Strengthening the Regional Development Bank Project (RRP SRI 52219-001)

DEVELOPMENT COORDINATION

A. Major Development Partners: Strategic Foci and Key Activities

1. Several development partners, including the Asian Development Bank (ADB), have been engaged in micro, small, and medium-sized enterprises (MSMEs) because of their importance in reducing poverty and promoting economic growth in Sri Lanka. ADB is the only development partner that actively supports the government in enhancing MSMEs’ access to finance through various lending and non-lending products.

Major Development Partners Development Amount Partner Project Name Duration ($ million) SME Finance ADB (sovereign) Small and Medium-Sized Enterprises Line of Credit Project 2016–present 175.0 Women Entrepreneurs Finance Initiative (We-Fi) Grant 2018–present 12.5 Technical Assistance for SME Cluster Development and 2016–present 4.1 Financial Innovationa Technical Assistance for Mobilizing Finance for Sri Lankab 2016–present 0.5 ADB Senior Unsecured Loan to for the Small 2013–present 15.0 (nonsovereign) and Medium-Sized Enterprises Finance Project (senior loan) LOLC Finance and LOLC Micro Credit (senior loan)c 2015–present 55.0 DFCC MSME Finance 2018–present 50.0 MSME Finance and Credit Guarantee 2018–present 20.0 EIB SME and Green Energy Global Loand 2014–2015 81.9 World Bank Small and Medium Enterprises Development Facility Project 2011–2015 57.4 International Emerald Sri Lanka Fund I Limited (equity investment) 2014–present 10.0 Finance NDB Debt Syndication (senior loan)e 2014–present 20.0 Corporation NDB Loan Package (senior loan) 2013–present 24.0 Commercial (financing facility) 2011–present 65.0 Commercial Bank of Ceylon (subordinated loan) 2013–present 75.0 Nations Trust Bank (senior loan) 2017–present 50.0 SFCL Senior Loan (senior loan to Senkadagala Finance PLC) 2014–present 7.0 Sanasa Development Bank Limited (equity investment) 2017–present 3.0 SME Banking SL (advisory services for NDB and Seylan 2014–present 0.8 Bank) Sanasa Development Bank Limited (senior loan) 2018–present 15.0 Alliance Finance Company 2018–present 10.0 USAID Connecting Regional Economies Project 2008–2012 13.5 and Hatton National Bank Credit Guarantee: 2018–2025 9.0 Access to Finance for MSMEs International Trade Related Assistance in Sri Lanka: Increasing SMEs 2016–present 9.17 Trade Centre Trade Competitiveness in Regional and European Union DID Markets 2016–present 6.18 Establishment of Entrepreneur Financial Expertise Centre: Sanasa Development Bank ADB = Asian Development Bank; DID = Development International Desjardins; EIB = European Investment Bank; LOLC = Lanka Orix Leasing Company; MSMEs = micro, small, and medium-sized enterprises; NDB = National Development Bank; SMEs = small and medium-sized enterprises; USAID = United States Agency for International Development. a Financed by the Japan Fund for Poverty Reduction ($2.0 million) and by Women Entrepreneurship Financing Grant ($2.1 million) and administered by ADB. b Financed by the Financial Sector Development Partnership Special Fund and administered by ADB. c Including B-loans. d EIB’s loan was €63 million. e Projects that will support trade finance are excluded.

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Sources: ADB, EIB, European Union, High Commission of Canada, IFC, International Fund for Agriculture Development, Japan International Cooperation Agency, USAID, and the World Bank.

B. Institutional Arrangements and Processes for Development Coordination

2. With its expertise, lessons from past engagements, and implementation capacity, as well as complementing the efforts of other development partners, ADB’s engagement is supporting the government’s medium-term strategic objectives, including MSME sector development. An active development coordination forum in which major bilateral and multinational development partners meet quarterly. ADB has held consultations with other development partners, such as the International Finance Corporation, the Japan International Cooperation Agency, and the World Bank, to prevent any overlapping and to share knowledge and resources for the MSME finance sector.

3. ADB has also coordinated with development partners to develop a country system for accounting, auditing, procurement, and safeguards to streamline project administration.

4. ADB will continue to support other key development partners by disseminating the progress of projects in a timely manner and sharing key lessons learned so that the partners can design new projects more effectively. ADB will also coordinate closely with the International Monetary Fund (IMF) to minimize the risks to the government’s debt sustainability.

C. Achievements and Issues

5. ADB has been successfully providing comprehensive support for enhancing MSME access to finance through loan, grant, and technical assistance (TA) projects, some of which are externally funded by other development partners but administered by ADB.1 The lessons from earlier MSME projects, including the lessons of other development partners, have shaped the design of the proposed ADB loan and TA project.

6. Support for the Regional Development Bank. The capacity of the Regional Development Bank (RDB) has been strengthened through its implementation of several projects by multiple development partners. RDB performed successfully in the World Bank’s Small and Medium Enterprise Development Facility by disbursing 99.6% of its allocation of the TA grant to cover 50% of the cost of training staff new skills, including credit appraisal.2 RDB also performed successfully in the credit line from the European Investment Bank. RDB is one of the 10 participating banks in ADB’s Small and Medium-Sized Enterprises Line of Credit Project and has been successfully implementing it.3 Because of its successful implementation, the proposed project will rely largely on RDB’s internal system for project administration.

7. Technical assistance to support women entrepreneurs. The gap analysis under ADB’s ongoing TA for small and medium-sized enterprises cluster development confirmed that most MSMEs have limited capacity to develop bankable projects even in relatively competitive export- oriented clusters. MSMEs do not have sufficient business skills or value chain links for better access to market information or the expertise to effectively communicate their business ideas to

1 Summary of Asian Development Bank’s Support for Small and Medium-Sized Enterprise Finance Sector in Sri Lanka (accessible from the list of linked documents in Appendix 2 of the report and recommendation of the President to the Board of Directors). 2 World Bank. 2010. Small and Medium Enterprise Development Facility. Washington, DC. 3 ADB. 2016. Report and Recommendation of the President to the Board of Directors: Proposed Loan and Administration of Technical Assistance Grant to the Democratic Socialist Republic of Sri Lanka for the Small and Medium-Sized Enterprises Line of Credit Project. Manila.

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banks. Although several development partners have provided business development training directly to MSMEs, there is still a significant need for capacity development, especially for micro and small enterprises in rural areas or those led by women. The proposed TA will address this issue directly.

8. Sovereign guarantee on ADB’s subordinated loan to the Regional Development Bank. The enactment of the Fiscal Management (Responsibility) Act in 2003, revised in 2013, was a step towards making fiscal discipline mandatory by increasing transparency and accountability in Sri Lanka’s government operations. The act includes ceilings on central government debt, the budget deficit, and government guarantees. ADB consulted with the IMF and confirmed that the debt guarantee issued by the central government to a financial enterprise as a borrower, RDB in this case, would count as treasury guarantees for which a new quantitative indicative target is set under IMF’s extended fund facility. The IMF has set a new quantitative indicative target for government guarantees of SLRs718 billion (about $3.9 billion) by the end of 2018.4 The outstanding treasury guarantees were valued at SLRs591 billion (about $3.2 billion) as of the end of 2017. As of 30 June 2018, SLRs670 billion out of the SLRs718 billion target had been committed (used) for treasury guarantees for 2018. This leaves a headroom of SLRs48 billion (about $263 million) for the second half of 2018. The $50 million loan to RDB accounts for about 19% of this headroom.

D. Summary and Recommendations

9. Given ADB’s strong presence and expertise in the MSME finance sector in Sri Lanka, ADB recommends continuing to engage in this sector and proactively introducing innovative approaches, such as tier 2 capital support for RDB under the proposed project.

10. The proposed project has a catalytic effect to mobilize additional financing from development partners. The attached TA will strengthen RDB’s operational capacity, such as in risk management and safeguards. The successful implementation of the TA will provide the groundwork for (i) a possible strategic investment in RDB from private sector investors, including the International Finance Corporation and ADB’s nonsovereign window; and (ii) continued engagement with RDB as a participating financial institution in other development partners’ credit facilities. Also, the white paper evaluating the government’s support for MSMEs will help the government, ADB, and other development partners to understand the key issues.

4 Currency equivalent as of 11 January 2019.