Project Information Document (Pid) s10

PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Report No.: AB4097 Project Name MU-Support for SME Dev. Project Region AFRICA Sector Micro- and SME finance (50%);General industry and trade sector (50%) Project ID P112943 Borrower(s) GOVERNMENT OF MAURITIUS GOVERNMENT OF MAURITIUS Mauritius

Implementing Agency Ministry of Finance and Economic Development New Government House Port Louis Mauritius Tel: 230-111-1111 Ministry of Industry, SME, Commerce and Cooperatives (MISCC) Mauritius

Environment Category [ ] A [ ] B [] C [X] FI Date PID Prepared August 19, 2008 Estimated Date of May 15, 2009 Appraisal Authorization Estimated Date of Board August 17, 2009 Approval

1. Key development issues and rationale for Bank involvement

1. As a middle income country (MIC), with a per capita of US$6431, Mauritius has achieved remarkable economic and social success, underpinned by good governance, exceptional use of preferential trade agreements for its sugar and textile exports, and the development of strong tourism and financial services industries. While economic performance remains good by regional and international standards, the country is facing multiple development challenges as it is forced to transition from dependence on trade preferences to open competition in the global economy and adjust to rising energy prices. These macroeconomic forces are impacting the survival of the industrial, specifically, small and medium enterprise (SME) sector,1 with the consequent slow down of trend growth rate2 and a rise in unemployment to around 6 percent.

1 Central Statistics Office (CSO) defines small firms as having less than 10 employees. Medium and large firms are categorized as having more than 10 employees. According to the latest Census data (CSO, 2002), SME comprises 74,928 small establishments, with the sector accounting for 35% of the total employment and 12% of the gross output (see Jenders, S. August 2008, Mauritius Industrial and SME Strategy, Final Draft), AFD. When medium enterprises are included these percentages would go up substantially. 2 The Vision 2020 (July 1997) anticipated seven percent or more average growth, the actual outturn in 2000-05 averaged only 3.1 percent. Thanks to the GoM’s bold reforms, since 2006 growth rates have increased above 5 percent. 2. Mauritius’s challenge is to boost economic growth through higher productivity, reliance on more value-added and innovative skill-intensive activities and by developing human capital, move the country to a more knowledge based economy, while preserving its long standing commitment to social welfare.3 The Mauritius Investment Climate Assessment (2006), focusing primarily on SMEs,4 has identified the following top 4 constraints for private sector growth: (i) access to finance; (ii) bureaucratic red tape; (iii) skills and education; and (iv) macroeconomic instability. While some progress on the regulatory fronts has been reported, Mauritius still ranks 97 out of 178 economies in access to finance (Doing Business, Mauritius 2008).

3. The Government of Mauritius (GoM) has embarked on bold, multi-year structural reforms aimed at restoring macroeconomic balance and diversifying the economy into new growth sectors such as Business processing operations (BPO), seafood, manufacturing activities and light engineering knowledge hub and specialty tourism.5 The overall goals and objectives of the Mauritian government with regard to industry and SMEs have been set out in consecutive budgets. GoM’s commitment for SMEs has also been articulated in the recent Budget 2008/09, which contains measures and incentives aimed at sharpening the competitive edge of Mauritian firms in an open economy. Initiatives include broadening the availability of finance and facilitating access, in particular for those enterprises that have viable projects but are short of equity; and allowing for the setting up of private credit information bureau, through an amendment in the Banking Act. Increasing the flow of business to SMEs and opening up opportunities through empowerment, in particular of women, are addressed, through dedicated programs. In parallel an Industrial and SME Strategy has been drafted by the Ministry of Industry, SMEs, Commerce and Cooperatives (MISCC) and the Ministry of Finance and Economic Development (MFED), with the support of the Agence Francaise de Developpement (AFD).6 The Strategy aims at the consolidation, diversification and modernization of the SME sector in Mauritius.

4. Currently, the Government provides a range of direct and subsidized financial and non-financial services to SMEs, predominantly through public institutions. Despite multiple SME initiatives and substantial resources, the results have been less than satisfactory, both in terms of impact and sustainability. Access to finance continues to be identified as a major constraint for growth despite the availability of government sponsored schemes to help SMEs access finance.

5. Reflecting global experience, publicly provided Business Development Services (BDS) in Mauritius tend to be generic, supply-driven, and of poor quality. For enhancing productivity and competitiveness, and tapping export markets, SMEs identify major gaps in the areas of product and market development support, up-gradation of skills, technology absorption, quality certification, and finance.

6. The challenge is how best to align content and delivery mechanism of SME services in Mauritius to good practice models around the globe. It is in this context that the Bank Group has been requested to support the GoM. As the country continues to implement its bold reform program, the GoM expects assistance from the Bank to help design and change the delivery mechanism, using global experience and knowledge from around the world. The Bank’s involvement in Mauritius is consistent with its

3 Refer to World Bank (October 12, 2006), Country Partnership Strategy (CPS) for Mauritius, 2007-2013, IBRD Report No. 37703-MU; and World Bank (January 2007), Country Economic Memorandum (CEM) for Mauritius, Report No. 36196-MU. 4 Over 65 percent of the firms in the sample were SMEs. The ICA defines small firms as having 1-49 employees; medium 50-99 employees; and large as having above 100 employees. 5 See GoM, National Long-Term Perspective Study (Vision 2020), July 1997; and World Bank (October 12, 2006), CPS for Mauritius, 2007-2013, IBRD Report No. 37703-MU. 6 Jenders, S. August 2008, Mauritius Industrial and SME Strategy, Final Draft, AFD. As part of this work, a qualitative and interview-based survey of SMEs has been undertaken from June-August 2008. comparative advantage as a knowledge institution in line with the MIC approach. The project is supported within the Country Partnership Strategy (CPS), 2007-2013,7 under which the World Bank’s engagement in Mauritius is governed, given the country’s MIC status. It supports all four pillars of GoM’s reform program: (i) improving trade competitiveness; (ii) improving investment climate; democratizing the economy through participation, social inclusion and sustainability; and fiscal consolidation and improved public sector efficiency. The project was agreed between the GoM and the Bank’s as part of the early 2008 annual business plan meetings that are developed in parallel with the Government’s planning and budget processes.

2. Proposed objective(s)

7. The objective of the proposed operation is to support SME growth, competitiveness and employment creation by (i) improving access to quality BDS and markets; (ii) increasing access to finance; and (iii) promoting a conducive business environment through policy and institutional support.

3. Preliminary description

8. Based on the Identification Mission findings, Bank’s analytical work in Mauritius, and lessons learnt from global best practices in SME development, the team has proposed an integrated and multi-pronged approach that will address key bottlenecks constraining SME development and competitiveness. The proposed operation aims to support the GoM’s SME strategy through an improved access to finance and markets, training and technology absorption for enhanced productivity and competitiveness for SMEs, and rationalization and strengthening of institutional arrangements in SME sector. SMEs across existing and new emerging sectors would be eligible for support under the proposed project,8 with an emphasis on supporting commercially viable businesses including manufacturing, exports, services, and trade.

9. The traditional approach to SME assistance is based on old assumptions: that the demand for financial and non-financial services by SMEs is low because of their inability to pay, that such services cannot be provided profitably and that SMEs care more about cost than quality and access. Empirical work has called these assumptions into question.9 The new strategy – reflected in the project design - focuses on increasing SME access to markets – for a diverse range of services, both financial and non-financial, that support SME growth and competitiveness; for the good and services that SMEs produce (both domestic and export); and for inputs used by SMEs (including information, technology).

10. A summary of the three components of the proposed project are as follow: (i) Strengthening the enabling policy and institutional framework for SME Development: Potential areas of indicative support may include: (i) establishment of an Overarching Coordinating Mechanism for strategy, implementation, budgeting, Monitoring &Evaluation, and coordination of development partners’

7 The World Bank, Country Partnership Strategy for the Republic of Mauritius, October 12, 2006, IBRD Report No. 37703-MU. The CPS, prepared in partnership with the Government of Mauritius (GoM) and close coordination with the European Union, is based on three guiding principles: (i) alignment with the Government’s support; (ii) flexibility; and (iii) harmonization with other development partners. 8 As part of the project preparation, the definition of SMEs shall be refined further – based on latest CSO data and market assessments - for designing and targeting policies for the varying needs of different segments within the SME sector. 9 Hallberg, Kritsin May 1999, A Market-Oriented Strategy for Small and Medium Enterprises, IFC, Discussion Paper 40, The World Bank. interventions; (ii) strengthening Regulatory and Legal systems; and (iii) optimization and consolidation of existing public SME institutions and programs.

(ii) Strengthening Business Development Services (BDS) via Matching Grants scheme: In an effort to assist SMEs in developing and strengthening technological links to support project design, product development, marketing, skills upgrading etc., the proposed component will establish a matching grant scheme (MGS). The starting point for designing a successful MGS is a detailed analysis of the existing market conditions – what is currently provided and by whom; the characteristics, needs and willingness- to-pay of SMEs; and the nature of market failures that constrain market development. It is clear that in any successful intervention there needs to be consistency and coherence between its initial market analysis, its picture of sustainability, the instrument it uses and the provider (and facilitator) it works with, all of which need to be implemented within the good practice framework. The specific focus and design of the MGS shall be undertaken at pre-appraisal stage.

(iii) Access to Finance: This component may support a Partial Credit Guarantee (PCG) as a potential instrument for addressing access to finance constraint for SMEs. PCG is a risk-sharing program proposed to commercial banks established and operating in Mauritius. SMEs are perceived to be higher-risk borrowers and usually lack cash collateral needed to obtain bank loans, the PCG instrument in turn provide banks with the credit protection needed to mitigate the perceived high risk of SME lending. The PCG is aimed at encouraging these banks to lend to SMEs by partially back-stopping potential losses resulting from non-payments of their respective SME loan portfolios. The risk sharing ensures that the participating banks conduct proper borrower credit appraisal and apply strict loan underwriting criteria in establishing the loan portfolio. The Participating Banks are selected based on their financial strength and demonstrated intention to expand into the SME sector. The Bank team had the opportunity to discuss this proposal with a range of commercial banks operating in Mauritius - all of whom indicated potential interest in participating in the PCG scheme.

11. The Bank Group team is exploring the potential for leveraging joint IBRD and IFC resources and capacities for this component. Based on the market assessment, the incentive features of the operational design, pricing, implementing structure and selection of the participating Banks for the PCG would be identified by the IFC team during the next mission. IFC would also take the lead in administering the PCF for a fee from the Banks. The TA facility may be designed jointly by IBRD and IFC. While taking the dialogue further on the PCG, IFC team shall also be undertaking a comprehensive analysis of the market needs and exploring a broader range of financial products.

12. Government ownership and stakeholders’ support: The GoM has already put in place credible steps over the last couple of years to indicate commitment and ownership of the SME reforms and policies. In line with the global trends, there is increasing recognition that the Government’s role should be limited to that of a facilitator rather than a director provider of financial and non-financial services. Attempts to streamline the SME policies and institutions are underway. These include the passing of the Business Facilitation Act and the drafting of a new SME Bill. The Business Facilitation Act of 2006 significantly streamlined and shortened procedures.

13. A Government counterpart Project Implementation Team (PIT), collaborating on the preparation of the SME project, has been established. The PIT includes representatives from Ministry of Industry, MoF, Private sector representatives, with the chair from the private sector. 4. Safeguard policies that might apply [Guideline: Refer to section 5 of the PCN. Which safeguard policies might apply to the project and in what ways? What actions might be needed during project preparation to assess safeguard issues and prepare to mitigate them?]

5. Tentative financing Source: ($m.) Borrower 0 International Bank for Reconstruction and Development 20 Total 20

6. Contact point Contact: Asya Akhlaque Title: Senior Economist Tel: (202) 458-8780 Fax: (202) 614-8780 Email: [email protected]