective of the amount collected from their clients. Activities to be financed through subloans/subleases will be carried out in accordance with ADB’s procurement requirements and environmental and other safeguard policies. The project loan will be available for 5 years from the effectiveness of SMESDP. It is expected that the completion date for the project will be 30 June 2010 and the loan closing date will be 31 December 2010. Subsequently, BB will recycle the funds repaid by 40 It is assumed that SME borrowers will contribute one third from their own equity and seek external financing for the

rest from PFIs and other sources. Based on discussions with the preidentified FIs, it is expected that PFIs will finance about 65% of their SME loans from SEF and about 35% from other sources of funds.

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PFIs for new subloans/subleases. Subloans/subleases drawn down under the facility will be coterminous with the ADB loan (i.e., 32 years maturity). 81. An imprest account will be established for the purpose of SEF administered by BB. The initial advance to the imprest account will be based on estimated expenditures for the first 6 months of the project loan or 10% of the respective loan amount (i.e., $3 million equivalent), whichever is lower. The imprest account will be replenished as eligible expenditures are incurred and liquidated. The imprest account will be established, managed, and liquidated in accordance with ADB’s Loan Disbursement Handbook, and detailed arrangements as agreed by the Government and ADB. ADB’s statement of expenditures procedures may be used to reimburse eligible expenditures and to liquidate advances made into the imprest account in accordance with ADB’s Loan Disbursement Handbook. Statement of expenditures procedures will be applicable to individual payments amounting to $50,000 or less. E. The Technical Assistance Loan

1. Components and Outputs 82. The TA loan will provide technical advice and resources needed to build capacity and assist in program implementation to achieve the stated outcomes of the Program. The components of the TA loan are discussed in the following paragraphs. The rationale, scope, and approach of each of the components of the TA loan are in Appendix 7. Terms of reference for TA loan components are in Supplementary Appendix 5. 83. Rationalization of Government Assistance to SMEs. The TA loan will deliver the following outputs, among other things: (i) a diagnostic analysis of BSCIC and its restructuring plan or phaseout plan, together with a timebound roadmap; (ii) restructuring plans for SCITI and BSTI or plans for their strategic reorientation; (iii) recommendations on the rationalization of existing SME credit facilities provided by the Government; and (iv) conceptual design of clusters and industrial parks. 84. Design and Development of SME Web Portal/Virtual Front Office. The SME web portal will (i) disseminate information about SMEs in Bangladesh such that any local or foreign buyer or investor can easily reach the SMEs and initiate any business relationship; (ii) facilitate e-governance and provide online information for SMEs on government facilities and services, such as requirements for business registration, licensing and product certification; and (iii) contain a library of SME-related information, such as a list of BDS providers and link to the SME database. This will require a wide-area network connecting remote nodes located in districts outside Dhaka with the data center in the SME Cell at MOI. 85. Establishment and Operation of SME Helpline Outreach Centers. This component will assist in establishing SME helpline outreach centers at the district offices of BSCIC and facilities of the Dhaka and Chittagong chambers of commerce and industry to provide advisory support to facilitate SME access to government services, including registration and licensing. The helpline outreach centers will be linked to the SME web portal to facilitate their services to SMEs. 86. Targeted SME Capacity Building. SCITI, in collaboration with FBCCI, district chambers and line associations of FBCCI, accredited women entrepreneurs’ associations, National Association of Small and Cottage Industries of Bangladesh, and helpline outreach centers where available, will carry out suitable and affordable training programs targeted for

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(i) entrepreneurs and small enterprises in rural areas; (ii) women entrepreneurs; (iii) displaced workers in the RMG industry; and (iv) PFIs under SEF, or other FIs that may wish to avail of these training services. The TA will strengthen capacity of SCITI to implement these training programs on a continuing basis. In addition, the TA loan will provide capacity-building assistance for PFIs to establish or improve their SME financing systems and procedures and adopt new financing modalities such as cash-flow-based lending, and movable asset-based secured transactions to enhance their SME credit operations. 87. Upgrading of Product Certification System to International Standard. Assistance in terms of advice, capacity building, and equipment facilities will be provided to improve the quality of product certification system in Bangladesh to international standard in collaboration with the planned project of the European Commission and United Nations Industrial Development Organization. Certification services to SMEs will be facilitated. The TA loan will also assist BSTI in conducting campaigns to promote the importance of product certification among SMEs and help guide SMEs through the certification process. 88. Development of Integrated SME Database. Consulting inputs will be needed for the planning, design, and development of an SME database. Using a registry of SMEs as sampling frame, a nationwide survey will be conducted to capture attributes of the SMEs. The database design will define SME populations and their characteristics by industry, sector, geographic location, and development contributions, e.g., employment and value added. 89. Environmental Assessment and Monitoring. This TA loan component will assist in building up capacity of the executing agency (EA), implementing agencies (IAs), and PFIs to ensure compliance with ADB’s environmental safeguard policy. PFIs will be assisted in setting up an environmental impact monitoring system.

2. Costs and Financing 90. The total cost of the TA loan project is estimated at $8.46 million equivalent, of which $5.0 million equivalent will be financed by ADB, and $3.46 million equivalent by the Government, and the project beneficiaries including SMEs, PFIs, training participants, chambers, and associations, as summarized in Table 3. For the SME targeted training and the helpline outreach centers, it is assumed that chambers and associations under the umbrella of the FBCCI will contribute under a public-private partnership arrangement. The contributions of the private sector will be by way of fees for training and advisory services and use of facilities. (Detailed cost estimates and the financing plan are in Appendix 8.) 91. ADB will provide the TA loan of SDR3.318 million ($5 million equivalent) from its Special Funds resources for a term of 32 years, including a grace period of 8 years, interest rate of 1% per annum during the grace period and 1.5% per annum thereafter, and other terms and conditions set out in the TA Loan Agreement to cover the total foreign exchange cost and part of the local currency cost. The TA loan will finance consulting services, procurement of equipment, workshops and seminars, surveys, and report preparation. Interest during the implementation period will be capitalized. The TA loan will be implemented over 2.5 years and the loan closing date is expected to be 30 June 2008.

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Table 3: Summary of Technical Assistance Loan Cost and Financing ($)

Source Foreign

Exchange Local

Currency Total Cost

A. Asian Development Bank Financing Component 1: Rationalization of Government Assistance to SMEs 673,000 183,000 856,000 Component 2: Development of Web Portal and Virtual Front Office 45,000 70,000 115,000 Component 3: Establishment of Helpline Outreach Centers 209,000 263,000 472,000 Component 4: Targeted SME Capacity Building Rural Enterprise Training 297,000 175,000 472,000 Women Entrepreneurs Training 161,000 85,000 246,000 Retraining of Displaced Readymade Garment Workers 298,000 257,000 555,000 Development of SME Lending Capability of PFIs 655,000 170,000 825,000 Component 5: Upgrading of Product Certification System 379,000 58,000 437,000 Component 6: Integrated SME Database Development 441,000 330,000 771,000 Component 7: Environmental Assessment and Monitoring 124,000 47,000 171,000 Interest during Implementation Period 80,000 0 80,000 Subtotal (A) 3,362,000 1,638,000 5,000,000 B. Government and Beneficiaries Financing

Component 1: Rationalization of Government Assistance to SMEs 0 290,000 290,000 Component 2: Development of Web Portal and Virtual Front Office 0 70,000 70,000 Component 3: Establishment of Helpline Outreach Centers 0 480,000 480,000 Component 4: Targeted SME Capacity Building Rural Enterprise Training 0 500,000 500,000 Women Entrepreneurs Training 0 260,000 260,000 Retraining of Displaced Readymade Garment Workers 0 540,000 540,000 Development of SME Lending Capability of PFIs 0 840,000 840,000 Component 5: Upgrading of Product Certification System 0 150,000 150,000 Component 6: Integrated SME Database Development 0 270,000 270,000 Component 7: Environmental Assessment and Monitoring 0 60,000 60,000 Subtotal (B) 0 3,460,000 3,460,000 Total 3,362,000 5,098,000 8,460,000

PFI = participating financial institution; SME = small and medium enterprise. Source: Asian Development Bank estimates.

3. Procurement

92. Procurement of goods and services will be in accordance with ADB's Guidelines for Procurement. Each supply contract for equipment, computers, vehicles, or materials estimated to cost the equivalent of more than $500,000 will be awarded on the basis of international competitive bidding. Each supply contract estimated to cost the equivalent of $500,000 or less (other than minor items) will be awarded on the basis of international shopping, and supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB.

4. Consulting Services 93. Recruitment of consultants to be financed from the proceeds of the ADB loan will be in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the selection and engagement of domestic consultants. A total of 95 person-months of international and 160 person-months of domestic consultants will be required. The quality-and-cost-based selection method will be used for the recruitment of consulting firms for targeted SME capacity building, upgrading of the product certification system, and integrated SME database development. Individual consultants will be recruited for other components. The

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breakdown of consulting inputs and selection method for each component are summarized in Table 4.

Table 4: Summary of Consulting Services and Selection Method Technical Assistance Loan Component

International (months)

Domestic (months)

Total (months)

Selection Method

1. Rationalization of Government Assistance 20 20 40 Individual 2. Development of Web Portal and Virtual Front Office 1 5 6 Individual 3. Establishment of Helpline Outreach Centers 6 30 36 Individual 4. Targeted SME Capacity Building 47 79 126 Firm by QCBS Rural Enterprise Training 10 20 30 Women Entrepreneurs Training 5 10 15 Retraining of Displaced Readymade Garment Workers

10 27 37

Development of SME Lending Capability of PFIs 22 22 44 5. Upgrading of Product Certification System 5 5 10 Firm by QCBS 6. Integrated SME Database Development 12 18 30 Firm by QCBS 7. Environmental Assessment and Monitoring 4 3 7 Individual Total 95 160 255

PFI = participating financial institution, QCBS = quality-and-cost-based selection method, SME = small and medium enterprise. Source: Asian Development Bank staff estimates. 94. Under the targeted SME capacity-building component, full technical proposal will be used for the PFI capacity-building assistance subcomponent, while simplified technical proposal will be used for the other subcomponents, which will possibly be combined under one contract. Full technical proposal will also apply to the upgrading of the product certification system component while simplified technical proposal will be used for the integrated SME database development component.

5. Disbursements 95. Disbursements for the TA loan will be subject to imprest account and direct payment procedures in accordance with ADB’s Loan Disbursement Handbook dated January 2001. An imprest account will be established for MOI at a commercial bank approved by the Ministry of Finance (MOF). The imprest account will be replenished as eligible expenditures are incurred and liquidated. The initial advance to the imprest account will be based on estimated expenditures for the first 6 months of the project loan or 10% of the respective loan amount (i.e., $500,000 equivalent), whichever is lower. The imprest account will be established, managed, and liquidated in accordance with ADB’s Loan Disbursement Handbook, and detailed arrangements as agreed by the Government and ADB. ADB’s statement of expenditures procedures may be used to reimburse eligible expenditures and to liquidate advances made into the imprest account in accordance with ADB’s Loan Disbursement Handbook. Statement of expenditures procedures will be applicable to individual payments amounting to $50,000 or less. F. Implementation Arrangements for the Sector Development Program

1. Program and Project Management 96. Central Program Coordination Unit. The Ministry of Finance, Finance Division (MOF-FD) will be the EA for SMESDP. MOF-FD will establish a central program coordinating unit (CPCU) that will coordinate activities between the various entities involved in delivering outputs of the Program. The CPCU will be in charge of supporting and overseeing the implementation of

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policy actions including compliance with tranche conditions and related project and TA components under SMESDP. It will ensure that adequate counterpart resources are made available. The CPCU will liaise with the IAs to ensure effective management, close monitoring, and timely reporting. It will ensure timely submission by each IA of reports that will be consolidated for transmission to ADB. The CPCU will be the focal point for coordination of SMESDP and communication with private sector stakeholders and external agencies, particularly ADB, regarding the Program. The CPCU will be headed by the SMESDP program coordinator at the level of joint secretary directly reporting to the secretary, MOF-FD. Such coordinator will also function as the project director and will be assisted by the project consultants to be engaged under the TA grant. The program implementation schedule is in Appendix 9. (The program organization chart is in Supplementary Appendix 4.)

2. Program and Project Implementation Units 97. MOI as IA for the Program Loan. The SME Cell set up at MOI will provide secretariat support initially to the SME Task Force and subsequently to the SME Advisory Panel in drafting the SME policy and development framework as well as the action program to support the development strategy, and will be responsible for its implementation. Further, the SME Cell will undertake policy research and prepare reports for consideration by the Guidance Committee. MOI will prepare quarterly progress reports on the program loan and submit such reports to MOF-FD for submission to ADB. 98. Bangladesh Bank as IA for the Project Loan. BB, as administrator or facility manager of SEF, will (i) provide information to ADB on candidate PFIs including its assessment of their eligibility for SEF; (ii) disqualify any PFI that has become ineligible based on a semiannual review; and (iii) review utilization and repayments of subloans/subleases of PFIs. In accordance with the administrative agreement with the Government, BB will maintain proper accounts, procedures, and records adequate to monitor and record the progress of subprojects financed by PFIs out of the subsidiary loans every 6 months. BB will review and report to ADB the utilization of the facility through progress reports every 3 months. The terms and conditions of the facility will be amended as necessary based on the outcome of the review in coordination with ADB and WB to increase utilization of the fund and respond to market needs. BB will also monitor the socioeconomic and environmental benefits of the subprojects. In this regard, ADB will provide TA grant resources for benefit monitoring and evaluation. 99. MOI as IA for the TA Loan. The SME Cell will oversee the implementation of the TA loan to ensure the timely recruitment and effective supervision of consultants. The SME Cell will closely coordinate with and submit required reports to the CPCU. Under the TA grant, the consultants will provide technical and administrative support to the SME Cell.

3. Accounting, Auditing, and Reporting 100. Accounting and Auditing. MOF-FD will keep a record of the utilization of the SMESDP loans and will ensure that the record keeping and accounting done by the IAs follow accounting and financial management procedures acceptable to ADB. The IAs will maintain separate records and accounts for the SMESDP loan components, which will be audited annually in accordance with sound accounting standards by independent auditors acceptable to ADB. Annual audited reports and financial statements, in English, will be submitted to ADB within 6 months after the end of each fiscal year. The auditor’s opinion of that part of the examination relating to the imprest account should be separately set out in the auditor’s report.

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101. Reporting. MOF-FD will monitor implementation of SMESDP. Through the CPCU, MOF-FD will prepare quarterly a consolidated progress report on SMESDP (including a BB report on accredited PFIs and review of utilization of SEF as stated in para. 98) in a format acceptable to ADB that gives information on implementation progress, issues encountered, and measures taken to resolve them, and the status of compliance with loan covenants. The progress reports will be submitted to ADB not later than 30 days after the end of the relevant quarter. MOF-FD will submit to ADB a completion report for SMESDP within 3 months of the end of the program period. The completion report will provide a detailed evaluation of the SMESDP design and implementation including performance of the IAs, associated government entities, consultants, and the socioeconomic and outreach impact of the Program.

IV. TECHNICAL ASSISTANCE 102. The TA grant will support program implementation and coordination to ensure timely compliance with policy conditions and other deliverables to achieve the stated outcomes. The TA will (i) assist in operationalizing the SME Cell; (ii) assist the SME Advisory Panel in formulating an action program for the implementation of the SME policy and development framework; (iii) assist in establishing and operationalizing the SME Foundation; (iv) strengthen monitoring and reporting of the implementation of various components under SMESDP to enable timely corrective action if needed; (v) build up capacity of the EA and IAs in implementing the activities and monitoring benefits of SMESDP; (vi) provide administrative support to the CPCU and the SME Cell in the procurement of equipment, recruitment of consultants, and provision of other resources needed; (vii) coordinate all activities between the EA, IAs, and other private and public sector stakeholders; (viii) assist in and monitor the implementation of the gender action plan; and (ix) build up capacity of PFIs under SEF in monitoring benefits of the SME loans. 103. The total cost of the TA is estimated to be $750,000 equivalent. ADB will provide $600,000 equivalent on a grant basis from the ADB-funded TA program to cover the foreign exchange cost and part of the local currency cost of the TA. The Government will provide the remaining $150,000 equivalent through the provision of counterpart staff, offices, transportation, and incidental expenses. The TA will be implemented over the implementation period of the SMESDP. MOF-FD will be the EA and MOI will be the IA of the TA. Individual consultants will be recruited in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the engagement of local consultants. Detailed objectives, scope, terms of reference of consulting services, and target dates for submission of consultants’ reports are in Appendix 10.

V. PROGRAM BENEFITS, IMPACTS, AND RISKS A. Benefits and Impacts 104. Policy Measures. SMESDP will be the principal vehicle in the formulation and implementation of SME-targeted public policy that has been developed through a participatory process involving all stakeholders. The growth of the SME sector supported by the Program will help generate employment, promote economic growth, and reduce poverty. SMEs will benefit in a number of ways, among others. First, targeted SME policy measures will guide the concerned government agencies in providing support to the SME sector. Second, tax incentives will reduce the financial burden and enhance viability of small start-up enterprises. Third, more extensive outreach of guidance and handholding assistance will be provided through the SME web portal and helpline outreach centers. Fourth, there will be centralized information regarding market

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opportunities and improved linkages to international markets. Fifth, SMEs will have improved access to capacity building, training, and BDS. Sixth, e-governance registration that will be made possible using the SME web portal will promote transparency and minimize opportunities for rent seeking. Lastly, improved quality of the product certification system and enhanced acceptability of Bangladeshi products in international markets will allow SMEs to broaden their foreign market access and increase international competitiveness. 105. Institutional. SMESDP will support the development of institutional mechanisms and provide the opportunity for the mobilization of public policy bodies at the highest level of the Government to promote the SME sector. At the implementation level, SMESDP will provide capacity-building assistance to the SME Cell and SME Advisory Panel to develop and implement an action program, and will assist in establishing and operationalizing the SME Foundation in the form of public-private partnership as a dedicated SME development agency on a sustainable basis. Further, the Program will support studies to improve the effectiveness of the concerned agencies that provide services to SMEs; prepare a plan for their restructuring and strategic reorientation; rationalize and enhance effectiveness of government credit assistance to SMEs; and provide capacity-building assistance. 106. Financial. Small enterprises will have better access to credit through SEF. The Program will also enhance the capabilities of PFIs in extending credit to SMEs. Given more familiarity with the SME sector, and enhanced capabilities of their staff, PFIs are expected to focus more on the SME segment and strengthen their SME unit. PFIs will be able to grow and diversify their portfolios, in the process building their base of recurring earning assets. It is anticipated that at least 15 PCBs and 13 NBFIs will use SEF. Capacity-building assistance for the development of SME lending systems and procedures will be provided for PFIs. Training will be provided to over 1,000 SME credit staff. As a result, it is envisaged that the volume of SME loans will increase by at least 15.8% annually on average during FY2005–FY2007 from a historical rate of about 12.3% per annum. Moreover, it is estimated that over 10,000 subloans/subleases will be made through PFIs under SEF throughout the life of the ADB loan. Lending to SMEs will have a strong linkage impact on BDS providers who will likely respond to generated demand for their services and PFI referrals. 107. Economic and Poverty. On a strategic level, SMESDP will contribute to the country’s goal of raising real economic growth, creating employment, and reducing poverty incidence. SMESDP will promote the growth of employment in the SME sector by at least 8% per annum throughout the program implementation period. It is estimated that over 8,000 participants from SMEs, including 2,000 women, will undergo training to be conducted by SCITI in partnership with chambers and associations during the TA loan implementation period. It is projected that about 150,000 entrepreneurs and other individuals interested in setting up an enterprise will visit and use the services of the helpline outreach centers and at least half will be repeat visits by regular clients. Over 12,000 RMG workers will undergo training and at least 50% will be reemployed during the TA implementation period. 108. Safeguards. The BB unit designated to manage SEF will monitor PFIs’ adherence to ADB’s Environmental Policy (2002) and Environmental Assessment Guidelines as well as to ADB’s policies on involuntary resettlement and indigenous peoples. PFIs are to be advised not to lend or lease to companies in the negative list (those not complying), and will have to report any violation or noncompliance by their borrowers with health, safety, and environmental regulations. Provision to this effect will be made in the participation agreement with the PFIs as indicated in the Project Agreement between BB and ADB. As for environmental safeguards, ADB’s own due diligence will identify areas for remedy, including training as necessary. Since

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the PFIs’ subloans/subleases to SMEs will be largely in the light-manufacturing, agro-processing, trade, and services sectors, and since none is expected in infrastructure, it is unlikely that involuntary resettlement or detrimental impacts on indigenous peoples will occur. (The summary poverty reduction and social strategy, which includes a gender action plan section, is in Appendix 11.) B. Risks 109. Despite changes in officials at the helm of the Government, it is expected that reforms under the Program will continue unhampered given the high priority assigned to SME development and the Government’s strong commitment as exemplified in the formation of the SME Task Force spearheaded by the principal secretary. Regulatory reforms will continue to create a more conducive environment for private sector development. Stakeholders will participate in the consultation process and policy dialogue for the SME development. The holding of the SME workshop in February 2004, where over 100 participants from the public and private sectors participated, is a clear indication of strong stakeholder interest. The fact that the Government initiated the process of consultation leading to the development of the SME policy and development framework demonstrates the Government’s ownership of policy reforms. 110. The implementation risks have been addressed through the institutional mechanism, which involves all tiers in the Government including the NCID at the top policy level, Guidance Committee at the ministerial level, and the dedicated SME Cell and SME Foundation at the implementation level. The TA grant will provide capacity-building assistance to the EA and IAs in carrying out activities under the Program. To successfully implement the restructuring plan of the concerned agencies under MOI, it is essential that qualified professionals be recruited to run the organizations. The salary and incentive structure of the government employees should be reviewed to attract such professionals. 111. The Program also reduces risks and institutes checks and balances through the use of participatory consultation mechanisms and public-private partnerships. The SME policy and development framework will be developed through consultation and participation of various stakeholders and will be disseminated to the public through publication in newspapers of nationwide circulation The SME Foundation will have private sector representatives on its board. The private sector through FBCCI and the business associations and chamber bodies will be involved in program implementation and make a substantial contribution to the total resources, in addition to their business network, practical knowledge and skills, and linkages to sources of market information and technology. 112. For the expansion of their loan portfolio to accommodate SMEs, it is assumed that the PFIs will increasingly view lending to SMEs through setting up dedicated SME units staffed with capable personnel, efficient systems, and proper procedures.

VI. ASSURANCES 113. The Government has given the following assurances, in addition to the standard assurances, which are incorporated into the program, project and TA loan documents: 114. For the program loan:

(i) The Government will maintain the policies adopted and actions taken prior to the date of the Program Loan Agreement and promptly adopt the other policies and

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take the other actions included in the SMESDP, in each case as described in the development policy letter and the policy matrix, and ensure that such policies and actions continue in effect for the duration of SMESDP and subsequently. The Government will consult with ADB in preparing and finalizing the SME policy and development framework, including the inclusion as appropriate of internationally accepted market-based principles regarding SME development.

(ii) The Government will ensure, through an active consultation process, the participation of various stakeholders including the private sector, financial institutions, development partners, nongovernment organizations, and research and academic institutions in the finalization and implementation of the SME policy and development framework and the components under such policy, as detailed in the policy matrix.

(iii) The Government will ensure that (i) women entrepreneurs are represented in the preparation of the SME policy and development framework, and (ii) women entrepreneurs are represented on the NCID. The Government will also ensure that the SME database has gender-disaggregated data.

115. For the project loan:

(i) BB will ensure that the PFIs satisfy the selection and ongoing eligibility criteria to

serve as a PFI under the SEF described in para. 66 above. BB will also ensure that subprojects are selected based on the criteria described in para. 64 above.

(ii) A minimum of 10% of SEF will be earmarked for lending to women entrepreneurs to ensure access by women borrowers. Earmarked funds that are not utilized within a period of 1.5 years will revert to the general pool.

(iii) Activities financed through the subloans and subleases will be carried out in accordance with applicable ADB procurement, environment, involuntary resettlement, and other guidelines and policies. With respect to the environment, the Government will carry out the Project in compliance with the relevant laws and regulations and ADB's Environment Policy (2002). The Government will also ensure that BB develops an appropriate environmental monitoring system comprising policy and procedures for monitoring of and reporting on PFIs’ environmental management systems for implementing compliance by subborrowers with all relevant environmental regulations.

(iv) The Government will ensure that the performance of SME credit facilities currently administered directly by various government agencies and public sector FIs is reviewed and measures are taken to improve the targeting and efficiency of utilization of such facilities.

(v) The Government will ensure that, in a phased manner, management of the SME credit facilities currently directly administered by the Government will be transferred to the SME Foundation to be established under the Program.

116. For the TA loan, the Government will ensure that (i) targeted training programs for women entrepreneurs are developed to address their specific needs; and (ii) a forum is organized to allow women labor and employees to discuss their training and capacity building needs; such needs shall be taken into consideration in the training programs under the TA loan. 117. Conditions for Effectiveness of the Program, Project, and TA Loan Agreements. Conditions for effectiveness will include cross-effectivity such that effectiveness of any of these agreements will require satisfaction of all conditions of effectiveness of the other two agreements (excluding effectiveness of such other agreements).

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118. Condition for Disbursement of the Project Loan. Execution of the administrative agreement between the Government and BB and entry into a participation agreement acceptable to ADB between BB and an eligible PFI.

VII. RECOMMENDATION

119. I am satisfied that the proposed loans would comply with the Articles of Agreement of ADB and recommend that the Board approve:

(i) the loan in various currencies equivalent to Special Drawing Rights 9,954,000 to the People’s Republic of Bangladesh for the Small and Medium Enterprise Sector Development Program from ADB’s Special Funds resources with an interest charge of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 24 years, including a grace period of 8 years; and such terms and conditions as are substantially in accordance with those set forth in the draft Loan Agreement presented to the Board;

(ii) the loan in various currencies equivalent to Special Drawing Rights 19,908,000 to

the People’s Republic of Bangladesh for the Small and Medium Enterprise Sector Development Project from ADB’s Special Funds resources with an interest charge of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan and Project Agreements presented to the Board; and

(iii) the loan in various currencies equivalent to Special Drawing Rights 3,318,000 to

the People’s Republic of Bangladesh for the Small and Medium Enterprise Sector Development Program from ADB’s Special Funds resources with an interest charge of 1% per annum during the grace period and 1.5% per annum thereafter; a term of 32 years, including a grace period of 8 years; and such other terms and conditions as are substantially in accordance with those set forth in the draft Loan Agreement presented to the Board.

Tadao Chino President

26 November 2004

35Appendix 1

PROGRAM FRAMEWORK

Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks a Goals Accelerate development of SME sector and enable SMEs to attain their full potential for contributing to sustainable economic growth and poverty reduction

• Income poverty reduced to 43% in 2006, 35% in 2010, and 25% in 2015 from 50% in the base year 2000

• GDP growth increased to meet the targets for FY2005-FY2007 under the PRGF of IMF

• Government macroeconomic and social statistics • IMF review on the PRGF • BB’s annual reports

Purpose Enhanced growth of commercially viable SMEs and increased employment in the SME sector

• Employment in the SME sector increased by at least 8% p.a. during FY2005–FY2007

• SME loan portfolio of PFIs under the SEF increased to at least 15.8% p.a. on average, during FY2005–FY2007

• Government SME statistics • Report on development contributions of SMEs,

including employment to be generated from SME database

• Surveys on SMEs • Report on loan portfolios of PFIs with breakdown

by size of enterprises

• Government’s commitment to reforms under the PRSP despite changes in Administration

• Reforms will continue to create a more conducive environment for private sector development

• Macroeconomy remains stable • Political stability is assured

Outputs 1. SME policy and

development framework • Government to approve the SME policy

and development framework by December 2005

• Government’s announcement • Summary SME policy disseminated to the public

in Bangla and English in at least three newspapers of nationwide circulation

• Relevant agencies effectively implement SME development strategy and action program

2. Institutional structure and mechanisms to implement the SME development strategy

• SME Advisory Panel constituted by December 2005

• SME Foundation established by June 2007

• Government’s announcement • Minutes of meetings of the SME Advisory Panel

and the Board of the SME Foundation

• Effective public-private partnership and active participation by private sector representatives in the SME Advisory Panel and SME Foundation

3. Action program to support SME development strategy

• SME Cell organized at Ministry of Industries by December 2004

• SME development strategy and action program prepared by June 2006

• Progress reports of SME Cell • Government providing the needed resources for the SME Cell and SME Advisory Panel

4. Rationalized government assistance to SMEs

• MOI to complete human resource restructuring of BSCIC field and head offices by September 2006

• Initiate restructuring of BSCIC by June 2007

• Credit facilities administered by the Government rationalized by December 2006

• BSCIC’s human resource restructuring plan and profile of BSCIC’s staff

• Annual reports of BSCIC and other concerned agencies under MOI involved in the SME sector

• Quarterly progress reports of MOF CPCU and MOI

• Government committed to improve effectiveness of support for SMEs

• MOI has leadership to implement the study result without being politicized

Continued on next page

36 Appendix 1

Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks a 5. Tax and Incentives • Government to provide tax incentives to

small enterprises that have fixed investment (excluding land and buildings) less than Tk3 million to take effect from FY2006 (starting June 2005)

• Finance Act 2005 and Budget FY2005/06 • Tax regulations

• Government committed to give financial relief to small enterprises

6. Improved SME access to business support services and government assistance

• Integrated SME database to be developed fully by December 2006

• SME web portal operationalized by March 2006

• Helpline outreach centers operating in Dhaka and Chittagong by June 2006 and in at least half of the districts by December 2007

• Targeted SME training programs operationalized by June 2006

• BSTI’s special window for certifying SME products opened and operational by June 2005

• Accreditation Law introduced in Parliament by June 2006

• Accreditation Board established by December 2006

• Accreditation Board to apply for membership in the International Accreditation Forum by June 2007

• Government’s announcement for formation and operation of SME database, SME web portal, and helpline outreach centers

• Quarterly progress reports of MOF CPCU and MOI and BSTI’s annual reports

• Reports on SMEs to be generated from the SME database

• Operational plan and budget of helpline outreach centers

• Statistics of SME visitors to SME web site and helpline outreach centers

• Feedback from training participants • Accreditation Law • Registration document, business plan,

organizational and board structure, and budget of the Accreditation Board

• Application for membership in the International Accreditation Forum

• IT capacity is internalized and sustainable

• Each system is continuously updated and upgraded by a dedicated unit

• A cost recovery system is established for sustainable implementation of the training programs

• Active participation by targeted training participants

• Active collaboration from private sector stakeholders

• Government’s commitment to reform and upgrade the product certification system

• Accreditation is effectively decentralized and properly monitored

• Recruitment of qualified staff and adequate budget for relevant agencies

7. Greater access to sustainable credit by SMEs

• SEF to be fully operational and head of unit in BB responsible for facility management to be designated prior to effectiveness of project loan

• SEF to be fully utilized by December 2010 • 10% of SEF earmarked for women

entrepreneurs fully disbursed by December 2006

• PFI training programs established and PFIs’ staff undergo training programs by December 2006

• PFIs to set up formal SME units to provide advisory services by June 2007

• Report of BB on utilization of SEF including the proportion disbursed for women entrepreneurs, and on progress of subprojects financed by PFIs out of the subsidiary loans

• Certified copies of the audited accounts and financial statements on SEF within 6 months of the end of each fiscal year

• Feedback from PFI training participants and PFI clients

• Organizational structure of PFIs to indicate SME unit and staff

• PFIs find it cost effective to lend to small borrowers and actively engage in SME financing operations and expand their SME loan portfolios

• PFIs establish appropriate systems and procedures for SME lending operations

• Productive utilization of the loan by small enterprises

Continued on next page

37Appendix 1

Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks a Activities 1. SME Policy and Development Framework SME policy and action program for implementation of policy measures issued and disseminated to the public

• MOI to draft SME policy based on the Government’s policy directions, and the SME Task Force Report in consultation with stakeholders by June 2005

• MOI to prepare an action program for implementation of the SME development strategy under guidance of SME Advisory Panel by June 2006

• Documentation of consultation process including seminars, and roundtable discussions among stakeholders

• Quarterly progress reports of MOF CPCU and MOI

• Government’s commitment to promote SME development

• Stakeholders will participate actively in the preparation and implementation of the SME policy and action program

2. Institutional Structure and Mechanisms to Support SME Development Establishment of institutional structure and mechanisms to implement and operationalize SME policy

• NCID to be designated as the body to be responsible for the promotion, growth, and development of SMEs

• SME Cell to be organized within MOI and adequately staffed for implementing the action program by June 2005

• Memorandum and articles of association of SME Foundation to be set up with at least 50% private sector representation on the board approved by December 2006

• MOI’s budget to provide for the operations of the SME Cell and subsequently the SME Foundation

• Memorandum and articles of association of the SME Foundation

• Budgetary support for SME Cell and SME Foundation

• Availability of qualified staff in the SME Cell and SME Foundation

• Effective implementation of the TA grant to support the SME Cell and assist in establishing the SME Foundation

3. Rationalized Government Assistance to SMEs Rationalized incentive and tax structure for SMEs

• Tax amendments to allow 75% income tax rebate passed by June 2005

• Use of accelerated depreciation method for SMEs allowed by June 2005

• Finance Act 2005 and Budget FY2006 • Tax regulations

• Government’s commitment to provide tax incentives to small enterprises

More effective and streamlined operations of concerned agencies under MOI that interface with and provide services to SMEs including BSCIC

• Diagnostic studies on concerned agencies under MOI involved in the SME sector including BSCIC by December 2005

• Government to prepare restructuring plan, with TA loan assistance to enhance effectiveness of the concerned agencies by June 2006

• Restructuring plan for the concerned agencies approved by December 2006

• Review of credit facilities administered by the Government and preparation of rationalization plan for such facilities completed by December 2005

• Draft report and diagnostic analysis of the concerned agencies

• Restructuring or phase out plan including time-bound monitorable targets and progress reports on its implementation

• Business plan, organizational structure, staffing plan, budget, and audited financial statements of concerned agencies under the study of the TA loan

• Rationalization plan for credit facilities

• Government’s commitment to pursue restructuring of the concerned agencies

• Cooperation from employees of the concerned agencies to implement the restructuring plan and no politicization

• Private sector participation in the management of the restructured organizations

• Recruitment of professionals for the restructured organizations

Continued on next page

38 Appendix 1

Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks a • Rationalization plan for credit facilities

approved by June 2006 4. Improved SME Access to Business Support Services and Government Assistance Support infrastructure to improve SME access to market information and government services

• SME sampling frame completed by September 2005

• Nationwide survey of SMEs for establishment of SME database completed by March 2006

• Database updated with survey data by June 2006

• TA loan to assist in developing SME web site to commence by June 2005

• TA loan to assist in establishing helpline outreach centers to commence by June 2005

• Quarterly progress reports of MOF CPCU and MOI

• TA loan progress reports • SME sampling frame and registry of SMEs • Survey results

• Adequate budget and qualified staff. • Timely implementation of the TA loan. • Upgraded telecommunication facilities

for nation-wide and global Internet linkages.

• No bureaucratic or technical problems. • Collaboration and deployment of

resources by chambers and associations.

Enhanced access to capacity-building assistance

• Training needs assessment to commence by June 2005

• TA loan to assist in developing and implementing targeted SME training programs for SMEs in rural areas, women entrepreneurs, and displaced workers in the RMG industries to commence by June 2005

• First meeting of the forum for women labor and women entrepreneurs to express their training and capacity-building needs as well as other constraints in operating their businesses to be held by July 2005. Subsequent meetings to be held at least semiannually.

• Quarterly progress reports of MOF CPCU and MOI/SCITI

• TA loan progress reports • Workshop syllabus and reports • Feedback from training participants • Progress report on gender action plan for women

entrepreneurs targeted training programs and retraining of RMG workers

• Minutes of meetings of the forum for women labor and women entrepreneurs

• Availability of qualified staff of SCITI, FBCCI, women entrepreneurs’ associations, and district chambers and line associations of FBCCI

• Active collaboration of SCITI and the above chambers and associations

Product certification system upgraded to international standard

• Cabinet to approve draft Accreditation Law by June 2005

• Implementation of TA loan for improving product certification system to commence by June 2005

• Quarterly progress reports of MOF CPCU and MOI

• TA loan progress reports

• Recruitment of qualified experts and timely implementation of the TA loan.

• Availability of qualified technical staff and facilities of BSTI

5. Greater Access to Sustainable Credit by SMEs SEF for small enterprises in the “missing middle”

• Loan to become effective by June 2005 • SMESDP loan effectivity • SEF progress reports of BB

Continued on next page

39Appendix 1

Design Summary Performance Indicators/Targets Monitoring Mechanisms Assumptions and Risks a Capacity building of PFIs and training of SME finance staff for SME lending

• Consultants to identify PFIs that need capacity-building assistance by July 2005 and to commence capacity-building activities by September 2005

• TA loan to assist in developing and implementing training programs to commence by June 2005

• Quarterly progress reports of MOF CPCU and MOI/SCITI

• TA loan progress reports • Workshop syllabus and consultant reports

• PFIs’ commitment to set up or strengthen their SME finance units

• Availability of qualified SME finance staff in PFIs

Inputs • Program loan ($15

million equivalent) • Project loan for SEF

($30 million equivalent) • TA loan ($5 million

equivalent) • Advisory TA ($600,000

equivalent) • Staffing and budget of

CPCU and implementing agencies

• Program loan to be released in two tranches, the first tranche of $5 million equivalent by June 2005, and the second tranche of $10 million equivalent by June 2007

• Project loan to contribute to SEF • TA Loan to provide for consulting

services, seminars and workshops, reports and surveys, and equipment. It will engage 95 person-months of international and 160 person-months of domestic consultants.

• TA grant to facilitate program coordination. It will engage 10 person-months of international and 48 person-months of domestic consultants.

• Quarterly progress reports of MOF CPCU and IAs

• ADB review missions • Annual budget allocations for

agencies/institutions that are mandated to provide support to SMEs

• Government meets effectiveness conditions and complies with loan covenants

• Counterpart budget is available when required

• Counterpart staff and facilities are available

• Competent consultants are timely mobilized

ADB = Asian Development Bank, BB = Bangladesh Bank, BSCIC = Bangladesh Small and Cottage Industries Corporation, BSTI = Bangladesh Standards and Testing Institution, CPCU = central program coordination unit, FBCCI = Federation of Bangladesh Chambers of Commerce and Industry, GDP = Gross Domestic Product, IA = implementing agency, IMF = International Monetary Fund, IT = information technology, MOF = Ministry of Finance, MOI = Ministry of Industries, NCID = National Council for Industrial Development, PFI = participating financial institution, PRGF = Poverty Reduction and Growth Facility, PRSP = Poverty Reduction Strategy Paper, RMG = readymade garment, SCITI = Small and Cottage Industries Training Institute, SME = small and medium enterprise, SMESDP = Small and Medium Enterprise Sector Development Program, SEF = Small Enterprise Fund, TA = technical assistance. a Factors listed are assumptions. No risk factors.

Appendix 2

40

DEVELOPMENT POLICY LETTER

Appendix 2

41

Appendix 2

42

Appendix 2

43

44

Appendix 2

Table A2: Policy Matrix

Component Actions Taken Prior to Board Consideration

First Tranche Second Tranche

Policy Outcome 1: Establish Small and Medium Enterprise (SME) Policy and Development Framework

1.1 Declare SMEs as a priority sector under Government Policy

Government to state the development of SMEs as a priority under the Industrial Policy and the Poverty Reduction Strategy Paper.a

1.2 Formulate an SME Policy and development framework

Government to establish a Task Force for SME Policy Development. Government to hold a national workshop with the participation of various stakeholders, including the Government, private sector, financial institutions, donors, nongovernment organizations, and research and academic institutions, in order to identify problems, constraints, opportunities and issues regarding the development of SMEs in the country. Government Task Force to prepare and submit its recommendations for SME development, based on the results of the national workshop, to the Prime Minister.

Government to adopt a single, uniform definition of SMEs and incorporate such definition under the Industrial Policy.a National Task Force on Development of SMEs to finalize and submit the Report on Development of SMEs to the Government for the formulation of the SME Policy.a

Government to approve the SME Policy and disseminate the summary SME Policy to the public in the Bangla and English languages in at least three newspapers of nationwide circulation.a

Policy Outcome 2: Establish Institutional Framework and Mechanisms to Support SME Development

2.1 Set up an structure and mechanism to implement the SME Policy and development framework

National Council for Industrial Development (NCID) to be responsible for the promotion, growth, and development of SMEs, in addition to its other responsibilities under the Industrial Policy.a

Ministry of Industries (MOI) designated to implement SME Policy.a

SME Cell organized within the MOI to implement the SME development action program.a

SME Advisory Panel to be constituted and mandated to develop an action program to implement the SME Policy. The Panel will consist of representatives from the MOI and other concerned ministries, industry associations, and representatives from the private sector and academia, and report to the Guidance Committee set up under the Industrial Policy.a Government to approve Memorandum and Articles of Association for setting up SME Foundation, with at least 50% private sector representation on the Board and a Chief Executive Officer recruited from the private

Continued on next page

45Appendix 2

Component Actions Taken Prior to Board Consideration

First Tranche Second Tranche

sector, to be set up to assume the responsibilities of implementing the SME Policy from the SME Cell and to take over, in a phased manner, management of SME credit facilities currently directly administered by the Government.a

Policy Outcome 3: Define Government Support to SMEs, and Improve SME Access to Various Services 3.1 Rationalize Government assistance to the SME sector including the restructuring of Bangladesh Small and Cottage Industries Corporation (BSCIC) and other concerned agencies under MOI involved in the sector and rationalization of direct credit assistance currently provided

Government to take policy decision regarding human resource restructuring of BSCIC field offices.

MOI to commission a study to be financed by the Technical Assistance (TA) loan to determine effective approaches for delivering assistance to SMEs, including possible restructuring options for BSCIC. Government to take policy decision regarding human resource restructuring of BSCIC head office. MOI to commence review of individual cases under restructuring plan for BSCIC field offices.

MOI to implement recommendations from the study funded by the TA Loan, including the submission of a time-bound monitorable plan, commencement of implementation of recommended actions, and possible overall restructuring of BSCIC.a MOI to complete human resource restructuring of BSCIC field offices and head office.a

3.2 Rationalize incentive and tax structure for SMEs

As part of the recommendations of the National Task Force on Development of SMEs, Government to review the current fiscal incentives being provided to SMEs with the end in view of enhancing fiscal support to SMEs.

Government to provide tax incentives to SMEs to take effect from assessment year FY2005/6; by then, for SMEs with fixed investment (excluding land and buildings) less than Tk3 million, provide, as a minimum, (i) a 75% income tax rebate, and (ii) accelerated depreciation rates for, inter alia, plant and machinery. Such tax incentives to apply for a minimum period of 5 years for SMEs located in Dhaka, Chittagong, and other major cities, and for a longer period to SMEs located in underdeveloped and undeveloped areas. Such tax incentives will not apply to SMEs availing of tax incentives under existing export incentive schemes.a

3.3 Enhance SME access to market and Government services

MOI to constitute committee for implementation of e-governance that will include (i) the development of an SME web portal/virtual front office, and (ii) the establishment of SME helpline outreach centers to

MOI to operationalize the SME web portal/ virtual front office to provide information on market opportunities regarding SMEs and to facilitate access to Government services by

Continued on next page

46

Appendix 2

Component Actions Taken Prior to Board Consideration

First Tranche Second Tranche

provide coordination and assistance for facilitating access to Government services by SMEs.a

SMEs, including start-up assistance.a MOI/BSCIC, in partnership with the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), and district chambers and line associations of FBCCI, to establish SME helpline outreach centers at the district offices of BSCIC to assist SMEs in their organizational and expansion activities.a

3.4 Enhance SME access to capacity building

Government to upgrade Small and Cottage Industries Training Institute (SCITI) from a development project to a regular revenue budget agency of BSCIC.

MOI to recruit experienced professionals and faculty members for SCITI.a

SCITI in collaboration with FBCCI, district chambers and line associations of FBCCI, accredited women entrepreneurs’ associations, and National Association of Small and Cottage Industries of Bangladesh (NASCIB) to commence a training needs assessment for SMEs, for the development of suitable and affordable training programs to reach out to SMEs, particularly those located in rural areas, participating financial institutions under the Small Enterprise Fund (SEF), women entrepreneurs, and displaced workers in the readymade garment industry.a

SCITI in collaboration with FBCCI, district chambers and line associations of FBCCI, accredited women entrepreneurs’ associations, and NASCIB to offer training programs in accordance with the results of the training needs assessment.a

3.5 Enhance SME access to product certification and upgrade product certification system to international standard

MOI to draft Accreditation Law. Bangladesh Standards and Testing Institution to set up a special window for certifying SME products.a Cabinet to approve draft Accreditation Law.

Government to introduce Accreditation Bill before Parliament.a Government to set up an autonomous Accreditation Board.a Accreditation Board to apply for membership in International Accreditation Forum.a

3.6 Develop an integrated SME database

Bangladesh Bureau of Statistics (BBS) to publish report on the Census of Non-Farm Economic Activities (urban and non-urban, 2001–2003).

MOI and BBS to prepare a registry of enterprises (nonagricultural) and conduct a nationwide survey of SMEs for establishment of an integrated SME database that will serve as the basis for monitoring SME performance and development and for targeting assistance.a

a Tranche release condition.

Appendix 3

47

SECTOR ANALYSIS AND FRAMEWORK FOR SMALL AND MEDIUM ENTERPRISE DEVELOPMENT

A. Small and Medium Enterprise (SME) Sector 1. Definition of SMEs. The Industrial Policy 1999 defines SMEs as enterprises employing fewer than 99 workers and/or with a fixed capital investment of under Tk300 million.1 The Bangladesh Bureau of Statistics (BBS) classifies enterprises in the 2001-2003 Census of Non-Farm Economic Activities (the Economic Census) according to total persons engaged and define microenterprises as those with total persons engaged of fewer than 10, small between 10 to 49, medium 50 to 99, and large 100 or more. Development partners involved in the SME sector have different definitions of SMEs.2 The major commercial banks follow the Industrial Policy definition in terms of investment capital for lending purposes. In the new Industrial Policy, manufacturing SMEs are defined in terms of fixed investment excluding land and building: small, with fixed investment less than or equal to Tk15 million and medium, with fixed investment greater than Tk15 million and less than or equal to Tk100 million. For nonmanufacturing, small enterprises are those with fewer than 25 full-time employees, and medium enterprises with between 25 and 100 full-time employees. 2. Population of SMEs. There are varying estimates of the SME population in line with different definitions of what constitutes the SME sector. The most recent estimates are from the Economic Census, which covered a total of 3.68 million establishments including microenterprises of fewer than 10 persons engaged, which constitute the informal sector. The number of small, medium, and large establishments totaling 85,427 is broken down by size: 74,629 are small, 5,125 medium, and 5,673 large. The breakdown of SMEs into urban and rural is as follows: 48,584 urban-based SMEs, of which 92.2% are small and 7.8% are medium, and 31,160 rural-based SMEs, of which 95.7% are small and 4.3% are medium. These include cottage and handloom industries, provided the total number of persons employed is 10 or more. Total number of manufacturing SMEs is 28,296 of which 14,755 are in urban areas and 13,541 are in rural areas. From the 2003 National Private Sector Survey of Enterprises in Bangladesh,3 it was estimated that approximately 6 million micro-, small, and medium enterprises (MSMEs) defined as enterprises with fewer than 100 employees are operating in Bangladesh. The MSMEs are generally very small in size, with 5 workers on average (including the proprietor); about 90% of MSMEs have 10 or fewer workers,4 and less than 2% have 50 or more workers. MSMEs are heavily concentrated in wholesale and retail trade, production and sale of agricultural goods, and manufacturing. Over three quarters of MSMEs are located in rural areas. 3. Significance of SMEs. SMEs have a significant role in generating growth and employment. SMEs are reported to account for about 40% of the gross manufacturing output, about 80% of industrial employment, and about 25% of the total labor force in Bangladesh. In 1991, Bangladesh Small and Cottage Industries Corporation (BSCIC) reported around 0.81 million employed in small enterprises and 1.67 million in cottage industries. The Economic Census reports total employment of 3.90 million in the nonfarm formal sector, with 1.37 million employed in small enterprises, 0.34 1 Most enterprises located in the BSCIC industrial estates, other than the major ones in Chittagong, Dhaka, and

Narayanganj, are reported to have asset values in the range between Tk0.2 million and Tk10 million. 2 The issue of non-uniform and inconsistent definitions was one of the major topics discussed in the February 2004 SME

workshop supported by the Asian Development Bank (ADB) held in Dhaka. 3 The survey was funded by the Department for International Development of the United Kingdom (DFID), United States

Agency for International Development (USAID), Swiss Agency for Development and Cooperation, and Swedish International Development Cooperation Agency. Conducted from March to June 2003, it enumerated 10,096 enterprises (defined as income-generating households or activities that market at least 75% of their products).

4 The balance of 10% of the estimated population, about 600,000, can be considered to be in the SME category. However, this number is excessively higher than other estimates. In part, it includes enterprises in the farm sector.

Appendix 3

48

million in medium enterprises, and 2.19 million in large enterprises. The 2003 Private Sector Survey estimated that the MSMEs employ 31 million and contribute 20–25% of total gross domestic product. 4. Distribution by Sector. In manufacturing, 56% of enterprises are in food and allied products. A distant second in terms of numbers, is the textiles, wearing apparel, and leather industries category. Over the past two decades, the share of food and allied products has decreased and that of textiles, wearing apparel, and leather industries has increased, and other industries have grown with the introduction of new and more modern products. The growth of the readymade garments industry, which directly employs over 1.5 million workers, mostly women, and indirectly supports employment of up to 15 million, is phenomenal. Food products and textile and garment firms account for over 60% of registered SMEs. In recent years, there has been a rapid growth in numbers and types of activities of SMEs in the service sector; however, these are generally of very small size and there is scant information regarding these enterprises. Nonetheless, their economic potential is expected to be significant, considering their contribution to employment. 5. Women Entrepreneurs and Women-Run SMEs. The majority of women entrepreneurs in Bangladesh fall under the categories of either micro or small. At least 86% of women entrepreneurs are believed to be home-based and categorized as microenterprises. Women entrepreneurs are heavily concentrated in manufacturing of clothing, retail sales not in stores, spinning and weaving of textiles, and livestock and dairy production. B. Issues and Constraints 6. Despite positive macroeconomic figures, Bangladesh remains one of the poorest countries in the world, with a per capita income of around $385, and income poverty of 50%. Although Bangladesh has performed well in the past decade both on macroeconomic and social indicators, the country has not reached its growth potential. A survey of 1,000 manufacturing firms conducted in 1992 for an investment climate assessment by the World Bank reported that the main obstacles to their growth are: (i) poor physical infrastructure; (ii) frequent power outages and surges; (iii) pervasive corruption; (iv) regulatory governance problems; and (v) limited access to finance. Ineffective, inadequate, and antiquated laws and regulations; non-enforcement of existing laws; and weaknesses coupled with lack of transparency and accountability in the bureaucracy, judiciary, and legislative bodies further complicates business operations. The culture of informal payments, kickbacks, and political interference remains prevalent. The discretionary powers afforded to the inspecting authorities are also abused. While these problems affect all enterprises irrespective of size, SMEs are disproportionately affected due to their small scale of operations and limited resources to address the problems. 7. The proposed Small and Medium Enterprise Sector Development Program (SMESDP) aims at introducing policy reforms and creating support infrastructure targeted at SMEs to enhance their capabilities and facilitate their access to necessary resources to deal with the regulatory, credit, capacity, and other key constraints. In parallel, assistance programs of ADB and other development partners are addressing the structural problems in the areas of private sector and financial sector development. The attached framework for SME development presents the problems grouped into three areas: lack of access to credit, poor enabling environment, and inadequate business support services and capacity-building assistance. The table summarizes ongoing government initiatives, and development partner assistance programs, identifies gaps, and describes key features of SMESDP to address the gaps.

49Appendix 3

Table A3: Framework for Small and Medium Enterprise Development

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP

A. Lack of Access to Credit

A.1 Lack of Understanding of SMEs and Capabilities of SME Credit Staff • Perceived high credit risk of

SMEs. • High administrative and

servicing costs of small loans. • Inadequate knowledge and

capacity for SME financing by FIs.

• Problem more pronounced for small enterprises in the “missing middle”, which are too large to qualify for microcredit assistance but too small to be within the scope of bank lending.

• Credit Information Bureau, which is being administered by BB, covers information on loan size above Tk50,000. BB plans to put the Credit Information Bureau online in 2005 and further expand the coverage of credit information.

• SEDF provides (i) TA catering to the needs of partner financial institutions including SME strategy formulation, and credit scoring, and (ii) generic training programs for FIs.

• Simplification of financial reporting standards for SMEs is one of the long-term recommendations provided in the Report on the Observance of Standards and Codes prepared jointly by IMF and WB.

• Gap in funding for the “missing middle.”

• Need to train PFI credit staff on lending to SMEs, and monitoring SME loan portfolio performance and compliance with safeguard policies.

• Project loan as contribution to SEF to meet the needs of the “missing middle”.

• TA loan to assist PFIs in setting up or strengthening their SME lending procedures and systems and train SME credit staff to appraise credit and provide basic advisory services to SME borrowers.

A.2 Market Failures in SME Financing • Lack of interbank market to

channel excess liquidity lodged with NCBs to FIs that need funds.

• Restriction on expansion of loan portfolio of NCBs due to nonperforming loan problem.

• Nascent development of capital market.

• Lack of legal framework for development of alternatives for long-term financing such as securitized debt securities.

• Lack of term funds at reasonable interest rates by PCBs and NBFIs.

• High interest rates offered by NSC schemes crowded out long-term borrowing by FIs.

• Amendments of Banking Companies Act of 1991 (amended in 1997) and Bangladesh Bank Order of 1972 (amended in 1995) to strengthen BB’s oversight of the banking sector and ensure its autonomy over monetary and exchange rate policies.

• Stricter prudential regulations have been introduced and include an increase in capital adequacy requirements and revisions to loan classification and provisioning guidelines.

• Restructuring of NCBs initiated with aim to privatize starting with Rupali Bank.

• Various reforms to upgrade the legal and regulatory framework to international standard and build up capacity of the SEC.

• The legal framework for securitization being developed.

• WB: EGBM project assists in preparing the resolution strategies for NCBs, improve their governance arrangements, and divest the Government’s shares.

• WB: Central Bank Strengthening project supports the reorganization and modernization of BB, staff rationalization, and training especially in the areas of banking supervision, research, accounting, and auditing.

• ADB: Loan 1580-BAN: Capital Market Development Program ($77.2 million, 1997-2001), TA3533-BAN: Capacity Building of the Securities and Exchange Commission and Selected Capital Market Institutions ($850,000, 2000-2004), and TA Loan on Financial Markets Governance Program (expected to be approved in 2005 for $5 million to be implemented during 2005–2007) provide continuing support to strengthen the overall debt recovery framework and the legal and regulatory

• Need to provide term funds at reasonable rates to PCBs and NBFIs for their lending to SMEs.

• SEF with a fund size of $56.7 million equivalent of which the contribution of ADB is $30 million equivalent, WB, $10 million equivalent, and the Government $16.7 million equivalent (Tk1 billion).

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50

Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP • ADB and WB engaged the

Government and BB in policy dialogue on rationalizing taxation of debt securities, and as a result, NBR granted value-added tax exemption on issuance of securitized debt instruments through SPV and also stamp duty and income exemption for SPV.

• The Government has abolished some NSC schemes that paid disproportionately high interest rates, and reduced interest rates on NSCs to make them more market-based.

framework of the securities markets, promote good governance practices, and strengthen the supervisory functions of the SEC.

• WB: Financial Institutions Development project ($57.7 million, 1999-2005) provides Credit, Bridge and Standby Facility for collateralized loan and lease assets and assist in developing legal framework for issuance of securitized assets.

A.3 Lack of Legal and Institutional Framework for Secured Financing • No law providing for taking

movable property as security of a loan.

• No comprehensive registry for secured interests.

• Registration system of RJSC is limited to companies, excluding majority of SMEs, which are not in corporate form.

• ADB: TA4140-BAN: Supporting Good Governance Initiatives provides support for reform of secured transactions law, which will facilitate lending against movable property collateral and assist in establishing an electronic registry system.

A.4 Lack of Measurement of Effectiveness of Various Government’s Credit Facilities • No indicator to measure

effectiveness, outreach, and impact of various credit facilities being provided by public institutions including BB, NCBs, and SDBs.

• Some credit programs at subsidized rates provided through loans in contradiction with the restructuring plan of NCBs.

• SEF to be channeled through PFIs to small enterprises that have fixed assets less than Tk10 million.

• Rural Agricultural Credit Fund for rural-based agro-processing industries beyond the divisional towns of PFIs. The facility has low utilization due mainly to the geographical restriction.

• Refinancing of industrial term loans of Basic Bank to SCIs (Tk450 million at 6%, accounting for about 4% of Basic Bank's funds).

• Various refinancing facilities for targeted industries and

• WB contributes to SEF under EGBM project.

• NORAD: Rajshahi Krishi Unnayan Bank—Small Enterprise Development Credit project ($7.2 million, 2001–2005) provides credit facility to small enterprises in 3 districts in the Northwest region.

• USAID: Agro-based Technology Development project for $19.6 million provided financing for agro-based industries and trade.

• USAID: Loan Portfolio Guarantee program ($3 million, since 2000)— guarantee facility for micro- and small enterprises.

• USAID: Development Credit Authority

• Need to rationalize credit facilities available from public institutions including BB, NCBs, and SDBs.

• TA loan to conduct comprehensive review of all credit facilities being provided by the Government to the SME sector and identify ways to rationalize the existing government credit assistance and to ensure efficient and effective delivery mechanisms.

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51Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP enterprises channeled through NCBs and SDBs.

• Equity and Entrepreneurship Fund set up as a venture capital fund to co-invest in projects in software, food processing, and agro-based industries.

Guarantee (about $10 million, to start in July 2005) to guarantee loans of selected PCBs.

• ADB: Loan 1070-BAN (SF): Small and Cottage Industry Project (1991–1996) provided credit line for SCIs coursed through five PFIs.

B. Poor State of the Enabling Environment for SMEs

B.1 Lack of Dedicated Policy and Institutional Setup for SME Development • No policy framework to guide

development of an enabling environment for SMEs.

• Interventions to support SMEs are ad hoc and uncoordinated.

• The Task Force constituted by the Government prepared the Report on Development of SMEs, which was endorsed by the prime minister and is being reviewed by the Economic Affairs Committee of the Cabinet.

• Industrial Policy 2004, drafted and submitted for approval by Cabinet, gave priority to the SME sector.

• ADB supported a national SME workshop held in February 2004, with participation from government ministries, chambers of commerce and industries, private sector individuals, academicians, and researchers. The workshop recommendations were subsequently taken up by the National Task Force on Development of SMEs.

• No SME policy and dedicated SME development agency.

• Program loan to support the development of an SME policy and establishment of institutional setup to implement the policy on a sustainable basis.

• TA grant to support formulation of the SME policy and action program and operationalization of the SME Cell at MOI and eventually, SME Foundation.

B.2 Inadequate Support to SMEs by Public Sector Institutions • BSCIC, the principal

government organization mandated to promote the development of SCIs has not effectively performed its role.

• SCITI under BSCIC has inadequate training facilities and has been charging nominal fees that are not sufficient to cover its costs.

• Other concerned agencies providing service and assistance to SMEs (e.g., BITAC, BIM, and NPO) are resource strapped and lack capacity.

• SCITI has been upgraded from development budget project to regular revenue budget agency of BSCIC, and is recruiting experienced staff and faculty members.

• A parliamentary subcommittee was formed to look into the issue of substantial accumulated losses of BSCIC.

• MOI has formed a committee to study human resource restructuring of BSCIC and the committee recommended staff rationalization including downsizing of BSCIC’s head office and field offices.

• WB: EGBM project ($250 million, with $88 million DFID cofinancing, 2004–2009) includes institutional strengthening of BOI, Bangladesh Export Processing Zone Authority, and BSCIC. Focus of assistance to BSCIC is e-governance, training, introduction of computer-aided design in the Design Center, and support for physical infrastructure.

• TA 1444-BAN (1991-1996): Strengthening Entrepreneurial Training Program of BSCIC provided capacity-building assistance and developed training programs for SCITI.

• BSCIC, SCITI, BTAC, BIM, and NPO need to undergo significant strategic reorientation of their core competencies.

• Program loan to support human resource restructuring of BSCIC and improve its governance by recruiting qualified professionals and collaborating with the private sector in activities that meet market needs.

• Based on results under TA loan, identify options for BSCIC and if option chosen is to restructure, prepare a restructuring plan.

• TA loan to conduct analysis of the other concerned agencies

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52

Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP under MOI; and prepare plans for their strategic reorientation.

• Program loan to strengthen SCITI’s role in delivering its training services and ensure its financial sustainability.

B.3 Lack of Incentives • The tax system provides

incentives to promote exports and certain strategic industries but does not give parallel treatment to domestic SMEs.

• The abolition of the tax holiday scheme, expected to be approved in the next fiscal year, will adversely affect small enterprises to a greater extent than larger enterprises.

• Government provides export incentives to exporters by way of income tax rebate and exemption of import duties on capital machinery.

• Government provides tax holiday for all manufacturing and service enterprises, irrespective of size, if established before end-June 2005.

• Need for continued tax incentives specifically for small enterprises.

• Program loan to support the provision of a 75% income tax rebate and accelerated depreciation rate for plant and machinery, for small enterprises which have fixed assets excluding land and building less than Tk3 million. (This was discussed in consultation with IMF.)

B.4 Absence of Reliable SME Database • Lack of reliable updated data

on SMEs with nationwide coverage to facilitate targeted SME assistance and evaluation of SME-related policy measures.

• Multiple definitions of SMEs used within and outside the Government.

• Census of Non-Farm Economic Activities conducted; summary report at industry level drafted; final report with disaggregated statistics expected in mid-2005.

• Single, uniform definition of SMEs incorporated in the draft Industrial Policy and the Report of the SME Task Force.

• The survey funded by DFID, USAID, SDC and SIDA provides updated data on characteristics of microenterprises and SMEs, but still inadequate for SME analysis because of aggregation of microenterprises with SMEs, cross-tabulation, and data gaps.

• No integrated SME database.

• Need to adopt uniform definition for SMEs and basis for monitoring and assessment; and ensuring effective delivery of assistance.

• Program loan to support adoption of a single uniform definition of SMEs and completion of Report on the Census of Non-Farm Economic Activities and registry of SMEs.

• TA loan for developing SME database.

B.5 Cumbersome Procedures and Regulatory Governance Problems in Registration and Licensing • Manual systems at many public

service institutions including RJSC.

• Duplication of procedures and requirements (for example, establishing a business requires 5–25 different licenses and registrations. etc.)

• High compliance and

• Computerized registration system being developed at RJSC will enable on-line registration of companies.

• DCC set up a help desk at FBCCI for issuing and renewing trade license. DCC is developing a simple form of application with reduced number

• SEDF, ($38 million, 2002-2007) jointly contributed by IFC, CIDA, DFID, EC, NORAD, and The Royal Netherlands Government has established knowledge centers in DCCI and CCCI which provide computerized library services and access to SME tool kits of WB/IFC.

• DFID: Regulatory and Investment

• No centralized information about Government’s requirements and services (e.g., registration and licensing).

• Coverage of knowledge centers

• Program loan to support e-governance including development of SME web portal and helpline outreach centers.

• TA Loan to design and develop SME web portal.

• TA Loan to help establish and operate SME

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53Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP regulatory costs (for example, firms are visited by regulatory agencies about 17 times per year. Time spent by management in dealing with regulatory matters costs about Tk50,000 annually, and cost of using facilitators is about Tk600,000 annually).

• Cumbersome customs procedures resulting in side payments and delays to importers and exporters.

• Tedious tax filing, and payment and rent-seeking behavior of tax officials.

• Inefficient services by BOI and BOI registration viewed as another bureaucratic layer.

of certifications required for issuing trade license, and has introduced automatic annual renewal of trade license up to 5 years through payment of license renewal fee at designated banks.

• One-stop assistance center at Bangladesh Garment Manufacturers and Exporters Association reduced processing time for export license from 14 days to 3 days.

• Simplified and automated custom procedures established with assistance from the WB under its Export Diversification project.

• Government’s decision to provide online services of BOI.

Systems Improvement for Enterprise Growth program planned for 2005 to potentially cover: - mechanisms and policies to streamline regulatory constraints (i.e., company registration, inspections, export and import clearances, commercial arbitration); - strengthening of specific agencies (e.g., land registry institutions); - streamlining procedures related to foreign direct investments.

• BEI-SEDF SME Advisory Service project collected information from about 250 SMEs regarding problems in registration and licensing. Actual assistance was extended to some SMEs in obtaining or renewing licenses/certificates.

• Taxpayer education activities under the DFID’s Revenue Administration Reforms project (£5 million, 2002–2008) include Bangla and English tax information leaflets and a web site containing tax information and forms.

limited to Dhaka and Chittagong.

• SMEs especially in rural areas need handholding assistance in their establishment and operations.

helpline outreach centers in 64 district offices of BSCIC.

B.6 Lack of Credible Product Certification System • Weak capacity of BSTI to

conduct monitoring, testing, and certification.

• Product certificate issued by BSTI is not credible in Bangladesh and abroad. Reportedly, BSTI’s certificate could be purchased. The certification process is time consuming.

• Lack of materials-testing facilities.

• New and modern testing and laboratory equipment have been acquired by BSTI.

• Prepared draft Accreditation Law to provide for establishment of a National Accreditation Board to accredit certification bodies including those in the private sector.

• EC, UNIDO, ITC: Quality Support program planned for 2005 (€2.5 million) to support quality infrastructure and export diversification, strengthen BSTI (with focus on its testing function), assist in the establishment of the National Accreditation Board, and strengthen the National Institute of Textile Training and Research.

• Difficulties of SMEs in obtaining certification for their products.

• Low quality of certification system.

• SME products for export not meeting certification standards in export markets.

• Program loan to support: (i) BSTI to set up a special window for certifying SME products; (ii) Government to approve draft Accreditation Law; and (iii) Government to set up autonomous National Accreditation Board and support its application for membership in the International Accreditation Forum.

• TA loan to strengthen BSTI’s certifying function and contribute additional equipment and facilities.

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Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP

C. Inadequate Business Development Services and Capacity-Building Assistance

C.1 Underdeveloped BDS Market • Lack of knowledge about

marketing technique and market opportunities.

• Lack of expertise in the relevant fields.

• Weak product development and technology.

• Limited number of BDS providers.

• Unaffordable fees charged by BDS providers and low interest among SMEs to buy such services.

• DFID, SIDA, SDC: KATALYST project ($20 million, 2003–2007) promotes the development of more effective markets for BDS and provides BDS to selected sectors.

• USAID: JOBS program ($11.8 million, until 2005) finances part of cost of direct service provision (e.g., training for skills improvement, and product development) to micro- and small enterprises in sectors with strong export potential.

• SEDF assists local service providers to develop their capacity to provide services to the target subsectors, i.e., garments, agribusiness, information technology, software, and light engineering.

• USAID: Global Trade and Technology Network is an e-commerce platform for matching buyers and sellers which are registered in the electronic database. It provides business linkage opportunity for Bangladeshi SMEs to companies based in the US.

• Need to link SME clients to BDS providers, especially in rural areas.

• SME web sites and helpline outreach centers will facilitate linkages between BDS providers and their potential SME clients, and will be linked to other web sites and database to facilitate linkage between SMEs and their potential markets.

• PFIs under SEF will refer to BDS providers for more extensive services.

• TA loan to support studies of business activities and supply chain of industries with potential for development into clusters or industrial parks.

C.2 Need for Targeted Training and Capacity Building • Current training programs are

inadequate to meet needs of SME entrepreneurs and limited in scope. Fees charged by private sector providers are also prohibitive to small enterprises and women entrepreneurs.

• Existing programs are neither demand driven nor specifically targeted to meet the needs of SMEs that are in a disadvantaged position, such as those in the rural areas.

• SCITI under BSCIC has

• GTZ: Promotion of private sector program in collaboration with nongovernment organizations focuses on training entrepreneurs’ and micro enterprises through Competency-based Economies Formation of Enterprise (CEFE) method, an action oriented and experiential learning approach (to be completed by end 2004) as well as assistance in new product development through a center for product design and technology support.

• SEDF provides training programs for entrepreneurs, managers, and workers

• Need for targeted training programs for SMEs in rural areas and women entrepreneurs to be implemented on a sustainable basis.

• Need for skills retraining of displaced RMG workers due to the phaseout of MFA by end 2004. The number is

• TA loan to provide targeted training and capacity-building assistance to SMEs in rural areas, women entrepreneurs, and displaced RMG workers.

• TA loan to develop capability of PFIs in environmental assessment and monitoring.

• TA loan to provide equipment and facilities support for SCITI.

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55Appendix 3

Issues and Constraints Government Initiatives Development Partner Interventions Gaps SMESDP inadequate training facilities and has been charging nominal fees that are not sufficient to cover its costs.

of SMEs in the four target subsectors. • EC: Small Projects Facility (€3 million)

provides small grants for proposals in the areas of vocational training, trade facilitation, and technology transfer during immediate post MFA period.

• UNDP: project assistance ($500,000, April 2004 to March 2005) to address the impact of the MFA expiration on employment and livelihoods, identify employment-oriented export sectors, and create crisis-coping mechanism for retrenched workers including training modalities for skill upgrading and social safety net schemes.

estimated at over 200,000, the majority of whom are women.

C.3 Women Entrepreneurship Development • Constraints to SMEs are more

pronounced for women entrepreneurs due to sociocultural barriers and negative perception of women in business.

• Procedures for the bank facilities are complex and difficult for women to access.

• Sonali Bank has a program for training women entrepreneurs.

• MIDAS conducts women entrepreneurship development program that was supported by USAID.

• BSCIC has a training program for women entrepreneurs.

• USAID: JOBS program has provided training to women in the northern districts in the production of footwear.

• CIDA: Gender Fund ($1.6 million) to provide funding to organizations, institutions or individuals for planning and implementing projects that address gender equity issues.

• UNDP: Entrepreneurship Development of Women ($3.9 million, 1998–2003) to build capacity of women entrepreneurs and provide them with skills training (completed in 2003).

• Need for women entrepreneurship development programs tailored to meet their unique requirements.

• Women entrepreneurs not capable of preparing bankable proposals.

• TA Loan for Women Entrepreneurs Training.

• TA Loan to build up capacity of PFIs finance staff to provide advisory assistance to SMEs including women entrepreneurs.

• Project loan to earmark 10% for women borrowers.

ADB = Asian Development Bank, BB = Bangladesh Bank, BDS = business development services, BEI = Bangladesh Enterprise Institute, BIM = Bangladesh Institute of Management, BITAC = Bangladesh Industrial Technology Assistance Center, BOI = Board of Investments, BSCIC = Bangladesh Small and Cottage Industries Corporation, BSTI = Bangladesh Standards and Testing Institution, CCCI = Chittagong Chamber of Commerce and Industry, CIDA = Canadian International Development Agency, DCC = Dhaka City Corporation, DCCI = Dhaka Chamber of Commerce and Industry, DFID = Department for International Development, EC = European Commission, EGBM = Enterprise Growth and Bank Modernization, FBCCI = Federation of Bangladesh Chambers of Commerce and Industry, FIs = financial institutions, GTZ = Deutsche Gesellschaft für Technische Zusammenarbeit, IFC = International Finance Corporation, IMF = International Monetary Fund, ITC = International Trade Centre, JOBS = Job Opportunities and Business Support, MFA = Multi Fibre Arrangements, MIDAS = Micro Industries Development Assistance and Services, MOI = Ministry of Industries, NBFI = nonbank financial institution, NBR = National Board of Revenue, NCB = nationalized commercial bank, NORAD = Norwegian Agency for Development Corporation, NPO = National Productivity Organization, NSC = National Savings Certificate, PCB = private commercial bank, PFI = participating financial institution, RJSC = Registrar of Joint Stock Companies, RMG = readymade garment, SCIs = small and cottage industries, SCITI = Small and Cottage Industries Training Institute, SDB = specialized development bank, SDC = Swiss Agency for Development and Cooperation, SEC = Securities and Exchange Commission, SEDF = SouthAsia Enterprise Development Facility, SEF = Small Enterprise Fund, SIDA = Swedish International Development Cooperation Agency, SME = small and medium enterprise, SMESDP = Small and Medium Enterprise Sector Development Program, SPV = special purpose vehicle, TA = technical assistance, UNDP = United Nations Development Programme, UNIDO = United Nations Industrial Development Organization, USAID = United States Agency for International Development, WB = World Bank.

Appendix 4

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LIST OF INELIGIBLE ITEMS 1. The proceeds of the loan will be utilized to finance the foreign exchange expenditures for the reasonable cost of imported goods (excluding any dues or taxes) required during the execution of the Small and Medium Enterprise Sector Development Program. All imported goods financed from the proposed loan must be produced in, and procured from, Asian Development Bank member countries. 2. Notwithstanding the provisions of para.1, no withdrawals will be made from the loan account in respect of the following:

(i) expenditures for goods included in the following Customs Coordination Council Nomenclature chapters of headings:

Chapter Heading Description of Items

22 22.03–22.10 Alcoholic Beverage 24 24.01 Tobacco, unmanufactured tobacco refuse 24 24.02 Tobacco, manufactured (whether or not containing

tobacco substitutes 28 28.50–28.52 Radioactive and associated materials 71 71.01–71.04 Pearls, precious and semi-precious stones, unworked or

worked 71 71.05–71.06 Jewelry of gold, silver, or platinum group metals (except

watches and watch cases) and goldsmiths or silversmiths wares (including set gems)

71 71.07–71.08 Gold, non-monetary (excluding gold ores and concentrates)

84 84.59 Nuclear reactors and parts thereof, fuel elements (cartridges), non-irradiated for nuclear reactors

(ii) expenditures for goods intended for a military or paramilitary purpose or for

luxury consumption; or (iii) expenditures for pesticides categorized as extremely hazardous or highly

hazardous in Class 1a and 1b of the World Health Organization’s Classification of Pesticide by Hazard and Guidelines to Classification.

Appendix 5

57

SMALL ENTERPRISE FUND

Parties. The parties to the Small Enterprise Fund (SEF) are (i) Borrower. Government of Bangladesh (ii) Lender. Asian Development Bank (ADB) (iii) Executing Agency. Ministry of Finance (MOF) (iv) Implementing agency. Bangladesh Bank (BB). A unit in the Agriculture Credit

and Special Programs Department will manage SEF, which will include separate subaccounts for: (a) ADB’s contribution of $30 million equivalent; (b) World Bank’s (WB) contribution of $10 million equivalent under the Enterprise Growth and Bank Modernization project; and (c) BB’s initial fund of Tk1 billion ($16.7 million equivalent).

(v) Participating financial institutions (PFIs). The six preidentified PFIs are Basic Bank, Eastern Bank, Industrial Development Leasing Company of Bangladesh Ltd., Industrial Promotion & Development Company of Bangladesh Ltd., Prime Bank, and United Leasing. Accreditation of other PFIs based on agreed eligibility criteria will be delegated to BB, subject to review by ADB. There will be no upper limit as to the number of PFIs that could avail of SEF if they meet the eligibility criteria as agreed between BB, ADB, and WB.

(vi) Clients of PFIs. SME borrowers/lessees which have fixed assets not exceeding Tk10 million.

Table A5: Terms for Small Enterprise Fund

Terms ADB→GOB. GOB→

SEF/BBSEF/BB→PFI PFI→Client

Currency $ Taka Taka Taka Grace period 8 years — — Maximum of 1 year Maturity 32 years — — Maximum of 5 years

Front-end fee — — — Based on PFI pricing

Commitment fee — — — Based on PFI pricing

Interest rate 1% during grace period, 1.5% thereafter

— BB rate Market-based rate of

PFI

Use of proceeds — — Refinancing new loans to small

enterprises lent by banks and NBFIs

Capital investment and working capital of the enterprise

Size of project subloan/sublease

— — — Tk0.2 million–5 million

PFI eligibility criteria

Compliance with ADB criteria under the FIL policy

— Not more than 10% classified loans of small loans portfolio. Full compliance with BB prudential regulations.1

—

Enterprise eligibility criteria

— — — Fixed assets not exceeding Tk10 million

ADB = Asian Development Bank, BB = Bangladesh Bank, FIL = financial intermediary loan, GOB = Government of Bangladesh, NBFI = nonbank financial institution, PFI = participating financial institution, SEF = small enterprise fund. Source: Bangladesh Bank.

1 Including requirements for: (i) minimum capital of 9% on risk-weighted basis; (ii) exposure limit to a particular

customer or group; (iii) loan-loss provisioning, and capital adequacies; (iv) internal control system; (v) risk management and antimoney-laundering procedures; and (vi) early warning system.

Appendix 7

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TECHNICAL ASSISTANCE LOAN COMPONENTS

The main features of each of the components of the technical assistance (TA) loan are summarized below. The cost estimate and financing plan are in Appendix 8. Detailed terms of reference for each component are in Supplementary Appendix 5.

Component 1: Rationalization of Government Assistance to Small and Medium Enterprises (SME)

Objective 1. The objectives are to enhance the efficiency and effectiveness and to introduce innovative approaches for the delivery of government assistance to the SME sector. Scope 2. The consulting work entails three components: (i) restructuring plan of select concerned agencies under the Ministry of Industries (MOI) which provide services to SMEs, (ii) rationalization of existing government credit facilities to SMEs, and (iii) conceptual design and development of clusters and industrial parks. The first component covers (i) the review of government assistance to SMEs and their effectiveness; (ii) the review of the role of the select agencies including Bangladesh Small and Cottage Industries Corporation (BSCIC) in delivering assistance to SMEs and the causes of their poor performance; (iii) determination of approaches and alternatives that provide the best prospect of deepening on a sustainable basis the Government’s assistance to SMEs; (iv) preparation of a restructuring plan or orderly phaseout plan as appropriate; (v) estimation of the fiscal impact of staff rationalization and redeployment and costs to the Government of the restructuring option selected; and (vi) preparatory work for implementation of long-term restructuring activities. The second component covers (i) inventory taking of objectives, scope, and terms of the existing credit facilities to SMEs managed by various public institutions including Bangladesh Bank (BB), nationalized commercial banks, specialized development banks, and development financial institutions engaged in social development activities, (ii) identifying indicators to measure the effectiveness, outreach, and impact of such assistance, (iii) recommending credit delivery mechanisms to reach out to SMEs especially the ones in rural areas, and (iv) recommending innovative approaches for providing SME assistance including ways of dealing with collateral, providing credit enhancement, and insurance. The third component will review existing lines of production and business activities in Dhaka and Chittagong and prepare a plan for the development of promising industries or business sectors into clusters or industrial parks. Procurement and Consulting Services 3. Computers and software, Internet and networking facilities, office equipment, transport, books and publications will be procured following Asian Development Bank’s (ADB) Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 4. This TA component will require the services of two international and two domestic consultants: international restructuring expert (15 person-months), international SME strategic development specialist (5 person-months), domestic corporate financial specialist (10 person-months), and domestic SME credit specialist (10 person-months), The consultants will be recruited on an individual basis in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the engagement of domestic consultants

Component 2: SME Web Portal and Virtual Front Office Development Objective 1. The objective is to develop an SME web portal/virtual front office to provide two-way information on market opportunities to domestic SMEs and foreign buyers regarding domestic SME products and services, provide linkage for domestic SMEs to foreign markets, and facilitate access by SMEs to government services. Scope 2. The scope of work comprises web site development and management of information. The former will require the expertise for (i) preparation of written materials to be incorporated into the web portal upon its launching; (ii) design of the information layout; and (iii) development of programs and creation of web pages taking into consideration existing SME web sites and portals in other countries. The latter will cover updating the web site information and handling inquiries. The web portal will have access to the SME database. Further, the TA will carry out a campaign to promote public awareness; and a training program on the maintenance and usage of the web site. Counterpart staff of MOI will undergo training to update and maintain the web site. Procurement and Consulting Services 3. Computers, Internet and networking facilities will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 4. The services of an international web technical designer (1 person-month) and a domestic communications specialist (5 person-months) will be required. The consultants will be recruited on an individual basis in accordance with ADB’s Guidelines on the Use of Consultants, and other arrangements for the engagement of domestic consultants satisfactory to ADB.

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Component 3: Establishment and Operation of SME Helpline Outreach Centers Objective 1. The objective is to establish SME helpline outreach centers at the district offices of BSCIC to assist SMEs in their organizational and operational activities. The centers will provide advisory support to facilitate access to government services as well as provide basic office support facilities, and a feedback mechanism for SME concerns. Scope 2. The plan is to form the centers initially in Dhaka and Chittagong, and in at least half of the country’s districts by end-2007. BSCIC will assign full-time personnel who will undergo training and operate the centers in close collaboration with the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), Dhaka Chamber of Commerce and Industry, Chittagong Chamber of Commerce and Industry, and other district chambers and line associations of FBCCI. Training will be provided for the staff to run the facilities. 3. There will be a committee cochaired by highest officials of BSCIC and FBCCI to oversee the centers at the national level and provide guidance for future development. At the district level, the cochairs of a committee will be the head of the BSCIC district office and the president of the district chamber, with members including representatives from the municipality and SMEs in the area. FBCCI or its chamber member will be requested to assign a full-time staff in each center. The operating budget of the centers will be mainly funded from the resources of BSCIC with contribution from the chambers and associations. However, the centers will be allowed to charge reasonable fees for services rendered, such as documentation services, and use of business facilities. Procurement and Consulting Services 4. Computers and software, Internet and networking facilities, office equipment, transport, books, and publications will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 5. The TA component will require the services of an international SME public-private interface advisor (6 person-months) and two domestic SME business advisors (30 person-months). The consultants will be recruited on an individual basis in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements for the engagement of domestic consultants satisfactory to ADB.

Component 4: Targeted SME Capacity Building Overall Objective, Scope, and Consulting Services 1. The objectives are to (i) train and build up capacity of SMEs located in rural areas, and women entrepreneurs; (ii) retrain the displaced workers in the readymade garment (RMG) industry to be reemployed; (iii) encourage participating financial institutions’ (PFI) lending to SMEs through the development of appropriate systems and procedures for SME financing and capacity building of SME credit staff; and (iv) strengthen capacity of the Small and Cottage Training Institute (SCITI) to effectively implement the training programs on a sustainable basis. 2. This TA component has four subcomponents, as summarized below. A consulting firm will be engaged to work on each of the four subcomponents in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements for the engagement of domestic consultants satisfactory to ADB. However, the same firm may be engaged for more than one component. Quality-and-cost-based selection (QCBS) method will be used. Full technical proposal will be used for PFI capacity-building assistance subcomponent because the consulting work will require innovative techniques tailored to meet requirements of each PFI. Simplified technical proposal will be used for the other subcomponents, which will possibly be combined under one contract.

Subcomponent 4.1: Rural-Based Enterprises Training Scope 1. The TA will (i) determine training needs of SMEs in rural areas; (ii) assess adequacy of existing training programs; (iii) formulate practical and affordable training programs; (iv) design training delivery mechanism to reach out to such SMEs; (v) support a faculty development and training of trainers program of SCITI; (vi) foster coordination between SCITI, and district offices of BSCIC, chambers, and associations to carry out training programs on a sustainable basis; (vii) design ways to promote awareness of training programs through various channels including the SME web portal and helpline outreach centers; and (viii) study existing revenues and costs structure of SCITI and recommend how to adopt the principle of cost recovery for implementation of the targeted SME training programs on a sustainable basis. There could be exceptions to the principle in cases that involve very small rural participants who do not have the immediate capacity to pay regular training fees but who could influence the direction and pace of SME development in their communities. Procurement and Consulting Services 2. Computers and software, audio-visual equipment, teaching aids, furniture for classrooms and seminar and conference rooms, office equipment, transport, books and publications for library, and teaching materials will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB.

3. An international human resource development specialist (10 person-months), will formulate the framework for the various task items discussed above, guide a long-term domestic training specialist, (20 person-months) on the pilot testing and implementation of various phases of the capacity-building subcomponent, and periodically provide oversight inputs on the implementation work carried out by the training specialist.

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Subcomponent 4.2: Women Entrepreneurs Training Scope 1. The TA will (i) review and assess the effectiveness of existing and past women training programs and lessons learned; (ii) design specific programs catered to the needs of women entrepreneurs; (iii) conduct training programs in collaboration with SCITI, women entrepreneurs’ associations, district offices of BSCIC, and chambers; (iv) recommend sustainable training delivery mechanisms; (v) facilitate a forum for women employees and entrepreneurs to express their capacity-building needs and other concerns; and (vi) promote awareness of and participation in the training programs. Procurement and Consulting Services 2. Teaching materials and equipment, books and publications, and transport will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 3. An international human resource development specialist (5 person-months), will formulate the framework for the various task items discussed above, guide a long-term domestic training specialist, (10 person-months) on the pilot testing and implementation of various phases of the capacity-building subcomponent, and periodically provide oversight inputs on the implementation work carried out by the training specialist.

Subcomponent 4.3: Skills Retraining of Displaced RMG Workers Scope 1. This component will design the retraining program based on the needs by both the displaced RMG workers looking for work and the enterprises looking for personnel to hire. The skills required by the enterprise sector will be analyzed and defined, and based on the information on the workers in the database, candidates will be screened and training provided prior to actual hiring. Arrangements will be made for prospective employers to pay for a share of the training cost even before actual hiring, and for the full cost of the training if workers are hired. Design of the training programs will be in consultation with different stakeholders, including BSCIC. Collaboration will be forged with other external agency-funded programs such as the Job Opportunities and Business Support Program funded by the United States Agency for International Development, which is actively providing business development services (BDS) in identified industry subsectors, and with nongovernment organizations such as the Association for Social Advancement that is assisting enterprises that have graduated from the level of micro business operations. Procurement and Consulting Services 2. Teaching materials and equipment, books and publications, and transport will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB.

3. An international retraining and reemployment advisor (10 person-months), a domestic skills training expert (21 person-months), a domestic skills analyst (6 person-months), and a local survey firm will be recruited under this subcomponent.

Subcomponent 4.4: Development of SME Lending Capability of Participating Financial Institutions Scope 1. The TA will cover two main areas, (i) capacity building of participating financial institutions (PFIs) under the Small Enterprise Fund (SEF) in terms of systems and procedures for their SME lending operations, and (ii) training of SME credit staff to promote understanding of SMEs and enhance their skills and capabilities to provide guidance to SME credit applicants in strengthening their business plans and preparing financial projections, analyze credit applications, effectively monitor SME loan portfolio performance including compliance with safeguard policies, and provide handholding assistance to SMEs. The capacity building will lead to the establishment or improvement of SME lending systems and procedures and the enhanced capacity of SME finance units equipped with in-house business advisory services for SMEs. PFIs would have to refer to outside BDS providers for more extensive services. The TA will also provide an orientation program for accredited BDS providers that will interface with PFIs to tailor their BDS to the PFI requirements. Procurement and Consulting Services 2. Teaching materials and equipment, books and publications, computer equipment and teaching software, e.g., credit scoring software, and transport will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 3. An international SME finance operations specialist (18 person-months), an international SME finance training expert (4 person-months), a domestic SME finance operations consultant (15 person-months), and a domestic SME finance training consultant (7 person-months) will be recruited for this subcomponent.

Component 5: Upgrading of Product Certification System Objective 1. The objectives are to provide assistance in upgrading Bangladesh product certification system to international standard and to build up capacity of Bangladesh Standards and Testing Institution (BSTI) to enhance the effectiveness of its certifying function so that Bangladeshi products that bear its certification mark will be acceptable to importers.

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63

Scope 2. The TA will provide consulting assistance to evaluate BSTI’s laboratory facilities for product testing of a select group of products that have a strong export potential. The consultant will assess BSTI’s conformities in product-specific testing and recommend corrective actions. BSTI will invite a team of assessors from foreign accreditation bodies, particularly those in the primary export markets for the Bangladesh-made products, to assess if the testing accreditation facilities meet their requirements. BSTI staff will receive hands-on training by working with the consultant. Study tour to visit foreign accreditation bodies will be arranged as part of capacity building. The TA will also help develop marketing and public relations campaigns to promote awareness of the importance of certification among SMEs to enhance their export potential, especially to developed markets. Procurement and Consulting Services 3. Laboratory equipment and testing facilities, computers and software, and office equipment will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 4. The TA will engage the services of a consulting firm in accordance with ADB’s Guidelines on the Use of Consultants. An international consultant (5 person-months) and a domestic consultant (5 person-months) will be recruited. QCBS selection method will be used. Full technical proposal will apply because a specific capacity-building program will have to be tailored to address BSTI’s problems and meet its requirements.

Component 6: Integrated SME Database Development Objective 1. The objective is to develop an integrated SME database and build the capacity to maintain it. This TA loan component will have two key outputs, (i) creation of a directory of SMEs from an inventory of available data sources, and (ii) design and development of the SME database. Scope 2. The Bangladesh Bureau of Statistics is completing the processing of the 2001 Census of Non-Farm Economic Activities (Urban) and 2003 Census of Non-Farm Economic Activities (Rural), and will be publishing the Census report by end-2004. Primary data for nonagricultural enterprises (small, medium, and large) from the census will be supplemented by other data sources from relevant government agencies and private surveys to produce a directory that gives a listing of SMEs with name, address, nature of business, industry, (main product/service according to the International Standard Industrial Classification, and some other basic information. 3. Using the directory of SMEs as sampling frame, large-scale nationwide sample surveys will be conducted to obtain data on attributes of SMEs such as employment (with gender breakdown) and output. Such data will be captured in an integrated SME database, which will facilitate conduct of policy research on such areas as the causal relationships between growth and performance of SMEs and poverty reduction, and impact and effectiveness of government policies. The database will be designed, tested, and developed with appropriate procedures on its access, use, and controls to safeguard it from unauthorized access and loss or corruption of data. Procurement and Consulting Services 4. Computers, information technology, and communications equipment and software, office equipment, and transport needed for survey work will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 5. This TA loan component will require the services of an international economic statistician (12 person-months), a domestic database design expert (18 person-months), and a team of national survey enumerators. The TA will engage the services of a consulting firm in accordance with ADB’s Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the engagement of domestic consultants. QCBS method and simplified technical proposal will be used.

Component 7: Environmental Assessment and Monitoring Objective 1. The objective is to assist in building up capacity of the executing agency (EA), implementing agencies (IAs), and PFIs to ensure compliance with ADB’s environmental safeguard policy. Scope 2. The consultant will (i) explain the ADB safeguard policy on environment to the EA, IAs, and PFIs to enhance their understanding; (ii) develop capability of IAs to monitor the compliance with the ADB’s Environmental Policy; (iii) assist PFIs in assessing the environmental impact of SME applicants and setting up an environmental impact monitoring system; and (iv) train PFI staff in conducting environmental impact monitoring. Procurement and Consulting Services 3. Training materials and computer equipment and software will be procured following ADB’s Guidelines for Procurement. Supply contracts valued at $100,000 equivalent or less may be procured based on local procedures under the Government’s Public Procurement Regulations, 2003 and acceptable to ADB. 4. The TA will engage the services of an international environmental specialist (4 person-months) and a domestic environmental specialist (3 person-months). The consultants will be recruited on an individual basis in accordance with ADB’s Guidelines on the Use of Consultants, and other arrangements for the engagement of domestic consultants satisfactory to ADB.

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TECHNICAL ASSISTANCE LOAN COST ESTIMATES AND FINANCING PLAN ($’000)

Item

Foreign Exchange

Local Currency

Total Cost

A. ADB Financing Component 1: Rationalization of Government Assistance to SMEs i. Consultant Remuneration and Per Diem 496 87 583 ii. International and Local Travel 50 6 56 iii. Seminars and Workshops 0 18 18 iv. Reports and Communication 0 10 10 v. Equipment and Transport 50 41 91 vi. Contingencies 77 21 98 Subtotal (1) 673 183 856 Component 2: SME Web Portal and Virtual Front Office Development i. Consultant Remuneration and Per Diem 25 22 47 ii. International and Local Travel 10 1 11 iii. Seminars and Workshops 0 15 15 iv. Reports and Communication 5 5 10 v. Equipment and Transport 0 19 19 vi. Contingencies 5 8 13 Subtotal (2) 45 70 115 Component 3: Establishment and Operation of SME Helpline

Outreach Centers

i. Consultant Remuneration and Per Diem 149 126 275 ii. International and Local Travel 8 1 9 iii. Seminars and Workshops 0 21 21 iv. Reports and Communication 0 15 15 v. Equipment and Transport 30 70 100 vi. Contingencies 22 30 52 Subtotal (3) 209 263 472 Component 4: Targeted SME Capacity Building

Subcomponent 4.1: Rural-Based Enterprises Training

i. Consultant Remuneration and Per Diem 233 98 331 ii. International and Local Travel 12 2 14 iii. Seminars and Workshops 0 15 15 iv. Reports and Communication 0 10 10 v. Equipment and Transport 18 30 48 vi. Contingencies 34 20 54 Subtotal (4.1) 297 175 472 Subcomponent 4.2: Women Entrepreneurs Training i. Consultant Remuneration and Per Diem 118 49 167 ii. International and Local Travel 8 1 9 iii. Seminars and Workshops 0 10 10 iv. Reports and Communication 5 5 10 v. Equipment and Transport 12 10 22 vi. Contingencies 18 10 28 Subtotal (4.2) 161 85 246 Subcomponent 4.3: Skills Retraining of Displaced RMG Workers i. Consultant Remuneration and Per Diem 242 142 384 ii. International and Local Travel 12 2 14 iii. Seminars and Workshops 0 14 14 iv. Reports and Communication 0 40 40 v. Equipment and Transport 10 30 40 vi. Contingencies 34 29 63 Subtotal (4.3) 298 257 555 Subcomponent 4.4: Development of SME Lending Capability of PFIs i. Consultant Remuneration and Per Diem 543 111 654 ii. International and Local Travel 28 3 31 iii. Seminars and Workshops 0 12 12 iv. Reports and Communication 0 10 10

Continued on next page

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Item

Foreign Exchange

Local Currency

Total Cost

v. Equipment and Transport 9 15 24 vi. Contingencies 75 19 94 Subtotal (4.4) 655 170 825 Component 5: Upgrading of Product Certification System i. Consultant Remuneration and Per Diem 123 25 148 ii. International and Local Travel 12 1 13 iii. Seminars and Workshops 0 10 10 iv. Reports and Communication 0 10 10 v. Equipment and Transport 200 5 205 vi. Contingencies 44 7 51 Subtotal (5) 379 58 437 Component 6: Integrated SME Database Development i. Consultant Remuneration and Per Diem 298 74 372 ii. International and Local Travel 20 1 21 iii. Seminars and Workshops 0 47 47 iv. Surveys, Reports, and Communication 12 110 122 v. Equipment and Transport 60 60 120 vi. Contingencies 51 38 89 Subtotal (6) 441 330 771 Component 7: Environmental Assessment and Monitoring i. Consultant Remuneration and Per Diem 98 14 112 ii. International and Local Travel 12 1 13 iii. Seminars and Workshops 0 8 8 iv. Reports and Communication 0 10 10 v. Equipment and Transport 0 9 9 vi. Contingencies 14 5 19 Subtotal (7) 124 47 171 Interest during Implementation Period 80 0 80 Subtotal (A) 3,362 1,638 5,000 B. Government and Beneficiary Financing Component 1: Rationalization of Government Assistance to SMEs - Government Financing 0 290 290 Subtotal (1) 0 290 290 Component 2: SME Web Portal and Virtual Front Office Development - Government Financing 0 35 35 - Contribution of Chambers and Business Associations 0 35 35 Subtotal (2) 0 70 70 Component 3: Establishment and Operation of SME Helpline

Outreach Centers

- Government Financing 0 240 240 - Contribution of Chambers and Business Associations 0 240 240 Subtotal (3) 0 480 480 Component 4: Targeted SME Capacity Building

Subcomponent 4.1: Rural-Based Enterprises Training

- Government Financing 0 200 200 - Training Fee Contribution of SMEs/Entrepreneurs 0 150 150 - Matching Contribution of Chambers and Business

Associations 0 150 150

Subtotal (4.1) 0 500 500 Subcomponent 4.2: Women Entrepreneurs Training - Government Financing 0 100 100 - Training Fee Contribution of SMEs/Entrepreneurs 0 100 100 - Matching Contribution of Chambers and Business

Associations 0 60 60

Subtotal (4.2) 0 260 260 Subcomponent 4.3: Skills Retraining of Displaced RMG Workers - Government Financing 0 240 240 - Training Fee Contribution of Training Participants 0 100 100

Continued on next page

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66

Item

Foreign Exchange

Local Currency

Total Cost

- Matching Contribution of Prospective Employers, Chambers and Business Associations

0 200 200

Subtotal (4.3) 0 540 540 Subcomponent 4.4: Development of SME Lending Capability of PFIs - Government Financing 0 250 250 - Matching Contribution of PFIs 0 590 590 Subtotal (4.4) 0 840 840 Component 5: Upgrading of Product Certification System - Government Financing 0 150 150 Subtotal (5) 0 150 150 Component 6: Integrated SME Database Development - Government Financing 0 270 270 Subtotal (6) 0 270 270 Component 7: Environmental Assessment and Monitoring - Government Financing 0 60 60 Subtotal (7) 0 60 60 Government Financing 0 1,835 1,835 Beneficiary Financing 0 1,625 1,625 Subtotal (B) 0 3,460 3,460 Total (A + B) 3,362 5,098 8,460

ADB = Asian Development Bank, PFI = participating financial institution, RMG = readymade garment, SME = small and medium enterprise, TA = technical assistance. Source: Asian Development Bank staff estimates.

67Appendix 9

PROGRAM IMPLEMENTATION SCHEDULE Item 2005 2006 2007 2008 2009 2010 A. Loan Effectiveness B. Tranche Release C. Program Loan 1. Establish SME Policy and Development Framework 1.1 Declare SMEs as a Priority Sector under Government Policy 1.2 Formulate SME Policy and Development Strategy 2. Establish Institutional Structure and Mechanisms to Support SME 2.1 Set Up an Institutional Structure and Mechanisms to Implement the SME Policy and Development Framework 2.2 Prepare an Action Program to Support the SME Development Strategy 3. Define Government Support to SMEs and Improve SME Access to

Various Services

3.1 Rationalize Government Assistance to the SME

Sector including the Restructuring of BSCIC and Other Concerned Agencies under MOI, and Rationalization of Government Direct Credit Assistance Currently Provided

3.2 Rationalize incentive and Tax Structure for SMEs 3.3 Enhance SME Access to Market and Government Services 3.4 Enhance SME Access to Capacity Building 3.5 Enhance SME Access to Product Certification and Upgrade Product Certification System to International Standard 3.6 Develop an Integrated SME database D. Project Loan 1. SEF Disbursement 2. Fund Utilization Monitoring and Reporting System 3. Semiannual Review 4. Benefit Monitoring E. TA Loan 1. Rationalization of Government Assistance to SMEs 2. SME Web Portal/Virtual Front Office Development 3. Establishment and Operation of SME Helpline Outreach Centers 4. Targeted SME Capacity Building 4.1 Rural-Based Enterprise Training 4.2 Women Entrepreneurs Training 4.3 Skills Retraining Displaced RMG Workers 4.4 Development of SME Lending Capability of PFIs 5. Upgrading of Product Certification System 6. Integrated SME Database Development 7. Environmental Assessment and Monitoring F. Monitoring and Review G. Procurement and Consulting Services H. TA Grant Implementation

BSCIC = Bangladesh Small and Cottage Industries Corporation, MOI = Ministry of Industries, RMG = readymade garment, PFI = participating financial institution, SEF = Small Enterprise Fund, SME = small and medium enterprise, TA = technical assistance.

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68

TECHNICAL ASSISTANCE GRANT TO SUPPORT PROGRAM IMPLEMENTATION AND COORDINATION OF SMESDP

1. Rationale. The technical assistance (TA) is intended to help the executing agency (EA) for Small and Medium Enterprise Sector Development Program (SMESDP), the Finance Division of the Ministry of Finance (MOF-FD) to ensure the effective implementation of the SMESDP covering all of its components. 2. Objectives, Scope of Work, and Resources. The TA will (i) assist the Government/Small and Medium Enterprise (SME) Advisory Panel in preparing a results-based time-bound action plan stipulating all relevant medium-term reform and capacity-building measures; (ii) assist in operationalizing the SME Cell at the Ministry of Industries (MOI) that will implement the SME policy; (iii) monitor the SMESDP programs and various components to ensure that beneficiaries are reached and desired outcomes are attained; (iv) assist in ensuring the smooth implementation of SME support systems (database, web portal, helpline centers); (v) review and supervise the administration of the training programs and provide feedback on their effectiveness; (vi) build up capacity of implementing agencies (IAs) in monitoring the policy impact, and train participating financial institutions (PFIs) under the Small Enterprise Fund (SEF) in conducting benefit monitoring of their SME loans; (vii) synchronize all activities under SMESDP; (viii) provide administrative support to the central program coordination unit (CPCU) at MOF-FD and the SME Cell in MOI in procurement, consultant recruitment, and provision of other resources under SMESDP; and (ix) assist in and monitor the implementation of the gender action plan. 3. The implementing agency for the TA is MOI. The TA will be implemented over the implementation period of SMESDP. Individual consultants will be recruited in accordance with the Asian Development Bank (ADB) Guidelines on the Use of Consultants and other arrangements satisfactory to ADB for the engagement of local consultants. The terms of reference of the consultants are as follows: 4. International SME policy expert will be the team leader and will render 10 person-months of consulting services to perform the following:

(i) assist the SME Advisory Panel in formulating an SME policy implementation action program, and ensure participatory process and consultation with stakeholders during the development of such a program;

(ii) make recommendations to improve the accuracy and reliability of SME data linked to desired performance indicators for the sector;

(iii) review integrity of proposed comprehensive SME survey; (iv) assist in determining appropriate organizational structure and key result areas,

and prepare operational guidelines for the MOI SME Cell; (v) review consultant selection process and TA implementation to ensure smooth

delivery; (vi) assist MOI in establishing and operationalizing an SME Foundation; (vii) ensure proper implementation of SME support systems; (viii) secure feedbacks and recommend appropriate improvements and corrective

actions to ensure effective administration of training programs; (ix) monitor timely implementation of the Bangladesh Small and Cottage Industries

Corporation (BSCIC) phaseout or restructuring plan; (x) establish benefit monitoring systems for each IA, including for loans financed

under SEF;

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(xi) train PFI staff in conducting benefit monitoring of SME loans; and (xii) ensure that equipment and resources for administrative support to the

appropriate government agencies are efficiently delivered/served.

5. Domestic SME policy expert will be engaged for 8 person-months to assist the international SME policy expert in performing his or her assignments:

(i) provide the international SME policy expert with background information, and relevant laws and regulations, related to SME policy development;

(ii) assist in preparing legal documentation for the establishment of the SME Foundation;

(iii) assist in organizing stakeholders’ consultation meetings or discussions during the development of the action program; and

(iv) perform any other functions to assist the international SME policy expert. 6. Domestic project administration specialist will be engaged to provide 34 person-months of services for project administration and support systems implementation, as follows:

(i) follow up implementation progress of all measures under SMESDP; (ii) assist the CPCU and IAs in preparing regular progress reports and ensure

prompt submission of such reports to ADB; (iii) monitor development and ensure proper functioning of the SME support systems; (iv) monitor implementation and coordination of all SMESDP training programs; (v) assist in loan disbursements, recruitment and payment for consultants,

submission of reports to ADB, and other administrative matters; (vi) liaise with relevant stakeholders from Government, private sector, and funding

agencies; (vii) assist ADB’s missions; and (viii) assist the team leader in other tasks assigned.

7. Domestic gender specialist will be engaged for 6 person-months for the following tasks:

(i) prepare detailed activities to be implemented under the gender action plan; (ii) follow up on the implementation of the gender action plan; (iii) monitor the implementation of targeted women entrepreneurs’ training programs

and assist in coordinating accredited women entrepreneurs’ associations; (iv) develop a system to monitor women beneficiaries; (v) facilitate a forum for women employees and entrepreneurs; and (vi) prepare a forum report and ensure that forum concerns are addressed.

8. Outputs/Deliverables. It is expected that the consulting services will commence by April 2005. The international and domestic SME policy experts and the domestic gender specialist will work on an intermittent basis while the domestic project administration specialist will work on a full-time basis during the program implementation period. The key outputs/deliverables and target dates are listed in Table A11.1. Other outputs and deliverables will involve monitoring activities to be carried out on a regular basis.

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70

Table A10.1: Key Outputs/Deliverables and Target Dates

Outputs/Deliverables Target Dates International and domestic SME policy experts Work plan for the TOR 10 days from commencement Operational guidelines for the MOI SME Cell 30 days from commencement Review sources of statistics and data to monitor SME policy

impact and to prepare a directory of SMEs 30 days from commencement

Sampling frame for development of SME database By September 2005 Benefit monitoring systems of SMESDP By September 2005 Training of IAs and PFI staff for benefit monitoring By October 2005 Action program for SME policy By September 2006

Domestic project administration specialist Monitoring reports covering SMESDP and its components Quarterly

Domestic gender specialist Work plan for the implementation of the gender action plan 10 days from commencement Monitoring reports on gender action plan/women beneficiaries Semiannually Organizing forums for women labor and women entrepreneurs Semiannually (the first forum to

be held by July 2005) IA = implementing agency, MOI = Ministry of Industries, PFI = participating financial institution, SME = small and medium enterprise, SMESDP = Small and Medium Enterprise Sector Development Program, TOR = terms of reference Source: Asian Development Bank staff estimates.

9. Costing and Financing. The total cost of the TA is estimated to be $750,000 equivalent. ADB will provide $600,000 equivalent on a grant basis from the ADB-funded TA program to cover total foreign exchange cost and part of the local currency cost of the TA. The Government will provide the remaining $150,000 equivalent through the provision of counterpart staff, offices, transportation, and incidental expenses.

Table A10.2: Cost Estimates and Financing Plan ($)

Item Foreign Exchange

Local Currency

Total Cost

A. Asian Development Bank Financing 1. Consultants a. Remuneration and Per Diem 248,000 197,000 445,000 b. International and Local Travel 17,000 3,000 20,000 2. Workshops and Meetings 0 10,000 10,000 3. Reports and Communications 0 5,000 5,000 4. Training 15,000 0 15,000 5. Local Transport 0 20,000 20,000 6. Computer and Office Equipment 0 11,000 11,000 7. Contingencies 36,000 38,000 74,000 Subtotal (A) 316,000 284,000 600,000 B. Government Financing 1. Counterpart Staff 0 75,000 75,000 2. Office Accommodation and Facilities 0 50,000 50,000 3. Administrative and Other Expenses 0 25,000 25,000 Subtotal (B) 0 150,000 150,000 Total 316,000 434,000 750,000

Source: Asian Development Bank staff estimates.

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71

SUMMARY POVERTY REDUCTION AND SOCIAL STRATEGY

A. Linkages to the Country Poverty Analysis

Sector identified as a national priority in country poverty analysis? Yes

In its National Strategy for Economic Growth, Poverty Reduction, and Social Development (the Government’s Interim Poverty Reduction Strategy Paper [I-PRSP]), dated March 2003, the Government identified five broad sets of policies to reduce poverty: (i) pro-poor economic growth, (ii) human development, (iii) women’s advancement and closing of gender gaps, (iv) social protection, and (v) participatory governance. The development of small and medium enterprises (SMEs) will contribute to pro-poor economic growth.

Sector identified as a national priority in country

poverty partnership agreement? Yes Under the poverty partnership agreement signed in April 2000, the Government’s strategy for reduction of income poverty and human poverty is to accelerate economic growth and ensure adequate supply of basic needs. Poverty reduction will be facilitated through expansion of private investment and nonfarm employment, especially in less developed rural areas. The Government supports the development of financial intermediation to meet the requirements of SMEs in rural areas.

Contribution of the sector/subsector to reduce poverty in People’s Republic of Bangladesh:

As a consequence of steady economic growth during the past decade, income poverty in Bangladesh has declined from 59% to 50%. However, poverty rates and absolute numbers are still very high, and considerable urban-rural and regional disparities exist. Bangladesh remains one of the poorest countries in the world, with a per capita income of around $385. To achieve the goal of halving the poverty level by 2015, Bangladesh needs to sustain a gross domestic product (GDP) growth rate of about 7% per year over the next 10 years. The development of SMEs is one of the priority policy measures to promote pro-poor growth. The SME sector has played a very important role in the economy and accounts for about 40% of gross manufacturing output, 80% of industrial employment, and 25% of the total labor force. Many SMEs are concentrated in certain industries, such as the textile and garment industry, which accounts for about 75% of the country’s exports. SMEs have increased participation in the rural economy, where most of the poor live, providing livelihood and employment opportunities in agro-processing, food production, and nonfarm rural economic activities. However, SMEs have not been able to attain its full potential in contributing to economic growth and poverty reduction due to various bottlenecks in the SME sector (such as lack of access to credit, market, and business support services), and structural problems in the overall business environment (such as poor law and order, weak governance, inadequate infrastructure, and market failures in the financial sector). Small and Medium Enterprise Sector Development Program (SMESDP) will aim at strengthening the policy environment and providing support infrastructure for SMEs to improve access by SMEs to credit and related support services to help overcome constraints to their efficient operation, growth, and expansion.

B. Poverty Analysis Targeting Classification: General Intervention (GI)

SMESDP is expected to have direct poverty impact through an improved access to necessary resources for the SME operations including credit and capacity-building support targeted at the small end of SMEs and disadvantaged groups such as SMEs located in rural area, women entrepreneurs, and workers in the readymade garment (RMG) industry displaced due to the phaseout of the Multi-Fibre Arrangement (MFA). Further, SMESDP will introduce policy reforms and create support infrastructure to facilitate the growth of the SME sector and consequently promote economic activities through supply chain linkage between SMEs and other businesses. Various components under SMESDP will contribute to poverty reduction, as follows.

Improved Access to Credit. Lack of access to finance is one of the main impediments to SME growth. Because of their limited financial base, SMEs face difficulties raising funds from the formal sector. SMEs often borrow money from relatives and friends, or from informal credit sources that are costly and inadequate. The problem is more pronounced for the “missing middle” group, consisting of enterprises that are too large for funding from nongovernment organizations, microfinance institutions, or government assistance programs but too small for formal bank borrowing. The Program will directly address this gap by contributing to the Small Enterprise Fund (SEF), which was set up by the Government to be channeled through participating financial institutions (PFIs) to small enterprises that have fixed assets of less than Tk10 million. Provision of Incentives. Currently, the Government provides a tax holiday for newly established enterprises, irrespective of size. However, this tax holiday scheme is expected to be abolished in the next fiscal year. Given their small scale of operations and more limited resources, SMEs will be more adversely affected by the discontinuance of the tax holiday. SMESDP will support other tax measures, i.e., 75% income tax rebate and

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accelerated depreciation rates, in lieu of the tax holiday. These incentives will be provided to very small enterprises, which have fixed assets excluding land and building of less than Tk3 million, to alleviate their financial burden and enhance their viability during the startup phase. Targeted Training and Capacity-Building Assistance. Training programs under SMESDP will be targeted at a disadvantaged group of SMEs, i.e., those in the rural areas and women entrepreneurs. In addition, SMESDP will support retraining programs of displaced RMG workers which will be demand driven taking into account skills requirements of prospective employers. These training programs will be implemented in collaboration with the Federation of Bangladesh Chambers of Commerce and Industry (FBCCI), which has affiliated with district chambers and business associations as well as women entrepreneurs’ associations. This public-private partnership is expected to have outreach impact through business network and linkages between these chambers and associations and SMEs in their respective areas. More Effective Public Service Institutions. Bangladesh Small and Cottage Industries Corporation (BSCIC), the principal government organization mandated to promote the development of small and cottage industries (SCIs) has an institutional network of industry service centers in 64 districts, industrial estates in all districts, product development projects, poverty alleviation projects, Small and Cottage Industries Training Institute (SCITI), Design Center, and skills development centers. Despite its long experience in the sector, its performance has not met expectations. The Program will conduct a diagnostic study of BSCIC to identify restructuring alternatives, move BSCIC towards a leaner and more effective organization, and strengthen the role of BSCIC’s district offices in the delivery of government assistance to SCIs nationwide. SCITI will also be strengthened to play a more effective role in implementing demand-driven training programs on a sustainable basis. In addition, SMESDP will strengthen the capacity of Bangladesh Standards and Testing Institution (BSTI) in its product certification function to ensure the credibility of BSTI’s certification mark. SMEs will be provided with a special window to access BSTI’s services. BSTI will conduct public awareness campaigns especially among SMEs to encourage them to comply with the product certification requirements. The improvement in quality of SME products will enhance export potential and generate additional income. A study will be conducted to identify industries with potential to be developed into clusters or industrial parks. This will be a step towards identifying competitive advantage of enterprises, providing appropriate infrastructure to nurture their growth, thus diversifying Bangladeshi exports and preparing the country for the entry into the World Trade Organization. Making these industries competitive in the world market will not only improve economic growth, but also reduce vulnerabilities, especially of the poor. More Extensive Outreach of SME Support Infrastructure. SME helpline outreach centers will be established in BSCIC’s district offices nationwide in phases. First, the centers will be set up in Dhaka and Chittagong and then expanded to at least half of districts in 2.5 years. The helpline outreach centers will provide one-on-one “handholding” assistance and advisory services to SMEs. The presence of the centers in the vicinity is expected to encourage SMEs and other persons interested to set up an enterprise to use their services. C. Participation Process Stakeholder analysis prepared: No Participation Strategy: No Stakeholder Analysis. The Report of the National Task Force on Development of Small and Medium Enterprises was based on the discussions in the Asian Development Bank-supported national SME workshop held in February 2004 with participation from various stakeholders consisting of various government ministries and agencies, development partners, chambers and industry associations, financial institutions, and research and academic institutions to identify constraints, opportunities, and issues regarding the development of SMEs in the country. Participation Strategy. The implementation of SMESDP will be based on public-private collaborative processes. An SME Advisory Panel to be established and mandated to develop an action plan to implement the SME policy will consist of representatives from the concerned ministries, industry associations, private sector, and academia. Beneficiaries under the training programs will participate in training need assessments. Moreover, a forum will be organized for women workers and entrepreneurs to express their training needs and other concerns. The participatory process will ensure the outreach of the Program to targeted beneficiaries. D. Gender and Development Strategy to maximize impact on women. The Program will (i) encourage participation by women entrepreneurs and women-owned businesses in policy advocacy; (ii) facilitate access to credit by women entrepreneurs; (iii) enhance women entrepreneurs’ capacity, productivity, and competitiveness through training and provision of business development services (BDS); (iv) promote networking among women entrepreneurs’

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associations for efficient delivery of government services and effective implementation of collaborative public-private mechanisms; and (v) develop a gender-disaggregated database to be used for planning, and monitoring and evaluation of programs promoting and supporting women-run SMEs. Gender plan prepared? Yes. (see Supplementary Appendix 1)

E. Social Safeguards and Other Social Risks

Issues Significant/

Not Significant/ Uncertain/

None

Strategy to Address Issues

Plan

Required

Resettlement

None Since the PFIs’ subloans/subleases to SMEs will be largely in the light manufacturing, agro-processing, trade and services sector and probably none in infrastructure, it is unlikely that involuntary resettlement will occur.

No

Indigenous Peoples

None No adverse impact is anticipated. On the other hand, targeted training programs and helpline outreach centers could reach out to indigenous people who could be either SME entrepreneurs or employees.

No

Labor

None Restructuring of concerned agencies involved in the SME sector could also cover human resource rationalization. However, analysis of restructuring alternatives will also explore the impact on labor employees of these institutions. Nevertheless, the Program is expected to have net positive labor impact from the capacity-building assistance, especially the retraining programs for displaced RMG workers that will help them reenter the job market.

No

Affordability

None First, SMEs will have better access to credit at a lower cost. Based on the discussions during the program processing stage, preidentified PFIs expect to pass on lower costs from SEF to SME borrowers. Further, more intense competition is expected to drive down the interest rates. Second, tax measures will reduce the financial burden of newly established small enterprises. Third, SCITI will ensure that training programs will be affordable to training participants. SCITI will charge for, at least, cost recovery for those who can afford to pay for the services. Exceptions could be made for very small rural participants who do not have capacity to pay training fees.

No

Other Risks/ Vulnerabilities

None No other risks are anticipated. No

F. Components and Targets for Gender Strategy Component/Activity Strategy to Address Issues

Enabling Environment for SMEs

• Women entrepreneurs will be represented in preparation and implementation of the SME policy and action plan.

• SME database will have gender-disaggregated data to facilitate the planning, implementation, and monitoring of women-targeted policy measures.

Access to Credit by SMEs • At least 10% of the funds of the SEF will be earmarked for women borrowers for 1.5 years, or more depending on utilization of this allocation for lending to women borrowers.

• Women borrowers will be provided with assistance and advisory services for their loan applications.

SME Capacity-Building Assistance • Targeted training programs for women entrepreneurs will be developed to address their specific needs.

• Women entrepreneurs’ associations will participate in the implementation of the programs.

• A forum will be organized for women entrepreneurs and workers to express their training needs and other concerns.