OMie 1 1j-prt N ,y,.II1 CE -...

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FOR OF

Report No. 9724

PROJECT PERFORMANCE AUDIT REPORT

SRI LANKA

FIRST SMALL AND MEDIUM INDUSTRIES PROJECT(CREDIT 942-CE)

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

AND

INDUSTRIAL DEVELOPMENT PROJECT(CREDIT 1401-CE)

JUNE 28, 1991

Operations Evaluation Department

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

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CURRENCY AND EQUIVALENT UNITS(Annual Averages)

Sri Lanka Rupee per US$1.00

1978 = Rs 15.611979 - Rs 15.571980 Rs 16.531981 = Rs 19.251982 = Rs 20.811983 Rs 23.531984 Rs 25.441985 = Rs 27.161986 = Rs 28.021987 = Rs 29.441988 Rs 31.811989 = Rs 36.041990 Rs 40.00

FISCAL YEARS

Government of Sri Lanka = January 1 to December 31Commercial Banks = January 1 to December 31NDB January 1 to December 31DFCC = April 1 to March 31

FOR OFFICIAL USE ONLYTHE WORLD BANK

Washngwn, D.C. 2043U.S.A.

Office of Director-GeeralOperations Evaluation

June 28, 1991

MEMORANDUM TO THE EXECUTIVE DIRECTORS AND THE PRESIDENT

SUBJECT: Project Performance Audit Report on Sri LankaFirst Small and Medium Industries Project (Credit 942-CE)Second Small and Medium Industries Project (Credit 1182-CE)Industrial Development Project (Credit 1401-CE)

Attached, for information, is a copy of a report entitled *ProjectPerformance Audit Report on Sri Lanka - First Small and Medium Industries Project(Credit 942-CE), Second Small and Medium Industries Project (Credit 1182-CE), andIndustrial Development Project (Credit 1401-CE)* prepared by the OperationsEvaluation Department.

Attachment

This docum has a restricted distribution and may be used by recipients only in the performance of their official duties. Itscontent mal . A otiherwise be disclosed without Word Bank authoritation.

FOR OFFICIAL USE ONLY

ABBREVIATIONS

BOC - Bank of CeylonBTT - Business Turnover TaxCBOC - Commercial Bank of CeylonCBSL - Central Bank of Sri LankaCDIC - Capital Development and Investment CompanyCOPE - Parliamentary Commission on Public EnterprisesDFC - Development Finance CompanyDFCC - Development Finance Corporation of CeylonEDB - Export Development BoardEPR - Effective Protection RatesFCBU - Foreign Currency Banking UnitsFIAC - Foreign Investment Advisory CommitteeFMO - Nederlanske Financierings Maatschappij voor

Ontvikkelingslanden NVFRR - Financial Rate of ReturnFTZ - Free Trade ZoneGCEC - Greater Colombo Economic CommissionGDP - Gross Domestic ProductGOCUs - Government Owned Business UndertakingsGOSL - Government of Sri LankaHNB - Halton National BankICICI - Industrial Credit and Investment Corporation of IndiaIDA - International Development AgencyIDB - Industrial Development BoardIDP - Industrial Development ProjectIFC - International Finance CorporationIMF - International Monetary FundLIAC - Local Investment Advisory CommitteeLOLC - Lanka Orient Leasing CompanyMISA - Ministry of Industries and Scientific AffairsMLCF - Medium Long Term Credit FundMOFP - Ministry of Finance and PlanningNCB - National Commercial BankNDB - National Development Bank of Sri LankaNSB - National Savings BankPCI - Participating Credit InstitutionPCR - Project Completion ReportPEC - Public Enterprise CellPED - Public Enterprise DivisionPFP - Policy Framework PaperPME - Public Manufacturing EnterprisesPPAR - Project Performance Audit ReportRRDB - Regional Rural Development BanksSEP - Study of Effective ProtectionSMI - Small and Medium Industries

UNDP - United Nations Development ProgrammeWBG - World Bank Group

Th*-de **fr it - ar tri-t i '-trihutt n -pd r vt -s d hV r-ir'hnt nqv in th -rfnrf r-A

PROJECT PERPORMANCE AUDIT REPORT

SRI LANA


SECOND SMALL AND MEDIUM INDUSTRIES PRO:ECT(CREDIT 1182-CE)

AND


TABLE OF CONTENTS

Page No.

Preface . . . . . . . . . . . . . . . . . . . . . . . . . . . .iData Sheets . . . . . . . . . . . . . . . . . . . . . . . . . .iiiEvaluation Summary . . . . . . . . . . . . . . ....... ix


I. Introduction . . . . . . . . . . . . . . . . . . . . . . 1II. Overview of Economic Policy Reforms (1978-1989) . . . . . 2

III. The Manufacturing Sector . . . . . . . . . . . . . . . . 5A. Structure and Performance . . . . . . . . . . . . . 5B. Small and Medium-Scale Industry (SIMI) . . . . . . . 7C. The Industrial Finance System . . . . . . . . . . . 7D. Credit Allocation and Interest Rates . . . . . . . 9

Selective Credit . . . . . . . . . . . . 10Interest Rate Policies . . . . . . . . . . . . 10

E. Capital Market . . . . . . . . . . . . . . . 11IV. Evaluation of SMI I (Cr. 942-CE) and SiMI II (Cr. 1182-CE) 11

A. Project Objectives and Scope . . . . . . . . . 11SMI I . . . . . . . . . . . . . . . . . . . . . 12SHI II . . . . . . . . . . . . . . . . . . . 12SHI III . . .. o . . . . . . . . . . . . . . 13Subproject Conditions . . . . . ... . . . . . 13

B. Implementation Results . . . . . . . . . . . . . . 14C. The Role of NDB and PCIs . . . . . . . . . . . . . 16

NDB . . . . * . . . . . . . . . . . . . . . . . 16PCIs . . . . . . . . . . . . . . . . . . .. . . 17

D. Technical Assistance (TA) for SMI . . . . . . . . . 19E. Sustainability . . . . . . . . . . . ... . . .. 21

Project Benefits . . . . . . . . . . . . . . 21Sustainability of Institutions . . . . . . . . . 21

TABLE OF CONTENTS (Cont*d)

PROJECT PERFORMANCE AUDIT REPORT (Cont'd) Page No.

F. Conclusions . . . . . . . . . . . . . . . . . . . . 22G. Lessons Learned ........ . . . . . . . . . 23

Use of Commercial Bank as Financial Intermediaries 23Role of the Apex Institution . . . . . . . . . . 23On-lending Terms . . . . . . . . . . . . . . . . 24Technical Assistance . . . . . . . . . . 24

V. Evaluation of IDP I . . . . . . . . . . . . . . . . . . . 25A. Objectives and Design . . . . . . . . . . . . . . . 25B. Implementation Experience . . . . . . . . . . . . . 26

Credit Component . . . . . . . . . . . . . . . . 26C. Performance of Financial Intermediaries . . . . . . 27

Development Finance Corporation of Ceylon (DFCC) 27Ownership . . . . . . . . . . . . . . . . . . . . 27Institutional Aspects . . . . . . . . . . . . . . 27Operational Performance . . . . . . . . . . . . . 28Financial Performance . . . . . . . . . . . . . . 28Portfolio Management . . . . . . . . . . . . . . 29Resource Mobilization . . . . . . . . . . . . . . 30Strategic Planning, Institution Building andIDA's Role . . . . . . . . . . . . . . . . . . . 30

D. National Development Bank of Sri Lanka (NDB) . . . . 32Operational Performance . . . . . . . . . . . . . 34Financial Performance . . ........ . . . 34Institutional Development and IDA's Role . . . . . 35

VI. Evaluation of Industrial Policy Reforms . . . . . . . . . 37A. Public Enterprise (PE) Reforms . . . . . . . . . . 37

Implementation . . . .. . .. . . . . . . . . . 38B. Reform of Import Protection . . . . . . . . . . . . 43C. Export Incentives . . . . . . . . . . . . . . . . . 45D. Conclusions and Lessons Learned . . . . . . . . . . 45

IDA's Role . . . . . . . . . . . . . . . . . . . 47

APPENDICES

I. Impact Assessment of Technical Assistance Under SMI I and II 48II. Comments Received from National Development Bank . . . . . 55

ANNEXES

1. Interest Rates of Major and Savings Institutions, 1970-89 582. Financial Indicators for SMI-I and SMI-II . . . . . . . . . 593. DFCC Financial Indicators . . . . . . . . . . . . . . . . . 684. NDB Financial Indicators ......... . . . . . . 80

TABLE OF CONTENTS (Cont'd)

Page No.

PROJECT COMPLETION REPORT (Credit 1401-CE)

Part It Project Review from IDA's Perspective . . . . . . . . . 891.0 Project Identity . . . . . . . . . . . . . . . . . 892.0 Background and Sectoral Content . . . . . . . . . . 893.0 Project Objectives and Description . . . . . . . . 904.0 Project Design and Organization . . . . . . . . . . 915.0 Project Implementation . . . . . . . . . . . . . . 926.0 Majot Project Results . . . . . . . . . . ..... 957.0 Project Sustainability . . . . . . . . . . . . . . 968.0 IDA's Performance . . . . . . . . . . . . . . . . . 979.0 Borrower's Performance . . . . . . . . . . . . . . 97

10.0 Project Relationship . . . . . . . . . . . . . . . 9811.0 Consulting Services . . . . . . . . . . . . . . . . 9812.0 Project Documentation and Data . . . . . . . . . . 9813.0 Conclusions and Lessons Learned . . . . . . . . . . 98

PART III: STATISTICAL INFORMATION . . . . . . . . . . . . . . . 101

Table 1 Related Bank Loans . . . . . . . . . . . . . . . . 102Table 2 Project Timetable . . . . . . . . . . . . . . . . . 103Table 3 Loan/Credit Disbursements . . . . . . . . . . . . . 104Table 4 Indicators of Project Implementation and Results . . 105Table 5 Status of Covenants . . . . . . . . . . . . . . . . 106Table 6 Use of Bank Resources . . . . . . . . . . . . . . . 111Table 7 Arrears of Subprojects - DFCC . . . . . . . . . . . 112Table 8 Arrears of Subprojects - NDB . . . . . . . . . . . 114Table 9 Cash Collection Performance - NDP . . . . . . . . . 16Table 10 Cash Collection Performance - DFCC . . . . . . .. 117Table 11 Balance Sheet FY1983-1989, NDB . . . . . . . . . 118Table 12 Balance Sheet FY1983-1989, DFCC . . . . . . . . . . 119Table 13 Income Statements FY1984-1988, NDB . . .. . . . . 120Table 14 Income Statements FY1983-1989, DFCC . . . . . . . . 121

PROJECT PERORMANCE AUDIT REPORT

SRI LANKA

FIRST SMALL AND MEDIU 7NDUSTRIES PROJECT(CREDIT 942-CE)

SECOND SMALL AND MEDIUM INDUSAIRS PROJECT(CREDIT 1182-CS)

AND


PREFACE

This Project Performance Audit Report (PPAR) reviews the First and

Second Small and Medium Industry (SMI) Projects and the First IndustrialDevelopment Project (IDP-1). The first SMI credit was approved in June 1979,became effective on October 1979 and was closed on December 31, 1985. An

undisbursed amount of $0.9 million was canceled. The second SMI credit was

approved in September 1981, became effective on May 1982 and was closed in

1989. IDP-I was approved in July 1983 became effective on January 1985 and

was closed on September 1989, fully disbursed.

The PPAR, prepared by the Operations Evaluation Department (OED), is

based on the PCR of the SMI-I credity prepared by the IDF Division, South

Asia Project and the PCR of IDP-I (attached) prepared by the Industry and

Energ, Division, CDI, Asia Region, the staff appraisal reports, President

reports, summaries of the Executive Director's Meetings at which all three

credits were considered, project files and discussions with Bank staff. An

OED mission visited Sri Lanka in November 1990 to review IDA assistance.

The PCR for SMII and IDP-I, prepared by the Bank are satisfactory

accounts of the utilization of the credit proceeds. The PPAR focusses on the

institution building achievements as well ae on the industrial and trade

policy reforms introduced under the three projects.

The draft PPAR was cent to the Borrower for comments. The comments

received from National Development Bank are reproduced as Appendix II to the

PPAR.

& PCR: Sri Lanka First Small and Medium Industries Project (SMI), Report

No. 6795, May 22, 1987. The PCR for the second SMI project (Credit 1182-

CE) is under preparation. However, considerable data for this project is

already available and hence this project has been included in the

evaluation.


SRI LANKA


BASIC DATA SHEET(US$ mill. .-n)

LOAN POSITIONAs of 03/31/91

Original Disbursed Cancelled Repaid Outstanding

Loan 0942-CE 16.00 15.08 0.92 0.30 14.78

CUMULATIVE ESTIMATED AND ACTUAL DISBURSEMENTS

FY79 FY80 FY81 FY82 FY83 FY84 FY85

Appraisal Estimate (US$ '000) 180 4.3 10.3 15.1 16.0 16.0 16.0Actual (US$ '000) 5.8 2.7 8.5 11.1 12.2 13.1 14.7Actual as Z of Appraisal .03 .63 .83 .73 .76 .82 .92

Date of Final Disbursement: February 4, 1986

PROJECT DATES

Original Actual

Preparation n.a. 06/00/78Negotiation n.a. 05/23/77Board Approval n.a. 06/26/79Credit Agreement n.a. 07/24/79Effectiveness n.a. 10/23/79Closing Date 06/30/84 06/30/85

STAFF INPUTS(st.aff weeke)

FY78 rY79 FY80 FY81 FY82 FY88 FY84 FY85 FY88 FY87 TOTAL

Preappreisal 7.5 4.6 - - - - - - - - 12.1Appraisal - - - - - - - * - - -Negotiation - - - - - - - - - - *Supervision - - 20.8 12.5 6.6 8.9 6.0 8.0 4.0 5.2 65.5Other - 8.8 - 8.8

Total 7.5 8.4 20.8 12.6 6.6 8.9 5.6 8.0 4.0 6.2 81.4

- iv -

MISSION DATA

Month/ No. of No. of StaffYear Weeks Persons weeks Date of Report

Preparation 05/78 3 2 6 06/00/78Preparation 12/78 4 7 28 02/06/'9

Appraisal 03/79 3 6 18 06/08/79Supervision I 06/79 2 1 2 08/08/79Supervision II 08/79 2 2 4 09/26/79Supervision III 11/79 1 1 1 02/19/80

Supervision IV 04/80 1 1 1 04/28/80Supervision V a/ 02/81 4 3 12 03/26/81Supervision VI a/ 11/81 3 4 12 01/14/82Supervision VII a/ 04/82 3 2 6 04/17/82

Supervision VIII a/ 08/82 1 1 1 08/07/82Supervisici IX a/ 11/82 1 1 1 11/13/82Supervision X a/ 03/83 2 1 2 04/19/83Supervision XI a/ 10/83 2 1 2 19/28/83Supervision XII a/ 05/84 1 2 2 03/14/84Supervision XIII a/ 07/84 2 3 6 09/10/84Supervision XIV a/ 05/85 2 2 4 06/14/85Supervision XV 11/85 2 1 2 12/26/85

A Joint supervision SMI I (Cr. 942-CE) and SMI II (Cr. 1182-CE).

OTHER PROJECT DATA

Borrower : The Democratic Socialist Republic of Sri LankaExecuting Agency: National Development Bank (NDB), Development

Finance Corporation of Ceylon (DFCC) and othercommercial banks

FOLLOW-ON PROJECT:

Project: Second Small and Hedi%n IndustriesAmount: US$30.0 millionLoan No: 1182-CE

Board Date: October 13, 1981


SRI LANKA

SECOND SMALL AND MEDIUM INDUSTRIES PROJE!TtCREDIT 1182-CE)

BASIC DATA SHEET(US$ million)

LOAN POSITION

As of 03/31/91Original Disbursed Cancelled Repaid Outstanding

Loan 1182-CE 30.00 32.31 0.21 0.00 35.84


FY82 FY83 FY84 FY85 FY86 FY87 FY88

Appraisal Estimate (US$ Million) 1.9 8.7 18.7 27.7 30.0 - -

Actual (US$ Million) .1 .6 1.7 6.11 14.1 27.5 29.79

Actual as X of Appraisal .5 2.0 5.8 20.4 48.2 91.9 99.3

Date of Final Disbursement: April 14, 1988

PROJECT DATES

Ori%inal Actual

AppraisalBoard Approval 10/13/81

Loan Agreement 02/05/82

Effectiveness 05/05/82Closing Date 12/31/87

STAFF INPUTS(st0f week)

FY80 FY81 FY82 FY88 FY84 FY85 FY88 FY8? FY88 FY91 TOTAL

Preappralsel - 28.2 8.2 . . - - - - * 29.4

Appraisal - 26.8 .4 - . - - - - - 28.7Negotiation - - 2.7 - - - - - - - 2.7Supervision - - 17.5 8.2 17.1 18.7 12.8 16.2 1.6 .1 88.8other .1 2.5 6 .1 -, - . *, .Z 8.7

Total .1 55.0 80.0 6.2 17.1 18.7 12.8 16.2 1.6 .1 158.1

- vi -

MISSION DATA

Month/ No. of No. ofYear Weeks Persons Manweeks Date of ReRort

Preparation 12/80 2 2 4 01/21/81Appraisal 01/81 3 3 9 02/25/81Supervision I /a 02/81 4 3 12 03/26/81Supervision II /a 11/81 3 4 12 01/14/82Supervision III /a 04/82 3 2 6 04/17/82Supervision IV /a 08/82 1 1 1 08/07/82Supervision V Ia 11/82 1 1 1 11/13/82Supervision VI /a 03/83 2 1 2 04/19/83Supervision VII a 10/83 2 1 2 09/28/83Supervisio: VIII ]a 05/84 1 2 2 05/14/84Supervision IX a 07/84 2 3 6 09/10/84Supervision X /a 05/85 2 2 4 06/14/85Supervision XI 12185 2 1 2 12/26/85Supervision XII 08/86 2 2 4 08/29/86Supervision XIII 11/87 4 3 12 11/09/87

/a Joint supervision SMI I (Cr. 942-CE) and SMi II (Cr. 1182-CE).

OTHER PROJECT DATA

Borrower a The Democratic Socialist Republic of Sri LankaExecuting Agency: National Development Bank (Ntob), Development

Finance Corporation of Ceylon (DFCC) and othercomercial banks

FOLLOW-ON PROJECTt

Project: Third Small and Medium IndustriesAmounts US$20.0 million

Loan No.: 1860-CEBoard Date: December 15, 1987

- vii -


SRI LANKA

INDUSTRIAL DEVELOPMEMT PROJECT(CREDIT 1401-CE)

BASIC DATA SHEET(US$ million)

LOAN POSITION

As of 03131191Original Disbursed Cancelled Repaid Outstanding

Loan 1401-CE 25.00 25.95 0.00 0.00 31.23


FY84 FY85 FY86 FY87 FY88 FY89

Appraisal Estimate (US$ Million) 1.1 5.39 13.0 22.2 25.0 25.0Actual (US$ Million) 1.6 6.26 18.0 22.2 23.5 26.1Actual as X of Appraisal 1.45 1.17 1.38 100 .94 100

Date of Final D'sbursement: April 11, 1989

PROJECT DATES

Original Actual

Preparation 04/81 4/30/81Preappraisal 08181 9/08/81Appraisal 11/81 11/24/81Credit Negotiations 05/83 5/24/83Board Approval 07/83 7/12/83Credit Signing 10/83 10/12/83Effectiveness 01/84 1/05/84

Completion 03/88 3/31/88Closing Date 09/88 9/30/88

STAFF INPUTS(UTf I weeke)

FY79 FY81 FY82 FY88 FY84 FY86 FY8 FY87 FY88 FY89 FY90 FY91 TOTAL

Preappraisal .1 2.6 19.8 - - - - * - - 22.0Appraisal - - 42.9 11.5 - - - - * - - 54.4Negotiatlon - - - 4.2 1.4 - - - - - - 5.6Supervision - - 5.3 8.9 28.9 28.6 4.9 7.5 8.4 8.5 6.0 .8 84.8Other .2 .5 - 8.4

Total .1 2.8 72.7 22.8 25.8 28.6 5.4 7.6 8.4 0.6 6.0 .8 174.7

- Viii -

MISSION DATA

Month/ No. of No. ofYear Weeks Persons Hanweeks Date of Report

Preappraisal 09/81 3 4Appraisal 11/81 3 4Post-appraisal 03/83 3 2Supervision I 10/83 1 1Supervision II 04/84 3 2Supervision III 07/84 3 3Supervision IV 09/84 1 1Supervision V 10/84 2 1Supervision VI 01/85 1 1Supervision VII 02/85 1 2Supervision VIII 11/85 2 1Supervision IX 03/86 1 1Supervision X 07/86 3 2Supervision XI 11/86 3 4Supervision XII 05/87 3 7Supervision XIII 08/87 3 5Supervision XIV 10/88 2 1

OTHER PROJECT DATA

Borrower : The Democratic Socialist Republic of Sri LankaExecuting Agency: National Development Bank (NDB), Development

Finance Corporation of Ceylon (DFCC) and othercommercial banks

FOLLOW-ON PROJECT:

Projects Third Industrial DevelopmentAmount: US$43.80 million

Loan No.: 1948-CEBoard Dates July 26, 1988

- ix -


SRI LANKA


SECOND SHALL AND HEDIUI INDUSTRIES PROJECT(CREDIT 1182-CE)

AND


EVALUATION SUMMARY

Introduction more successful than the SMI proj-ects wit. regard to the credit

1. Following the reversal of Sri component, but the TA componentLanka's inward-oriented anti-private aimed at public enterprise reformsector policies in 1977, the Bank did not achieve intended objectives.Group (IDA) initiated a series ofcredits aimed at assisting the new I. SMI I & SMI IIGovernment to liberalize economicpolicies further, particularly in Objectives and Settingthe areas of industrial and tradepolicies and the role of the public 2. The overall objectives ofsector and to provide investment SMI I and SMI II were to strengthenresources to the private sector. the private sector by assistingThis PPAR evaluates the first and viable existing small and mediumsecond Small and Medium Industry scale industrial and service firms(SKI) Projects and the first and new entrepreneurs to expandIndustrial Development Project output, employment and exports,(IDP I). These credits were through access to institutionalfollowed by a seLond IDP approved in sources of financial and technical1986, a third SMI credit approved in assistance as well as assist GOSL in1987, and a third IDP approved in undertaking trade policy reforms1988. Although the projects under (paras. 4.01-4.05). Both projectsreview are traditional lines of had two components:credit through financial intermedi-aries, all three included broader 3. Credit Component (Improvingpolicy reform components in line Access to Credit;. IDA channelledwith IDA and GOSL objectives. The credit through the National Develop-SKI projects were implemented with ment Bank (NDB), to four commercialmixed results, particularly because banks and the Development Financeof deficiencies in the implementa- Corporation of Ceylon (DFCC). Thetion of technical assistance (TA) aim was to develop the capabilitiescomponents. IDP I was relatively of the commercial banks to grant

- X -

term loans based on project apprais- and extension programs by providingal than on reliance on collateral, advisors to coach regional extensionand to induce them to finance SKI. officers, establish a SMI consul-NDB created a special SKI department tancy fund to tap local private ex-- the SKI Fund - to undertake on- pertise, and expand its engineeringlending to the intermediaries, service facilities. In line withprovide technical assistance, and SKI II's objective of promotingmaintain accounts. The credit com- export-oriented SKI, the projectponent included provision of attrac- supported a new agency, the Exporttive spreads to the participating Development Board (EDB), in its pro-

credit institutions (PCIs), a credit gram of export promotion and supplyguarantee from the Central Bank of development in key light industrialSri Lanka (CBSL), and a special product lines.capital facility for new entrepre-neurs unable to raise adequate equi- Implementation Experience

ty. Both credits assisted in theinstitution building of NDB, and, in 6. SKI I was rapidly committedparticular, the formulation of sys- due to strong loan demand althoughtems and procedures of the SKI Fund. disbursements were delayed by can-

cellations and the ethnic conflict4. Technical Assistance. Under in 1982-83. SKI II was committedthe TA component of SMI I, $4 much more slowly due to possiblemillion was provided to employ overestimation of demand by IDA, the

local/expatriate advisors to: (a) PCI's growing awareness of the poor

reinforce the main Government agency repayment performance of sub-loans(IDB) responsible for promotion and made under SMI I, and a large

provision of technical services for increase in the final on-lendingSMIs by improving its regional rate from 14Z to 22%-24%. The PCI's

extension network, starting a subloan approval procedures under SKI I

contracting exchange, and establish- were lax and funds may have beening training and technical service diverted to other uses because of

facilities for rubber products, poor PCI supervision (PCR,

building materials, foundries and para. 5.06). Subproject cost

light engineering subsectors; (b) overruns were quite significant for

improve the focus and effectiveness both credits attesting again to the

of other SKI technical service agen- PCI's weakness in project appraisal.

cies by providing finance for estab-lishing: (i) training programs in Results

garment manufacturing; (ii) exten-sion programs in white coir extrac- 7. The two SKI credits financed

tion and processing; and (iii) an subprojects mainly in traditional

export organization for handloom products/industries -- food process-

products; and (c) assist GOSL to ing (27%), construction materials

carry out geaeral policy studies on (102), metal, products (82), paper

aspects of export incentives and the products (62), etc., with limited

tariff system. The impact of these market growth potential. Under

policy studies is discussed under SKI I, a large percentage were new

IDP I (PPAR, Section 6). borrowers (48%); but mostly expan-sion projects were financed under

5. Under SKI II, the TA program SKI II. Export potential of sub-

sought to strengthen IDB's promotion projects financed under both credits

-xi -

appears rather limited although assisting management in strategicSMI II emphasized the development of planning (paras. 5.26-5.27). Tech-export-oriented investments. nical assistance to the SMI Fund

(responsible for administering the8. The two projects assisted SMI lines of credit) was effective3,679 subprojects which are in building up staff capability,estimated to have created 36,306 particularly for reviewing subproj-jobs at an estimated investment cost ects above a "free limit" and over-per job of between $1,000-$1,500. all monitoring of credit utiliza-Data on ex-post economic and tion. However, its impact onfinancial performance of subprojects improving the efficiency of SMIare fragmentary and NDB's estimates lending operations of PCIs has beenof IFRR for subprojects financed limited by its own staffing con-under SMI I of 30Z could not be straints. Its involvement inconfirmed (PCR, para. 5.08). For sectoral studies on SMI developmentSMI II a limited survey of 66 has been minimal for the samesubprojects undertaken in 1989 reason. The TA fund being managedindicated that about one-third were by the SMI Fund under SMI III hasfinancially shaky because of cost yet to make a noticeable contribu-overruns or poor sales (para. 4.14). tion to generating new types of

investment. The effectiveness of9. Subloan repayment performance this fund would be considerablyis generally a good indication of enhanced if local consultants couldactual performance. For SMI I, the assist potential SMI to preparerepayment performance has been poor, project proposals for financing byas of December 31, 1985, some 372 of the fund (para. 4.39). This policysubloans (by number) were in arrears is now being implemented.over 3 months and the correspondingprincipal infection ratio was 76Z. Technical Assistance to IDB and EDBFor SMI II, it has been only slight-ly better; as of December 31, 1989, 11. The TA programs directed atabout 36Z of loans (by number) were building up IDB's extensionin arrears over 3 months and the centers/activities were not particu-correspondLng principal infection larly effective (para. 4.23). Theratio was 40.9%. The average col- impact of the Rubber Product Devel-lection ratio of the PCIs as of this opment Center which was the mostdate was only 62.5Z. A part of the active was modest. The subcontract-poor recovery performance stems from ing exchange acted as "a broker con-the ineffectiveness of the debt veying marketing information to po-recovery procedures which were in tential suppliers, rather than play-place during this period. The Gov- ing a catalytic role in assistingernment has recently introduced new SMI to become effective ancillarydebt recovery laws to correct this suppliers to large firms. The con-lacuna. sultancy services from IDB also

failed to have much impact except in

Technical Assistance to NDB and PCIs some cases (e.g., mushroom farming).The only center which has been suc-

10. The technical assistance pro- cessful is the Clothing Industryvided to NDB for institution build- Training Institute (CITI) which ising was effective in terms of build- involved in the training of garmenting up systems and procedures and workers.

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12. Technical assistance to the performing loans in their portfo-EDB was generally more effective. lios. IDA has proposed the estab-Advisory assistance to EDB for lishment of a debt restructuringimproving export policies and agency to deal with the issue andprocedures resulted in considerable appropriate recapitalization. 1 A keyimprovements in both export issue, however, is whether the PCIsadministration and incentives (para. would continue to provide term loans6.27). to SMI without refinancing by the

Government/IDA. If refinancing is13. Three factors explain the not available, the extent to whichmixed performance of the TA program. institutional funds will flow inFirstly, it was overly ambitious, future to this group is uncertaingoing beyond the management capabil- and is likely to be small; it willity of IDB. IDA's own limitations depend on reforms to interest rateon supervision prevented it from policies and the pace of institu-close monitoring of implementation. tional strengthening of the PCIs.Secondly, some of the TA activities Both are being addressed by IDAwere supply driven rather than based under SMI IV and the proposed FY93on a careful analysis of market Banking Sector Reform Project.demand (paras. 4.23-4.25). Thirdly,government agencies proved unable to Lessons Learned and Recommendationsretain qualified and trained person-nel as experts because of poor com- Use of Commercial Bank as Financialpensation policies. IDA recognized Intermediariesthis issue during the appraisal ofSMI II but was unable to address it 17. The implementation experiencewith persistence. in Sri Lanka and elsewhere clearly

indicates that unless commercialSustainability banks are prepared to make a sub-

stantial effort towards building up14. Based on the limited informa- specialized organization structurestion available on actual subproject for lending and servicing SMI loans,performance and repayment records, a the results are unlikely to be sat-fairly large number of SMI subproj- isfactory. This organization struc-ects have doubtful financial viabil- ture has to be decentralized down-ity. wards, at least to the level of

major branches and staffed with ade-15. Sustainability of the TA quately trained individuals. Suchinstitutions also presents a mixed an investment in organization build-picture. Since IDB is a govern- ing would imply that the PCI adoptsmental agency, it is not subject to lending to SMI as part of its long-market tests. Nevertheless, a re- term corporate strategy and not as a

organization and change in policies transient involvement due to thewould be beneficial. EDB is being availability of IDA/World Bankreorganized and refocussed to credit lines. Allowing all commer-enhance its effectiveness. cial banks to participate on the

basis that greater competition would16. The PCIs are generally finan- improve the project impact does not

cially viable institutions although seem to be born out by resultsboth BOC and PB, the two government (para. 4.21).banks have high levels of non-

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18. In SMI lending operations debt service coverage and debt-

involving use of multiple commercial equity ratios as otherwise firstbanks, the World Bank should allow time SMI sub-borrowers may notparticipation of only those commer- observe the financial discipline

cial banks which are prepared to set required. Excessive gearing, as is

up appropriate organizational struc- observed in many SMI subprojects,tures and make a long-term commit- increases the vulnerability ofment to SMI lending. subprojects to temporary setbacks

which may account for the high levelRole of Apex Institutions in SMI of non-performing loans.

Lending21. The SMI Fund should prepare

19. An apex institution has an improved guidelines for PCIs

important role in monitoring and detailing appraisal norms possibly

promoting SMI lending, particularly by subsectors; further improvements

in the early stages. However, the are needed in both appraisal and

establishment of such institutions supervision.also entails considerable institu-tion building effort which should be Technical Assistancerecognized and provided for infuture projects. Additional func- 22. In designing TA programs fortions that can be performed by the implementation by Government agen-

apex body include management of a cies, issues of basic managementcredit guarantee fund which would capabilities of the agencies and

benefit from the deeper insight that incentive policies needs to fully

the apex institution would have of addressed and resolved before

SMI lending and the PCIs capabili- finalizing the program. Also, aties. The SMI Fund should undertake comprehensive demand analysis should

periodically systematic sample be carried out before introducingsurveys of SMI borrowers to assess new TA initiatives (para. 4.39).

the actual economic impact of thesub-loas. Finally, a SMI fund of 23. The high incidence of projectthe type established under these failures in the case of new entre-projects can generate significant preneurs as well as the paucity ofresources from the "float" arising projects in new technology/new prod-from the differences in the maturity uct areas suggests an acute need forstructure of its assets and liabili- technical support for this class ofties. Given the extreme shortage of entrepreneurs including training inequity capital faced by SMI entre- business management. The financialpreneurs, particularly new entrepre- institutions may wish to establishneurs, the potential use of some of an entrepreneurial development cen-these resources in equity support ter. run on private lines to deal

should be explored. with these needs.2The TA fund in NDBcould also provide assistance for

On-lending Terms this activity.

20. On-lending terms for SMI sub- 24. There is also a scarcity of

borrowers should follow norms for qualified consultants to assist SKI.commercial loans. It is also This deficiency could be met throughimportant that prudent financial training programs for appropriately

ratios are observed, particularly qualified individuals who would e

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induced to set up private consulting for management and encouraging waysbusinesses. The financial interme- to increase private sector partici-diaries could also establish in- pation in ownership and managementhouse technical assistance groups. of PMEs (SAR, para. 3.07).IDA could assist NDB and otherfinancial institutions, to organize Implementation Experience andsuch training programs by bringing Resultsin foreign experts to develop andimplement such courses. Credit Component

II. INDUSTRIAL DEVELOPMENT 26. The credit component of SDRPROJECT (IDP I) 21.5 million was fully committed

within the three years envisaged inObjectives and Design the SAR. The TA allocation was also

fully committed by the closing date25. IDP I, the third in the series of September 30, 1988. Disburse-of credits to the GOSL for indus- ments were completed by March 1989,trial development after 1977, was nine months behind schedule. Adesigned to increase output, employ- total of 127 subprojects werement and efficiency of both private financed, of which 120 were belowand public enterprises through both SDR 0.5 million (PCR, para. 5.4).investment finance and support for Only 13 subprojects were aLove thepolicy reform (SAR, para. 3.01). It free limit. DFCC on-lent 602 of thecomprised a credit component of credit by amount and accounted forSDR 21.5 million (US$23 million) for 642 of the total number of sub-on-lending by the two development projects.finance institutions (DFIs) -- NDBand DFCC -- and a technical assis- 27. Ex-ante ERRs for DFCC's sub-tance component of SDR 1.85 million projects varied between 15? (automo-(US$2 million) aimed at: (a) bile battery) and 50% (textiles).strengthening the system of indus- Ex-post ERRs have not been calcu-trial finance by improving project lated except for only two subproj-promotion, appraisal and supervision ects which ranged from 7? to 8?. Inprocedures of the two DFIs, ration- terms of financial performance, 68alizing the interest rate regime for out of 90 DFCC subloans and 32 outindustrial lending, and assisting in of 47 NDB subloans were operatingestablishing an equity fund under satisfactorily and meeting repaymentNDB to provide scarce equity obligations on time. 81etals, chemi-resources to new private projects; cals, and engineering subprojects(b) assisting in improving trade and accounted for half of the totalindustrial policies, particularly credit. The project created 3128with regard to tariff reform and jobs compared to 2,500 estimated inindustrial incentives, building on the SAR; the average cost per jobthe study of effective protection created was Rs. 385,903 (US$12,833)undertaken earlier under the SMI I compared to US$15,000 estimated.Credit (SAR, para. 3.08); and (c) Performance failures have been dueassisting in improving the perfor- to weak management and financialmance of public manufacturing enter- problems of borrowing firms as wellprises (PMEs) by introducing corpo- as due to the severe civil unrestrate planning, performance incen- prevailing in Sri Lanka for much oftives coupled with greater autonomy this period. Against this back-

-xv-

ground, subproject performance loans affected by arrears over threecannot be faulted too strongly. months comprise 12.5% of total port-

folio as of September 30, 1990.Performance of Financial Given the serious ethnic problems inIntermediaries and the Bank's 1988, this is not unexpected. DFCCContribution to Institution Building has been transferring 40% of its

profit which is tax exempt to aDevelopment Finance general loan reserve which totalledCorporation of Ceylon (DFCC) Rs. 153 million in FY90. The adeq-

uacy of this policy should be re-28. DFCC, established in 1955, is viewed periodically by IDA (para.a private sector institution (but 5.09).subject to considerable Governmentinfluence) because of its 39? owner- 31. DFCC, like NDB, is totallyship by BOC And PB, the two large dependent on the Government for bothGovernment banks as well as the foreign and local resources. It hasappointment of two other government been unable to raise resourcesdirectors on its Board. The pres- locally because of the interest rateence of two competing banks on the structure. A market for MLT bondsBoard has led to some conflicts. does not exist and the long-termDFCC's overall performance in util- loan rates are at present based onizing Bank credits has been satis- short-term rates (average weightedfactory. Its procedures are sound deposit rates), resulting in a flatalthough economic analysis could be yield curve. DFCC's future growthfurther strengthened, particularly and role in the financial sectormarket and price trends, in light of will depend on how successfully thisthe opening up of the economy. resource mobilization issue is ad-

dressed (para. 5.10). Floating rate29. DFCC's investment portfolio loan pricing for working capitalcomprised 739 projects totalling loans, leases and even investmentRs. 2,409 million as of March 31, projects may allow DFCC to use1990. Approvals during FY86-FY90 short-term market instruments. DFCChave grown at 27? p.a., higher than needs to adopt more flexible loanthat of NDB. Foreign currency based pricing to increase rates commensu-approvals accounted for 55? of total rate with the riskiness of projectsapprovals in FY90. Loans comprise and entrepreneurs. Other possibili-the bulk of its operations; leasing ties are to link up with commercialand equity investments, currently banks or insurance companies insmall, are expected to increase to syndicated financing and deposit14? of gross approvals by FY95. mobilization. Nevertheless, finan-

cial sector liberalization will30. DFCC is profitable and its increase pressure on the DFIs.financial performance has improved Priority should be given to interestsince 1986 due to rapid portfolio rate reform by IDA (para. 3.16).growth, better use of leverage,lower operating expenses and higher 32. IDA has made significant con-earning spread (para. 5.08). Port- tribution to DFCC's institutionfolio quality has been improving building. DFCC's new strategysince the 1985 collapse of the hotel formulated with T.A. from IDA (para.sector where DFCC had high exposure 5.16) calls for diversification of(33?). Excluding hotel loans, total activities into capital market oper-

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ations, merchant banking, consultan- on equity which averaged 142 betweency, venture capital management, etc. 1980-82 declined to 8.02 in 1990.Diversification is important to due to declining interest spreads.reducing risk and maintaining and NDB's portfolio deteriorated sharplyimproving profitability and competi- in 1988-89 (infection level of 43Ztiveness. The biggest constraint to in December 31, 1989) but hasdiversification has been shortage of improved to 162 as of September 30,skilled staff because of uncompeti- 1990, due to vigorous restructuringtive salary scales. This issue is which was facilitated by theof vital importance to DFCC's future improved debt-recovery climate.competitiveness and needs to be However, NDB has benefitted from aaddressed by IDA. ten-year tax holiday (expired in

1990) and consequently has notNational Development Bank expensed provisions for bad debt but(NDB) treated these as appropriations.

This overstates its true profits.33. NDB, established by theGovernment in 1979, is a competitor 36. NDB faces similar problems asto DFCC in long-term lending to DFCC in resource mobilization (seeindustry. NDB operates under the para. 32 above and para. 5.26). Itgeneral supervision of MOFP and its needs to explore alternative mecha-Board consists of six officials. nism for raising Rupee resources.Although empowered to finance bothpublic and private sector projects, 37. IDA has played a critical roleNDB's lending to public enterprises in NDB's institution building byis small (less than 102 of providing technical assistance sinceportfolio). its founding (para. 5.27). The

assistance has been extremely valu-34. During 1980-90, gross loan able in all areas, but more so inapprovals increased at an annual staff training and in formulatingaverage rate of 172 with approvals strategy and policies. Relationshipgrowth increasing faster in the with IDA may have also fended offsecond half (202) (para. 5.22). SHI potential interference from Govern-refinance accounts for 202 of total ment. A major current problemapprovals. Like DFCC, project loans concerns staffing because of non-account for the bulk of NDB's activ- competitive salary scales. Thisities. NDB's merchant banking issue should be addressed early.operations, started in 1988, has GOSL has agreed to privatize NDBmade fair progress. But the CDIC, which should facilitate action onestablished in 1984 by NDB, has so this matter. IDA should encouragefar not been effective in providing this move which should help correctequity capital to small firms; more a number of problems. However, therecently it has been playing a resource issue deserves priorityuseful role in building up the stock attention for privatization to be aexchange. workable proposition.

35. NDB's financial performance Sustainability of PCIshas been satisfactory but lackluster(para. 5.24). It has not used its 38. The two developments banks arecapital base to its full potential profitable, well-managed institu-(debt-equity 32t68 in 1990). Return tions, although they have had port-

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folio problems. Their financial corporate plans had been preparedviability is not in question. How- but had minimal impact on changingever, both DFIs cannot mobilize the relationship between MISA andresources, particularly local cur- PEs (para. 6.10).rency resources, without Governmentsupport. Reforms in the interest 41. The firm level consultancyrate regime are necessary for the assistance was rjrn ined to onlyDFIs to mobilize resources from the three ?Es -- Ceramic, Mineral Sandmarket. Without these reforms, and Plywood Corporations -- out oftheir sustainability is an issue. the eight identified during the 1982There is a high likelihood that appraisal (para. 6.11). The onlythese reforms will be sustained. study that was assessed as good was

that for the Plywood Corporation butPublic Enterprise (PE) Reforms even in this case, implementation

could not be realized because of39. IDP-I had a two-pronged ethnic disturbance, loss of key man-approach to improving PE efficiency. agers and labor disputes. Iade-The first involved technical assis- quate follow-up by IDA (para. 6.12)tance to the Ministry of Industry partly accounts for the lack ofand Scientific Affairs (MISA) to effectiveness.establish a Public Enterprise Cell(PEC) which would (a) assist PEs 42. Technical assistance to theunder its control to prepare PED resulted in the development of acorporate plans and (b) provide standardized financial reportingconsultancy service to specific PEs system for the PEs. PED also workedto resolve technical and management towards improving financialproblems hindering performance. accounting practices focussing onCorporate plans were intended to valuation of assets with the viewreplace direct controls with a towards privatization. The substan-contractual system of signalling and tive impact of these measures onperformance rewards based on improving PE performance to date isexplicit targets. The second prong unclear. However, some of thesewas assistance to the Public initiatives should be useful inputsEnterprise Division (PED) of the in the propoLed program of privati-MOFP which was responsible for zation of PEs being implemented byimproving management information GOSL.systems, performance evaluationprocedures, etc., in all PE9 as well Findings and Lessons of PE Reformas serving as the technical arm ofthe parliamentary Committee on 43. The most important lesson thatPublic Enterprises (COPE) to enable emerges from this experience at FEit to carry out its monitoring reform is that partial measures suchactivities more effectively. as strengthening management systems

and procedures, devising signalling40. Results achieved in both areas systems to set targets and monitorwere minimal (para. 6.05). Imple- performance, etc., are unlikely tomentation of the relevant tasks set succeed unless the overall economicout under the MISA program was environment in which PEs operate isdelayed considerably due to lack of changed. This requires changing thea real commitment on the part of legal, incentive and regulatoryMISA officials. By January 1988, 12 framework to expose Ps to market

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competition while simultaneously of high budgetary deficits due andproviding management with autonomy its heavy dependence on trade taxes.

in operational matters such asproduct pricing, production levels, 46. Following the deterioration in

wages and salaries, staffing levels, macroeconomic indicators in 1987.financial decisions, etc. However, IDA initiated a second study of theeven the partial measures could have protection regime financed underled to some tangible improvement if IDP II. On the basis of thisit had the full support of senior review, GOSL announced a four-bandgovernment officials. tariff system (5Z-15Z-352-50%) to be

implemented within two to three

Trade Policy Reforms years. IDA endorsed these proposalsas a substantial liberalization of

44. The 1977 trade policy reforms the import regime. A 1989 review ofled to a substantial liberalization the tariff regime showed that theof the economy but the criteria by average nominal protection to manu-which tariffs were adjusted led to a facturing was 31Z and the averagewide dispersion of effective protec- effective protection was 40Z and thetion rates in manufacturing with tariff system still showed a sub-adverse implications for resource stantial cascading structure. How-allocation. Thus, further trade ever, the variance of protectionrationalization of the regime was between different branches of manu-needed. IDA tried to promote these facturing was smaller. Moreover,reforms under an adjustment opera- out of a total of 6,634 tarifftion which was not acceptable to positions, 500 product categoriesGOSL for political reasons. It had were still subject to import licens-to settle for promoting these ing of which 440 were manufacturedreforms through technical assistance goods. Finally, the Goverment wasto the Tariff Reform Commission still exercising monopoly control

(TRC) (later called the Presidential over some imports, e.g., textiles.Tariff Commission) in analyzing the It would thus appear that between

incentive impact of the protection 1985-89, the pace of tariff

regime under projectlinvestment reduction has been rather modest,operations. This approach, as it although PEs may have become lessturned out, was sub-optimal. protected. Nevertheless, GOSL is

committed to further liberalization

45. In response to a 1983 IDA of the import tariff regime afterstudy advocating lowering of nominal the four-band tariff system is intariffs to a uniform !5Z rate over a place.five-year period) and elimination ofmost export incentives, in 1984, Export Incentives and PromotionGOSL introduced tariff reductionsreducing most tariff rates to 47. Technical assistance to thebetween 5Z and 752 with the average EDB was extremely effective inunweighted nominal protection rate helping it to develop a rationalat 312 (para. 6.24). However, export incentive structure based on

special tariff protection continued granting exports "extended neutralto be provided to PEs. In status' (para. 6.27). These recoi-retrospect it is clear that GOSL did mendations have been incorporated innot adopt IDA's proposals in light GOSL s Industrial Policy Statement.

The appreciation of the real

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exchange rate had adverse conse- substantial appreciation of thequences for Sri Lanka's exports and underlying real exchange rate.the signals it gave to export indus- Another constraint to adopting atries. The export incentives pro- flexible exchange rate policy wasvided by EDB partly mitigated the Sri Lanka's large external debtnegative effects of the exchange which was mainly a public sectorrate appreciation but failed to make liability. Since non-traded goodsan appreciable impact on exports. are a major source of GovernmentMoreover, the slow pace of import revenue, a real devaluation wouldliberalization blunted competitive have conflicted with the objectivepressures on domestic firms prevent- of fiscal stabilization and therebying efficiency gains which may have exacerbated inflation. Given thataffected export performance. This trade taxes amount on average to 40Zis particularly true in the case of of total tax revenues, there waspublic enterprises. Sustained little leeway for the Government toexport growth and diversification reduce import taxes, which undoubt-depends on Sri Lanka's ability to edly adversely affected the pace andproduce at internationally -ompeti- extent of liberalization. Thus, thetive costs. The main strategy requirements of fiscal stabilizationshould be further significant conflicted with import liberaliza-reduction of import protection tion. A thorough tax reform effortcoupled with investments of should have accompanied or preceededsufficient scale and technological the program of import tariffcapability to enable competitive reduction.exports. Ability to attract directforeign investment will be a IDA's Rolecritical factor in this effort.

49. IDA has played a catalyticFindings on Trade Policy Reform role in fostering trade policy

reforms in the post-1977 period. It48. The main issues which arise in would4 appear that its analysis ofreviewing the progress of trade trade liberalization, at least untilliberalization concern the pace and 1985, did not fully take intoextent of import liberalization that account the fiscal constraintshas occurred in Sri Lanka after over arising from GOSL's macroeconomic13 years of reform effort. To com- policies. Pursuing trade policyment on this, one needs to examine reforms through project credits didthe linkages of trade policies with not allow for adequate monitoring.the overall macroeconomic policies Since 1987, however, IDA has beenfollowed by the Government during more sensitive to the revenuethis period. Following the 1977 implications of tariff reform andliberalization measures, the its links to the overall macro-Government adopted an expansionary economic framework. It is likelyfiscal policy resulting in very high that the macroeconomi,; parametersbudget deficits (1980 deficit was - would have been better defined and22.2Z of GDP). The expaniionary controlled had the reforms beenfiscal policy resulted in e double undertaken under an adjustmentdeficit inflation rate which the operation which could have allowed aGovernment sought to control partly faster and deeper liberalization ofthrough a rigid nominal exchange the import regime.rate policy. This led to a

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1.See Sri Lankat Financial Institutions Study, Report No. 9339-CE.February 1, 1991.

2.IDB has established a Center for Entrepreneurship Development andConsultancy Services (CEDACS). However, CEDACS could suffer from thesame problems that have affected IDB's other operations. If CEDACScould be operated along private lines with close links to the financialinstitutions, it could substitute for the proposed center.

3.These numbers refer to subloans rather than to subprojects, some ofwhich have received more than one subloan. In the case of DFCC, somethirteen subprojects had arrears of principal and interest as apercentage of loan balance exceeding 102 as of March 31, 1989; for NDBthe corresponding number was nine.


SRI LANKA


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

AND


I. INTRODUCTION

1.01 Promoting the development of Sri Lanka's industrial sector has been along-standing objective of the World Bank Group (WBG) since the sector hasbee- viewed as an important channel for both employment creation andstrengthening the balance of payment position through export diversification.Between 1966-1977, WBG provided four lines of credit to the DevelopmentFinance Corporation of Ceylon (DFCC) for assisting private investment proj-ects in industry, tourism and related activities. A supplementary objectivewas to st-engthen DFCC as an institution.v As standard DFC operations,these loans did not include any broad industrial sector policy conditionali-ty, even though the industrial policy framework during this period was char-acterized by complex and far reaching administrative regulations, high importprotection, dominance of public enterprises in most industrial activities anda repressed financial system.

1.02 Following the change in Government in 1977,a new regime of economicliberalization was introduced which start(d to reverse the bias against theprivate sector. The Government moved str"3ly to revive the economy and theprivate sector in particular, through the &doption of market-oriented priceand trade policies, easing of investment licensing restrictions, thepromotion of direct foreign investment in export-oriented ventures, and thebroadening of the financial system. Following the change in Governmentpolicies, starting in 1979 the Bank initiated a series of loans aimed atdeveloping the private industrial sector through both credit and technicalassistance as well as assisting the Government in its efforts to liberalizetrade policies and internal regulations, enhance public enterprise efficiencyand strengthen the financial sect.r. Between 1979-90, the Bank extended sixloans - three for small and medium-scale industry (SMI) development and threeIndustrial Development Projects (IDP); the most recent loan (an adjustmentoperation) aims at restructuring and privatizing publicly owned enterprises.Conditionality on broad policy reforms under project loans is rather unusual

y Sri Lanka Development Finance Corporation of Ceylon (Credits 68-CE and 742-CE), PPARNo. 6821, June 27, 19M6.

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and it appears that the Bank adopted this approach as the Sri LankanGovernment did not feel that the poll ical climate was right for the intro-duction of quick reforms through adjustment operations. This PPAR evaluatesthe first two SMI loans (Cr. 942-CE and Cr. 1182-CR) and the first IDP(Cr. 1401-CE).

II. OVERVIEW OF ECONOMIC POLICY REFORMS (1978-1989)

2.01 The 1977 economic reforms represented a dramatic reversal of the state-oriented import-substitution philosophy that had guided economic managementfor the previous two decades and resulted in poor economic growth. Thethrust of the reforms was to reorient the economy in an outward direction andto reverse the bias against the private sector. The main elements of thereform package were a large devaluation coupled with elimination of the dualexchange rate system, elimination of a great number of import quotas andtheir replacement by tariffs, easing of exchange controls, decontrol of mostproduct prices and recourse to interest rates to determine credit allocation.

2.02 Between 1978-85, the Government adopted further measures, some of whichwere supported by the three projects under review, to deepen the marketorientation of the economy and strengthen the private sector. On the tradeside, liberalization of the trade regime in 1977 was followed by furtherreforms in 1984 aimed at lowering and reducing dispersion of effectiveprotection rates. The Export Development Board (EDB) was created in 1979 toadminister a variety of export incentives aimed at encouraging non-tradition-al exports. A duty rebate scheme and a bonding scheme--whereby importedinputs for exporters are exempted from tariffs--were put into place in 1980.Another measure aimed at encouraging non-traditional exports was the creationof a Free Trade Zone (FTZ) near Colombo in 1979. Foreign owned export-oriented enterprises were encouraged to locate in this zone by making skilledlabor available at relatively low cost, and providing free access to importedinputs and generous tax incentives. A new agency, the Greater ColomboEconomic Commission (GCEC), was created to manage these incentives and givenauthority to approve investments in the FTZ. Another agency, the ForeignInvestment Advisory Committee (FIAC), under the Ministry of Finance andPlanning was given the role of promoting foreign investments outside the FTZ.The strict rules and regulations on private domestic investment approvalsenforced by the Local Investment Advisory Committees (LIACs), were alsoeased. To encourage traditional exports, export taxes on tea, rubber, andcoconuts were reduced substantially, from levels in the range of 40-50Z in1978, to 10-202 in 1985.

2.03 The financial sector also benefitted from the liberalization ofeconomic policies and has been one of the fastest growing sectors of theeconomy. New foreign banks were allowed to enter the market bringing thenumber of foreign banks in Colombo from 4 to more than 20. Foreign CurrencyBanking Units (FCBUs), which are subsidiaries of commercial banks, wereallowed to transact in foreign currency with non-resident enterprises, suchas those established in the FTZ, and to take foreign currency deposits from

- 3 -

non-residents, mainly Sri Lankans working abrsad. Two equipment leasingcompanies were created between 1980-82.

2.04 The economy responded vigorously to these reforms with GDP groMing atbetween 5Z to 7% between 1978-85 and unemployment declining to 12% in theearly 1980s from 262 in 1976. The main areas of growth were in construction,agriculture, garment manufacture and services. Since the mid-1980s, however,slow economic growth and high unemployment have re-emerged as serious prob-lems. There are three reasons for this deterioration of economic perfor-mance: (i) the expansionary macroeconomic policies pursued since 1977 ledto unsustainably large deficits in the external and internal accounts; (ii)failure to reduce the public sector's size or address the root causes of itsinefficiency; and (iii) the outbreak of the ethnic conflict in 1983, putheavy pressures on the budget, caused output losses, and reduced foreigninvestment and tourism.

2.05 Despite the 1977 liberalization, the Government's role in the economyincreased. The availability of external finance, both from donors and com-mercial sources, led to a massive expansion of the public investment program.Current expenditures increased both as a result of increased public sectoremployment and of public enterprises' need for budgetary support after theywere exposed to market forces and international competition without beinggiven autonomy to make decisions on pricing, procurement and recruitment.As total Government expenditures soared, so did fiscal deficits despite SriLanka's relatively high revenue to GDP ratio, which gradually increased froma historical 16-172 of GDP to slightly over 20Z of GDP in the mid-1980s. Thefiscal deficit during 1978-87 averaged 14% of GDP, about half of which wasfinanced by grants and concessional loans and the other half by domesticborrowing. At close to one-half of national savings, this level of domesticborrowing has been the main cause for relatively high real interest rates.Commercial lending rates averaged 82 per year in real terms during the lastfour years. The Government-led expansion in aggregate demand was the princi-pal factor underlying the acceleration in inflation in the first half of the1980s. Because of an insufficiently flexible exchange rate, inflation ledto a gradual appreciation of the real exchange rate. This appreciationimpeded a more vigorous development and diversification of the export sectorand contributed to a current account deficit which averaged 162 of GDP in1980-82, with a gradual decline to around 102 of GDP thereafter.

2.06 By 1986, it became clear that Sri Lanka could no longer sustain itshigh levels of fiscal and external current account deficits in the face ofdwindling reserves. In November 1986, the Government articulated a three-year stabilization program which, in turn, led to the first-year PFP (1988-1990). The program's main objectives were to restore growth, reduce thefiscal deficit to an acceptable level by 1990, and stimulate export-ledmanufacturing output through trade policy reform and exchange rate deprecia-tion. While adoption of this first-year PFP was seen as a MaRjor breakthroughat that time, its implementation turned out to be a disappointment. With theintroduction of the second-year PFP program in mid-1989, overall economicmanagement and performance strengthened. Policy actions and tightenedexpenditure controls kept the overall deficit in 1989 at 112 of GDP, well

within the PFP target of 12.52 of GDP. To complement these measures, theGovernment also devalued the rupee, from Re. 35/US$ in July 1989 toRe. 40/US$ in September 1989, and tightened monetary and credit policies.Although foreign aid inflows were slightly less than anticipated, the 1989domestic financing of the budget at 5.12 of GDP was still lower than the PFPtarget of 6.32; this was also significantly less than the 1988 domesticfinancing which reached 9.42 of GDP. The stabilization program, however, wasnot as successful in controlling inflation. Despite the tightening ofmonetary policy--and partially as a result of the rupee devaluation andelimination of subsidies--inflation accelerated in late 1989.

2.07 Recognizing the importance of furthering the gains achieved thus farin the stabilization efforts, the Government reached agreement with the Bankand the IMF on a third-year PFP. The main macroeconomic objectives over themedium-term are to: (i) accelerate growth to over 52 through 1993; (ii)reduce inflation to 62 by 1993; and (iii) reduce the external current accountdeficit from about 82 of GDP in 1989 to about 52 by 1993, accompanied by anincrease in gross official reserves from the current level of about 1.7months of imports to 1.9 months. Fiscal constraint is expected to result inthe budget deficit declining from about 102 GDP in 1990 to about 9Z in 1991with further reduction thereafter. The attainment of these objectives willdepend upon a gradual diminution of the civil conflict; a stable macroeconom-ic environment including tight fiscal and monetary policies coupled withappropriate exchange rate managetent; the establishment of a consistentenabling environment for the private sector which will promote an increasein private investment and export-oriented output; and a reduction in the sizeof the public sector and its claims on resources so as to make room for theprivate sector.

2.0R The Government's program of reducing the size of the public sectorcomprises measures to reduce the level of central Government expenditures aswell as to restructure and commercialize and/or privatize public sectorenterprises. The government is already taking steps to privatize andrestructure public enterprises. It has divested an auto dealership and twotextile mills and is in the process of divesting two public companies (liquidoxygen and ceramics). The Government has also begun a phased implementationto commercialize, restructure or privatize much of its large PME portfolio.Recent measures taken by the Government to promote domestic and foreigninvestment are expected to contribute to encouraging private investors'participation in PME commercialization, as explained below.

2.09 In December 1989 the Government announced a strategy to promoteindustrial growth based on the private sector as an engine of growth. Thestrategy delineates the public and private sectors' respective roles in thecountry's industrial development, stressing equal public and private sectoraccess to financing, equal pricing flexibility as well as equal effectiveprotection for comparable industries and confirms that all PMEs would becommercialized and privatized wherever possible. It takes into account theneed for a transparent, cost-effective and non-discriminatory system ofincentives and gives special emphasis to export incentives, development ofmarketing services, infrastructural support and manpower training. To

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facilitate implementation, the Government has formed a high level comitteeto coordinate policy and incentives across ministries. A new IndustrialPromotion Act is being formulated on the basis of the IndustrializationStrategy.

2.10 The industrialization strategy gives special emphasis to the key rclethat foreign direct investment can play in alleviating domestic shortages ofcritical factors such as capital, specialized skills, transfer of technologyand managerial expertise, and access to foreign markets. To actively promotesuch investment, the Government has already consolidated all approvalprocedures in one entity, the Greater Colombo Economic Commission. In late1989, restrictions on foreign equity investment in existing enterprises andthe 100Z tax on transfer of equity shares to foreigners were eliminated. Tofurther emphasize the foreign investment promotion measures announced in theindustrialization strategy, the Government is formulating a comprehensiveforeign investment strategy that would clearly outline the new, streamlinedprocedures as well as guarantees afforded foreign investors.

III. THE MANUFACTURING SECTOR

A. Structure and Performance

3.01 In 1989, the manufacturing sector accounted for 15.3% of GDP comparedto 28.4% for agriculture, 48.4Z for services and 8.4Z for construction. Themanufacturing sector's share of GDP has declined since 1977 when its sharewas 23.1? in contrast to the construction and mining sectors (mostly gems)which increased their shares. Its share of the labor force has been steadyat about 14?. Currently, the manufacturing sector comprises some thirtypublicly owned manufacturing enterprises (PMEs) of which ten are in food,beverages and tobacco products and the remainder in industrial goods; about500 large scale private registered factories employing 75 workers or moremainly in Colombo; 5000 small and medium-scale registered private factories;some 25,000 dispersed unregistered small and cottage units concentrated inhandicrafts and servicest and an estimated 100,000 tiny units employing lessthan five persons." The private sector is estimated to account for 60% ofmanufacturing value added and 90? of manufacturing employment. Private firmsdominate the food, beverages, tobacco, chemicals, rubber and garmentsindustries whereas PMEs are engaged in more capital intensive operations intextiles, sugar, cement, ceramics, chemicals, petroleum, steel and woodindustries.

3.02 Despite a decade of liberalization, PMEs remain an important segmentof the economy. However, they contribute less than proportionately toindustrial output growth and exports. In 1988, the 20 enterprises whichmanufacture industrial goods accounted for 33? of the national industrialproduction or about 3% of GDP and employed about 40,000 people, representing

/ Based on the Annual Survey of Industries 1988, Department of Census and Statistics.

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62 of the industrial labor force or about 12 of total labor force. Theycontributed less than 51 of industrial exports (22 of total exports). PMEs'economic contribution is dominated by three corporations, Ceylon Petroleum,National Textiles and Sri Lanka Cement. In 1988 these contributed about 70%of PME output, or over a fifth of total industrial output. The Textiles andCement Corporations each contribute roughly 31 of national industrial produc-tion (together accounting for about 11 of GDP). Half of the PME exports wererefined oil products from the Petroleum Corporation; the other half weremainly minerals from the Mineral Sands, Mining and Mineral Corporations andtextiles from the National Textile Corporation.

3.03 PME production has stagnated since liberalization, in contrast toprivate sector output. PME value added grew at an annual average of 1.01 inreal terms during 1977-88, substantially lower than the growth of manufactur-ing GDP of about 61 annually. Private industries are estimated to have grownat more than 101 a year over the period. Liberalization policies adopted in1977 spurred the private sector to establish new industries, particularly intextiles (knitting) and garments, which have been the main thrust of privategrowth. The Government kept PMEs entangled in an array of controls and ia-

commercial functions, which were compensated for by high levels of tariffs,market privileges and budget financing. PME financial performance has beenpoor on average. Aside from the Petroleum, Mineral Sands, Cement Corpora-tions and two textile mills of the National Textile Corporation, PMEs haveeither been marginally profitable or accumulating losses, and returns oncapital have been low or negative. The economic cost of PME inefficienciesis not captured in the budget as the Government practically stopped budgetarytransfers to PMEs in 1982. Since then, PMEs have rescrted to running downtheir production facilities and/or building up arrears with the Treasury andthe state commercial banks.

3.04 The stagnation of the PME sector accounts for the structural changes

in the manufacturing sector between 1975-87. In 1975, consumer non-durablesintermediate goods and capital goods accounted for 501. 32Z and 141 of manu-facturing value added respectively. By 1987, the respective shares were 571,371 and 61, reflecting the greater dynamism of the private sector which areconcentrated in the consumer and intermediate goods subsectors. In addition,the manufacture sector has become much more outward oriented as a result ofthe trade policy reforms. Overall the share of manufactured exports inmanufactured output increased from 91 to 262 in 1987. Nevertheless, only asmall group of manufactured products, textiles and garment, leather goods andgems and jewelry have contributed to the export growth, attesting to need forsignificant improvements in the efficiency of the manufacturing sectors.

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B. Small and Medium-Scale Industry (SMI)

3.05 The SMI GroupV of enterprises is estimated to comprise 902 of privatesector enterprises and account for over 70? of employment and 55% of manufac-turing value added (PCR, para. 2.09). SMI firms are concentrated mainly infood and beverages, agro-processing industries, chemicals, rubber, andplastics, garments and leather goods, gems and jewelry, construction materialand metal products. Most SMI are oriented towards the domestic market, serv-ing local areas with the exception of SHI firms in garments, leather productsand gems and jewelry. The latter industries have emerged as extremely suc-cessful exporters with garments accounting for 57Z of manufactured exports.Foreign technical collaboration and investment has played a key role in thesuccessful expansion of garment exports and to a lesser extent in gem andjewelry exports.

3.06 However, in most other sectors, SMI's serve local and regional marketsand their growth potential as suppliers of final consumption goods is limitedby the small size of these markets. Most employ traditional technologieswhich result in low productivity and product quality. The gradual liberal-ization of the trade regime and deregulation of internal investment controlshave increased competition, putting pressure on SMI firms to improve effi-ciency, improve quality and reduce cost. New entrants are fewer and growthof the sector is occurring through expansion of successful firms as indicatedby the changing nature of the loan applicants under the three SMI creditlines. Nevertheless, the number of SMI firms engaged in activities involvingmodern technology and higher level skills is very limited. This situationhas arisen because of a dearth of trained engineers and technicians andlimited access of SMI firms to modern technical know-how. Lack of linkagesbetween small and large firms has been a critical constraint to the growthof SMI in sectors such as engineering products where a large number of SMIfirms can generally be found in most newly industrializing countries.

C. The Industrial Finance System

3.07 Prior to 1977, the institutional sources of industrial finance werefour domestic commercial banks (CBs), DFCC and four foreign commercial banks(FCBs). Traditionally, private industry relied on self-financing for up to80% of its fixed capital needs and on commercial bank credit to finance work-ing capital, with some rollover for long term investment. Overall, commer-cial bank credit accounted for about 85? of all institutional finance toprivate industry. Although public sector industrial corporations obtainedbank credit, budgetary allocations accounted for 80? of their financialrequirements. DFCC was the only source of long term equity and loans, andhad a monopoly in foreign exchange lending to private industry. Since 1977,a significant number of new types of financial institutions have joined thesystem. The expanded system consists of The National Savings Bank (NSB), two

f/ Defined as a privately or cooperatively owned enterprise with fixed assets excludinginvestment in land and building with a book value not exceeiing Re. 4 million. This Ilaltwas Re. 1 ml i Ion under the SMi I loan.

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public and two private domestic commercial banks, two industrial developmentbanks, four regional rural development banks (RRDBs), 21 FCBs, 24 foreigncurrency banking units of the commercial banks, 52 finance companies provid-ing leasing and hire purchase facilities, three major specialized leasingcompanies, several provident funds and insurance companies and two merchantbanks. There are six money brokers who operate ta, the interbank/secondarymarket. In addition to the institutions monitored by the Central Bank of SriLanka (CBSL), there is an active unofficial credit market.

3.08 Commercial banks mobilized more than 50% of total institutionaldeposits while NSB accounted for about 282 of deposits in 1989. The twoGovernment-owned national commercial banks (NCBs) - the Bank of Ceylon (BOC)and the People's Bank (PB) - dominate the commercial banking system account-ing for approximately 90Z of deposits. Most commercial bank resources comefrom short term deposits (less than 12 months). Because of the BusinessTurnover Tax (BTT) and high reserve requirements, and the cost of servicinglarge non-performing asset portfolios, the NCBs need high lending margins(6-82).

3.09 The non-bank financial institutions involved in providing services to

the industrial sector include finance companies, leasing companies and two

merchant banks. The merchant banks have been inactive mainly due. to the slowdevelopment of the securities markets. However, because of the tax advan-

tages of leasing, finance and leasing companies have developed rapidly; at

present more than 50 finance companies offer hire purchase finance. Six

leasing companies, including Lanka Orient Leasing in which IFC has a share-

holding, also provide term financing. These institutions have grown rapidlyby offering high interest rates on deposits and lend for consumer goods and

transport equipment.

3.10 The commercial (services, trade) sector accounts for over 502 of com-

mercial bank lending followed by industry with a share of about 252. This

pattern of sector tl distribution of commercial bank credit has remainedbroadly unchanged between 1980-89. However, the ratio of commercial bank

credit to industry as a proportion of its industrial value added is about

38?, considerably higher than the similar ratio for other sectors, pointingto the greater availability of credit for industrial purposes. The bulk of

commercial bank lending to industry (652) is short term although the shares

of medium term (between one and five years) of 24? and long-term (over 5

years) of 10? are fairly high compared to many other developing countries.

As of the end of 1989, private firms accounted for 722 of total industrial

credit outstanding from commercial banks with the balance of 282 due from

Government corporations.

3.11 Commercial bank lending is highly security-oriented with banks goingfor either liquid forms of collateral, e.g. documentary bills, trust

receipts, pro-notes and bonds or real estate. Such a conservative policy hasresulted in small or newer firms having very limited access to commercial

bank finance. The Central Bank has been operating a credit guarantee scheme

for small and medium scale borrowers under the SMI loans since 1978 but its

effectiveness in reducing collateral requirements or increasing the overall

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flow of credit to such firms is questionable. There is a substantial varia-tion in interest rates charged to borrowers depending on the collateralprovided; e.g. real estate backed loans carry an interest rate of 16.4Z com-pared to unsecured loans at 21.92 which attests to the reliance on collateralrather than cash flow in lending and pricing decisions of commercial banks.A major problem of new entrepreneurs as well as established private firms isthe paucity of equity capital which has resulted in highly leveraged borrow-ing thereby, increasing risks. Although bankers are well aware of thisissue, no significant initiative has been taken to address it.

3.12 The liberalization of entry into the banking system for foreign banksafter 1977 has resulted in significantly increased competition resulting inpressures on interest margins and profits. The state banks, because of theirextensive branch network have been able to maintain a high share of depositscompared to the private domestic banks. Gross interest margins as a percent-age of assets (difference between interest earned and interest paid plusother net income) for state banks declined slightly from 3.32 to 3.22 butsubstantially for private domestic banks (4.0% to 2.5%). Similarly thedecline of profits before taxes and provisions have been sharper for privateversus the state banks. Nevertheless, the state commercial banks arebelieved to have significant levels of non-performing assets. Under thethird SM project, IDA funded technical assistance for both the state banksto analyze portfolio quality and restructure their operations.

D. Credit Allocation and Interest Rates

3.13 A national credit plan is used by the Central Bank to influence, at theaggregate level, domestic credit allocation by commercial banks but thesecredit allocation policies do not seem to affect significantly the behaviorof lending institutions. The plan is based on estimates of credit availabil-ity derived from the Central Bank's annual monetary programming exercise andtakes into account credit ceilings and estimated demand for credit. Theprojected available credit is then allocated to priority and non-prioritysectors. However, the plan's actual impact on credit allocation is probablylimited as banks independently decide on the sectoral classification of aparticular credit and borrower are often engaged in several sectors and cantransfer loan funds between sectors to get around ceilings. Credit ceilingsare also used by the Central Bank to limit the volume and allocation ofcredit. For example, in June 1989, the Central Bank limited the total amountof advances granted and outstanding by commercial banks to the private sectorto the level of such advances as of May 31, 1989. However, agriculture,export finance and industry were exempted from the ceiling which again pro-vides room for credit leakage. In addition, to reduce the demand for importcredit, banks are required to take a cash deposit equal to the value of aletter of credit (L/C) before opening a letter of credit in favor of animporter.

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Selective Credit

3.14 In addition to influencing credit allocation, through the nationalcredit plan and credit ceilings, the Central Bank directly intervenes in banklending for priority uses or sectors through rediscounting loans made bycommercial and development banks at on-lending rates set by the Central Bank,often at below market rates. However, the volume of refinance is relativelysmall. Under the Central Bank's medium and long-term credit fund (MLCF), thetotal amount of refinance granted for industry and the hotel sector in 1989was Rs. 441 million, compared to Rs. 35 million and Rs. 390 million in 1987and 1988. The increase in refinancing in the past two years is due toadvances to commercial and development banks for rescheduling loans to hotelswhich were badly affected by the ethnic violence.

Interest Rate Policies

3.15 Deposit rates are influenced by the Government indirectly but have notbeen maintained in real terms at positive levels, on a consistent basis(Annex 1, Table 1). The discount rate of the Central Bank (the Bank rate)has basically ceased to have an influence since 1984 when the discount windowwas discontinued. Commercial bank rates are influenced by the floor rate ontreasury bills established by the Central Bank and the relatively high rateoffered by the National Savings Bank (NSB) on time deposits. However, sincethe Treasury bill rate is not a market clearing rate, it provides a mislead-ing signal to lenders and borrowers. These is a need for a reform of theauction process focussing on the role of the Central Bank as a participantin non-competitive bidding.

3.16 Lending rates are generally freely set by most institutions althoughthe Central Bank reserves the right to set maximum rates. The spread betweencommercial banks' deposit and lending rates have been fairly high due to highreserve requirements, high operating costs and losses from non-performingloans. The Central Bank publishes a weighted average prime lending rate(AWPR) of commercial banks on a weekly basis but there is a considerablespread in the rates charged by institutions for specific purposes. The AWPR,moreover, reflects the lending rate for short-term loans. The lack of along-term rate benchmark has created an anomalous situation in the settingof interest rates for medium and long-term maturities. The present systemfor setting fixed MLT rates for industrial loans is based either on theaverage weighted prime lending rate minus a spread of 61 or alternatively onthe average weighted cost of deposits (AWDR) plus a spread to be determinedby the lending institution. Since both benchmarks are related to short termrates, both parties to the loan contract are thus exposed to potentiallylarge interest rate risks. Until market based benchmark rates can be estab-lished for MLT loans, it is imperative to adopt variable interest rates toreduce the potential interest rate exposure. To reduce investor uncertainty,the possibility of introducing rate caps or other such devices needs study.The acceptability of such a system of variable rates needs to be explored butshould not pose a serious problem, given that a substantial part of short-term commercial bank lending is rolled over on a regular basis. Moreover,

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without flexibility in rate setting, medium and long-term lenders such asDFCC and NDB are likely to remain dependent on subsidized sources of funding.

E. Capital Market

3.17 The market for shares and other securities in Sri Lanka is undevelopedand stocks and debentures have not been significant sources of finance forindustry. Although a small number of brokers make a market for shares andabout 300 companies are listed, most are closely held or dormant, and tradingvolume is thin although there has been substantial increase in trading volumein 1990. Development of the market has been hampered on the supply side bythe relatively small number of medium and large companies in Sri Lanka andthe strong tradition of closely held ownership. On the demand side, interestin investing in shares is low due to relatively high returns available onfixed interest deposits and commercial activities. GOSL has taken steps torevitalize the market through (i) establishing a Securities Council to moni-tor the operations of the capital market, (ii) consolidation of the opera-tions of the country's two stock exchanges which have not operated effective-ly; and (iii) the formation of an equity fund.

3.18 GOSL has been attempting to stimulate greater securities activity andthe development of primary and secondary markets in Government instrumentsby provid-ing tax concessions for companies going public, reforming thesystem of share underwriting, developing new investment and unit trusts andissuing shares in profitable public sector corporations. This would comple-ment the establishment of the Sri Lanka Capital Development and InvestmentCompany (CDIC) by GOSL, NDB and other Sri Lankan financial institutions,including the state-owned commercial banks, to provide equity to new ven-tures, particularly joint ventures between public corporations and privateparties.

IV. EVALUATION OF SI I (CREDIT 942-CE) AND SMI II (CREDIT 1182-CE)

A. Project Objectives and Scope

4.01 The major objectives of both the SMI projects (as well as the subse-quent SMI III) were to increase output, employment, and exports throughassistance to SMI and by addressing constraints hindering their growth,productivity and technological improvements, particularly in subsectors withsignificant export potential. Both SMI I and SMI II were similar in designand comprised two major components - a credit and a technical assistancecomponent; under both projects, the Bank also included funding to assist GOSLundertake studies on trade policy, industrial incentives, etc. which aimedat broader policy reforms, an unusual feature for a SMI operation. The mainfeatures of the two projects as well as SMI III are summarized below.

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SMI I

4.02 Credit Component. Under the SMI I credit component, a separatelymanaged SMI Refinancing Fund (an apex body) within NDB was established toreview subprojects, and provide partial refinancing of subloans made to SMIswhich met appropriate financial and economic eligibility criteria. Responsi-bility for subproject appraisal, on-lending and supervision was delegated tofive participating credit institutions (PCIs): two public commercial banks,BOC and PB; two locally controlled private commercial banks, HNB and CBOC;and DFCC. The project aimed at improving the capabilities of the on-lendinginstitutions to undertake appraisal-based lending by assigning SMI special-ists to headquarters and key branches; providing SMI specialists and manage-ment with training in simplified SMI appraisal and supervision; and introduc-ing systems and tools to facilitate this work; and providing inducements toincrease financing of viable SMIs, through provision of attractive spreads,a credit guarantee scheme and a special capital facility for entrepreneurswith subprojects of strong economic merit but which are unable to meet thenormal equity requirements.

4.03 Technical Assistance. Under the SMI I TA component, funds were pro-vided to employ local/expatriate advisors tot (a) reinforce IDB's promotionand technical service programs for SMIs by improving its regional extensionnetwork, starting a subcontracting exchange, and establishing staff trainingand technical facilities for rubber products, building materials, foundriesand light engineer-ing subsectors; (b) improve the focus and effectivenessof other SMI technical service agencies by providing finance for (i) trainingprograms in garment manufacture; (ii) extension programs in white coirextraction and processing; and (iii) an export organization for handloomproducts; (c) assist NDB and the PCIs to improve their SMI and general lend-ing operations; and (d) assist GOSL to carry out general policy studies onaspects of export incentives and the tariff system, which affect industrialefficiency, expansion, and export prospects.

SMI II

4.04 Under SMI II, the same on-lending structure was kept for the creditcompo-nent but greater emphasis was given to assisting export-oriented SMIin light industries deemed to have high export potential. Increased emphasiswas given to institution building of NDB and the PC1s through training andconsultancy.

4.05 Under SKI II, the TA program sought to strengthen IDB's promotion andextension programs with improved organization and financing for coaching ofregional extension officers, a SKI consultancy fund to tap local privateexpertise, and engineering service facilities. To promote export-orientedSMI, the project aimed at strengthening EDB in its program of export promo-tion and supply development in key light industrial product lines, throughpractical consultancy and training, sales trips, policy studies and pilotprojects; exporters and manufacturers would be major participants in imple-menting these elements. A small amount of funding was earmarked for the

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expansion of successful subsector schemes launched under the first SHIproject.

SMI III

4.06 Under SMI III, the credit component through the SHI Fund to privatesector SMIs remained the same except that eligibility criteria for participa-tion by the banks in the scheme was strengthened and some changes were madein the credit guarantee scheme. The TA component to help GOSL and relevantagencies was redesigned to: (i) improve the efficiency of the financialsector through continued training for the PCIs, and TA was made available tothe BOC and PB to develop action programs to improve their overall operatingand financial efficiency; (ii) improve the access of indirect exporters toduty drawback and export credit facilities; (iii) improve the efficiency ofPHEs through the implementation of action programs developed under ongoingindustrial development projects; and (iv) establish a SHI technicalassistance grant scheme.

SubproJect Conditions

4.07 Under SMI I, US$12.0 million of the proposed credit of US$16 millionwas to be on-lent by the Government to the NDB via a subsidiary loan agree-ment for the account of the SMI Fund on the following termst (i) the loanto be denominated in Sri Lanka Rupees, with Government bearing the foreignexchange risk; (ii) 9Z) interest per annum; (iii) fixed amortization scheduleover 13 years, including four years grace. The SMI Fund provided refinancingto credit institutions for eligible SHI loans on the following terms: (i)refinancing up to 80Z of loan amount; (ii) interest per annum of 102 forloans up to Re. 100,000 (US$6,400), 112 for loans over Rs. 100,000 up toRs. 500,000 (US$32,000), and 12? for loans up to Rs. 1,000,000 (US$64,000);(iii) term would be parallel to the term of the individual loans, expectedto average 5-7 years. The average spread for the SHI Fund was about 2?.

4.08 Under SMI II, the US$28 million subloan component of the proposedcredit of US$30 million was to be on-lent by the Government to NDB via asubsidiary loan agreement for the account of the SMI Fund on the followingterms: (i) the loan to be denominated in Sri Lanka Rupees, with Governmentbearing the foreign exchange risk; (ii) initial interest of 11% per annum;(iii) fixed amortization schedule of 14 years, including 4 years of grace.The SMI Fund provided refinancing to credit institutions for eligible SMIsubloans on the following terms: (i) refinancing for up to 80Z of loanamount; (ii) initial interest per annum of 13? for loans of up to Rs. 500,000and 14? for loans of Re. 500,000 to Re. 2 million; (iii) maturity for amaximum of 10 years, including 2 years of grace. The credit institutionsmade subloans to eligible SMIs on the following terms: (i) maximum sub-project size of Re. 4 million, excluding permanent working capital; (ii)maximum subloan size of Rs. 2 million, including permanent working capital;(iii) initial interest of 18% per annum with review of the interest rateevery six months, and automatic revision if commercial bank rates on termloans to large industrial borrowers changed; (iv) up to 10 years maturity,with grace periods of 3 months to 2 years; and (v) sponsors' equity

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contribution of at least 20% of subproject amount. In the event that thefinal on-lending rate to SMIs changed, NDB's SMI Fund spread would remain atleast 2Z to 32 and the PCIs' spreads at least 4% to 52 depending upon subloansize.

4.09 Under SMI III, GOSL would on-lend the project proceeds to NDB for 18years, including a 5 year grace period, at an initial rate equivalent toseven percentage points below the average weighted prime rate for thecommercial banks for short term (i.e. 12 months or less) lending operations.In turn, NDB would refinance PCI operations at the average-weighted primerate, less six percentage points. The PCIs would relend the proceeds at a

rpte, fixed or variable, sufficient to cover their costs of operation and theproject risk. Given the spread between the IDA and GOSL on-lending rates,GOSL would bear the foreign exchange risk. On the basis of the then currentinterest rates and spread requirements, the re-lending rate would be between132-16%, which compared favorably with the prevailing commercial bank fundingof 142-222. The mechanism for establishing interest rates and spreads wouldbe reviewed semi-annually and, if necessary, adjusted based on proceduresagreed between GOSL and IDA. The actual rate charged to NDB, and subsequent-ly to the PCIs, was to be amended on January 1 and July 1 of each year toreflect any significant movement in the market reference rate, and to remainpositive in real terms vis-a-vis inflation as reflected by the Colombo PriceIndex. The maximum subproject repayment period would be 10 years, includinga 2 year grace period.

B. Implementation Results

4.10 The implementation experience of SMI I is summarized in the PCR (p. 15,Report No. 6795); for SMI II the audit mission collected relevant informationdirectly from appropriate banks and agencies. However, the paucity of accu-rate data on the actual performance of subprojects financed raises consider-able doubts on the estimated benefits, particularly with regard to employmentgeneration, one of the cardinal objectives of IDA lending to this group.

4.11 SMI I was rapidly committed due to the large demand for financing fromthis group although disbursements were delayed due to cancellations and theethnic conflict. There have been suggestions from knowledgeable sources thatthe strong loan demo stemmed partly from the substitution of bank financingfor financing from ;Uo informal market where the cost of funding was substan-tially higher. The PCI's loan approval procedures were also lax; disburse-ment procedures in many instances did not require payment to suppliers orcontractors and the loan funds may have been redirected to other uses becauseof poor supervision (see also PCR, para. 5.06). The PCI's also activelypromoted the first credit line and almost half of the loan amount (49Z) wason-lent to new firms or entrepreneurs. SMI II on the other hand wascommitted and disbursed much more slowly because of the over-optimisticassessment of loan demand under SMI I, the saturation of loan demand from thetraditional sectors, and the PCI's increasing awareness of the poor repaymentrecord of SMI borrowers, particularly new borrowers. The ethnic disturbancesadded to the problems.

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4.12 The two SMI projects mainly financed enterprises in traditional !ndus-tries: food processing (272), construction materials (102), metal products(82), printing and paper products (62) and wood industries (5.52) (Annex 2,Table 1). A total of 3679 subprojects were financed (1741 for SMI I and 2491for SKI II) with an estimated incremental direct employment generation of

36,306 jobs, although the accuracy of the latter figure cannot be confirmed(para. 4.14). Under SMI I, the average subloan size was Rs. 168,000 and 922of subloan were below Rs. 500,000. Under SMI II, with the increase in sub-loan limit to Rs. 4 million, about 422 of the loan amount went for subloansover Rs. 1 million; the average subloan size was over Re. 400,000 ($20,000)reflecting the larger proportion of expansion projects (Annex 2, Table 2).

4.13 The major concentration of subprojects were in urban areas: Colombo(37Z), Gampaha (182) with smaller subprojects located in smaller towns (Annex2, Table 3). The sectoral composition and regional distribution of the sub-projects financed reflects the sectoral and regional distribution of existingSMI units, since most of the subprojects were expansions of existing firms.Moreover, in Sri Lanka, as in most developing countries, new SMI entrepre-neurs usually tend to imitate existing SMI firms, leading to concentrationin selected industries. Social and cultural factors tend to reinforce suchimitative behavior. The lack of effective programs of entrepreneurialdevelopment and technical assistance may have compounded these trends. Itwould not be unreasonable to conclude that the two loans had very limitedimpact on promoting new technological processes or products or contributedmeaningfully to export growth or rural industrialization.

4.14 The lack of reasonably accurate follow-up data on subproject perfor-manc3 has made it difficult to carry out an objective analysis of the bene-fits of the projects. For subprojects under SKI I, a sample survey of some133 loans indicate that 442 had cost overruns up to 2002. The PCR statesthat the ex-post internal financial rate of return (IFRR) for subprojectsrange from 152 to 302 compared to estimated IFRR of between 152 to 502(average 302) at appraisal (PCR, para. 5.08), however, such estimates wereunavailable in the field. The management information system established byNDB for SMI III does not appear to provide systematic information in thisarea. Given the very poor repayment record of subprojects under SMI I, theseestimates of ex-post IFRR appear to be In conflict with the repayment perfor-mance. The PCR also estimates that 202 of the subprojects financed under SKII contributed directly or indirectly to exports although no data on exportperformance or productivity is provided. Judging from the distribution ofloans in potential export industries this estimate would appear to be on thehigh side. For SMI II, NDB carried out a sample survey in May 1989 of theactual performance of 66 subprojects; 33 subprojects (502) had cost overrunsof between 52 to 200Z, 9 were completed below cost and the remainder (24)were completed at cost. In terms of financial performance, 12 subprojects(182) were operating at a loss or were closed, while 11 (172) had annual netprofits as a percentage of investment (APOI) between 02 to 5%. Fifteensubprojects had an APOI of between 52 to 152 while the remainder exceeded152. It is difficult to generalize from this small and perhaps biased samplebut it appears that slightly over one-third of the subprojects were finan-cially shaky, primarily because of cost overruns or poor sales performance.

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The percentage of project costs financed by loans appears very high with mostcases falling between 60Z to 902.

4.15 In the absence of reliable data on the ex-post economic and financialperformance of subprojects, subloan repayment performance is a good proxy formeasuring the actual attainment of the subproject's objectives. For SMI Ithe cumulative collection ratio has ranged between 66% to 72Z between 1982-1986 with principal in arrears as a percentage of principal outstanding being752 as of December 31, 1986 (PCR Annex 7 and 8). The cumulative collectionratio stood at 88.2? in mid-1990 but a significant portion of the arrears(95Z) represent hard core arrears of over 24 installments. The performanceof SKI II has been only slightly better. Between 1986-1989, the number ofloans in arrears as a percent-age of the total loan portfolio steadilyincreased from 35? to 60.0? with the principal affected by arrears over fivemonths representing some 41? of total principal outstanding (Annex 2, Table4). The average annual collection ratio as of December 31, 1989 was only62.51 with some of the major participating banks showing significaatly lowerannual collection ratios (BOC - 50.22; PB - 52.5%) (Annex 2, Table 5).

4.16 The performance of SMI III has been substantially better than SMI IIbut the trend is nevertheless of concern. However, the new debt recovery lawshould help banks to deal with problem clients more expeditiously, particu-larly those that are willful defaulters. As of December 31, 1989 some 27?of loans (by number) were in arrears while the principal affected by arrearsas a percentage of total principal outstanding was almost 6?, up from 2.8?in the previous year (Annex 2, Table 6). Annual collection ratios for thetwo major PCI (BOC and PB) were below 80? (Annex 2, Table 7). These trendsare disquieting given that the PCIs are now more concerned about portfolioquality than earlier. A survey of projects financed under SMI III indicatethat only some 805 out of 1276 (63?) operating projects were performingsatisfactorily (Annex 2, Table 8).

C. The Role of NDB and PCIs

NDB

4.17 NDB was assigned an apex role under both the SMI projects (as well asin SMI III) and benefitted from technical assistance under both loans (paras.5.27-5.28). The main functions of its SMI Department are to (a) operate aSMI refinancing fund to recycle subloan repayment under the loans; (b)monitor loan commitmeats and utilizations including sectoral exposure limitsand provide regular reporting to IDA; (c) review appraisals above the freelimit; (d) liaise with the SMI Credit Guarantee Scheme of the Central Bank;(e) train staff of PCIs on project appraisal procedures; and (f) undertakesubsectoral studies. NDB received an initial spread of 1? under SMI I whichwas increased subsequently to 3?; however, under SMI II, the spread waseliminated; subsequently to defray the cost of running the SMI Department,a spread of 1? was provided under SMI III.

4.18 The SKI Department has attempted to upgrade standards of projectappraisal of the PCIs by establishing norms for financial parameters, and

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assisting in identifying sources of machinery, etc. Under SMI I, except forDFCC, project appraisal and disbursement procedures of the PCIs were slackand supervision poor (PCR, para. 5.06). Under SMI II, appraisal standardssomewhat improved, both through a recognition that the loan program was nota give-away program, better monitoring of subproject appraisals by NDB andan extensive training program for PCI officers funded under the credits. TheSMI Department, with the assistance of IDA, has Implemented a quarterlyreporting system for the PCIs. The PCI branches provide the basic datadirectly to the SMI Department which then collates and provides the summaryinformation to the PCI headquarters. This system has enabled NDB to monitorkey subloan utilization data as well as most importantly details of collec-tions and arrears in a timely manner. However, a serious weakness of themonitoring system is the lack of an in-buil, mechanim to collect informationon all subproject's ex-post economic and financial performance; this preventsan adequate assessment of the true economic benefits of the subprojects. Itwould be useful if the quarterly reporting system provided data on the totalinvestment cost of subprojects to enable calculation of key economic ratios.

PCIs

4.19 The projects initially employed commercial banks with large branchnetworks for on-lending on the assumption that smaller firms, particularlythose located in small town and non-urban areas have better access to thecredit lines. In general this assumption appears to have been borne out(PCR, paras. 7.06-7.07) but only two of four commercial banks (BOC and PB)

-actively participated in the on-lending operations (Annex 2, Table 8). DFCC,which had minimal participation in !MI I, had the second largest share ofsubloan approvals in the second operation. However, the average size of itssubloans approvals was Rs. 0.9 million compared to Rs. 0.36 million for theother PCIs. Compared to the other PCIs, DFCC's portfolio of SMI subloans(covering both SMI II and SMI III) is in better shape although DFCC hasfinanced comparatively riskier projects (new entrepreneurs, new productareas) than the other PCIs. This reflects DFCC's much stronger projectappraisal and supervision capabilities.

4.20 One of the major project objectives was to strengthen the capabilityof the participating commercial banks in undertaking term financing both forfixed assets and working capital without relying exclusively on collateral.The two state-owned banks set up their own SMI departments and have investedsubstantial effort in training staff on SKI lendingg but because of stafftransfers, promotion, etc. these departments continue to be inadequatelystaffed. As a consequence, until recently, SMI lending decisions were hig_ ycentralized in these departments; individual loans had to be approved at theAssistant General Manager level. Following studies by consultants financedunder SMI III, plans are underway to decentralize and delegate such decisionsto branch managers. Part of the problems can be traced to the lack of rigor

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of the training programs themselves. Loan supervision is a particularlyweak area and there is no systematic monitoring of subproject performanceexcept when the client is not current on payments. The departments also havevery little capability, if any, of offering non-financial advice to clientsin difficulty. There is also li.'tle evidence that the banks are systemati-cally basing their lending decisions on project appraisal reports and cashflow criteria rather than on security. A conflicting signal may stem fromthe requirements of the Central Bank's Credit Guarantee Scheme which turnsdown claims if adequate security has not been taken against the loan.

4.21 An important issue concerning the design of the credit componentrelates to the eligibility criteria for participation by financial intermedi-aries. Under SM II, the credit component was opened up to all interestedcommercial banks to encourage competition. However, as the PCR for SMI-Inotes (para. 3.15) *this approach hampered the achievement of a uniformlyhigh standard of subproject appraisal and supervision because of the inabil-ity of the banks with low level activity to organize adequately for SMIlending... Limiting the participation in the credit program to PCIs whichcan meet clearly stated eligibility requirements (i.e. staffing) would facil-itate and improve future SMI operations. This is because lending to SMIraises difficult and very different issues during appraisal and supervisioncompared to lending to large firms. Acquiring this expertise requires time,capability, and on-the-job training. Experience of commercial bank lendingfor SMI in other countries strongly support this point. In fact, wherecommercial banks are significantly oriented towards lending to small enter-prises (e.g. the Citizens National Bank of Korea, or the Halk Bank in Turkey)the results have been very positive. Thus, only institutions which areprepared to make a long term commitment to SMI development through staffingand lending policy should be eligible to participate in future operations.It would be highly desirable if one or both of the state-owned banks were tobecome more strongly committed towards SMI lending, by building up special-ized capabilities in this area. For example, the ability to provide non-technical business advisory services to help clients in all phases of projectdevelopment and implementation would augment and complement the financialassistance provided. This could be achieved by selecting initially a fewlarge branches in locations with concentrations of SMI and staffing thesewith a small group of specialists" who could analyze problems and adviseSMI clients. This step would complement the private sector technicalassistance initiatives being pursued under SMI III.

1/ About 600 SMI officers were exposed to one and a half days training on appraisal and aequal amount of time on follow-up; 400 were trained for three days on appraisal and one anda half days on follow-up; and only 200 were trained for four days on appraisal and follow-up.

& These specialists could be hired as consultants to get around salary restrictionsapplicable to state banks. Flexible working arrangements may also allow branches to tapspecialists who are regularly employed In universities and businesses.

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D. Technical Assistance (TA) for SMI

4.22 Both projects included substantial technical assistance (TA) compcnentsto address technological, marketing, managerial and skills problems of SMIin subsectors with strong growth employment and export potential as well asto strengthen the institutional capabilities of the PCIs and NDB. IDAfinanced equipmeat, advisory inputs, and training to enable the IndustrialDevelopment Board (IDB), the main government agency involved in assistingSHI, to establish specialized product development and extension centers inthe following areas: rubber products, building materials, and heat treat-ment, common service facilities, and a subcontracting exchange to serve theengineering industries. A Clothing Industry Training Institute (CITI) wasalso established under the Ministry of Textiles. Under SHI II, the TA compo-nent focused on completion of the initiatives launched under SMI I givingparticular emphasis to building up IDB's extension activities at its regionalbranches through *coaching' of extension officers by specialists as well asexpanding the engineering service centers. A technical consultancy fund wasalso established in IDB to finance the provision of specialized extensionservices employing private sector consultants (para. 4.31, SAR, SMI II). Thecomponent also included technical assistance to the Export Development Boardto promote and assist SMI exports in 'light industrial" product lines.

4.23 The TA programs funded under both projects were implemented with rathermixed results. An independent assessment by GOSL of the impact of the tech-nical assistance programs established under the aegis of IDB is reproducedin Appendix I. The Rubber Products Development Center has been the mostactive of all the extension centers established by IDB but even 'the impactit has had is minimal and the large scale sector is mostly beyond its sphereof influence" (page 3, Appendix I). The subcontracting exchange processed62 orders worth Rs. 31 million in 1988 but its role has been 'mainly that ofa broker conveying market information to potential supplierso. While thisis a useful role, the exchange has not worked as a true subcontractingexchange involved in intermediating capacity information between small andlarger firms. A major limitation to the functioning of the exchange is thelimited number of large engineering industries that require subcontractingservices coupled with the small number of SMI engineering firms capable ofdoing precision work. The consultancy services made available to SMI firmsby IDB failed to have much impact except in isolated cases (e.g. mushroomfarming). However, the coaching provided to industrial extension officersappears to have produced some benefits in terms of improving their effective-ness but the sustainability of the program is questionable. The only centerwhich has been successful in its mandate is the Clothing Industry TrainingInstitute (CITI), whose main function is the training of garment industryworkers for garment firms involved in exports.

4.24 Two factors have affected the successful implementation of the programfirstly, the extremely ambitious scope of the overall TA program whosesuccessful implementation required exceptional organizational and managementskills on the part of the management of the relevant agencies; secondly, thelack of adequate incentives (salaries, etc.) to IDB's professional staffwhich made it impossible for IDB to retain staff trained at high cost. Thus,

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in the Engineering Division alone, 13 out of 23 trained officers left the IDBby 1987. It is clear that IDA was aware of the gravity of this problem atIDB and had made it a condition of disbursement that 0IDB would have ratifieda statement of policies and would have launched actions on these aspects ofIDB's organization, salaries, promotions and training, agreeable to IDA*.To ensure that these policies were actually implemented, IDB was required tosubmit annual action programs covering organizational and staffing changesand planned Implementation of elements under SMI II for IDA concurrence(para. 4.29, SAR). Unfortunately, it appears that IDA did not ensure throughits supervision that the above measures were carried out effectively.

4.25 A fundamental issue that arises in this review concerns the design ofthe overall TA program. It appears that the various industrial extensioncenters established under the project, with the major exception of the CITIand the lapidary school were mainly supply driven and not based on a carefulanalysis of demand for such services from SMI. This appears particularlytrue of the various engineering service facilities. Moreover, by establish-ing these centers under the ownership and management of the government mostlikely reduced their market responsiveness. An alternative approach toaddressing the TA needs of SMI would be to induce private sector firms toinvest in such facilities and subsidizing their use by SMI until they becomefinancially viable. This would have ensured a higher level of operatingefficiency as well as subjected the investments to market tests.

4.26 A part of the TA proceeds under SI II was earmarked for the promotionof exports of light industrial products, e.g. rubber, gems and jewelry, etc.(para. 4.33 of SAR) of SMI firms. The Export Development Board was allocatedUS$800,000 for providing SMI with practical consultancy, training, sales andexposure trips, etc. for export promotion as well as advisory assistance inimproving Sri Lanka's export policies and procedures. The EDB's influenceon improving export policies and procedures has been quite significant andpositive and is discussed more fully in para. 6.26.

4.27 The major uses of the TA funds by EDB under SMI II was for the estab-lishment of the Lapidary Training Center, the Jewelry Training School and theMushroom Development Center as well as in the provision of training, consul-tancy and market development assistance to SMI entrepreneurs. The LapidaryTraining Center, in particular, has been quite active in the training of alarge number of gem cutters and polishers and has had a catalytic effect inencouraging the establishment of a number of small private workshops. The

/ The Export Development Board was established by G08L in August 1979 to promote theexpansion of Sri Lanka's exports, particularly non-traditional exports through bothimproving export policies and procedures, assisting exporters with trade information, andmarket opening assistance, and assisting in the establishment of export-oriented projects.EDO is financed partly by a surcharge in tariffs applicable to certain imports. Over thedecade of the eighties, EDB has grown into a large institution with a wide range ofactivities stretching from financing of export-oriented projects, administering exportincentives programs and promoting non-traditional exports through product development andmarketing assistance. A recent evaluation report by the International Trade Centerrecomends a rationallaation and consolidation of D1B's activities to focus on product andmarket development involving some priority product areas in order to improve itseffectiveness (ITC/DTC/90/1298).

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other two centers have also had some success in diffusing technology andexport marketing skills to entrepreneurs. The success of these centers aswell as that of CITI suggests that center mainly providing training toskilled workers for specific export industries are likely to be more effec-tive than centers involved in such diverse tasks as product development andconsultancy services. The latter tasks in general are more diverse extensionexperts and require greater skill and experience which may account for theirless successful performance. Overall the EDB has been able to develop somedegree of expertise in assisting SMI firms in product and market developmentactivities. In contrast to the IDB, EDB's management appears to have beenmore successful in building up staff with a considerable degree of expertiseand professionalism. However, EDB also has been unable to compensate itsstaff in line with the market which has led to a great deal of turnover .3

well as erosion of staff morale. EDB's management is attempting to deal WLththese issues as part of the rationalization effort underway.

E. Sustainability

Project Benefits

4.28 Based on the information available from the limited surveys of sub-project performance and the repayment performance of subborrowers, thesustainability of a large segment of subprojects financed under SMI I isdoubtful but the situation is slightly better for SKI II. Sustainability inthis context refers to the ability of the subprojects to continue to generateexpected benefits over their useful life. These benefits include employment,output and profits. Without financial viability it is likely that employmentand output levels would not be maintained.

Sustainability of Institutions

4.29 The sustainability of the institutions supported through the TA pro-grams also presents a mixed record. The lack of success so far of the vari-ous initiatives supported under the umbrella of the IDB and the serious dif-ficulty of the IDB in retaining qualified personnel makes the sustainabilityof these initiatives very doubtful. On the other hand, CITI and the EDB havehad considerable success in both assisting SKI as well as in overall exportpromotion. The sustainability of these benefits is more likely, particularlyif EDB is strengthened through greater focussing of its core activities.

4.30 With regard to the issue of SMI financing, the sustainability findingis less clear although IDA is embarking on a fourth SKI line of credit. Itis not certain that the financial institutions, particularly the commercialbanks, have developed either a capability or a sense of commitment in thisarea that they would continue to finance SHI from their own resources withoutaccess to refinance from the SKI department. The PCI's perception, that SHIlending carries high risk and high transaction costs suggests that the volumeof SMI financing would decline without support from Government, particularlyin the form of refinance at a high spread. DFCC's SKI lending operations,although targeted at the relatively higher end of the SKI range has been moresuccessful in that subprojects financed have a higher chance of viability and

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operations are profitable. However, DFCC's ability to finance SMI lendingfrom its own resources would depend on its ability to mobilize local currencyresources at an appropriate cost (para. 5.11).

F. Conclusions

4.31 The two SMI projects were implemented with mixed results. On the posi-tive side, the credit financed a large number of subprojects which createda significant number of jobs (even after discounting for job losses due tothe subsequent failure or poor operational performance of the borrowers) ata very low capital cost per job of about US$1500). The employment impact ofthese projects is extremely important in a country with a significant levelof unemployment. The projects have also played a critical role in bringingSMIs into the formal financial system and providing them access to commercialbank financing for both fixed assets and working capital. The participatingcommercial banks, in turn, have also benefitted greatly from the training andtechnical assistance provided under the loans which have augmented theircapabilities. The projects have also helped GOSL to acquire a greater aware-ness of the constraints to the development of the private sector, particular-ly those faced by SMI, and to formulate an integrated policy framework toaddress these issues (see A Strategy for Industrialization in Sri Lanka,Ministry of Industries, Sri Lanka, December 1989). The TA program for tradepolicy reforms, in particular, helped to build up a capacity to analyze thetrade regime and make appropriate changes.

4.32 On the negative side, the projects have not been able to achieve sub-stantially a number of their objectives. The bulk of the subprojects havebeen in traditional product areas whose growth potential is limited ratherthan in products with more dynamic growth prospects. Subprojects have limi-ted export potential, either directly or indirectly and there appears limitedscope for establishing inter-industry linkages. The technical assistancecomponents of both loans seem to have fallen far short of expectations andhave not achieved any significant results in terms of institutional develop-ment except in a few specific cases. The inadequacy of the TA program isreflected to a large degree in both the nature of the subprojects financedand their poor operating performance (high arrears).

4.33 The objectives with regard to strengthening the commercial banks'abilities to provide term financing to SMI on the basis of project appraisalwithout resorting to excessive dependency on collateral has been met to alimited extent only. Institutional development in this area appears somewhatbelow expectations. It appears that IDA may have misjudged the extent anddepth of changes required in the commercial banks to reorient their lendingpractices away from collateral-based lending as well as the limitations inthe overall policies and management of the two largest banks stemming fromtheir public ownership. These issues are now being addressed undersucceeding loans.

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G. Lessons Learned

4.34 The PCR (Report No. 6795, paras. 7.09-7.14) points out a number ofimportant lessons concerning the eligibility criteria for defining subloanbeneficiaries, promoting sectoral and regional diversification of subprojectsand financing of new entrepreneurs, constraints in utilizing public institu-tions as delivery systems for channelling technical assistance to SMI and theuse of commercial banks as intermediaries for on-lending. Additionalfindings are discussed below.

Use of Commercial Bank as Financial Intermediaries

4.35 The implementation experience clearly indicates that unless commercialbanks are prepared to make a substantial effort towards building up aspecialized organization structure for lending and servicing SMI loans, theresults are unlikely to satisfactory. This organization structure has to bedecentralized downwards, at least to the level of major branches and staffedwith adequately trained individuals. Such an investment in organizationbuilding would imply that the intermediary adopts lending to SMI as part ofits long-term corporate strategy and not has a transient involvement due tothe availability of IDA/World Bank credit lines. Thus, in SKI lending opera-tions involving use of commercial banks, the World Bank should allow onlythose commercial banks to participate which are prepared to make a long-termcommitment to SMI lending. Allowing all commercial banks to participate onthe basis that greater competition would improve the project impact does notseem to be born out by results.

Role of the Apex Institution

4.36 NDB's SMI Department has played a useful role in terms of acting as acentralized information collection agency on subloan commitments anddisbursements and monitoring the collection performance of the PCIs, settingappraisal norms and improving appraisal standards, and training PCI staff.However, its impact on improving the efficiency of SMI lending operations ofPCIs has been limited by its own staffing constraints. Its involvement insectoral studies on SHI development has been minimal for the same reason.The TA fund being managed by the SHI Department under SMI III has yet to makea noticeable contribution to generating new types of investment. Theeffectiveness of this fund would be considerably enhanced if local consul-tants could assist potential SMI to prepare project proposals for financingby the Fund. This arrangement would also ensure proper supervision of theuse of its proceeds (para. 4.39(c)).

4.37 An apex institution has an important role in monitoring and promotingSKI lending, particularly in the early stages. However, the establishmentof such institutions also entails considerable institution building effortwhich should be recognized and provided for in the project. Additionalfunctions that can be performed by the apex body include operation of thecredit guarantee operation which would benefit from the deeper insight thatthe apex institution would have of SMI lending and the PCIs capabilities.Finally, a SHI fund of the type established under these projects can generate

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significant resources from the "float' arising from the differences in thematurity structure of its assets and liabilities. Given the extreme shortageof equity capital faced by SMI entrepreneurs, particularly new entrepreneurs,the potential use of these resources in equity support should be explored.

On-lending Terms

4.38 On-lending terms for SMI subborrowers should follow norms for commer-cial loans as otherwise first time SMI subborrowers may not observe thefinancial discipline required. It is also important that prudentialfinancial ratios are observed, particularly debt service coverage and debt-equity ratios. Excessive gearing, as is observed in many SMI subprojects,increases the vulnerability of subprojects to temporary setbacks which mayaccount for the high level of non-performing loans.

Technical Assistance

4.39 The following points emerge from the reviews

(a) As corroborated by the Bank's experience in other devel-oping countries, the use of public sector agencies asdelivery channels for technical assistance is fraughtwith high risk of failure because of the inherent prob-lems of such bureaucratic organizations in performingeffectively -- low staff morale and efficiency, inabili-ty to retain trained staff, and inadequate managementbecause of restrictions on salaries and political inter-ference. In this case, the TA components were far tooambitious and did not adequately take into account theconstraints arising from limited management capabilitiesand government regulations;

(b) The product centers were set up without an adequateassessment of the demand for their services; in otherwords, they were supply driven. The training centersfor clothing, gems and jewelry were set up in responseto clearly identified demand for skilled workers inthese industries which were experiencing strong growthfrom export demand. Consideration should be given tosetting up vocational training centers in other indus-tries which have good growth potential.

(c) To overcome the limited availability of trained person-nel in Sri Lanka, flexible working and compensationarrangements should be adopted by banks to induce quali-fied technicians and professional managers working inthe private sector, universities, etc. to assist SMI ona continuing basis after a loan is granted. The finan-cial intermediaries could also establish technicalassistance groups in-house.

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(d) the high incidence of project failures in the case ofnew entrepreneurs as well as the paucity of projects innew technology/new product areas suggests an acute needfor technical support for this class of entrepreneursincluding training in business management. Given theshortage of local skills, effective training may requireforeign advisory inputs including on-the-job trainingabroad in relevant industries. The financial institu-tions may wish to establish an entrepreneurial develop-ment center, run on private lines to deal with theseneeds.ZJ The TA fund in NDB could also provide assis-tance for this activity.

(e) There is a scarcity of qualified consultants to assistSKI. This deficiency could be met by training programsfor appropriately qualified and interest individuals whowould be interested in setting up consulting businessesin the private sector. NDB and other financial institu-tions, with assistance of IDA, could help to organizethese training programs.

V. EVALUATION OF IDP I

A. Objectives and Design

5.01 IDP I, which was the third in the series of credits to the GOSL forindustrial development after 1977, was designed to increase output, employ-ment and efficiency of both private and public enterprises through bothinvestment finance and support for policy reform (SAR, para. 3.01). Itcomprised a credit component (US$23 million) for on-lending by the twodevelopment finance institutions (DFIs) - NDB and DFCC and a technicalassistance component (US$2 million) aimed at: (a) strengthening the systemof industrial finance by improving project promotion, appraisal and super-vision procedures of the two DFIs, rationalizing the interest rate regime forindustrial lending, and assisting in establishing an equity fund under NDBto provide scarce equity resources to new private projects; (b) assisting inimproving trade and industrial policies, particularly with regard to tariffreform and industrial incentives, building on the study of effective protec-tion undertaken earlier under the SHI-I Credit (SAR, para. 3.08); and (c)assisting in improving the performance of public manufacturing enterprises(PMEs) by introducing corporate planning, performance incentives coupled withgreater autonomy for management and encouraging ways to increase privatesector participation in ownership and management of PMEs (SAR, para. 3.07).Under the credit component, NDB was expected to finance mainly private

ff I0 has estabitshed a Center for Entrepreneurship Development and Consultancy Services(CEDACS). However, CEDACS could suffer from the same problem that have affected IDB'sother operations. If CEDACS could be operated along privae lines with close links to thefinancial Institutions, It could substitute for the proposed center.

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projects; financing of public sector projects was restricted to balancing,modernization and replace)ent except for joint ventures (SAR, para. 3.03).The DFIs were also expected to promote consortium financing Lnvolving anumber of financial institutions with the objectives of spreading lendingrisks, offering a wider menu of financial services, improving appraisal andsupervision standards, and providing a mechanism for bringing in investmentand pension funds to finance suitable projects (SAR, para. 3.06). The TAcomponent included assistance for the Sri Lanka Capital Development andInvestment Company (CDIC), established in 1982 to provide equity finance tonew ventures receiving term loans from financial institutions, and tostimulate the growth of the capital market (SAR, para. 3.05). In terms ofthe financing of industrial projects, IDP I was a typical DFI operation butthe noteworthy feature was the provision of financing for studies whichallowed IDA to engage in a dialogue to further important policy reformsinvolving the trade regime and the public enterprise sector.

B. Implementation Experience

Credit Component

5.02 The credit component of SDR 21.5 million was fully committed within thethree years envisaged in the SAR. The TA allocation was enlarged slightlyfrom SDR 1.85 million to SDR 1.865 million and was fully committed by theclosing date of September 30, 1988. Disbursements were completed by March1989, nine months behind schedule. A total of 127 subprojects were financed,of which 120 were below SDR 0.5 million (PCR, para. 5.4). Only 13 subproj-ects were above the free limit. DFCC on-lent 60Z of the credit by amount andaccounted for 64Z of the total number of subprojects.

5.03 Ex-ante ERRs for DFCC's subprojects varied between 15Z (automobilebattery) and 5OZ (textiles). Ex-post ERRs have not been calculated by DFCC.NDB has calculated ex-post ERRs for only two subprojects which ranged from7% to 8%. In terms of financial performance, 68 out of 90 DFCC subloans and32 out of 47 NDB subloans were operating satisfactorily and meeting repaymentobligations on time.Y Metals, chemicals, and engineering subprojectsaccounted for half of the total credit. The project created 3128 jobscompared to 2,500 estimated in the SAR; the average cost per job created wasRs. 385,903 (US$12,833) compared to US$15,000 estimated. Many of the firmsin difficulties are in traditional industries and services. Performancefailures have been due to -#eak management and financial problems of borrowingfirms as well as due to the severe civil unrest prevailing in Sri Lanka formuch of this period. Against this background, subproject performance cannotbe faulted too strongly.

8 These numbers refer to subloans rather than to subprojects, some of which have receivedmore then one subloan. In the case of DFCC, some thirteen subprojects had arrears ofprincipal and interest as a percentage of loan balance exceeding 101 as of March 81, 1989;for NDB the corresponding number was nine.

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C. Performance of Financial Intermediaries

Development Finance Corporation of Ceylon (DFCC)

5.04 As noted above, DFCC's performance In the utilization of the credit hasbeen on the whole satisfactory. However, an important auxiliary objectiveof IDA was to continue to assist in DFCC's institution building which hadbeen major objectives of the two previous credits through the provision ofadvisory inputs. This section briefly reviews DFCC's overall development andperformance during the implementation of the project (1983-89).

Ownership

5.05 Prior to 1983, about 561 of DFCC's shareholding was held by the localprivate sector, 30% by three foreign investment institutions (IFC, DEG, andFMO) and 142 by two government owned banks (BOC and PB). Following two over-subscribed issues in 1983, which increased its initial capital from Re. 8million to Rs. 100 million, the two government banks increased their holdingto 39Z, the foreign institutions to 32.4% with the balance being held bypension/trust funds, individuals and private and public corporate bodies.Although two directors are appointed by the GOSL, and two more are appointedby government-owned banks, government control or involvement is not overt.However, the presence of the two competitor public sector banks in DFCC'sboard may not serve DFCC's interests. Greater private sector representationmight be beneficial to DFCC in its quest to become more responsive to themarket.

Institutional Aspects

5.06 As of March 1983, DFCC had a staff of 108, of which 39 were profession-als By 1990, the total had increased to 160, of which 76 were professionals(including 14 management trainees). Considering the sizeable growth inoperations, staffing levels have been contained tightly but this appears tohave been influenced by a high degree of turnover resulting from both non-competitive salaries as well as other external factors. DFCC has tried tocompensate for this attrition through extensive training programs supportedby IDA and ADB but success in this regard has been limited. Inadequateavailability of qualified staff has been a major factor behind DFCC's failureto implement its strategic plans as well as deficiencies in certain opera-tional areas. A high level of attrition of senior executives has led toweaknesses in overall operations management. However, DFCc's overall opera-tional procedures (appraisal, supervision, dealing with problem projects,etc.) are satisfactory, although some weaknesses, particularly in appraisinglarger projects, have been pointed out earlier by IDA. A substantive areaof weakness is deficiency in economic and sector/subsector studies. Thiscapability will become increasingly important in a more liberalized economy.DFCC is in the process of implementing a broad-based computerized managementinformation system which should enable significant improvements in staff andmanagement efficiency. A fully computerized accounting system is in place.

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Operational Performance

5.07 DFCC's main business involves providing long-term loans to industry(962 of gross approvals in FY90) which is supplemented by equipment leasingand bill discounting operations (the latter to finance permanent workingcapital). DFCC also engages in a small way in equity investments in compa-nies it lends to. Between FY1982 to FY1987 gross approvals increased by 20%p.a., although approval levels were sharply down in FY1983 due to ethnicdisturbances, economic slowdown and DFCC reaching its debt-equity limit of7:1 (Annex 3, Table 1). During the past four years (FY86-FY90) growth ofapprovals has increased at an average rate of 27% p.a., attesting to DFCC'ssuccess in increasing market share. Until 1982 lending for hotels was amajor focus of lending, accounting for 33Z of portfolio. The collapse of thehotel industry in 1983 forced a sharp reduction in lending to that sectorwhich reduced the hotel industry's share in the portfolio to about 12.6? in1990 (Annex 3, Table 2(a). Food, garments, chemical products, engineer-inggoods and paper and printing accounted for over 60? of gross approvals inFY90 (Annex 3, Table 2(b). As of March 30, 1990, DFCC's investment portfoliocomprised 739 projects with loans accounting for 93?, leases 3? and shareinvest-ments 4? of the total portfolio value of Rs. 2408.8 million. Over thepast five years, the share of foreign currency loan approvals have steadilyincreased and accounted for over 55? of total approvals in FY90 (Annex 3,Table 3). DFCC has continued to finance SMI projects extensively; loansbelow Rs. 5 million have averaged about 23Z of total approvals between 1983-89, which reflects the availability of targeted resources under the Bank'sSMI credit lines (Annex 3, Table 4). DFCC's future strategy (para. 5.11)calls for a higher growth in financial leasing and bill discountingoperations compared to loans, with the share of these non-traditionalproducts increasing to 14? of gross approvals by FY1995 (Annex 2, Table 1).

Financial Performance

5.08 DFCr,'s net profit after taxes (NPAT) increased from Rs. 12.5 millionin 1981 to Rs. 16.7 million in 1985 and to Rs. 112.1 million in 1990 (Annex3, Table 5). Profits after tax as a percentage of average total assetideclined from 4? in 1982 to 2.0? in 1984-85 but has improved gradually sincethen to reach 4.1? in 1990. Similarly, return on average equity has reached29.2? in 1990. The deterioration in performance during 1984-85 was due tosignificant increases in levels of specific and general loan loss provisions,and a decrease in net spread (see para. below). In addition, DFCC stoppedaccruing interest on loans which were overdue by six months or more. Since1986 the improved financial performance can be traced to the rapid growth ofthe portfolio, better use of leverage, continuing reduction of operatingexpenses and a higher earnings spread. The table below summarizes thefinancial indicators for FY84-FY90. DFCC's balance sheets for FY82-FY89 aresummarized in Annex 4, Table 6.

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Summary of DFCC*s Financial Performance andFinancial Position - Key Indicators: FY194-FY1990

FY ended March 81 1984 1985 1986 1987 1988 1989 1990

RatiosToR/*quity ratio 8.8:1 4.8:1 6.2:1 6.7:1 8.4:1 6.4:1 6.5:1Debt Service coverage (times) 1.1 1.2 1.8 2.0 2.1 2.8 2.4

Return on equity (X) 9.8 10.8 16.8 20.5 23.0 24.6 29.2Interest spread 6.7 8.4 8.9 4.2 4.8 3.8 4.6Earnings spread 5.5 4.0 8.8 4.5 5.1 4.2 4.8Operating expenses/averagetotal asset (%) 1.8 1.3 1.0 1.0 0.8 1.1 1.2

Current ratio (times) 2.1 1.6 8.2 8.2 2.5 3.0 3.1Collection ratio (X)o 66.3 80.9 78.8 85.1 80.3 78.6 88.7

* Collection ratio after rescheduling and write-offe.

Portfolio Management

5.09 DFCC's portfolio was badly affected following the ethnic disturbancesin 1983 when the hotel sector collapsed due to the virtual cessation oftourism. DFCC's exposure to the hotel sector constituted 32.6z of its port-folio in 1984; by the end of FY84 over 512 of its total portfolio wasaffected by arrears (Annex 3, Table 8). In April 1985 (FY86), GOSL providedrefinancing of Rs. 14.3 million of DFCC's hotel arrears with funding at 6%interest through the Central Bank which has eased the situation. Partly atIDA's suggestion, DFCC responded aggressively to the deteriorating collectionperformance (Annex 3, Table 9) by introducing a comprehensive restructuringprogram covering all projects in arrears over six months. A separaterestructuring unit was established to deal with corporate workouts. Never-theless, total loans affected by arrears over three months as a percentageof total loan portfolio stood at almost 20Z as of September 30, 1990. How-ever, if hotel loans, which are covered by the government moratorium areexcluded, this percentage reduces further to 12.52 (Annex 3, Table 10). Animportant issue in this context is DFCC's treatment of hotel loans includedin the relief program. DFCC does not consider these loans non-performing andhas not made any specific provisions. However, when the program expires in1993, write-offs will need to be made, the extent depending on the health ofthese projects. It is difficult to gauge the extent of this write-off now.DFCC has been transforming 402 of its profits which is exempt from income taxto a general reserve for loan losses which totalled Rs. 153 million in FY90.The adequacy of this policy needs to be assessed by DFCC and the Bank on aperiodic basis.

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Resource Mobilization

5.10 DFCC's major sources of funds in FY90 were internal cash generation(262), portfolio recoveries (422), local currency loans (8X) and foreigncurrency loans (242). In the past DFCC was allowed to sell 8-year bonds atsubsidized rates (7Z) to local commercial banks which counted as part (up to1/8th) of their reserve requirements. A total of Ra. 398.6 million wasraised. However, with the liberalization of the financial sector, it isuncertain whether DFCC will be allowed to raise funds on concessional terms.DFCC will need to explore alternative mechanisms to raise local currencyfunds at market rates and utilize these resources in appropriate ways. e.g.switching to variable interest rates for working capital loans may give itflexibility to use resources raised through floating rate debentures. DFCC'sability to utilize resources mobilized on commercial terms and use it withan adequate spread will depend on macroeconomic policies followed by theGovernment, as well as financial sector liberalization and development. Itis likely that while these riforms are being put into place, DFCC willcontinue to need access to concessional funding for part of its resources.However, diversification of local currency funding sources through newfunding instruments as well as corresponding changes in loan and leasepricing should be explored actively.

Strategic Planning, Institution Building and IDA's Role

5.11 DFCC's strategic planning and organization structure have been majorand continuing foci of attention of both ADB and IDA stemming from concernabout DFCC's ability to compete effectively in the changing economic environ-meat. IDA assisted DFCC's management to formulate a strategy statement forthe 1982-86 period (SAR, Annex 10), which took into account IDA's suggestionson project promotion, sector studies, diversification of financial servicesand manpower development needs. IDA felt DFCC should give special emphasisto project promotion. Establishment and adequate staffing of a projectpromotion unit was made a condition of DFCC's participation in IDP-I. Inaddition, 24 man-months of advisory inputs was made available as TA for DFCCto strengthen project promotion activities. DFCC, however, did not act onthis initiative as it felt that its regular operational staff could undertakepromotion work satisfactorily in addition to normal operational activities.It was not until 1985 that efforts were made to recruit staff since staffingthe unit became a condition for participation in IDP II.

5.12 Following the economic disruptions in 1983 another strategic study wascarried out with the help of consultants (an Asian DFI) at ADB's initiative.Based on the study, DFCC prepared a new strategic plan for the period 1986-91, which emphasized the need for achieving a more rapid asset growth, whilediversifying products and services and improving profitability. The specificproposals for diversification were the provision of working capital loans,financial leasing, agricultural lending, export finance, insurance brokering,money market operations, unit trust management and letters of credit. Thenew strategy also envisaged diversification of the sources of funds for DFCCso that no one source comprised more than 201 of the total as well as thedirect mobilization of local currency resources through the issue of bonds.

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The internal organizational strength was to be enhanced by recruiting addi-tional staff and adding new departments, including departments for economics,development, training, etc. Ambitious financial targets envisaged an annualcompounded rate of increase of gross finance approvals amounting to 17.3%p.a., a compounded portfolio growth of 23Z p.a. and growth of assets of 19.4Zp.a. The profitability targets aimed at a profit after tax increasing fromRs. 28 million in fiscal year ending March 31, 1986 to Ra. 123 million infiscal year ending March 1991.

5.13 As discussed in para. 5.07-5.08, this strategic plan was only partiallyrealized. While the financial indices for 1985/86 and 1986/87 were generallyon target, profits were much lower in 1987/88 due to erosion of interestmargins. However, the major shortfall was the failure to implement most ofthe new business initiatives, e.g. unit trust, letters of credit, moneymarket operation, etc. According to DFCC management, the main reason for notbeing able to implement the strategy was human resource constraints arisingfrom the departure of many senior staff with requisite skills.

5.14 DFCC commissioned yet another strateric study with the help of foreignconsultants in 1987 at the instance of IDA (financed under IDP II) to re-assess its competitive thrust, the major rationale being the need for afundamental reassessment of DFCC's role in the financial system. Theconsultant's study, which took into account the expected economic develop-ments in Sri Lanka, recommended that DFCC consolidate and improve itsexisting lending operations and diversify into advisory, consultancy,:,erchant banking and capital market operations. It emphasized that DFCCshould focus on human resource development and staff motivation andstrengthen its organizational capability to implement the recommendations.

5.15 Based on this new study, DFCC prepared a new strategy statement in 1988which highlighted three functional areas for intensive development with theassistance of foreign advisors - Corporate Planning and Development, MerchantBanking, and Personnel Development. The strategy also called for changes inthe organizational structure to implement the new programs and tasks moreeffectively.

5.16 The new strategy is under implementation with IDA advisory assistancefinanced under IDP III. A new Action Plan for 1991-95 has been finalizedwhich identifies major new activities and formulates specific steps to carrythese out. The action plan, which is extremely ambitious in scope, not onlyfocuses on the development of new activities, e.g. venture capital manage-ment, property development, unit trust op:ration, provision of consultancyservices in privatization and corporate workouts, but also involves thestrengthening and improvement oZ a range of internal systems and proceduresincluding appraisal, approval and disbursement of both term loans and leas-ing, legal procedures including collections, management information systems,etc.

5.17 DFCC has also reorganized itself in order to implement the newstrategy. The new organization consists of six divisions, viz. Credit,Investment Banking and Promotion, Research and Development, Finance,

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Legal/Administration and Internal Audit. The first three are headed by aDeputy General Manager and the last two by Assistant General Managers. TheCredit Division consisting of four Credit Departments, iu responsible forappraisal, implementation and the monitoring of projects. Each CreditOfficer is responsible for both appraisal and the monitoring activities ofclients. The Investment Banking and Promotion Division covers the functionalareas of financial services, advisory services, rehabilitation, businesspromotion, leasing and insurance services. The Research and DevelopmentDivision oversees research, development, human resource development andinformation technology while the Finance Division controls three functionsof accounting, loans administration and treasury functions. Finally, theLegal and Administration Division oversees legal, office administration,secretarial and personnel functions and has responsibility for branchoperations.

5.18 The new strategy and organization structure seems sound and shouldenable DFCC to position itself properly to respond effectively to thechanging economic situation in the nineties. However, while this strategyappears good on paper, success will depend on its effective implementation.DFCC's previous strategies which share a lot of common elements with the newstrategy could not be effectively implemented primarily because of internalhuman resource constraints, although external factors, particularly theunsettled ethnic problem, were also relevant. DFCC's management is aware ofthis issue. There is clearly a need for DFCC to offer salaries in line withother private competing financial institutions, including foreign banks inorder to attract and retain capable staff. There is also a need forstrengthening management practices, particularly performance evaluation andthe reward system. DFCC's success in the coming years will primarily dependon how successfully it is able to deal with these issues as well as furtherpolicy reforms in both the real and financial sectors in order for it tobecome financially self-sustain'ig. DFCC actively needs to explore mecha-nisms for mobilizing local currency resources from the market and also chargehigher and more risk differentiated lending rates to obtain an adequatespread on its operations.

D. National Development Bank of Sri Lanka (NDB)

5.19 Btckground. NDB was established in January 1979,-V with the principalobjectives of providing medium- and long-term credit to private and publicindustries and mobilizing internal and external resources, including stimula-tion of capital markets. It is empawered to offer a wide range of financialservices, including direct lending, refinancing, underwriting and financingequity and debenture issues, providiiig guarantees, accepting deposits andissuing letters of credit. NDB's authorized share capital is Rs. 2 billion(about US$50 million), of which Re. 600 million has been paid up. 1

Although NDB's Act makes provision for issuing shares to the public, the

/ Under the National Development Bank of Sri Lanka Act of 1979.

L0/ Of this amount, Re. 460 million was In cash and Re. 160 millIon in promissory notes of theNCB*.

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initial issue was taken up by GOSL (672), CBC (17Z) and by People's Bank andthe Bank of Ceylon (82 each). NDB enjoys the full support of GOSL, its majorshareholder. In accordance with the NDB Act, GOSL bears the exchange riskon NDB's external borrowings has granted NDB a tax holiday for the first tenyears of operation and guarantees NDB's borrowings from internal and externalsources. NDB is under the general supervision of the MOFP and its adminis-

trative budget is subject to the approval of the Minister of Finance andPlanning.

5.20 Institutional Aspects. NDB's operations are controlled by its Boardof six Directors, all of whom are appointed with the concurrence of theMinister of Finance and Planning. The Chairman of the Board is appointed bythe Minister for a period of four years. The Board meets regularly to setNDB's overall operational policies and role in the financial sector as wellas to approve all direct lending proposals. The Chairman also acts as the

Managing Director. NDB was fortunate in being able to attract and retain a

highly experienced and able person as its first Chairman until his retirementin 1990. His replacement is also an extremely well qualified and experiencedmanager. The present senior management structure has evolved from the recom-mendation of a study financed under IDP II but is yet to be fully implementedbecause of NDB's inability to attract and retain qualified professionals.There were twelve vacancies out of 26 senior management positions as ofDecember 31, 1990. The staffing problem has been a serious constraint sincethe early 1980s but has exacerbated as more private financial institutionshave entered the market offering higher salaries. Unless resolved, this

problem is likely to constrain NDB's ability to become a competitive insti-

tution. Recent moves to privatize NDB are a step in the right direction.Nevertheless, the salary issue needs addressing on an urgent basis. NDB's

professional staffing levels have not increased significantly since 1985.While this can be viewed in a positive light reflecting increasing staffefficiency, a growing institution like NDB needs to have a reservoir oftrained staff to draw upon during periods of stress.

5.21 Policies and Procedures. NDB's operational policies are governed by

its Act and more specifically by its Operating Policy Statement which was

last amended by NDB's Board on March 5, 1988. Although the amended policy

statement provides for an increased focus on expanded operations to develop

Sri Lanka's capital markets, the major operational emphasis remains on NDB's

role as a project promoter and financier providing financial facilities in

local and foreign currency to support the development of public and private

industries in Sri Lanka. NDB has been providing assistance through (M)

medium and long-term loans for fixed assets and permanent working capital

requirements; (ii) refinancing of loans made by other banking institutions

through the operation of the SMI Fund; (iii) equity investment; (iv) syndi-

cation and underwriting of equity and debenture issues; and (v) equipment

financing and leasing activities; and (vi) guarantee operations. However,

its involvement to date in equity, underwriting and guarantee operations has

been limited in comparison to its project lending operations. NDB's

appraisal procedures and project supervision practices are generallysatisfactory.

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Operational Performance

5.22 NDB's operational performance is presented in Annex 4, Table 1(a). Netloan approvals including equipment finance increased from Rs. 361.8 million

in 1980 to Rs. 1735.40 in 1990 or at an average annual rate of 17?. SMI

refinance activities have accounted for about 20? of total approvals between1979-89 with the share of SMI increasing during the latter half of the

decade. Out of the total of 859 projects financed in the decade 1979-89, 676projects accounting for one-third of direct financing approvals (Annex 4,

Table 1(b)) were below Rx. 10 million; another one-third (141) fell between

Rs. 10 million - Rs. 25 million while the remaining 42 projects were over

Rs. 25 million. The bulk of NDB's direct financing has gone to the private

sector. Public corporations and GOBU's accounted for only 41 loans totallingabout 10? of total direct funding. In terms of sectoral distribution, metal,

chemical and plastic products had the highest share (19.7?), followed byservice industries-financial, construction, storage, etc. (19.2?), food,

beverage and tobacco (13.1?), rubber products (9.8?) and agri-business

(9.1?). The hotel sector accounted for 38 loans comprising 6.3? of total

direct financing facilities. Equity financing has comprised on average less

than 5% of total approvals and amounted for Rs. 125 million (US$3 million)

in 1990 (Annex 4, Table 2).

5.23 NDB's foray into capital market activities was initiated in January1988 when a new merchant banking unit was established. In 1989 the unit

underwrote part of the share issue of Union Assurance Ltd, Seylan Trust Bank,a Venture Capital Investment Company, and a new share trading company.

Besides acting as a manager to share or debt instrument issues, the unit has

been providing advice relating to preparation of documents, prospectuses,etc. NDB has also been acting as a market maker for shares of selectedcompanies.

Financial Performance

5.24 Key indicators of NDB's financial programs and financial position for

the period 1984-89 is summarized in the table below. Annex 4, Table 3, pro-vides a 10-year (1980-89) statistical summary of NDB's financial performance.

Although asset growth has been respectable, financial performance has been

lackluster. Return on equity which averaged 14? between 1980-82 declined

steadily to only 8.0? in 1990. Return on average total assets was also 7.62.

NDB has an overly conservative financial structure (debt/equity = 39:62 in

1990) and the debt service coverage ratio has been over 3:1. However,

declining interest spread has been a factor influencing this performance.

Interest spread declined from 6.8? in 1984 to 3.92 in 1989 because of higherborrowing costs (which is linked to the average weighted prime rate (AWPR)

and fixed lending rates.w NDB, however, plans to apply variable interest

rates based on the AWPR for a wide variety of loans.

LJ, Because of its tax free status, NDB has not been expensing provisions. Had NDS expensedprovisions of Re. 120 million for bad debt, It would have a n*t loss of 0.65 on averagetotal assets. NDB's provisions as of December 1989, were actually unexpensed reserves.

It has begun true provisioning from 1/1/91 following expiration of Its tax holiday.

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NDB: SUMMARY OF FINANCIAL PERFORMANCE AND FINANCIALPOSITION - KEY INDICATORS

FY ended 81 Dec. 1984 1985 1988 1987 1988 1999

Ratios: /aDebt/*q-uTty ratio 0.40 0.6 0.81 1.20 1.2:1 1.4:1Debt service coverage

ratio (tlmes) 6.16 4.27 8.49 8.12 12.2 8.9Return on equity (X) 12.1 10.8 8.7 7.1 8.1 8.0Intereet spread 6.8 7.2 2.4 2.8 8.4 6.9Earnings spread 12.2 10.69 7.58 4.49 5.9 6.8Operating expenses/

average total assets (X) 1.2 1.8 1.2 1.0 1.0 0.9Current ratio (times) 7.5:1 5.7:1 6.1:1 7.4:1 8.1:1 8.8:1Collection ratio (f) 68 77 79 80 76 75.6

5.25 Another critical factor affecting NDB's financial results has beendeteriorating portfolio quality. After 1984, when arrears were at an alltime high, the portfolio gradually improved until 1987; however, the port-folio infection rate has risen from 14% in 1987 to 432 as of December 31,

1989. Tourism, services and other sectors have contributed significantly tothe arrears in 1990 whereas manufacturing was the major offender in 1988-89.(Annex 4, Tables 4 and 5). NDB has taken vigorous steps to deal with its

non-performing loans through foreclosures and schedule as well as sharplyincreasing provisions for losses. As a result, the portfolio infection levelhas improved to 162 as of September 30, 1990 (Annex 4, Table 5). The collec-tion ratio has improved from 762 in 1988 to 90% in mid-1990. In order to

assist clients with financial problems, NDB has established a problem proj-ects unit in the operations department. This unit has been actively workingat restructuring non-performing projects.

5.26 NDB faces similar problems as DFCC in resource mobilization (see para.5.10 above) which has made it dependent on official sources of funding. Itneeds to explore alternative mechanism for raising Rupee resources. However,changes in the interest rate regime is essential for this to take place. NDBneeds to price its loans more aggressively because various Government subsi-dies (tax holidays and accounting policies that deferred bad debt expenses)and a large equity base has allowed it to set its interest rates at too low

a level. Rationalization of interest rates, a key objective of IDP I, stillremains to be addressed.

Institutional Development and IDA's Role

5.27 IDA has played a significant role in NDB's institution development over

the last ten years starting initially with the two SMI credits at.d later

through IDP- I, SMI-III and the subsequent IDP-II and -III credits. A Bank

Group staff member was seconded as senior advisor for two years to assist topmanagement in formulating policy and strategy and setting up operations.Technical assistance under the two SMI projects funded consulting assistance

from the Industrial Credit and Investment Corporation of India in developingsound systems and procedures and training staff. Under SMI II, technical

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assistance was provided on project appraisal, follow-up and supervision,accounting methods, and revisions to the operating manual. NDB was alsoassisted in designing and implementing a comprehensive training for staff ofthe participating commercial banks in term lending to SHI. IDP I provideda senior advisor and a banking advisor to strengthen overall operations andbuild up NDB's second management tier. The advisor assisted in the estab-lishment of a project promotion unit which unfortunately proved ineffectiveand was closed down in 1987. The focus of the promotion effort was onmarketing, whereas a more deeper approach based on promoting new technologiesand linkages with foreign and promising local firms was probably called for.Another area where progress has been limited concerns building up NDB'scapacity to undertake sector and subsector studies which was a key objectiveof IDP I. Strengths in this area would be of great value both in SMI lendingas well as in direct lending operations. Given the increasing openness ofthe trade regime and reduced regulatory control, it is vital that NDB buildup its capacity to undertake economic analysis of industrial sectors andsubsectors.

5.28 Under IDP II IDA financed a study by foreign consultants to examineNDB's organization, business activities and financial operations andformulate a strategy for its future role in the financial system. Thestudy's recommendations were received very positively by NDB's management andare being implemented with the assistance of foreign advisors financed underIDP III. Corporate planning, capital market activities and human resourcedevelopment are the areas being strengthened by the consultants.

5.29 There is no doubt that NDB has benefitted enormously from its relation-ship with the Bank Group. Besides the transfer of know-how, skills, poli-cies, procedures, et al, the Bank has always acted as a catalyst to NDB'smanagement, challenging them to explore new initiatives and new mechanismsto improve productivity. Relationship with the Bank Group has helped toshield NDB's management from interference by the Government into the day-to-day management of operations, a problem endemic among public enterprises inSri Lanka, allowing them to operate in a professional manner. The Bank'sregular supervision missions also were a constant stimulus to NDB's manage-ment and staff and enabled the Bank to spot potential problems in advance andget management attention to focus on them. While NDB has made substantialoverall progress, the deficiencies in staffing have been a major constrainingfactor in its overall development and could become binding if not addressedsoon. IDA could have taken a firmer stance on this issue much earlier.

5.30 Given the small size of the Sri Lankan economy and the dearth ofindigenous technical and marketing know-how, reliance on foreign firms fortechnology and management know-how to establish export-oriented industriesis vital. NDB could have played a more active role in this regard withappropriate IDA support. Finally, in the resource mobilization area, NDBremains overly dependent on official sources of financing for both local andforeign exchange. While raising foreign exchange from market sources mightbe difficult, NDB needs to explore alternative channels for mobilizing localcurrency resources, particularly as the money and capital markets aredeepening. This area deserves greater attention in its development strategy.

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VI. EVALUATION OF INDUSTRIAL POLICY REFORMS

6.01 IDA's strategy for promoting industrial davelopment in Sri Lanka hasfocused on assisting the Government to (a) adopt a more outward lookingpolicy regime by reducing import protection and offsetting the bias againstexports through appropriate export incentives; (b) improve resource alloca-tion by rationalizing the complex system of export and investment incentivesas well as reforming interest rate policies; (c) enhance competition throughreduction of barriers to entry, particularly licensing approvals, and facili-tating exit through improvements in debt-recovery laws; and (d) improvepublic enterprise efficiency through rationalization of rules and policies,physical and financial restructuring, improved performance monitoring anddivestiture. IDA has also been assisting the Government in improving thefinancial system and strengthening the technological and skill infrastruc-ture. The three projects under review assisted the Government in initiatingand furthering reforms in three major areas: public enterprise efficiency,import protection, and export policies. These are discussed below.

A. Public Enterprise (PE) Reforms

6.02 Following the IDA industrial sector mission of 1978 which examined thefactors affecting the performance of public enterprises, the governmentinitiated actions to improve PE performance by entering into managementcontracts with foreign private firms for five textile firms and establishingnew PE ventures only as private or public limited liability companies. Thesehad met with positive results and the Ministry of Finance and Planning (MOFP)was considering various alternatives to enhancing PE efficiency, e.g. a newcorporate law for all public enterprises aimed at increasing managementautonomy while enforcing higher performance standards. To assist theGovernment in exploring further initiatives, IDA included a substantial tech-nical assistance component in IDP I for both the MOFP and the Ministry ofIndustry and Scientific Affairs (HISA), which directly controlled 16 publicmanufacturing enterprises (PMEs).

6.03 MISA established a public enterprise cell (PEC) to implement its pro-gram of reforms which included assisting management of PEs prepare corporateplans, channelling firm level technical assistance to address specific prob-lems, instituting policy changes affecting PE performance, and initiatingpilot schemes to alter ownership and management. The objectives of thecorporate planning exerciseiv were to remove external controls over suchareas as pricing, procurement, personnel, etc. and replace these with acontractual system of signalling and rewards based on achievement of agreedtargets. The firm level assistance had two objectives - firstly to tackle

L/ Each corporate plan was to cover the following: (a) key performance targets, concentratingon Improvements in pubile prof Its with agreement on criterion values which would constituteacceptable and outstanding performance; (b) measures to be taken by the corporation toachieve these objectives; (c) criticaI Internal and external problems, and their impacton corporate performance; (d) valuation of assets based upon replacement rather thanhistorical costs; and (*) performance incentives for managers who exceeded the agreedtargets.

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specific firm level technical and management problems and secondly to demon-strate the merit of changing the system by implementing pilot changes in somePEs accompanied by loosening of controls. IDA provided two advisors to thePEC for two-year terms (1983-85) to assist in the preparation of the corpo-rate plans. Another 96 man-months of TA were provided to PEs under thecontrol of MISA for the firm level improvements.

6.04 A parliamentary Committee On Public Enterprises (COPE) had beenestablished in 1979 to review the performance of PEs. The Public EnterpriseDivision (PED) of MOF served as the technical arm of COPE. COPE's reportrecommended that PED function a the *focal point" on PE matters whichtranscend the normal supervisory work undertaken by line ministries. In

particular, PED was instructed to improve management information andperformance evaluation systems, corporate planning, financial policy andstructural policy issues in PEs in close cooperation with the line minis-tries. IDP I provided technical assistance and training to PED to strengthenits capabilities to undertake these functions. Arrangements were made underthe project to ensure that MOFP and MISA would coordinate their activitiesto ensure maximum impact.

Implementation

6.05 Implementation of the PE reform program was notable by its lack ofsuccess: primarily due to the lack of support for the program at the higherlevels in MISA and to some extent in the MOFP. The following excerpts fromsuccessive IDA supervision reports illustrate the problems encountered.

June 1984

"Since the Credit's effectiveness in January 1984, no action ofany real consequence has been initiated to meet the requirementsof Part C of the Project. Staff changes at the line Ministriesand at the Sector Corporations have contributed to the situation,but the delay is due to a lack of real commitment on the part ofsenior HISA officials, notwithstanding the commitments made atthe time of negotiations. This is evidenced by (i) the restrict-ed role of the PEC and the creation of a Progress Review Commit-tee; (ii) the inactivity in recruiting the Corporate Planning andMIS Advisors needed to develop the signallinglincentive system;(iii) the absence of any firm level technical assistance pro-grams; (iv) the proposed reallocation of TA funds for exposure

trips and (v) Government's inactivity in relaxing its controlsover the autonomy of the SICs'.

6.06 November 1984

*To address the many constraints (e.g. lack of autonomy, frequentmanagement changes, inadequate facilities) to the operating effi-ciency of the State Industrial Corporations (SICs), Part C ofCredit 1401-CE incorporated a two-part action program to improvetheir performance. The first part dealt with units under the

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control of Ministry of Industries and Scientific Affairs (MISA)while the second dealt with units/activities under the controlof the Ministry of Finance and Planning (MOFP). As of September30, 1984 the MIS action program was about 12 months behindschedule. The appointment of Corporate Planners to assist theSICs develop tbir objectives and control systems has not beenfinalized and this is not likely to be achieved before January1985. As required, a Public Enterprise Cell (PEC) has beenformed, but it has yet to work with the SICs to develop corporateplans and operating strategies. Planned firm level consultancyassistance to the SICs in the areas of (i) personnel policies andperformance incentive reviews; (ii) cost accounting and marketanalyses to enable the corporations to concentrate on competitiveproducts; (iii) assessment of balancing, modernization andreplacement, and energy efficiency investment need to improveproduction performance; and (iv) financial management, have yetto be taken up notwithstanding that the performances of the SICshas continued to deteriorate.0

6.07 "Part C of the project also provided finance for consultancyassistance to the MOFP to (i) improve management information andaccounting systems for all public sector corporations, focus onenterprises under supervising ministries other than MISA; (ii)tackle procedural and control issues which cut across publicsector enterprises; and (iii) prepare legislation which wouldfacilitate increased private participation in ownership andmanagement of public sector enterprises. As of September 30,1984 progress has been limited to the training of two officersat the Harvard Institute for International Development, and theparticipation of a three-member GOSL team in a conference inYugoslavia on public sector efficiency. This slow progress hasbeen caused in part by internal staff problems arising from therecent ethnic tensions and by the departure of the Director ofthe Division".

6.08 December 1985

'Notwithstanding GOSL's repeated commitment to improve theperformance of the public enterprises and to remove the burdenof their support from the Treasury, progress has been limited.Under the MISA Action Program, only the appointment of aCorporate Planning Advisor and preparation of a revised FY86 workprogram have been actioned. Despite on-going assessments byCOPE, ILO, individual Parliamentarians, and Select Committeesnothing has been done to develop policy measures to removeoperating constraints (e.g. procurement, personnel, investmentand pricing policies) or to implement specific firm levelrehabilitation/restructuring programs for the eight corporations(Paper, Hardware, Leather, Tyre, Ceramics, Mineral San4s, Saltand Cement) identified during the 1982 appraisal."

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6.09 "The action program to strengthen the MOFP's traditional functionas the advisory arm of the Parliamentary Committee on PublicEnterprises (COPE) and to act as financial management advisorsto the line Ministries and sector corporations has been imple-mented in part. This has been achieved through (i) improvedservicing of COPE requirements, (ii) participation of PED staffin programs focused on public enterprises management and evalua-tion techniques, (iii) provision of marketing consultancy to PEsand (iv) assistance to line Ministries in the preparation ofcapital/financial restructuring proposals for PE and GOBUs.Action is underway to assess the data processing needs of PED.Key elements of the MOFP program relating to non-MISA corpora-tions, however, still remain unactioned particularly in thedevelopment of an integrated MIS, review of controls affectingcorporation performance, and corporate planning performanceevaluation."

6.10 In spite of all the delays, a corporate planning specialist and aManagement Information System (MIS) expert were recruited to implement theTA program. By January 1988, 12 MISA corporations had prepared corporateplans which were in conformity with guidelines, but only one (Tyre) was ratedexcellent; four were rated good (paper, plywood, salt and mining) while therest were rated fair or incomplete (2). These plans, however, had minimalimpact on changing the relationships between MISA and the corporations. Thefollowing comment by the expert advisor is revealing. "It is a common beliefthat outside consultants can compensate for poor management. Three years ofclose interaction between the Advisor and the MI Corps have disproved this*."The Advisor considers that corporate plans in PEs have been beneficial inabout half the corporations and would probably be continued in these corpo-rations even if MISA did not require their submission. At the other extreme,some corporations (or rather some Chairmen) have so far treated corporateplanning as just a further reporting requirement of the Ministry. As aconsequence, plans have been prepared at senior management level with littleor no participation by middle or junior management". "Corporations observedthat the Ministry does not scrutinize or comment on the plans nor does it usethem on progress review meetings. Review comparisons are made with thebudget which has hitherto been treated as a separate document and submittedat a different time from the plan".

6.11 Firm level Assistance. The project design included 96 man-months ofTA (20 in 1984, 36 in 1985 and 40 in 1986) to MISA corporations. The advisorprepared a list of 16 assignments of which only three were implemented byMISA - ceramics, mineral sands and the plywood corporations. Evaluationstudies undertaken both by IDA and GOSL indicate that only one of the assign-ments was reasonably successful, i.e. for the Plywood Corporation. In thecase of the ceramics corporation, the TOR was modified and the scope of worksubstantially reduced, which adversely affected the contributions by theconsultant. The TA to the Mineral Sands Corporation fell short in terms ofeffectiveness, efficiency and impact. The study undertaken by a local firm"was not presented in a form that would enable management to take decisiveactions. As a result very few of the recommended actions have been

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implemented and the ultimate impact of the report is probably going to bemini-mall. The consultant's report for the Plywood Corporation was moreincisive and an expenditure of Ru. 7.0 million was expected to yield benefitof Re. 11.1 million per year. Unfortunately, the ethnic disturbances coupledwith loss of key management and labor disputes prejudiced the final outcome.

6.12 PED ultimately implemented a standardized reporting system for all PEcorporations. However, the utilization of the information for decisionmaking has been virtually negligible. Implementation of other elements ofthe program have been equally ineffective. TA programs at the firm levelcould have had a more profound impact if IDA supervision was more effective.The following comments from IDA's internal review bring out the main points.

6.13 *If IDA had been more vigilant in supervising the modifications of theconsultants' terms of reference in the case of CCC, a compromise might havebeen reached with MISA to allocate more time to cover the Corporation'smarketing aspects. In general, the three TAs reviewed here would probablyhave been more effective if they had been broken down into distinct phasesto take advantage of the Corporations', Government's and consultants' feed-back, learn from experience, and appreciate changes in the economic, politi-cal and managerial context of the corporations. IDA should also ensure thatall parties appreciate the time that may be required to achieve the objec-tives, and take steps to maintain TA staff's and the recipient's commitment.To the extent feasible, IDA should ensure clarity of decisions in importantsteps. In particular, IDA should spend enough time in reviewing/focusingterms of reference and TA performance criteria; making certain that appro-priate and timely organizational and administrative arrangements are made;and accommodating changes made necessary by the project implementation.Finally, goals under TAs should be set up so that they can reasonably beachieved. Similarly, tasks under TAs should be set up at a level of diffi-culty that the recipient feels capable of meeting so that the objectives ofthe assistance are achieved in a way that instills confidence and a desireto continue the development effort. Governments, organizations and individ-uals need to experience some success in order to maintain commitment towardachieving a meaningful goal. In sum, TA's design is critical to effectiveimplementation and to achieve the level of success that is needed to promotethe assisted entity's self-reliance.'

6.14 Because of the lack of substantive progress on PE reforms, theGovernment proceeded with measures to prepare PEs for sale. In August 1986,GOSL submitted a bill to Parliament to convert Public Corporation andGovernment Owned Business Undertakings (GOBUs) into public limited companies.With IDA support, a review of PE assets and capital structure was conductedto evaluate net worth and recommend new capital structures. However, neithercapital restructuring nor divestiture was implemented. In 1987-88, thereform effort was redirected by the Administrative Reforms Committee whichrecommended the establishment of a Public Investment Corporation to superviseall government investment in PEs.

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6.15 These recommendations provided the basis for a new PE reform programunder the 1988-90 Policy Framework. The program comprised two parts. First,to convert 16 PMEs whose assets constituted about half of total PME assets(excluding petroleum and cement) into companies under the Companies Act inorder to prepare them for privatization. Second, to divest a few PEs to thepublic. However, implementation of the reforms was again limited under thefirst-year PFP. A newly established Presidential Commission for Privatiza-tion selected mostly small PMEs for conversion in to public companies on thebasis that they were profitable and their equity was small enough to beabsorbed by the small domestic capital market. A Bill to Parliament enablingthe conversion of Public Corporations and GOBUs into Public Companies waspassed. But, with the country beset by wide-spread political violence, noconversions or privatizations took place.

6.16 The piecemeal reforms initiated during the 1980s put PMEs underincreasing pressures. Since the Government could no longer postpone essen-tial structural reforms to complement the stabilization program envisaged inthe second-year PFP, it requested IDA's assistance to formulate a comprehen-sive program of PME reforms. Two major studies were conducted by IDA in 1989in furtherance of this objective. A PHE Sensitivity Study focused on thesensitivity of the economic and financial performance of PMEs under theTextile and Industries Ministries to planned changes in the trade regime andexpected trends in market conditions. Another study focused on institutionalarrangements facilitating PME reform implementation. The latter recommendedbringing PMEs, upon conversion, under the purview of a commercially orientedholding entity, accountable to the Treasury. This entity would help PMEsdevelop and implement individual restructuring plans and adopt commercialbusiness practices. Based on these recommendations, in June 1989 the FinanceMinister advised the Cabinet to entrust the restructuring of specific PMEsto a commercially oriented Public Investment Management Board (PIMB), to beestablished under the Treasury.

6.17 To ensure efficient implementation of policy and enterprise reforms,the Government adopted a four-pronged strategy, consisting of (i) removingremaining specific tariff protection, market privileges and fiscal supportfor PEs in order to increase the competitive pressures on their operations;(ii) to remove Government regulations over labor, wages, sourcing of inputsand pricing of output through conversion of PMEs into companies; (iii)providing a new institutional framework to supervise and maximize returns onthe Government's investment in PMEs converted into public companies andinduce those which would continue to be controlled by the Treasury (i.e.majority Government ownership and no private management contract) to adoptan autonomous commercial operating mode, be accountable for performance andadapt flexibly to increased competition; and (iv) converting PMEs intocompanies and privatizing viable PME activities. These steps specificallyentail changing the PMEs' legal status to give them operating autonomy,restructuring their financial structure, privatizing and modernizing viableoperations through foreign joint ventures and domestic sales of shares andprogressively phasing out non-viable PME activities.

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6.18 IDA approved a Public Enterprise Restructuring Credit (PERC) in early1991 to assist the Government in implementing the strategy outlined above forall 14 major PMEs under the two key line ministries responsible for industry,i.e., the Textiles and Industries Ministries. In consultation with theMinistry of Finance, both ministries agreed to relinquish regulatory powersover the 14 PMEs, to progressively remnve price controls on PME outputs astariffs are reduced, and actively seek foreign direct investment to developthe PME potential for export-led growth. Concurrently, with these regulato-ry, incentive-related and trade reforms, a financial holding company, thePublic Investment Management Board, would manage the Government's investmentin converted and privatized PMEs on behalf of the Ministry of Finance.

B. Reform of Import Protection

6.19 The 1977 reforms to the import regime resulted in a significant liber-alization of the trade regime. Besides a large significant nominal deprecia-tion of the exchange rate, a substantial reduction in import licensing tookplace. A six band duty system was adopted with rates ranging from zero foressential items, 52 for raw materials and spares, 12.52 to 25% for intermedi-ate goods; 1002 on items competing with domestic production, and 5002 onluxuries. A Tariff Review Committee (TRC) was established in 1978 to hearappeals from industrialists and make modifications. Hoever, the criteriaon which the new tariff regime was based led to high protection for someitems and very little for others giving rise to potential misallocation ofresources. IDA felt that a systematic analysis of the protection regime wasin order, particularly to examine the effective protection levels accordedto various activities. The SHI I credit supported a study of effectiveprotection to manufacturing industry (SEP) which was completed in September1981.

6.20 The SEP was a pioneering study of Sri Lanka's tariff in that it broughtout clearly for the first time the relative efficiency of different manufac-turing activities, the linkages between activities and the level of protec-tion which was being provided not only by tariffs but by various other inter-ventions - turnover taxes, export taxes, import duty rebates, etc. It sensi-tized the members of the Presidential Tariff Commission (PTC), the successorto the TRC, to the implication of making various ad hoc changes to the tariffstructure. The SEP was particularly useful in pointing out the deficienciesof using tariffs for consumption control objectives. It also included guide-lines for use by the PTC in its appeals functions. The overall impact of theSEP was considerable on policy-makers.

6.21 In response to the pleas of industrialists, between 1977-80, some 584changes were made by the TRC, but there was little substantive change in thetariff, although the regime became somewhat more complex, a little more dis-criminatory among import substitution activities, and was able to raise somemore revenues from a given volume of imports.1V However, between 1980-83,there were two main sources of change to the tariffs requests to the PTCfrom industrialists for changes and changes introduced by the HOFP for

L/ Review of Industry Incent.ves to Sri Lanka. A.J. Cuthbertson, June 1984.

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revenue raising purposes. The PTC approved changes in this period fine tunedprotection for public corporations; they did not make for wide-rangingreform. On the other hand the MOFP introduced an across-the-board 52increase in duties including items previously imported duty free. An IDAreview of the protection regime in 1983 concluded that this increase resultedin higher and more disparate protection to industry and so are almostcertainly contrary to tariff reform.w

6.22 The 1983 IDA report1V recommended a major reform of the tariff regimeby adopting a uniform tariff rate which would meet the objective of neutral-ity of incentives between production for exports and the export market. Itrecommended the adoption of a 152 uniform tariff rate in two phases over afive-year period with the elimination of all import and export licensing anda maximum tariff ceiling of 60% in the first phase followed by gradual reduc-tion to the target level. It is recommended elimination of most exportincentives provided by the EDB. This recommendation, however, was rejectedby the government, primarily because of the severity of the tariff reductionand its impart on tax revenues as well as concern about public enterprise'sadjustment problems.

6.23 In response, however, the Government introduced a tariff reform packagein late 1984, reducing the wide variation in effective protection coeffi-cients to a narrow band between 2.5 and 1.5; before the reform, a coefficientof 5 was frequent. Most nominal tariff rates were reduced between 52 and 752with some cases at 1002. In numerical terms, to illustrate the magnitude ofthe change, the previous tariff schedule had tariffs above 752 in 514 tariffcategories; the new schedule had 86 only. However, there were a large numberof cases where tariffs remained high and unchanged because of representationsfrom public enterprises. Nevertheless, the Bank felt that the covenant ofthe two projects (section 4.03 of the DCA of Credit 1182-CE and section 4.02of the DCA of Credit 1401-CE) had been complied with.

6.24 Following the November tariff cuts, IDA continued its dialoguewith the PTC stressing to need the pursue subsequent phases of the reform andreexamine numerous exceptions in which the tariff remained unchanged primar-ily because of interventions from MISA. A 1985 assessment of the tariffregime indicated that the average (unweighted) rate of nominal protection was312 and the trade weighted rate was significantly lower at 182 because fewerimports entered at the higher duty rates. Nevertheless, there were stillsome 286 items subject to import licensing which included a large number ofitems produced by public enterprises.

6.25 IDA initiated another review of the import regime in 1987 with the helpof a consultant to the PTC financed under IDP II. The PTC's report recom-mended that the maximum protection provided to local industries should be aneffective protection rate of 50? and that a four tier tariff structure shouldbe adopted with a minimum rate of 52, a maximum rate of 502 and two interme-diate bands of 152 and 302. This proposal was accepted by the Government.The November 1987 budget speech of the Miniscer of Finance announced that the

Lf/ Selected Issues of Industrial and Trade Policies In Sri Lanka Report No. 4795-CE, 1988.

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PTC's proposals would be implemented over two to three years. The 1988budget reduced the maximum tariff to 602 and also eliminated all export taxesas non-traditional exports. In particular, all licensing that affordedspecial privileges to public enterprise was supposedly eliminated.

6.26 A 1989 review of the tariff system by consultants showed that theaverage effective protection was 402 and the tariff system still showed asubstantial cascading structure; however, the variance of protection betweendifferent branches of manufacturing was smaller. Moreover, out of a totalof 6,634 tariff positions, 500 product categories were still subject toimport licensing of which 440 were manufactured goods. Finally, theGovernment was still exercising monopoly control over some imports, e.g.,textiles. It would thus appear that hetween 1985-89, tariff reduction hasbeen rather modest, although PEs may have become less protected.

C. Export Incentives

6.27 The second item of technical assistance under IDP I was assistance tothe EDB for a comprehensive review of its export incentives and policies.The study, carried out by a consultant, was extremely comprehensive and setout a solid basis for guiding Sri Lanka's export promotion effort.1V Thestudy adopted as its guiding principle the general principles enunciated inRhee's paper "Instruments for Export Policy and Administrations Lessons fromthe East Asian Experiencem which include granting exports *extended neutralstatus', equal incentives for all export-oriented activities and automaticaccess to incentives. The study examined all of the prevailing instrumentsof export policy (exchange rate, investment incentives, duty rebate schemes,export expansion grants, export financing and credit, export insurance, etc.)and formulated a set of appropriate recommendation taking into account SriLanka's longer term export development goals. These policy recommendationswere subsequently incorporated in the Government's Industrial PolicyStatement (IPS) of 1987 which set out for the first time a comprehensiveindustrialization strategy for Sri Lanka. Preparation of the IPS was alsosupported by an IDA consultant.

D. Conclusions and Lessons Learned

6.28 The most important lesson which emerges from this review is thatattempts at public enterprise reform through partial measures such asstrengthening management systems and procedures through corporate planning,signalling systems, performance evaluation based on explicit targets, etc.are unlikely to be successful unless the overall economic environment inwhich PEs operate is changed. That requires changing the legal and regula-tory framework to expose PEs to competitive market forces, while simultane-ously providing autonomy in operating matters such as pricing, salaries andwages, personnel levels, finance, etc. The proposed reforms aimed atstrengthening management systems and policies could have resulted in ameasure of positive impact, had the PEs been able to attract capable top

1/ Draft Report of the Special omlttee on Export Incentives and Policies, Export DevelopmentBoard, Sri Lanka, March 196.

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managers to implement the proposed changes with the full support of officialsat the highest political level. However, even modest improvements could notbe realized because of the lack of commitment of relevant officials to thereform measures.

6.29 The main questions which arise in reviewing the progress of tradeliberalization in Sri Lanka concerns the pace and extent of import liberal-ization. To comment on this issue, one needs to examine the linkages oftrade policies with the overall macroeconomic policies followed by theGovernment during this period. Following the 1977 liberalization measures,the Government's fiscal policy was expansionary resulting in very high budgetdeficits (1980 deficit was -22.22 of GDP). A major contributor to thedeficit was the Mahaveli project which locked the Government into a massivepublic investment program. The expansionary fiscal policy resulted in adouble deficit inflation rate which the Government sought to control partlythrough a insufficiently flexible nominal exchange rate policy. This led toa substantial appreciation of the underlying real exchange rate.1V Anotherconstraint to adopting a flexible exchange rate policy was Sri Lanka's largeexternal debt which was mainly a public sector liability. Since non-tradedgoods are a major source of Government revenue, a real devaluation would haveconflicted with the objective of fiscal stabilization and thereby exacerbatedinflation. Given that trade taxes amount on average to 40% of total taxrevenues, there was little leeway for the Government to reduce import taxes,which undoubtedly adversely affected the pace and extent of liberalization.Thus, the requirements of fiscal stabilization conflicted with importliberalization.

6.30 The appreciation of the real exchange rate had adverse consequences forSri Lanka's exports and the sgnals it gave to export industries. The exportincentives provided by EDB partly mitigated the negative effects of theexchange rate appreciation but failed to make an appreciable impact onexports. Although Sri Lanka was able to generally equalize the incentivesfor domestic vis-a-vis export sales, this was accomplished at a highbudgetary cost. Incentive payments accounted for 82 of import duties and 32of total tax revenue in 1988. Moreover, the slow pace of import liberaliza-tion may have affected export performance by blunting competitive pressureson domestic firms preventing efficiency gains. This is particularly true inthe case of public enterprises, who were able to negotiate special tariffrates with the PTC. Sustained export growth and diversifications willrequire Sri Lanka to produce at interr,ationally competitive costs. The mainstrategy should be further significant reduction of import protection coupledwith investments of sufficient scale and technological capability to enablecompetitive exports. Ability to attract direct foreign investment will bea critical factor in this effort.

if The real effecti-e exchange index rate (vie-a-vis trade partners) appreciated to 180(1980100) in the first quarter of 1985 before declining to 100 In first quarter 1987.

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IDA's Role

6.31 IDA has played a catalytic role in fostering trade policy reforms inthe post-1977 period. However, its approach has been to rationalize thestructure of tariffs. It would appear that its analysis of trade liberaliza-tion, at least until 1985, did not fully take into account the fiscal con-straints arising from GOSL's macroeconomic policies. Pursuing trade policyreforms through project credits did not allow for adequate monitoring andconditionality of macroeconomic parameters relevant to the reform program.Since 1987, however, IDA has been more sensitive to the revenue implicationsof tariff reform and its links to the overall macroeconomic framework. Itis likely that the macroeconomic parameters would have been better definedand controlled had the reforms been undertaken under an adjustment operation.This could have allowed a faster and deeper liberalization of the importregime.

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IMPACT ASSESSMENT OF TECHNICAL ASSISTANCEUNDER SMI I AND II

The Industrial Development Board was set up with the objective ofpromoting growth and development in the industrial sector. It isessentially a service organization and functions as the premier Extensionarm of the Government. It promotes the growth and development of the smalland medium industrial sector by giving a package of services ranging fromadvisory and Extension Services, identicying investment opportunities andviable projects, undertaking feasibility studies to designing factorylayout, promoting technical advice and assistance and supply of necessaryindustrial information and advice and marketing prospects. It is with theobjective of improving and strengthening the institutional capability andinfrastructure facilities of the Industrial Development Board that variousassistance was given under the SMI I and SHI II Programmes by the WorldBank, to enable it to perform the services under the SMI Schemes in a verypurposeful manner.

The assessment of the impact of measures undertaken will involvereview of the performance as well as an assessment of quantitative andqualitative impact on the development of the SMI sector. The Institutionsthat were set up under the SHI Schemes are as follows:

(a) Rubber Products Development Centre(b) Heat Treatment Centre(c) Common Services Centre(d) Building Materials Centre(e) Sub-Contracting Exchange

In addition to these, a number of Training Programmes and ConsultancyServices were made available under this assistance.

Rubber Products Development Centre was set up with the World Bankassistance and it rendered services to the Rubber Products Industry inareas such as technical consultancy, quality control and testing andproduct development, semi-commercial services and it established rapportwith large scale manufacturers and other service organizations like CeylonInstitute of Scientific and Industrial Research, Rubber Research Institute,Sri Lanka Standards Institute and Export Development Board in working out acommon programme for the upliftment of local rubber products manufacturingindustry.

APPENDIX IPage 2 of 7

Table 1

Rubber Products Manufacturing Industries Accordingto Scale of Operation

-----------------------------------------------------------------Size ofUnit 1977/78 1982/83 1985/86 1987/88------------------------------------------------------- w----- w----

Large 12 22 26 30Medium 05 11 20 18Small 123 142 86 153------------------------- w---------------------------------------Total 140 175 132 201---------------------------- ------------------------------------

The above Table shows the development of the sector over the years. Due to

compulsions of competition under the open economy policy of the Government,the Rubber Products industry in the SMI sector obtained assistance fromthis Centre in technological advice, quality improvement and supply of rare

chemicals and correct processing techniques. It assisted them to competewith imported goods and also helped them to diversify into new products.With their assistance a number of SMI units have developed new prnducts

such as steering boots, gear boots, suspension bushes and engine mounts for

Japanese vehicles, footwear components, adhesives, seals for refrigerators,motorcycle parts, water pump seals, parts of agricultural machinery,underwater equipment and conveyor drive belts.

The Extension Services Section of the Centre has popularized

techniques of manufacture of items like rubberized coir foam, rubber

moulded goods, latex cast products such as masks and toys, latex dippedgoods like rubber bands and balloons at a scaled down level usingappropriate technology. The quality control sector has launched a QualityAssurance Scheme for a selected group of Rubber products such as automotive

parts jointly with the Ceylon Institute of Scientific Industrial Research

and Sri Lanka Standards Institute. It also assisted the Sri Lanka

Standards Institute in drawing up standards for a number of rubber products

such as foam rubber, rubberized coir, PVC coated fabrics, rubber bands and

retreading of tires.

Several commercial services provided by the Centre namely: (1)

production and distribution of rubber compound; (ii) sale of latex (raw and

compound); and (iii) sale of raw materials (chemicals and synthetic ribbons

has been a great boon to the local small scale industries, so much so tat

of the total of 201 rubber based industries in Sri Lanka as 20 SMI depend

on this Centre for supply of rubber compound and 20 units for supply oflatex and 20-30 units for supply of raw materials.


The impact of this Centre is significant in certain product areassuch as Rubber Automotives and Machinery Parts, Rubberized Coir, FoamRubber, Rubber bands, (for local market) balloons and cast products. Inaddition to the above services rendered, laboratory facilities were madeavailable in developing new products specifically in testing of rawmaterials, rubber components and finished goods.

Although the above services were rendered by the Rubber Products &Development Services Centre of the Industrial Development Board with SMIassistance had some influence on the small scale rubber products industriesbut an analysis of the overall magnitude of this impact is taken intoconsideration and a quantitative analysis is made, the impact it has had isminimal and the large scale sector is mostly beyond its sphere ofinfluence. A large number of rubber products that is being imported isstill being imported and the local rubber industry has not been able tostem this tide of imports though the raw material is available locally. Itis high time that a change of policy to make our rubber industry more self-sustaining is considered.

Electroplating Centre. This Centre was commissioned in March1986. The officers who underwent training under SMI Programme havegathered sufficient experience and knowledge to perform their dutiesefficiently and to execute external job orders. The training programmesare annually conducted for small and medium electroplating industrialists.On an average of 300 jobs a year are undertaken from industrialists.

Common Services Centre - (Matara and Anuradhapura). The Centre atMatara was established in 1982 and a monthly average of 180 jobs areundertaken annually from the industrialists. The training obtained by theOIC (Matara) has enable to carry out his duties efficiently. This Centrehas undertaken special work orders such as fabrication of a ruling machineand a stirer. The Small and Medium Industries obtained special servicessuch as Heat Treatment, machining, Fitting. Welding through the CSCworkshop. The Centre at Anuradhapura was commenced in 1986. The optimumuse of the facilities at this Centre have not been made by theindustrialists in the area, as the level of manufacturing activities in theEngineering Industry is fairly low.

Engineering Workshop and Foundry. The training obtained by theIDB Officers have enabled to design the manufacture dies, moulds, jigs andsmall scale machinery to suit local conditions and this service is providedto SMIs as and when requested by the industrialists.

The machinery brought under SMI Programme - I & II are beingutilized for the above mentioned manufacturing processes to assist thesmall and medium scale industrialists. The monthly average numbr of jobsundertaken by the workshop and foundry from SMIs are 45 and 10respectively.

The workshop is equipped to undertake heat treatment of dies,moulds, engineering components produced by metal industries. On an average60 jobs are executed annually for the SMIs.

APPENDIX I51 - Page 4 of 7

Consultancy Services. Consultancy services were made available tothe IDB under the SMI I and II programmes in a number of fields to trainpersonnel as well as to improve its extension services. Consultants wereengaged to assist entrepreneurs engaged in construction material industryand building material construction. Demonstration centres were establisheda Lunuwila, Matara, Mahiyangana and Colombo but this apparently did nothave any impact and most of these centres have now been closed.

Two chemical consultants were engaged to prepare process profilesfor the manufacture of 10 chemical items. Although the process profileswere made available on certain products it has not resulted incommercialization. Consultancy services were provided to set up a mushroomspawn unit which was successfully established at Panadura and this hastrained a number of entrepreneurs and a large number of entrepreneurs havereceived assistance and started cultivation of mushroom with the assistanceof this Centre. consultancy services were also provided for manufacture ofmotor spare parts and gravity die casting. A number of sezzinars anddemonstrations were conducted in selected areas but this too has notresulted in establishing of industrial units. A report on processing ofcentrifuged latex was also prepared by consultants and this has been madeavailable to the Rubber Products industrialists. As a whole consultancyservices obtained under the SMI I & II Scheme does not appear to have had asustained impact.

Training. Training was also given to a large number of Boardemployees under the SMI I and II Programmes. Most of these TrainingProgrammes were undertaken in foreign countries and they covered most ofthe activities of the Board. They were intended to enhance the capacity ofthe Board's personnel in performing the extension and advisory functions.It is very unfortunate that the IDB was unable to retain the services ofmost.of the trained personnel in view of the inadequate salary scales paidby the Board. Thus in the Engineering Division alone, 13 officers had leftover this period out of the 23 trained personnel. Necessary remedial

measures have to be taken to enable the Board to retain the services oftrained personnel so that it will have a real impact in its attempt topromote and develop the Small and Medium Industrial sector.

Industrial Extension Services. Assistance was given to improvethe Industrial Development Board's promotion and extension services withintense field level coaching of its Industrial Extension Officers and toactivate the SMI consultancy fund to tap the know-how of the localinstitutions/private sector industries in solving problems. A one yearproject was conceived with SMI funding wherein five industrial extensioncoaches were placed to cover nine regions of the IDB for the purpose of

upgrading the capabilities of the IEOs in promoting and renderingassistance to small and medium industries. At the end of the completion ofthe project. 57 Industrial Extension Officers and 9 Regional Managers were

able to improve the extension efficiency by actually promoting newindustries and upgrading existing industries apart from fulfilling thetraining objectives.


Further under this programme a project for *on-the-job* trainingin management consultancy for IDB extension officers were also undertakenand the objectives were to upgrade the capability of management consultancyand to enable officers to provide more effective and meaningful services tothe SMi sector. At the end of the completion of the project, 9 RegionalManagers and 44 IEOs were trained in this programme. Further, certainofficers were given specialized training in the activities of selectedIndustry subsectors.

The following table shows setting up of new industrial units andexpansion and diversification of existing units fro the period covered bythe SMI I and II Programmes.

EXPANSION AND DIVERSIFICATION

New Units Existing.UnitsNo. of Investment No. of Additional

Year Units (Rs.) Units Investment(Rs.)

1983 98 5,715,050 85 38,641,5751984 129 13,486,200 121 14,769,3501985 150 18,988,330 102 7,951,2701986 295 45,013,150 183 43,448,4801987 336 44,901,400 187 23,601,5601988 288 45,987,200 121 16,027,880

Sub-Contracting Exchange. With a view to bolster up the SMI unitsin the field of marketing, the Sub-Contract Exchange was set up in 1980with World Bank assistance. The SCX was expected to be the crucialinstitution through which small industries would be able to participate inthe overall export oriented strategy of development.

The objectives of the SCX was to assist small scale industries inproducing goods under sub-contract to major enterprises and to enable thesesubcontractors to meet market standards in their production. Theestablishment of the Sub-Contracting Exchange was designed to increase thecapacity of the IDB to provide marketing support for the output of the SMISector. The SCX caters exclusively to the SMI sector. The SCX approach tothe formation of market/supply links is to ascertain demand and findsuppliers to meet this demand. The present function of the SCX is mainlythat of a broker conveying market information to potential SMI suppliers.To a limited extent it performs service functions in presenting tenders andquotaticns mainly to Government and parastatal institutions for supply ofSMI prouncts.


The SCX carries out promotional and marketing activities on thebasis of direct contacts with potential customers. However, in procuringorders, SCX does not always receive complete cooperation of buyingdepartments. It does not generally receive preferential treatment at thehands of procuring agencies of the Government though it is a government-sponsored institution.

The undermentioned table gives the number of industrialistsenrolled and the value of orders executed by the SCX from 1982-1988.

No. ofIndustrialists No. of Value of Orders

Year Enrolled Orders in Rs. Million

1982 34 20 4.951983 69 22 4.891984 113 38 10.121985 146 24 17.511986 200 18 18.451987 251 22 20.441988 294 62 31.70

A special marketing assistance programme was drawn up by theDivision for the Weboda Blacksmiths with the State Trading (General)Corporation in March 1987 and Rs. 1.6 million worth of orders obtained foragricultural implements and about 40 members of the Weboda LightEngineering Cooperative Society have been benefited.

The functioning of the SCX has been subject to several independentassessments and evaluations. On observations made at the timeestablishment commented on the absence of deliberate procuring policy andprogramme to provide subcontracting and participation of SMI in Governmentprocurement. It also has problems in developing meaningful relationshipsbetween suppliers and potential buyers. In many countries, both developedand developing promotion of this type of activity is carried out throughlegislative and policy measures. In Japan government organizations andprefectural industries and public corporations are delegated by law toprovide small enterprises with opportunities for participation in public.The USA Small Business Act of 1953 declares that government should counsel,assist and protect insofar as possible the interests of small businessconcerns and ensure a fair proportion of the total purchase and contractsfor supplies and services for the government to be placed with the smallbusiness enterprises.


The Government of India pursues a deliberate and positive policyto encourage the participation of small scale units in governmentpurchasing programmes. It is essential that the Government should acceptthe social and economic importance of the SMI Sector and make a policycommitment to the development of this sector. It should accept thatpreferential treatment of this sector is not a deviation from the freeenterprise system, as evidenced by vigorous and preferential supportprovided to this sector in countries such as the USA and Japan.

The SCX should be recognized as the mechanism through whichpreferential participation in certain areas of state procurement could beeffected and monitored.

The achievements in respect of the objectives are as follows:

1. We have assisted 184 small and medium scale industries who have beenintroduced to subcontracting markets and many of them havediversified into new products using existing facilities.

2. We have communicated to over 200 Government departments, corporationsand large firms in addition to the Federation of Chamber of Commerceand Industry of Sri Lanka the production capabilities of potentialsmall and medium industries subcontractors and have received ordersfrom 40 organizations.

3. While we insist that every industrialist who receives an orderthrough the SCX has the necessary know-how and facilities, we alsoadvise them on how to improve the quality, cut down on unnecessarycosts through the use of proper jigs and tools and ensure thatspecifications and delivery dates are met. (Please see Annex I).

IT1I Il ank - APPENDIX IIL IIII Jill..l ilIII National Development Bank Page 1 of 3

P 0 Go 025, 40 NAvM Mairtha. Colombo 2. Sri LankaTeloplione 23900 0 437350 3 Uas 54-202 To-cA 2 399 NDJ CE

Office of the Gee al MaO.idt,Tolephomne 6400481

FAX LETTER TO WASHINGTONOur Ref: SMI/345/1Date : 7 June 1991

Mr George C ManiatisActinte ChiefPolicy Bm-sed Lending and Industry

Operations Evaluation DeptWorld tankI;ashington DC 20433

Dear Sir,

ProjecL Performance Audit Report on SM! t (0942 Cv)54I II (1182 CE) A41) TDPI (1401-ri)

Thank you for your letter dated 7 May 1991 and the enclosedReport on above subject. Our comments on the above report aregiven below;

1. ,endin, unler SMI I & II - Section IV

a. We are Lu agreemeit with the commentu tadt. Io the reportwith regard to the shortcomings on SMI I due t- weaknessesof PCIs in Project Appraisal and Supervision and themonitoring system. !Io-.ever. under SMI II '& TII, we wereable to overcome rst of these lapeu through theimprovements in the guidelines on Project Appraisal normsand supervision. Efficiency of SMI lending operationsof PC!s also has been improved by training PCs' staffin SMT lending. Steps are also being taken by the NORto carry out sectoral studivs to further improve theefficiency of SMI lending operations.

b. Weaknesses in monitoring systems due to lack of in-builtmechanisms to collect information hae now been rectifiedby collecting data on *.Ie total investment cost ofsub-projects which will enibl" cRlculation of key economicratings.

c. With regard to addition-:! ftnctioni that can be perrornedby the NrSR we are now 'r, 'h-* nr'r s*s of:

i, e*amining the potenti.' no of some resources inequity support to SMT entr"preneurs. and

ii. undertaking sample surveys of SMI sub-borrowersto assess the actual economic impact of thesub-borrowere

- 56 - APPENDIX IIPage 2 of 3

2, Wrvaiuation of TDPI - Section V

5.20 Tn;t i t it tot n l A pitt

* Approval of Direct Leandii8 proposals above Rs25 Mn is

by the Aniard and Approvals below are delegated andreported to Board.

* The Chief Executive 1.s the General Manager, a position

provided in the nank'n Act of Incorporation.

5.24 Financial Performance

* Financial structure with debt/equity or 39/62 appears

'overly conservative'. This is a result of the age of

I10B, and the high initial capital contribution from its

original shareholders. It is also a result of the policyof building up reserves during its first years of

operations covering the tax exempt period. This position

is rapidly changing.

* Declined interest spread was a function of the mix of

funds with a predominance of lower spread credit line

funds in the later years.

* NT)B has offered variable interest rates to clients with1

the IDP-II credit coming into place, buL IL is the

experience of the DFIs that. project customers are reluctant

to obtain term loan facilities on variable interest rates.

5.25 The poor portfolio performance was mostly due to

the disturbed conditions in the country starting

In mid 1983 which after settti.ng down started again

in late 1987. After the ctnditions have settled down

In late 1989, the portfolio improved and our collection

ratio since early 1990 is 9010. We have atso managed

to restructure the projects purtfolio badly affected

during the disturbed period.

5.27 Tnstittitiontal Development

* NT)B's early attempt in project promotion with the help

of a Consultant from IDA, Ireland was not a success.

Our approach now is differe-it. We are pursuing a more

aggressive business development strategy and have set

up Merchant Banking and Business Consultancy Units and

have already established linkages with foreign and local

firms.

* Being aware of the significance and importance of economic

evaluation and sub vector studies, we have taken steps

- 57 - APPENDIX IIPage 3 of 3

to establish an economic unit and to recruit it least9 - " experienced staff. tn thie CARe too, your commentsunder 5.29 regarding sthfftna iN valid. With the impendingprivatisAtion of the Rank, we expect more flexibilityof action.

5.30 Although not in a very significant way, we have usedthe TA funds to obtain technical assistance to solvesome of our clients' problems. The TD? facilitiesprovided under IDP-TII and SMIT-TV were of someassistance to our clients.

We very much regret thL delay in responding to your letter.

Yours faithfullyNATI 2 L DEV OPMEN AK

(Nie C D Iddamalgneputy Oeneral Manag r (Services)

C D I :1e

rNIffET RATES OP NAR CREDT »C SAVXNC flBTITUrtfB. 1970-89

1970 178 1980 1981 1982 1988 1914 1985 198 1987 198 1989

Oøvermøn Tre~sury il.a /a 4.78 8.00 13.00 13.00 18.50 12.® 14.00 11.82 11.00 16.AK 1.00 16.5-19.2 18.2-19.4Cøetrl h Ret. /k 6.50 6.80 12.00 14.00 14.00 13.00 13.00 11.00 11.00 3i 00 10.00 14.0

~EI5T RATE12 4the Fined rp~ltø 4.80-4.75 7.00-7.50 20.00 20.00-22.00 15.00-22.00 16.00-25.00 14.00-22.00 12.00-16.00 8.50-14.00 8.80-14.00 9.00-18.50 11.00-20.50SacTg Deposit* 4.50 8.50 10.00.14.00 10.00-14.00 10.00-14.80 10.00-18.00 10.00-15.00 10.00-13.50 6.00-12.00 1.00-11.00 5.00-11.00 8.00-14.00

soIme intltutimmmatiaml Saving hkel

oving, Depile 4.00 7.20 12.00 12.00 12.00 12.00 12.00 12.00 12.00 12.00 12.00 14.012 Kmthe Flaed Depolta 4.80 7.50 20.00 22.00 22.00 18.00 16.00 15.00 13.00 13.00 13.00 10.010-Yenr Smin"g Cetificae 8.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00 11.00

LO1E~ M6TEBCalrcif lnke,

6~Mrd O.80-12.00 1.30-13.00 11.002.00 11.000.00 11.00-80.00 11.00-0.00 10.00-80.00 9.~0-80.00 9.00-2.00 9.0.00~ røecured 6.50-12.00 9.10.14.00 19.00-0.00 19.00-92.00 14.00-80.00 11.00-30.00 13.753~.00 15.00-30.00 9.00-.00 9.7~-3.00 13.00-39.00 13.00-3.00

Lane-Teom Credl6 In=titutane~tote "ertge~ a / 5.00-10.80 8.00-12.00 3.<0-20.00 &.0-20.00 12.00.24.00 12.00-24.00 12.00-24.00 10.00-24.00 8.00-20.00 9.00-20.00 10.00-20.00 16.0-19.0

AgricuIturel and tndustrialCrodil Corpermti~n /& 9.00-12.00 9.00-12.00 lå låt

Devel,opmnt Piec C~rporuti1am 9.80-10.50 9.40-12.W0 10.80-17.00 10.80-17.00 12.00-17.00 11.00-14.00 11.00-14.00 14.00-21.00 14.00-10.00 14.00-19.00 14.00-19.00 14.00-19.00Neoimnl ng b=ser t0en 11.00 6.00.9.00 6.00-9.00 O.00-9.00 6.00-4.00 g.00-9.00 3.00-10.00 3.00-10.00 3.00-10.00 3.00-10.00 3.00-10.00 3.00-10.00#lbimal Sevinga ak 10.00-12.00 10.00-12.00 9.00-17.00 12.00-17.00 12.00-17.00 12.00-17.00 12.00-17.00 12.00-21.00 12.00-21.00 13.00-20.00 14.00-20.00 14.00-20.00

/l Waistd overog of bli I.mlea.d on tnder./h kfoto o% hich Central ae" peovdeødvnce te coameiel banko rcur.d by ~*~t Rd oefrent gutren~ uriti~. Winnce facillet for productivo pureem are

currmtly ovele, 4 r*eti raging frem 1.S0-19.001./ Itermt ra% »o the C*& yon gevinga Bm^k 0he fast Offica Soaving ank, med the Savling Certifice Fund./l Om Jerurr 1. 1979, the Agriculturol med Zndustriol Crodit Corporullanø vere amlgømtd into te Stat* Øbr~gge elnk.

Surc: Cntrøl lal of Ceylan

OQ0

a

i-'

ANNE- 2 TABLE 1- 69 -Page 1 of 9

SUB-SECTORAL CLASSIFICATION - SMI I. I AI III - AS AT 12/81/90(R. un)

SMI I SMI II SMi III TOTAL

SUB-SECTOR NO. AMOUNT NO. AMOWT NO. AMOUNT NO. AMOUNT x

Cons. Contracting 11 6.0 24 19.6 19 10.1 54 84.6 1.4Cons. material 272 42.9 172 69.4 271 97.0 716 209.3 8.8Food processing 474 56.6 665 287.2 556 805.9 1695 649.7 26.7Garments 89 9.6 187 61.2 240 159.6 466 280.3 9.1Metal products 215 22.4 211 67.6 230 38.0 656 198.0 7.6Other agro industries 120 10.1 46 18.2 73 28.0 289 46.3 1.6Repair workshop 51 4.1 120 29.4 89 27.7 260 81.2 2.4Rubber products 29 6.6 74 42.7 64 56.0 167 105.5 4.2Textile 52 7.7 54 88.7 S9 47.4 165 98.8 8.7Wood products 176 20.4 174 47.9 196 62.4 546 180.7 5.2Animal Husbandry A Horticulture - - 156 53.2 146 47.6 806 101.0 4.0Chemical products - - 8 2.8 24 12.5 82 14.8 0.6Commercial transport - - 210 60.4 221 65.0 431 146.4 5.7Leather A allied products - - 28 11.1 80 7.6 so 16.7 0.7Plastic products - - 42 40.9 42 88.3 84 74.2 2.9Printing A paper products - - 186 74.7 104 63.0 242 187.7 5.4Others 262 44.0 280 119.2 209 117.8 691 260.6 11.1

TOTAL 1741 229.5 2491 1068.6 2575 1244.5 6607 2682.6 100.0

- 60 - ANNEX 2 TABLE 2Page 2 of 9

CLASSIFICATION OF SUB-LOANS BY SIZE - SMI I. I AND III - AS AT 12/31/90(Re. Mn)

SMi I SMi II SMi III TOTAL

CATEGORY NO. AMOUNT NO. AMOUNT NO. AMOUNT NO. AMOUNT

Re 0 - Re 60,000 1101 52.2 807 3.1 291 8.4 1699 48.7Re 50,000 - Re 600,000 504 110.4 1425 271.0 1471 284.4 3400 665.8Re 500,000 - Re 1,000,000 186 68.9 484 266.9 886 285.2 819 588.0Re 1,000,000 - Re 2,000,000 ---- 286 299.4 262 318.4 498 612.8Re 2,000,000 - Re 4,000,000 - 89 214.2 168 408.1 256 617.8

TOTAL 1741 229.5 2491 1058.6 2575 1244.5 6671 2532.6

EMPLOYMENT GENERATION - SMI I, II AND III - AS AT 12/31/90

SMI I SMI II SMI III TOTAL

No. of Job opportunItles 17520 25060 29806 71892

ANNEX 2 TABLE 8- e1 - Page 8 of 9

DISTRICT-WISE CLASSIFICATION - SUI I. Il AND III - AS AT 12f31/90(Ns. Mn)

SMi SMI_il SUI II TOTAL

DISTRICT NO. A~ NO. AVOUNT NO. AVOWRT NO. AMONT

1. Ampara 19 1.9 1 0.1 2 2.0 22 4.0 0.22. Aouradhapura 40 3.7 11 36.2 102 28.0 266 62.6 2.68. Badulla 6 4.8 6e 11.0 68 18.2 192 29.0 1.14. Batticaloa 22 3.7 8 1.6 -- --- 26 6.2 0.26. Colonbo 400 8.8 707 409.4 669 417.9 1776 910.9 86.06. Galle 76 7.6 246 89.6 208 117.6 628 214.6 8.67. Gompahe 218 80.1 815 141.9 88 192.0 910 804.0 14.48. Hambantota 87 4.6 66 28.7 44 14.8 147 42.6 1.79. Jaffna s1 12.4 6 8.8 8 1.9 60 17.6 0.7

10. Kalutara 67 7.6 90 46.6 119 88.0 266 188.7 6.411. Kandy 162 9.4 108 81.6 146 58.6 400 94.0 8.712. Kegalle 29 4.6 106 88.8 8 12.0 170 66.8 2.218. Kilinochehi -- --- --- ---- -- -- 0.014. Kurunegala 177 12.6 148 58.8 278 08.0 698 184.6 6.816. Mater& 92 11.6 187 48.4 101 64.8 880 114.8 4.616. Mannar 8 1.8 -- ---- -- -- 8 1.3 0.117. Matele 68 4.7 29 6.4 29 9.0 111 20.1 0.818. Moneragale a 0.2 29 6.8 18 2.8 46 7.8 0.819. Mulloltivu 8 0.4 -- --- -- --- 3 0.4 0.020. Nuwera Ellys 3 0.7 28 9.1 86 26.4 68 86.2 1.421. Polonnaruwa 85 8.6 69 14.9 40 12.1 184 80.6 1.222. Puttaim 148 16.6 155 62.7 211 88.7 612 166.9 8.228. Retnapurs 22 2.1 101 8.4 91 49.4 214 87.9 8.524. Trincoal.e S 2.1 8 0.4 6 2.8 16 4.8 0.226. Vavunlye _ 0.9 1 0.8 - __ - 7 1.2 0.0

TOTAL 1741 229.6 2491 108.8 2676 1244.6 607 2682.6 100.0


SR1 LANKCA

SECOND SALL A EDIUM INDUSTRY PR JCT M In

ANALYSIS OF ARREARS

LOANS IN ARREARS DEC. 1966 DEC. 1967 DEC. 1968 DEC. 1969

1. Total no. of loans in portfolio 148 2208 2295 2056

2. No. of loans in arrears with 6or lose than 6 months 865 508 1010 499

8. As a 2 of total loan portfolio 24.41 28.01 44.0S 24.2X

4. No. of loans in arrears over6 months 168 816 650 787

G. As aX of total loan portfolio 10.91 14.81 28.91 86.818. Total no. of loans in arrears 526 624 1560 12387. As a X of total loan portfolio 85.85 87.3 67.9z 80.01

PRINCIPAL AFFECTED BY ARREARS

8. Total principal outstanding (Re. In Mn.) 625.4 959.2 970.8 781.1

9. Principal affected by arrearswith over 5 mths (Rs. In Mn.) N/A N/A 282.8 811.8

10. As a X of principal outstanding N/A W/A 24.0S 40.91

ACTUAL ANOUIIS IN ARREARS

11. Arrears with 6 or less than8 months (Re. In Mn.) 5.0 8.1 10.2 9.4

12. As a X of principal outstanding 1.0s 1.01 2.01 1.21

18. Arrears between 7 to 12 months (Re. In Mn.) 8.9 10.7 15.7 18.6

14. As a 5 of principal outstanding 0.51 1.01 1.61 2.2X

15. Arrears over 12 months (Re. In Mn.) 9.8 22.0 54.9 92.7

18. As a X of principal outstanding 1.61 2.85 5.6 12.11

17. Total arrears (Re. In Mn.) 16.2 40.8 69.6 118.6

18. As a X of total principal outatanding 8.01 4.85 9.2X 16.65

-68 - ANNEX 2 TABLE 5Page 5 of 9

AIMUAL COLLECTION PERFORMANCE BY PCIs as et W06U Jun* 1990(Ra. MO)

8111 1

DOC, PS COC «4 DFCC sS TOTAL

(1) Opening arreåre -Interewt NOT AVA I LABILE-Principal N 0 T A V A I L AB L E

(2) Current Duce - Interest- Principal

(8) Total dues at theand of the perlod - Inte-est N 0 T A V A I L A B L E

84.6- Principal 41.7

(4) Col lectlone - Interest 0.8 0.9 0.6 0.4 - - 2.1- Principal 0.7 1.4 1.- 0.1 - 8.8

(6) Rescheduling - Principal

(0) Closing balance duo - Interest 9.6 20.0 1.6 1.6 - - 82.6- Principal 11.1 22.7 1.8 2.8 - - 87.9

2f.6 47 4 : 70.5

$m11I

(1) Opening arreara - Interest 16.2 15.6 4.8 1.8 11.4- Principal 65.0 26.6 2.4 2.0 24.4

(2) Current Duee - Interest 49.2 24.6 2.6 8.2- Principal 75.7 50.6 12.8 6.1

(8) Total dues at theend of the period - Interest 67.4 40.0 6.8 4.5

- Principal 180.7 77.1 14.7 10.1¶W. =r IM. 4.

(4) Collections - Interest 88.8 28.9 8.4 2.6- Principal 65.4 87.6 9.8 7.1

fi n i. " 2v M n

(6) Rescheduling - Principal 0.2 - - -

(6) Clowing balance duo - Interest 88.6 16.1 8.4 1.9- Principal 65.1 89.6 6.4 8.0

(7)(4) / (8) X 100 60.1% 62.5« 59.0% 66.4%()(6) /)(8) X 100 0.1% - - -

(9)(4) + X 100 50.2x 62.6% 69.0% 66.4%

64 - ANNEX 2 TABLE 6Page 6 of 9

Ott LANKA

SECO SM.L AI MDIM DUSRY PROJECT (SM! HI)(CEDIT 10-E)

A SIS OF AMEARS

LOANS IN AMEARS DEC. 1988 DEC. 1989

1. Total no. of loans in portfolio 299 10092. No. of loans in arrears with 6 or lo*e than 6 months --- 194S. As a X of total loan portfolio --- 19.2X4. No. of loans in arrears over 8 months --- 765. As a of total loan portfolio --- 7.658. Total no. of loans in arrears 56 2707. As a X of total loan portfolio 18.7s 28.75

PRINCIPAL AFFECD BY ARREARS

8. Total principal outstanding (Re. In Mn.) 164.4 628.59. Principal affected by arrears with over 5 mths (Re. In Mn.) 4.5 80.410. As a X of principal outstanding 2.7X 5.81

ACTUAL AM TS I ARREARS

11. Arrears with 6 or lose than S months (Re. In Mn.) --- 4.812. As a 1 of principal outstanding --- 0.8118. Arrears between 7 to 12 months (Re. In Un.) --- 2.214. As a X of principal outstanding --- 0.416. Arrears over 12 months (Re. In Mn.) --- 1.418. As a X of prinuipal outstanding --- 0.80117. Total arrears (Re. In Mn.) 0.6 7.918. As a X of total principal outstanding 0.4 1.51

-65- ANNEX 2 TABLE 7Pag* 7 of 9

ANNUAL COLLECTION PERFORMANCE BY PCI a at SOth Juna 1990(Ra. mn)

si 111

BOC P CDOC « DFCC 8S TOTA.

(1) Opening arrearg - Intereat 2.1 0.7 - - - 0.5- Principal 1.8 0.8 0.2 - 0.4 0.2

(2) Current Duc* - Interest 25.0 21.9 4.0 4.7 9.9- Principal 24.6 16.8 6.8 2.9 6.6

49. WT W.T n. U3.

(3) Total duo* at theend of the period - Intereast 27.1 22.6 4.9 4.7 10.4

- Principal 26.9 17.1 6.0 2.8 6.8m" M-iI.

(4) Collectiona - Interest 21.6 17.7 4.6 4.7 9.1Principal 20.6 12.9 6.7 2.8 6.1

T" 80 rm. 7. r4.2

(6) Reachodullng - Principal - - - - - -

(6) Closing balance du* - Interest 6.6 4.8 0.2 1.8- Principal 6.8 9.0 0.8 0.0 - 1.7

10.~9 M . n.

(7)(4) / (3) X 100 79.4% 77.8% 95.8% 100.06 82.56%(8)(6) 1(8) X 100 - - - - -(9) (4) (6) X 100 79.4% 77.85 96.86 100.06 82.6%

-8 - ANNEX 2 TABLE 8Page 8 of 9

PRESENT STATUS OF PROJECTS FINANCED

AND

REASONS FOR PROJECTS IN DEFAULT

SMI I SMI II SMI IIIAmount In Amount in Amount in

No. Re. Mn No. Re. Mn No. Re. Mn

Installments in arrears

Below 6 Installments 15 0.2 889 6.8 291 4.76 - 12 Installments 84 1.8 178 11.8 88 5.118 - 24 installments 88 2.8 218 26.8 27 1.6Above 24 installmen4e 211 94.1 286 69.5 - -

TO WY3 n 1-1-27 401T 1

Reasons for Default

Willful 141 27Genuine difficulties 288 97Disinterest of the Borrower 108 9Not Indicated/Other 477 268

Under implementation 28 111Operating at the expected level 788 805Operating below the expected level 254 98Abandoned 188 9Temporarily stopped 72 21Fully settled 491 15Not Indicated 405 888


NET REFINANCE APPROVALS BY PCI. - SMI I. II AND III - AS AT 1281{90(Re. Mn)

SMI I SMI II SMl III TOTAL

PCI NO. AMOUNT NO. AMOUNT NO. AMOUNT NO. AMOUNT

Bank of Ceylon 656 88.1 1810 468.8 758 828.1 2726 872.6

People's Bank 896 91.4 722 264.1 1012 864.2 2880 709.7

Commercial Bank of Cvylon Ltd. 115 29.6 90 49.2 89 72.8 294 161.0

Hatton National Bank Ltd. 6 21.7 76 88.2 207 86.9 848 145.8

Development Fin. Corpn. of Ceylon 07 0.8 298 258.8 277 278.7 677 538.8

Sampath Bank Ltd. - - - - 167 107.9 187 107.9

Regional Rural Dev. Bank-Kurunegala - * - - 8 2.7 68 2.7

Solan Bank Ltd - - * * 02 4.7 02 4.7

TOTAL 1741 229.6 2491 1068.6 2676 1244.6 6807 2682.6

ACTUAL. PROJECTION

Pinaretli Year 1986/87 1987/88 1988/89 1989/90 30.09.90 1990/91 1991/92 1992/98 1993/94 1994/95

ApprovaI 591.4 407.7 975.9 11M.0 512.0 1510.0 182.0 2382.0 298.0 3899.0Co~mlt~entwa 828. 561.7 827.9 9~0.9 40.0 1208.0 150.* 18.@ R3M0.4 2989.2Dmburscmnt 584.9 43.1 713.2 879.4 844.1 1402.7 1~87.4 200.4 2508.5 8150.8

L.AR*eApprovato 42.6 80.7 20.7 74.0 88.0 98.0 188.0 188.0 255.0 40.0Commitmenta 29.0 32.7 28.8 8.2 45.0 98.0 188.0 18.0 258.0 ~40.0Olebursementa 28.5 36.8 21.2 50.3 34.5 83.S 122.2 16.7 228.2 301.8

CilM DiscountingApprovale 0.0 0.0 0.0 53.3 89.0 50.0 75.0 88.0 100.0 120.0Commi tento 0.0 0.0 0.0 58.& 89.0 50.0 75.0 8.0 100.0 120.0Oimburcament 0.0 0.0 0.0 0.0 184.4 50.0 75.0 85.0 100.0 120.0

5hare InvestuenteApprovala 12.8 10.0 19.9 17.0 8.0 20.0 20.0 20.0 20.0 20.0Commi timnta 12.8 10.0 19.9 17.0 3.0 20.0 20.0 20.0 20.0 20.0Disbursamento 8.6 8.9 5.6 19.4 21.6 20.0 20.0 20.0 20.0 20.0

oWher OperationaApprovala 0.0 0.0 0.0 0.0 0.0 185.5 90.0 81.0 100.0 128.0Cosmi tamnta 0.0 0.0 0.0 0.0 0.0 185.5 96.0 81.0 100.0 125.0Dimbursementi 0.0 0.0 0.0 0.0 0.0 185.5 96.0 81.0 100.0 125.0

Annuai Orowth Rat* ofTotai Approvale 9 17.6 34.3 17.1 80.9 40.1 18.6 22.4 26.1 26.1

DEVAP"Wf IMMH COMPORAION- OFCELON

WSINIRAL *kAy fIt7ett API'VALA

Pinancial Year 198/04 S 1968/87 9 1967/68 S O / 1909/90 1 80.00.90 9

Agriculture. forestry A fishing 19.0 2.2 21.0 8.2 57.1 8.1 W.1 2.7 29.0 2.2 10.0 2.7

Mining & quarrying 6.8 1.2 7.4 1.1 0.0 0.0 2.0 6.1 6.0 0.8 3.0 0.5

Manufacture of food. baverage and tobacco 188.7 25.2 6.9 18.4 18.4 18.7 181.4 14.9 LJ9.0 21.7 147.0 82.1

anufacture of texti le& 17.8 8.2 21.9 8.4 96.0 8.2 1.6 6.0 78.0 8.6 8.0 1.2

Manufacture of wearing apparel

including footwear 10.1 8.8 88.8 8.1 18.9 1.6 67.4 8. 188.6 11.7 86.0 12.5

Manufacture of leather and leather products

including footwear 10.9 2.0 8.7 0.9 6.7 1.0 9.8 9.9 5.8 0.4 12.0 1.6

Wood and manufacture of wood products 1.2 0.2 5.9 0.9 8.8 0.6 14.5 1.4 11.2 0.6 80.7 4.6

Manufacture of paper products, printing.

publishing and packaging 20.2 8.7 85.4 8.6 84.1 8.9 48.7 4.8 106.0 7.9 42.0 6.8

Manufacture of chemicals and chemical Aroducts

other than rubber and plastic products 60.8 11.0 22.9 8.8 88.0 4.0 201.8 19.6 116.8 6.8 26.0 8.9

Rubber product* aenufacture 11.9 2.2 28.4 8.6 8.9 0.7 72.8 7.1 88.0 2.5 12 0 1.6

Plastic producte manufacture 48.8 6.9 61.0 9.4 18.9 2.2 48.8 4.6 84.0 4.1 69.2 6.9

Manufacture of non-matellix aineral product

including pottery. china and gies manufacture 29.7 8.4 30.2 4.7 100.0 11.8 48.2 4.2 67.0 6.8 2.0 0.8

Basic metal production 0.0 0.0 47.9 7.4 40.6 4.7 16.1 1.8 8.0 0.6 0.8 0.0

Manufacture of fabricated metal products

machinery and equipment including

electrical iteas. tranaport equipeent

and instrument manufacture 71.1 12.9 2.9 8.7 71.9 8.8 20.9 2.8 107.6 8.1 90.8 1.6

Electricity, gas and water industries 0.8 0.1 80.0 7.7 10.1 1.2 26.4 2.6 1.0 0.1 0.0 0.0

Construction induetries 17.8 8.2 18.0 2.9 8.8 0.6 18a 1.8 81.6 8.9 16.0 2.4

Hotels, restaurant.s and trade 0.0 0.0 4.7 0.7 15.7 1.8 17.1 1.7 81.8 2.4 1210 1.6

Transport, storage and communications 7.1 1.8 29.7 4.8 98.9 10.8 30.8 8.2 91.0 6.6 40.0 6.0

Financing. insurance, real estate, and

business services 89.4 12.6 80.8 12.8 178.9 20.6 41.8 4.1 48.0 8.8 80.0 7.8

Comnity. social and persnal services ... LA . 4 ..5J _LA3 ...=U A .....- ,2 LU .Ufj2 -A .1

Total 880.0 100.0 648.8 100.0 88.4 100.0 1,016.8 100.0 1,830.8 100.0 686.0 100.0

* 70 *Ne. m1;2aGh

AOWIMt PtN&NC CM ATIIPCYLt

UFMAlfT AlRilWl TO D

Pinancial Vear OWN/8 10/17 1 197/ * Ion./"* S 1909/90 S 30109.90 S

Agriculture. forestry A fiahing 8.5 0.0 7.8 0.8 1S.8 0.6 29.9 1.4 52.4 2.0 60.9 9.1

ining A quarrying 7.2 0.6 10.2 0.7 7.0 0.4 4.6 0.2 8.1 0.0 9.7 0.3

Moufacture of food, beverages and tobacco 189.2 18.6 262.0 17.0 837.7 1V.4 808.0 16.3 425.2 16.3 867.0 19.6

Manufacture of tUsti Ies 63.8 5.8 8.S 4.4 8.1 4.5 98.9 4.8 119.4 4.6 127.6 4.4

Manufacture of wearing apparel

Including footwear 45.4 4.0 48.0 2.8 77.0 4.2 96.1 4.4 110.7 4.3 130.0 4.8

Manufacture of eather and leather products

including footwear 17.6 1.0 22.6 1.5 25.2 1.4 21.2 1.0 44.1 1.7 48.4 1.5

Wood and 40nufacture of wood products 6.0 0.5 7.1 0.8 9.4 0.8 17.1 0.0 26.8 1.1 385.5 1.2

Manufacture of paper products, printing,

publial-ing and pecliging 40.5 8.6 96.4 6.2 100.0 5.5 116.0 8.8 148.6 8.6 148.2 5.1

Manufacture of chemicals and chemical products

other than rubber and Plastic products 96.0 .7 124.0 8.0 116.6 6.4 147.0 6.7 262.0 10.1 248.1 8.9

Rubber products manufacture 45.7 4.1 86.0 8.6 64.6 3.0 68.0 0.8 98.8 8.8 96.6 8.4Plastic products manufacture 06.2 8.0 8.8 5.5 91.5 8.0 102.? 4.7 119.7 4.3 112.6 3.9

Manufacture of non-metallis mineral product

including pottery, chins and glass manufacture 90.7 6.0 107.8 7.0 110.9 6.2 100.8 0.0 125.0 4.8 168.6 5.7

Basic metl production 0.0 0.0 12.3 0.6 76.7 4.2 84.2 3.8 102.9 4.0 97.4 0.4

Manufacture of fabricated meatl products

machinery and equipment including

electrical items. transport equipment

and instrument manufacture 61.0 7.2 69.7 8.6 117.8 6.4 162. 7.4 172.5 6.6 184.9 6.4

Electricity, gas and water industries 2.9 0.8 86.0 3.8 47.8 2.6 41.9 1.9 48.9 1.7 48.7 1.5

Construction industries 19.1 1.7 26.7 1.7 85.0 1.9 09.2 4.8 79.6 6.1 98.6 V.4

Hotel*. restaurants and trade 276.6 24.6 301.8 19.5 3821.7 17.5 337.7 15.4 327.9 12.6 35.0 12.3

Transport, storage and comynications 9.5 0.8 06.0 2.8 40.4 2.2 96.6 4.8 181.9 6.7 177.4 6.1

Financing, insurance. real estate. and

busin*** *ervices 69.7 0.2 118.9 7.5 144.5 7.9 141.6 6.4 154.0 5.2 189.9 4.8

Community, social and pereonal services 4 .... A .. 12 ....0J ..... J. ... 11 -AM -LA -- AA .. ... JA

Total 1,127.4 100.0 1,544.5 100.0 1,634.8 100.0 2,197.0 100.0 2,601.9 100.0 2,07.2 100.0

-711

19000 00PATW0B

ACTUAL PROJECTION

Financial Ycar 198/87 1987/88 198/89 1989/90 30.09.90 1990/91 1991/92 1992/98 199/94 1994/95

A. Approva1. Locel Currency

Lamn 898.1 84.4 364.8 88.4 281.2 MO.0 88.0 1121.8 1480.5 1122.5Lcaoing 42.6 50.7 90.7 74.0 56.0 98.0 18.0 148.0 255.0 340.0Bill Ditcounling 0.0 0.0 0.0 58.8 69.0 80.0 78.0 85.0 100.0 120.0Share Inveatuenta 12.8 10.0 19.9 17.0 3.0 20.0 20.0 20.0 20.0 20.0Other oera&Monå 100,0M3a§ R E. Ma E

448.8 9.1 605.1 679.7 181.2 111.5 1212.0 1495.8 190.5 2427.52. Foreign Currency Lmnan 22. 2ZU .mu& 610.8 N .O .29.0 1210.5 1507.5 1878.5

Total Approvalm 648.8 88.4 1018.8 1380.8 862.0 188.5 2211.0 2708.0 8413.0 4304.0

8. Commit0ent.1. Locri Currency

Loana 288.7 315.4 487.2 477.6 205.0 81.0 708.4 897.2 1144.4 1488.0Loaoing 29.0 32.7 28.8 8.2 45.0 98.0 138.0 188.0 255.0 840.0Bill Diacunting 0.0 0.0 0.0 58.8 89.0 50.0 75.0 85.0 100.0 120.0Share Inventmente 12.8 10.0 19.9 17.0 8.0 20.0 0.0 20.0 20.0 20.0Other Operatione _..Q ._Q.Q ... O -QL -L0 2. -E -M1O.. .J96.0 1M0

825.s 858.1 80.9 60.1 842.0 877.5 1085.4 1271.2 1619.4 2088.02. Foreign Currency Lan* 2" 2" &0Z 491.1 2nuO .306, ,.Z92 98.4 10.0 101.2

Total Co=it~nte 587.1 604.4 871.6 1097.4 87.0 1861.5 1884.8 219.6 82.4 8M4.2

C. Diabureme~nta1. Local Currency

Loana 843.8 259.0 471.2 827.0 164.9 88.6 818.8 1085.1 1818.9 1667.9Leaoing 28.5 386.8 21.2 80.8 84.5 88.8 122.2 168.7 226.2 301.8Bill Dicounhing 0.0 0.0 0.0 0.0 184.4 80.0 75.0 85.0 100.0 120.0Share Inveåtmenta 8.8 8.9 5.6 19.4 21.6 20.0 20.0 20.0 20.0 20.0Other Operation* - _Q.u 00 ,LO- I1A -2~ -JLO 100. .0

880.9 804.7 498.0 596.7 405.4 972.4 1181.7 1887.8 1760.1 24.72. Foreign Currency Loan 2cL, M.si SE a 1Z2a2 2Hal .n1n.2 .z273 1121,8 140J

Total Dibura..ate 822.0 689.8 740.0 949.1 784.6 1741.8 180.6 2881.1 2981.7 8717.8

-72- ANNEX 3 TABLE 4Page 5 of 12

0 0 N J

Cl 2

lii i

li sa

a a a 9

!iJi

*78 - AMMM AM A

DMn3ANW FDOM ONORTI OF CEYLON

ACTUAL PROJECTION

FY ended 81st Narch 6/87 87/88 88/89 89/90 80.00.90 90/91 91/92 92/98 98/94 94/95

INCOME

Interest from loans 158.9 193.9 202.0 210.2 172.8 861.0 497.2 684.8 842.0 1047.8

Dividend income 6.0 8.6 10.8 6.8 5.9 15.7 21.0 26.2 82.0 85.8Profit on leasing operations 4.9 9.6 9.5 10.8 8.5 26.1 88.9 50.3 69.8 92.0

Recovery of Bad Debts 4.6 6.7 9.4 11.0 8.1 9.0 10.0 12.0 12.0 12.0

Profit on Bill Discounting 0.0 0.0 0.0 0.0 2.7 7.2 18.0 7.5 6.8 10.5

Profit on Property Development 0.0 0.0 0.0 0.0 0.0 7.5 10.8 18.8 20.9 89.4

Income from Venture Capital Co. 0.0 0.0 0.0 0.0 0.0 2.0 2.0 2.0 2.0

Profit or Privatizatlon ... & .... 0,& ..... - - 2SA .B.Income from Portfolio 178.4 217.8 231.2 800.8 198.0 426.5 569.6 771j.6 1015.0 1289.0

Surplus Fund Inv. Incom 89.8 37.2 55.6 77.2 24.8 89.9 84.2 48.7 47.0 72 1tiacellaneous Income 4.8 _ _...A .19.4 .g, -L .9 2.8 24. - 2gg1Total Income 217.2 259.6 294.8 387.9 231.6 482.2 640.7 846.6 1066.0 1840.5

OPERATINQ EXPES

Salaries A overhead expenes 14.1 16.2 25.6 88.4 19.5 46.4 52.8 60.7 69.5 79.1

Bad debts/provision for had debts 25.8 27.1 26.8 26.0 12.1 38.8 86.2 41.8 54.1 6.2

Depreciation .. M JA M .7 aM .2 M.2 1.9 1.7 -MRTotal Operating Expensea 41.8 80.1 57.9 86.1 34.1 08.0 99.2 112.9 1385.8 188.1

Operating income before

finance charges 175.4 209.5 286.9 821.8 197.5 394.2 541.5 732.7 950-7 1182.4

FINANCE CHAROE

Interest on - ADO Loans 24.8 27.8 29.2 85.8 20.4 64.0 121.7 168.1 277.1 885.8

- IDA Loans 27.8 86.7 48.0 68.6 89.6 91.9 149.5 218.6 804.2 409.1

- Other FC Loans 5.9 6.0 9.8 17.8 8.6 16.4 16.0 15.1 18.4 11.8- Rupee Loan.s1 -AU -MA 57.4 -AM -"A . 2.4 49.0 .

Total 119.2 140.7 144.4 177.2 104.8 201.9 861.5 494.2 648.7 689.8

Profit before taxation 56.2 68.8 92.5 144.8 95.2 162.8 180.0 238.5 307.0 842.9

Leee: Taxation .. 4 19. ILI .9" 2u A. 4112 .ALA j .Profit after taxation 47.8 88.6 75.4 112.1 84.6 116.3 188.8 187.9 238.4 262.1

APPROPRIATIONS

Dividend 12.0 14.0 15.0 20.0 0.0 20.0 20.0 20.0 20.0 20.0

Special reserve 9.0 0.0 0.0 0.0 0.0

Reserve under Intend Rev. Act 18.0 22.0 81.0 51.0 0.0 69.8 71.8 67.0 116.9 187.8

General Reserve & Net Earnings 2u 2LA LI 4L A -MRI 7.8 1Q. l 12ggATotal 47.6 8.8 78.4 112.1 84.6 116.8 186.9 188.0 288.5 262.1

RATIOS

Return an average equity (5) 22.2 28.0 24.8 29.2 14.0 24.8 28.7 25.8 28.8 22.7

Return on average total aset (5) 2.8 2.8 8.2 4.1 2.1 8.5 8.2 8.5 8.7 8.8Adaiiletrative A general expenaef/

everage total easete (5) 0.8 0.8 1.1 1.2 0.8 1.4 1.2 1.1 1.1 1.0

Intereest spread () 4.2 4.8 8.8 4.6 2.8 4.9 4.7 4.8 4.4 4.0

Earning spread () 4.9 8.1 4.7 5.8 8.7 6.1 6.2 6.6 7.0 6.6

-74-

ACTUAL PROJECTION

FY ended ltet March 44/67 7/n 01/09 49/90 30.0.90 90/91 91/92 92/ 93/04 94/9

ASSETSInvestments

Foreign currency 548.7 1.204.7 1.800.6 1,501.6 1.767.1 2,095.9 2.881.9 8.815.8 4,105.4 5.0165.4

LAcal currency 678.4 297.8 ag.? a9.4 40.5 824.0 s. 1.o M.9 1.028.8 1,206.9

Working capital 1M.1 161.6 81.8 416.0 377.0 487.8 411.2 447.7 815.7 001.0

Lase: Provision for Bad Debts (20.2) (37.6) (67.2) (57.2) (57.9)

Not term portfolio 1.405.0 1,648.9 1,990.9 2,881.6 2.867.4 8,107.2 8.701.1 4,892.4 5,647.4 6,698.8

Share Investments (net) 82.8 89.1 98.7 110.2 180.2 127.4 144.4 160.9 177.4 191.9

Leas*old property 86.6 61.6 61.6 82.9 100.4 106.2 150.6 208.9 206.1 870.7

Bill Discounting 0.0 0.0 0.0 0.0 6.1 11.8 14.0 15.7 18.9 21.6

Unit Trust 0.0 0.0 0.0 0.0 18.1 87.8 98.8 99.8 W9.6 9.6

Venture Capital Company 0.0 0.0 0.0 0.0 0.0 90.0 20.0 20.0 20.0 90.0

Insurance Company 0.0 0.0 0.0 0.0 0.0 2.5 2.5 2.8 2.5 2.5

Property Development 0.0 0.0 0.0 .0 0.0 10.0 2W.0 87.5 80.0 82.5

Privatized Enteprises 0.0 0.0 0.0 0.0 0.0 80.0 90.0 66.0 45.0 45.0

Total investments perkfollo 1,84.8 1,796.9 2,146.4 2.544.7 2.916.2 832.4 4,241.4 8,202.7 6,846.4 7,709.8

Lasm: current portion of loans (289.9) (854.8) (461.2) (80.4) (1.150.0) (1.140.8) (1.844.9) (1.770.0) (2.88.0) (2,828.4)

Total 1.34.4 1,442.6 1,665.2 1,666.8 1,768.2 2,861.6 2,986.5 8,42.7 8.991.4 8.88.9

FIE %D NON-CURW ASSEIS

Fined Assets (at cost) 86.8 80.2 88.2 57.9 08.6 78.2 76.2 81.8 6.1 91.4

Leas: Accumulated depreciation 7.0 18.4 19.8 20.9 29.4 84.1 48.5 88.6 64.8 78.8

NET FDED ASSES 29.8 36.8 85.9 82.0 8.2 41.1 84.7 27.7 21.8 14.9

Loans to staff 6.6 7.8 8.9 10.0 10.9 10.9 12.8 14.4 17.1 20.4

Special Reserve Fund Investments 18.0 15.0 18.0 18.0 18.0 18.0 18.0 15.0 15.0 18.0

51.1 89.1 59.8 57.0 61.1 67.0 62.0 87.1 88.7 50.8

CUtREfTASSEMS

Debtors A deposeit 2.6 8.4 8.9 84.2 80.8 20.8 26.8 28.8 28.8 20.8

Accrued income 14.5 24.8 81.6 88.7 46.8 78.5 106.9 187.0 178.8 218.8

Cash A bank balances 842.8 801.1 824.8 196.6 186.5 76.1 448.9 297.4 420.6 66.1

Current esition of leen portfolio 209.9 854.8 481.2 6859.4 1,150.0 1,140.8 1,344.9 1,770.0 2,386.0 2,826.4

Total Current Assets 649.8 M.6 841.9 948.9 1,866.1 1,818.7 1,919.0 2,22.6 2,977.2 8,248.1

Total Assets 1,984.6 2,190.8 2,868.2 2,666.2 8,198.4 8,787.8 4,677.5 8,718.4 7.022.8 6.684.6

* 75 -

nFvFlanne PINarF ranR "i - miA UrFIUt (cont'd)

ACTUAL PROJECTION

FY ended sat March M/87 6/se ss/80 al90 s0.00.0 0l91 01/92 92/9s es/94 94/0s

EWITY AND LIAITIESElWITY

Pald in capial 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

special reserve* 18.0 18.0 15.0 15.0 15.0 15.0 15.0 1s.0 15.0 15.0

IWilding reserve 25.0 25.0 25.0 25.0 25.5 25.0 25.0 25.0 25.0 25.0

Nitervr. under Inland Rev. Act 49.0 71.0 102.0 158.0 153.0 2.8 298.6 890.7 497.6 684.9

General Reserves 42.0 65.0 04.0 135.0 135.0 162.2 210.0 290.6 892.4 497.2

Profit A Lows A/c 1.1 0.6 1.2 1.0 65.9 1.9 1.9 1.9 1.9 1.9

Total 932.1 976.S 857.2 420.9 408.# agM.4 645.5 618.4 1081.9 1274.0

LONO-TEMU LEAMILITIEGovernment Loans 10.7 8.5 7.5 6.4 6.4 5.8 4.2 8.1 2.0 0.9

CS Refinance Loans 260.9 199.9 288.9 241.0 2A6.5 226.0 217.2 210.9 173.5 188.6

NOg Refinance Loans 181.0 226.5 241.2 260.8 24.8 844.5 488.2 679.4 927.0 1242.6

OFM Development Sonds 396.7 898.7 898.7 896.7 806.7 89.7 896.7 206.7 290.7 2*67

ADS Credit Line 278.5 297.9 860.9 401.8 455.8 885.0 1190.5 1458.8 1672.6 2371.1

IA Credit Line 409.6 84.9 657.9 812.8 941.9 1104.0 1617.0 1758.0 2159.8 2610.8

Fi0 Loans 6B.0 65.2 64.1 57.5 51.1 51.1 44.7 88.8 81.9 25.5

08 Loans 0.0 0.0 191.0 191.0 191.0 191.0 191.0 179.0 158.0 181.0

Customer Deposits 0.0 0.0 0.0 0.0 0.0 25.0 100.0 200.0 800.0 500.0

Leas: Current portion of debts (94.8) (181.8) (202.4) (215.0) (191.0) (242.5) (582.8) (501.2) (784.6) (609.8)

Total 1,484.0 1.642.8 1,052.6 2.154.0 2.404.7 2,98.1 8.618.7 4.229.9 5.165.5 6.709.8

OtENr LIAILITIESundry Creditors 124.5 118.5 41.9 52.0 59.4 86.1 86.0 85.7 84.7 88.4

Income Tea Payable 7.9 9.4 16.9 2.4 84.8 14.8 24.5 29.2 85.4 88.8

Dividend Payable 12.0 14.0 15.0 12.0 10.1 10.0 W.0 20.0 20.0 20.0

Current Portion of Debt 94.8 181.8 202.4 215.0 101.0 242.5 532.6 691. ' 784.6 609.8

Total 238.7 271.2 276.2 802.8 294.8 802.9 618.8 675.1 324.9 701.0

Total Liability A Equity 1,984.S 2.190.8 2.568.2 2.66.2 8.198.4 3,767.4 4.677.5 5.716.4 7.022.8 8.684.8

RATIOSCurrent Ratio 2.7 2.5 8.0 8.1 4.6 4.4 8.1 8.8 8.6 4.6

Debt/Equity Ratio 6.7 8.4 6.4 5.5 5.8 6.0 6.4 5.9 5.7 8.7

DEVLOU2T0INNC COMM0at OF CEVLDN

tatens Some hef emolication of Funds

ACTUAL PROJECTION

FY ended 81s 1arch M/7 *7/8 08/89 69/90 a0.09.90 90/91 91/ 2 92/9 9s/94 94/95

0UCE OF 406Operating income before interest

eAp*naea A after ta 166.9 19.8 219.8 821.7 197.5 162.5 100.8 238.5 807.0 842.9Add: Non-cash expense items 26.8 88.2 82.5 83.0 14.8 41.0 46.4 52.2 68.6 79.0Leas: Dividend 12.1 f14Ml .11.91 £9.91 ... M . 0 20.0 .. 0. 20, .0Internal fund generation 161.2 218.8 287.8 84.7 212.0 224.1 246.7 810.7 892.6 441.9

PORTFOLIO REcVERIES- Loans 195.2 276.1 842.9 492.7 298.9 618.7 942.2 1062.9 1406.8 1848.9

- Share investments 0.5 2.8 1.0 8.0 1.1 2.8 8.0 5.5 8.5 5.5

-Lewwe amortixation 4.8 11.9 20.3 29.1 7.0 55.1 72.7 101.4 189.9 204.6- 0ill discounting 0.0 0.0 0.0 0.0 100.5 40.0 72.8 88.3 97.5 116.8- Property development 0.0 0.0 0.0 0.0 0.0 25.0 85.0 82.5 87.8 112.8Local - Central Bank 84.0 9.6 12.8 24.6 4.5 0.0 0.0 0.0 0.0 0.0

- Other& 184.8 128.8 66.6 82.6 61.8 176.9 255.0 115.2 809.4 448.1Foreign - AB/Oovt. 118.1 48.4 64.0 90.5 108.9 469.5 867.5 543.6 680.5 855.0

- IDA ovt. 120.7 182.6 128.7 204.5 151.9 886.8 870.8 848.6 600.5 855.0- New Credit Line 2.8 - 191.0 - 0.0 - - - - -

Others .L .4J -Ll .Z .0 2.9 319 .1...J ...- 4.L -- LA.J .1Total 81.8 824.4 1060.6 1264.8 949.6 1958.8 250.8 2850.1 8800.7 4887.2

APPLICATION OP PLASLoan diabursementse 585.0 548.8 718.2 879.4 546.8 1402.7 1867.4 2008.4 2505.5 8150.5Leases 28.5 86.8 21.2 50.8 24.8 88.8 122.2 166.7 226.2 801.8Share Investemnte 8.6 8.9 5.8 19.4 21.1 20.0 20.0 20.0 20.0 20.0Property Development 0.0 0.0 0.0 0.0 0.0 85.0 80.0 78.0 100.0 125.0

Bill Discounting 0.0 0.0 0.0 0.0 184.4 50.0 75.0 85.0 100.0 120.0Long-tern debt repaymentsLocal - Central Bank 27.8 80.8 18.5 17.9 9.0 15.0 8.8 6.8 87.4 84.9

- Others 14.5 87.8 56.1 64.9 87.8 68.7 164.1 814.0 829.7 476.0

Foreign - ADB/oat. 25.8 24.0 1.1 50.1 19.4 85.8 85.7 80.9 88.1 8518- IDA Govt. 18.5 7.8 0.8 49.6 22.8 47.8 57.5 118.2 110.6 127.7

Others 0.2 0.1 - 6.4 6.4 6.4 6.4 18.4 30.4 80.4

Interest payment 119.2 140.7 144.4 177.2 104.8 285.7 866.2 501.9 692.5 981.9

Capital espenditure 11.1 14.2 5.8 2.7 5.7 17.5 8.7 8.9 5.6 6.1Unitruet Investments 0.0 0.0 0.0 0.0 1.8 78.0 6.0 6.0 0.0 0.0

Venture Capital Company 0.0 0.0 0.0 0.0 0.0 72.5 40.0 0.0 0.0 0.0

Advances to staff A othere 1.0 1.7 2.8 8.7 1.8 8.8 4.8 5.5 6.5 7.4

Increase/(decrease) in netCurrent assets (2791 2061 .. 91A 0,31 M.21 f=.-21 ..19J.OD iW,li1 ( .1 (510.A1

Total 811.8 824.4 1060.6 1264.8 949.6 1988.8 2688.8 280.1 8800.7 4887.2

Debt/service coverage (timaes) 1.9 2.1 2.7 2.8 8.1 2.4 2.8 1.8 1.7 1.6

Interest coverage (ti*) 2.5 2.6 2.8 2.9 8.0 2.0 1.7 1.8 1.6 1.8

. 77 -

DEVELOPtN FDAC COPl~ATIM 0 P CEL

Ae.wala of Arreara

Ab a March 31 1962 19683 194 1988 1986 197 198 1969 1990 30.00.90

Na. of companes in arr"as 108 149 171 164 118 116 126 171 192 240

Total nufber of comanes 304 828 842 88 407 40» 470 498 640 676

Percentage of companies in arrega () 38.9 45.4 50.0 42.8 29.0 26.4 26.8 4.S 80.0 3.8

Aun% in arrears (Ro. mill ion)

1. Principal in apr.re 7.8 24.5 38.1 24.0 838.8 81.3 47.9 78.7 81.5 97.7

2. Interes a arrears 19.4 24.8 33.2 17.2 28.7 29.5 64.1 72.7 64.7 74.0

8. Total principal & intereat in arrearm 37.2 49.8 71.8 41.2 57.0 80.8 112.0 146.4 148.2 172.8

4. Total princieat 4 intreat outatanding

of loan in arrears 121.0 185.2 804.1 306.1 168.9 128.0 158.2 358.3 64.6 794.3

5. Totkl loan outatmading (including arreses) 486.6 529.0 5U.B 776.9 1089.9 1425.2 1688.8 2048.1 2408.8 2656.6

6. Tctal outatanding for loans under ropayment 805.0 878.S 424.6 481.8 708.7 899.1 1220.3 1606.0 164.4 1952.6

Percentages

3/5 8.5 9.3 12.1 5.8 5.5 4.3 6.7 7.1 6.1 6.5

3/6 12.2 13.0 16.8 6.4 8.0 6.8 9.2 9.7 7.8 8.6

8/4 80.7 26.6 28.4 13.5 8.7 47.5 70.8 41.4 21.4 21.7

4/5 27.7 35.0 51.6 39.4 16.2 9.0 9.4 17.8 28.4 29.9

4/6 39.7 48.9 71.6 62.6 28.8 14.2 13.0 28.5 86.7 40.7

sy Age af Arrear (IRa. Gi Ilion)

Lees than 3 mantho 9.7 5.0 20.9 5.4 14.5 15.5 35.3 45.3 15.9 28.8

8 - 6 monthm 2.1 1.8 2.5 0.8 2.6 2.8 1.5 26.2 6.4 15.8

7 - 12 mønth" 8.8 4.7 10.9 6.4 6.5 6.9 7.8 28.1 22.6 13.7

Over 12 months 2L2 nLi £.uQ M.2 NLA mLi . .,LI -" 10 11.

Total 37.2 49.8 71.8 41.2 57.0 60.8 112.0 148.4 148.2 172.8

y Sector (Re. mil lion)

Manufacturing 28.8 87.5 89.1 28.2 31.1 32.9 60.8 78.8 82.8 97.5

Tourim 6.8 9.0 26.6 10.3 10.5 14.4 25.8 38.7 81.7 37.2

Agriculture 0.1 0.1 0.1 0.2 0.2 0.6 1.1 1.5 1.4 1.6

Other ..2. ..2. å . 2 1U 1L2 .I -M£ -ni --

Total 87.2 49.3 71.3 41.2 57.0 60.8 112.0 148.4 148.2 172.8

Suboectoral nealyis af manufacturing aector

arregsø a at 81 Deceaber 1988

Tetiles and ready-made garmente 12.2 16.2 20.8 12.2 5.7 6.0 10.9 14.2 16.7 19.6

Duilding materiale 2.8 3.1 6.1 2.8 0.1 0.1 1.8 2.4 2.2 2.5

Cheialcal products 2.5 8.3 2.7 2.4 2.8 2.4 4.2 6.5 5.2 6

EngIneering 1.1 1.4 2.8 1.1 2.3 2.4 4.2 6.8 6.0 7

Rubber products 8.8 4.4 2.2 8.8 1.2 1.8 1.8 8.9 3.7 4.8

Food & beverage 0.1 0.1 1.1 0.1 8.9 6.2 11.0 15.0 19.2 22.5

Otherg .å ..-.U .-.U IL" -LU BL Ai 2Ru NATotal 28.8 37.5 39.1 28.2 31.1 32.9 60.5 78.8 a2.8 97.5

- 7n - KI

DEVELG~ PM ~ CTI I CEYLOI

Caeh Col leelon Påerfrmice

Financlel Year 192/88 193/84 1964/88 198/66 19 /«7 1987/88 19ø/89 1909/90 80.09.90

(1) Diance O/F19.89 24.61 8.24 17.28 28.73 29.84 64.05 72.67 72.40

nstallaen6 17,D gHJI MMl M.9 ". 9LI 47.92 .290 116.40

Total 37.24 49.27 71.m 41.20 57.11 60.18 111.97 146.37 189.80

(2) Due for %hø Year

Intereat 82.08 98.52 100.57 121.59 168.62 216.79 221.Ø8 269.00 25.6

Iltal &øn _. " .. .2 i 1g§ 201.10 295.94 U,» 05 §MS NTotal 140.45 1a.a 174.70 232.24 &78.72 512.73 590.99 774.15 861.4

(8) Total Du**Int*reat 101.48 119.88 183.81 188.12 192.35 246.8 2M.f 341.67 839.0

nstallmnt 76.24 11. l.27 ~ 248.48 Z2 417 a eZLs 672.2

Tot 177.69 231.68 248.08 278.44 488.88 73.58 702.96 920.52 1070.2

(4) A4Justfent* forVrit.-off of Int. 8.67 16.29 3.21 1.48 10.19 2.71 18.86 19.47 0

vrit-off & Reached. of nat. 9,6 .J 2L2 "2 HZiE a M Z -. Z0 9Total 6.02 25.97 30.50 3.88 27.21 5.94 19.25 24.17 0

<5) C~ah CollectionIntoret 72.97 ø8.90 118.37 113.66 152.62 179.57 194.45 257.70 809.3

Inatel lmnf .49 8.go _1.0 99.12 1L95.17 2M6S IA291 492.65 §Z-4

Total 1.40 134.80 174.36 212.78 347.79 455.85 37.M8 780.35 8a.a

(6) Balance C/FInteret 24.81 33.24 17.28 28.73 29.54 64.05 72.67 64.50 88.70

Inatallent 24,4ø M, UZ DA 2La7 ."Z 2 -2L JM2 81.0 97.7M

Total 49.27 71.39 41.20 87.11 60.8 111.97 146.P7 148.00 164.'Å

(7) Collection RatloInterest - 5 6.9 88.2 86.O 82.7 83.8 78.7 72.8 80.0 77.7

Inotallmt - Z iLA AZ ZLA Z"L 1.2 oEm m.i A oE.ATotal - S 71.8 85.8 80.9 78.8 85.1 00.3 78.6 18.7 02.8

- 79- NN I TABLE 10Page 12 of It-

DEVELOPMENT FlANCE CORPORATION CEYLON

Sectoral Analysis of Loans Affected by ArrearsOver a Months of Interest and Installments as at Sepiember 80, 1090

LoansTotal Affeted byLoan Arrears Over

Sector Portfolio 8 Month. Percentage

Agriculture, Forestry and Fishing 45.48 8.08 17.6Mining and quarrying 9.82 0.00 0.0Fooo, Beverages and Tobacco Manufacturing 589.80 21.49 8.9Textile Manufacture 94.49 19.06 20.1Wearing Apparel Manufacture 106.90 17.88 16.7Manufacturing of Leather Products

(Footwear and Wearing Apparel) 88,29 9.96 27.4Wood and Wood Products 86.10 6.60 16.1Paper Products, Printing, Publishing, Packaging 140.88 10.11 7.2Chemicals, Chemical Products and Petroleum

and Coal Manufacturing 241.14 18.95 5.7Rubbe Products Manufacturing 69.70 17.42 24.9Plastick Products Manufacturing 96.24 28.66 24.6Non-Metalix Mineral Products (Except Coal,

Petroleum) Pottery, China, Clas Manufacturing 148.88 9.88 6.8Basic Metal Production 06.68 68.09 60.1Fabricated Metal Production Machinery

Electrical Items, Transport Equipment andInstrument Manufacturing 171.18 18.97 8.1

Electricity, Gas and Water 42.87 40.88 96.8Construction 64.00 4.99 5.9Restaurants, Hotels and Trade 47.09 8.94 19.7Transport, Storage and Communications 148.51 0.41 0.2Financing, Insurance, Real Estate andBusiness Services 114.14 2.67 2.5

Community, Social and Personol Services 45.87 1.72 8.7

SUBTOTAL 2812.94 28.42 12.5

Hotels (Opted for relief) 204.88 226.02 84.4

GRAND TOTAL 2577.82 511.44 19.0

KkTIONA DEOEAPMef OWl

meratlonal and Financial Hiehilahes - (1988 - 1990I

1988 1987g 1988 1989 1990

No. Amount No. Amount No. Amount No. Amount No. Amount

Loans Including Equipment Finance 112 648.7 189 5869.8 164 1076.5 164 1298.0 161 14ss.4

Equity Investments - 10.g - 86.8 - 69.7 - 82.8 - 127.0

SMI Refinance 712 879.1 627 408.7 8 260.8 851 481.5 1848 619.0

Sus Refinance - - - - - -* - -M 296,

Total 824 1038.2 966 1029.6 692 1428.8 1015 1786.6 1880 2488.79

DiabursementsLAans Including Equipment Finance 887.4 $16.6 741.2 734.0 1687.2

Equity Investmentse 8.4 14.7 89.5 28.4 87.5

6MI Refinance 277.0 416.7 268.8 266.1 451.8

Bue Refinance ..-

Total 822.8 1050.5 1069.2 1028.5 2172.4

Economic Significant of ProlectsGroes In* etment Generated:

Direct Finance (Re. Mn.) 904.0 923.8 1827.0 1906.8 801.1

SHI Refinance (Re. No.) 738.8 748.8 806.4 874.0 1497.0

Employment Generated:

Direct Finance (No.) 2125 2687 8786 8374 4906

SMI Refinance (No.) S897 7449 5205 9855 15578

Financial Hiahlishta

Total income (Re. Mn.) 247.6 800.6 867.4 452.8 697.5

Net Profit Before Toa (Re. n.) 108.8 85.5 108.9 109.1 248.1

Net Profit After Tam (Re. N.) 100.8 86.8 103.9 109.1 162.1

Share Holders Funds(Capital & Reserves) (Re. Mn.) 1814.8 1897.0 1478.4 1588.8 1683.6

Total Assete Including

pro notes (Re. Mn.) 2584.8 8250.8 8771.8 4182.5 5517.0

Total Portfolio (Loenu A EquityInvestments) 202.9 2714.9 8817.8 8786.8 8078.5

Return on average equity (S) 9.9 7.1 6.1 8.0 16.6

Earnings per share (Re.) 24.09 19.00 28.09 24.25 54.04

Book value per share (Re.) 288.86 277.18 294.88 312.09 840.81

Equity debt ratio 49:81 41:89 40:60 88:62 81:69

As the Bank was not liable to pay tax prior to 1990. indicatore for 1990 have been computed on a pre-tax basis for

purposee of comparison. These indicators on an after tas bese for 1990 are given below:

Return an Average Equity 11.05

Earnings per share Re 386.04

- 81 - ANNEX 4 TABLE 1(b)Page 2 of 7

APPENDIX I

Sectoral Classification of Direct Financing Facilities

** pr so aimSECTOR 110 1979-11900

No As M No Re Mn

Food, Beverage & Tobacco industries It 204.67 9.9 SO 1.01181 12.3

Agriculture, Agro Business and Fisheries 18 44.64 2.2 6 607.61 7.4

Textiles and Garments 31 19.72 9.4 139 79.28 9.7

Wood & Paper Products 2 35.56 1.7 34 158.38 1.9

Rubber and Leather Products 10 60.37 84 98 089.75 6.2

Metal. Chemical and Plastic Products (including manufacture oflabrioated metal products, Machinery and Equipment) 30 758.87 36.5 216 1.0658 23.9

Hotels 3 68.42 3.3 3 453.38 5.5

Service Industries (including Financial Services, CMI Construction.Storage, Transport & Communication) 41 537.47 2.0 162 1,719.70 20.9

Miscellaneous 15 156.28 7.6 154 640.7 10.2

TOTAL 161 2,0m49 100.0 1.016 8214.45 100.0

APPENDIX H

Size of Direct Financing Facilities Approved

Gron**Apprvae* omlaSIZE OF LOAN 1990 1979 *1990

No Ru Mn No A Mn

Below Rs 10 Million 114 38.80 78 2.491.0

Between as 10-5 Million 25 36o.i1 168 2.522.27

Above Rs 25 MIllion 22 12688 64 3,200.58

TOTAL 161 2,068.49 1,018 8,214.45

* 62 - An 4 TABLE 2Page 8 of 7

NATIONAL DEVELOPMENT BANK

Portfolio Analysis by Sector Claseificetion(Project A Equipment Financing)

(Re M1IlIIon)

Jun. 80, 1990 September 80, 19

NO. AMOUNT N NO. AMOUN S

Food, Beverages and Tobacco 64 488.6 14.2 64 421.8 12.4Agriculture, Agro-Business

and Fisheries 57 199.2 6.5 58 287.3 7.0Textiles and Wearing Apparel 79 806.3 10.0 67 841.6 10.0Wood and Paper Products 26 61.68 2.0 26 a5' 1.9Rubber and Leather Products 69 190.0 6.2 61 204.19 6.0Metals, Chemicals andEngineering 141 644.1 17.8 140 749.63 22.0

Hote*Is 31 289.1 9.4 81 285.1 3.4Services 69 887.7 22.8 97 782.71 21.6"Iscellaneous 116 867.6 11.9 116 869.98 10.9

Total 661 3066.62 100.0 680 8406.28 100.0

Eqult Investments By Sector Classification(Re. illion)

June 80, 1990 September 80, 1990

NO. AMOUNT X NO. AMOUNT 5

Food, Beverages and Tobacco 1 8.5 2.4 1 8.6 2.1Agriculture, Agro-Bualness

and Fisheries 1 22.9 16.6 1 22.9 18.8Textiles and Wearing Apparel 8 9.0 6.1 8 9.0 5.4Wood and Paper Product* 0 0.0 0.0 0 0.0 0.0Rubber and Leather Products 8 9.6 6.6 4 9.6 5.8Motels, Chemicals andEngineering 6 24.1 18.6 6 19.5 11.7

HoteIs 0 4.8 2.9 1 27.7 18.7Services 5 44.2 80.2 6 44.2 26.6Miscellaneous 4 28.9 19.7 5 29.8 17.9

Total 22 148.4 100.0 26 166.2 100.0

NAI ALDEELPPNNBA6

MOSINCOMIntoreat Incoma 118.8 151.7 194.8 228.0 284.7 239.1 292. 874.2 4~0.2 M00.7

öthr Incomo .l .. .u -,M ._" . _u . _M . JQ . g ,JgA J§UTotal 120.1 158.9 197.1 231.8 2»9.8 247.6 900.1 867.4 482.8 697,8

LESS EXPENSESFinancial charges Incuding

provibion for porbfolio lussee 17.4 28.7 68.0 104.8 133.9 116.9 194.0 254.1 812.0 98.IAdminltrntive expen . deprocaton .f aL I .LLX .-1W -ul -M 21.1 29.4 31.4 .1.2

Total 26.2 39.9 82.1 121.0 1m.1 89.8 215.1 288.8 S48.4 4~4.4

PROFIT BEFRE TAX 98.9 114.0 115.8 110.8 100.2 $08.8 88. 108.9 109.1 248.1LiS: PROVISION FOR TAXATION - - - - - - - - - (81.0)PROFIT AFTER TAX 93.9 114.0 115.8 110.8 108.2 108.8 85.8 10*.9 109.1 162.1

FACILITIES TO MiSTOIL.oan invecteeanta not of proviniona s3.8 883.6 760.4 947.5 1228.6 1778.7 2415.8 28.4 819.0 48~8.1Ejulty investmenta 0.I8 12.6 .4 4 ....51.1 .. 5 .44 94.0 .,101... .- 1.äl

Total 894.6 598.2 7^9.8 997.0 1279. 1829.2 2479.7 2989.4 8820.8 4384.2

Cann & term funda at Banka 848.0 406.8 418.1 420.4 487.1 422.0 481.8 314.2 414.7 493.8Sundry debtora and consamblee 215.1 E14. 29 2 KI Z" 159. ~ 201 AL

Total S69.6 021.1 O8.4 649.2 687 7 841.9 818.8 870.4 616.8 716.8

FIXED ASSETSLand, Buildings and Equipment 2.1 2.1 2.1 8.0 10.4 17.9 .4.8 84.1 114.1 126.6

0Tfl NON-CLEN ASSETS AM DIRT T

Share at coat in CDIC (Acoociate Co.) - - - 1.0.0 30,0 86.0 85.0 100.0 100.0 100.0Staff loana 1. &åLI 4.u _§u a.t .5A _" .9 .d

Total - 2.0 4.3 18.4 48.4 75.8 107.5 127.4 131.8 137.4

TOTAL ASSEMS 966.S 1221.4 144.8 1070.4 2028.2 2184.3 3010.6 871.8 4187.5 5617.0

LESS LIAILITIESLong-ter. berrowinga 138.0 202.2 897.1 527.7 791.0 1192.8 1742.4 2041.9 2411.3 2470.4Curront LlsbillIblop _ju _LU -ii _zu i2, 57.. 111.4 2^, 204 ~6.

Total 138.8 998.2 399.4 611.0 628.0 1249.8 18.8 2496.0 2681.7 08.4

NET ASSETS å22.7 93.2 1068.2 1114.4 1198.2 1814.8 1397.0 1478.4 188.8 1683.6

CAPITAL AND RESERVESInitial contribution to &har. capita$ 600.0 600.0 600.0 800.0 600.0 600.0 600.0 00.0 600.0 600.0Rotaened earning2 m2 .411.2 U14.4 .322 714. 797.0 075.4 .j§1. 108..6

Total 22.7 9~0.2 10M.2 1114.4 1195.2 1814.8 1897.0 1478.4 15.8 1688.8

RATIOS*Return on averege *quity (1) 13.00 15.60 13.60 11.60 10.60 9.90 7.10 8.10 8.00 16,56

*Earning per &bara (Ra> 20.87 25.31 25.64 24.81 28.60 24.09 19.00 28.09 24.25 54.04

Sook valuo per ehar* (Re) 149.80 178.14 201.16 214.31 282.27 258.0 I77.18 294.8 312.89 840.81Equity/Debt ratio 83:17 74:26 9:81 683:87 88:44 49:51 41:59 40:60 38:62 31:69

a Befora Tax

NA1iL3ÉDiMLfPtNT 8AM<

gialvala of Arrar for P4 - ae. 1990 (Prolect and emulament PingnaIå

N. eLe in Arrara (8) 87 47 se 84 cm2 6200 $124 4141

lotal No. of Lonsa n Portfol«o 11 208 298 401 8m0 890 6m8 om8

Percentage of Lomne In Arreare 8 1 23 19 29 45 34 20 22

Amount In Arrgars fRa Milli1n1Principal ln Arrears 89.27 86.79 68.87 85.87 96.25 160.00 209.25 79.0

Intaros6 In Arreare 61.69 47.37 89.58 57.77 147.85 119.60 6.97 85.81Total Principal and Interet

In Arreara (*) 100.96 84.16 124.92 115.14 248.00 279.60 26.22 114.39

Total Princip! and IntereatStanding of Lmena ;n Arrears 493.586 4M.6 878.55 267.42 918.69 1107.00 615.27 8M.I1

Total to-na Outatanding(Inciuding Arrenro) 997.14 122.98 1604.88 1979.86 2518.42 2118.90 8012.68 4.80

Total Outötandng for LoanaUnder Repayment 618.50 702.70 922.00 1197.64 1186.20 1692.60 1906.28 1677.04

Total Principal and Interash In Arreara(Doeferred Ces*) 0.00 89.08 84.91 106.05 202.40 182.60 90.48 71.012

a/ 10 7 8 6 10 11 10 a

8/6 16 12 14 10 21 18 16 6

3/4 20 24 88 48 26 25 48 21

4/8 50 26 28 14 87 43 20 16

4/6 80 49 41 22 82 85 92 29

8v SeNtor fRa HillionSManufacturing 685.47 64.87 82.28 98.95 106.68 116.14 61.31 73.26

Taurlom 35.16 18.87 37.32 8.80 76.47 72.70 92.89 2.06

Agriculture 0.24 0.45 1.28 8.86 13.80 15.00 6.39 2.29

Othera 0,09 0.47 4.14 7.88 47.15 78.60 135.63 31.78

Totäl 100.91 84.16 124.92 115.14 248.80 279.80 296.22 114.39

SubUetoraf Analval of Manufac%uring Arromra

Textiles and Ready-made Gärmente 48.06 29.75 40.09 9.71 25.29 85.10 37.48 56.62

atlo and Ceholcala 10.88 14.96 0.38 25.89 17.65 67.60 12.58 8.48

Electrical 0.51 2.92 7.00 7.94 9.24 0.30 0.00 0.0

Rubbar Product 5.25 12.10 28.75 42.88 26.89 11.60 0.73 0.80

Pood and Beverage 0.98 4.84 2.58 9.07 18.38 2.60 3.27 4.14

Wood and Peper 0.00 0.30 0.28 3.48 14.C 1.30 7.35 8.32

Total 68.47 64.87 82.28 1.95 106.8 118.50 61.31 78.26

* Includoo Deferred Caoe.• Excluden Doferred Case.Sun. 90 and Sep. 90 figures *xcludem wr~teof caaea.

-86- ANNEX 4 TABLE 6Påg* 6 of 7


Actual Cach CollectIon Performance for FY84-90(Ra. M1!Ilon)

Jun. ep.84 19M 188 1987 1988 1989 190 im

Arrears at the begInnine (A)

Principal 21.61 89.27 88.79 65.87 56.87 6.60 148.84 79.88

Interet 27.87 61.69 47.87 59. 6 _9.77 88.88 110.01 72.28

Total 48.88 100.96 84.16 124.92 116.14 178.98 266.86 152.11

Current Duc. (1)

Principal 96.68 162.24 219.28 84.62 440.89 607.92 767.61 744.40

Interest 128.66 169.12 216.05 268.68 887.49 697.65 626.56 849.88

Total 226.32 821.86 486.88 605.28 778.88 1186.47 1888.17 1894.28

Total Collectible (C) u A+B

Principal 118.17 191.61 256.07 411.99 496.26 678.62 904.46 824.28

Interest 156.08 289.81 268.42 818.21 897.26 685.88 785.67 722.16

Total 274.20 481.82 619.49 780.20 898.62 1869.40 1840.02 1646.89

Cash Collection (D)

Principal 77.65 182.79 174.66 229.87 298.18 848.97 486.66 474.88

Interest 94.84 144.41 162.87 282.92 244.97 880.80 487.6 460.61

Total 171.99 277.20 886.98 462.29 688.10 674.27 878.20 986.44

Foreclosure (E)

Princpat 0.00 70.46 88.92 118.46 17.47

Interest ___0.00 ._.86 18.74 0.00 0:00

Total 0.00 0.00 0.00 0.00 126.81 62.68 118.45 17.47

Reschedu l ements (F)

Principal 1.26 21.98 16.14 127.26 47.07 128.88 170.02 159.11

Interest 89.08 41.50 25.52 7.61 178.86 114.59 6.95

Total 1.26 60.96 67.84 162.77 64.68 299.68 284.61 226.06

Wrte-Off (0)

Principal 0.00 0.00 98.18 188.81 187.66

Interest 0.00 0.00 74.81 2 180:9

Total 0.00 0.00 0.00 0.00 0.00 167.99 284.48 268.46

Arreara at 0*. rnd (H)

Principal 89.27 88.79 65.87 66.87 86.60 86.76 48.62 85.27

Interest 61.69 47.87 69.6 6977 88.88 79.04 66_88 .:.7.

Total 100.96 84.16 124.92 116.14 178.98 184.80 104.28 98.97

5 Collection Ratlo 68.01 76.71 72.96 80.00 76.00 76.60 89.88 90.48

D/(C-E-F-0)



Age Analysis of Arrears (Direct Financing)

SEP90

Less than 3 Months 17.78

3 - 6 Months 29.41

7 - 12 Months 16.63

Over 12 Months 49.31

Legal Action 1.26

Total in Rs Million 114.39

Arrears as at September 30, 1990

INT. INSTAL TOTAL

Performing 11.34 36.13 47.47

Non Performing 23.98 42.94 66.92

Total in Rs Million 35.32 79.07 114.39

- 87 --

PROJECT COMPLETION REPORT

SRI LANKA


June 1990

Industry and Energy Operations DivisionCountry Department IAsia Regional Office

- 89 -

PROJECT COMPLETION REPORT

SRI LANKA

INDUSTRIAL DEVELOPMENT PROJECT (IDP)(CREDIT 1401-CE)

PART I. PROJECT REVIEW FROM IDA'S PERSPECTIVE

1.0. Project Identity

Project Name: Industrial Development Project (IDP)

Credit No: 1401 CE

RVP Unit: Asia

Country: Sri Lanka

Sector: Industry

2.0. Background and Sectoral Content

2.1. Policy Context. In 1977 Sri Lanka adopted a bold economicliberalization program after a long period of control and regulation. Thereforms of 1977, although radical compared to the inward-looking policiesfollowed by previous governments, still maintained high protection byreplacing quantitative restrictions with tariffs and the tariff structurecontinued to be biased against exports. The IDP was designed to support theongoing process o5 trade policy reform and initiate a dialogue on reform.The project also sought to improve the efficiency of Sri Lanka's financialmarket by creating competition between the two participating DFIs, theDevelopment Finance Corporation of Ceylon (DFCC) and the NationalDevelopment Bank (NDB), and by introducing a mechanism for consortiumlending with participation from commercial banks.

2.2. The Industrial Sector. Sri Lanka has a limited industrial baseconsisting of 29 large public sector corporations, 9,000 small and mediumscale registered factories, and approximately 20,000 unregistered smallcottage units. The manufacturing sector's contribution to GDP averaged to14% and accounted for approximately 45% of all exports. According to thelatest employment data available (1985), the sector provided about 19% oftotal employment. Public Manufacturing Enterprises (PMEs) remain a largesegment of the industrial sector and contribute less than proportionately toindustrial output and exports due to inefficiency. The export base is alsonarrow, with a high degi:ee of concentration on light industry and the readymade garment sectors.

2.3. In 1978, immediately following Sri Lanka's policy liberalization,the manufacturing sector grew 7.8%, but the growth rate slowed down to 4.6Zin 1979 and 0.8? in 1980 and averaged only 3.3% during 1977-83. This low

- 90 -

average growth rate concealed divergent trends in different segments.Public corporations' output stagnated with an average annual growth rate ofless than 1Z, while output value in private industry, including the rapidlyexpanding garment export industry, grew at an average annual rate of 7.2%during 1979-1980 and 13Z during the period 1983-1987. Apart from petroleumand the garment and textile subsectors, the other growing product groupshave been wood products, non metallic minerals and structural steel. Theincrease in growth rates in the period immediately following the reforms of1977 was largely the result of greater capacity utilization in industry madepossible by the increased flow of raw materials due to the liberalization oftrade.

3.0. Project Objectives and Description

3.1. Project Objectives. The project's objectives were to:

(i) Strengthen the operation of the country's two development financeinstitutions (DFIs) by providing finance to meet their foreignexchange lending requirements and technical assistance for trainingin project promotion, appraisal and supervision;

(ii) Strengthen the system of industrial finance by rationalizing theinterest rate structure for industrial lending, assisting in theestablishment of an equity fund to be managed by the NDB, andfacilitating consortium financing arrangements among the DFIs andother financial institutions;

(iii) Improve trade and industrial policies by providing technicalassistance to build upon effective protection analyses preparedunder previous IDA projects, introduce tariff reforms and undertakea study on industrial incentives; and

(iv) Improve the performance of selected PMEs by providing technicalassistance to the Ministry of Industries and Scientific Affairs(MISA) to assist them in formulating corporate plans, increasingmanagement autonomy, introducing performance incentives, andencouraging various pilot schemes to increase private sectorparticipation in ownership and management. Legislation was to beprepared to facilitate increased private sector participation inthe management and ownership of public enterprises.

3.2. Project Description. The project provided US$25 million equivalent(SDR 23.1 million) in IDA financing, of which US$23 million was forreimbursement of industrial loans disbursed by NDB and DFCC. NDB and DFCCare the only DFIs in Sri Lanka. NDB was established in 1979 to meet theincreased demand for term loans and equity participation resulting from the1977 liberalization. Previously DFCC, which was established in 1955, wasthe only source of long-term equity and credit, with a monopoly in providingforeign exchange loans to private industry. IDA funds were to cover 1002 ofthe foreign exchange cost of imported machinery and equipment net of dutiesand taxes.

3.3. The remaining US$2 million of the credit was to finance technicalassistance. IDA funds were to be used to finance the cost of advisors and

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foreign training to (a) continue to strengthen the DFI's term lendingcapabilities, (b) analyze industrial and export incentives and make neededchanges in the tariff structure; and (c) improve efficiency of stateindustrial enterprises. Technical assistance costs were based on anestimated 298 staff months of consultancy and advisory services, of whichapproximately 250 staff months were expected to be from foreign consultants,and 155 staff months of foreign training.

4.0. Project Design and Organization

4.1. The project was originally proposed as a sectoral adjustmentoperation which included a large policy reform program, focussed on trade.Since GOSL did not want to undertake such a high visibility operation forpolitical purposes, IDP was designed as a compromise to support theGovernment policy reform program and to support the significant policychanges through a rapidly disbursing investment project rather than balanceof payments support.

4.2. Access to funding under the credit line was made for the first timeon a first-come-first-served basis for commitments and utilization of funds,with no prior allocation.

4.3. The IDP was seen as the integral component of an incrementalapproach to policy reform through a series of lending operations includingSmall and Medium Industries (SMI) and Industrial Development Projects(IDPs). The changes in policy were to be incremental and less comprehensiveand spread over a longer (i.e. 3-5 years) than normally expected under asectoral adjustment operation. For this reason, T.A. components in thedifferent projects often supported the same policy reform program orinstitutions in an incremental manner. Specifically the IDP focussed uponthe need for:

(a) Tariff Reform. Most tariff revisions since the 1977 liberalizationhad been ad hoc, and in the direction of greater protection. Theproject included technical assistance in the implementation of afirst phase of tariff reform, by September 30, 1984 (SAR para.3.08) based on findings of a study financed under the first SHIproject.

(b) Industrial Incentives Reform. TA was provided for a study ofIndustrial Incentives to analyze the absolute and relativeincentives provided for investment, particularly export-orientedinvestment (SAR para 3.09).

(c) Public Enterprise Reform by providing TA to develop corporateplanning and related performance incentives, improve firm-leveloperations and introduce enabling legislation and pilot schemes toincrease private sector participation in ownership and managementof public enterprises (SAR para 3.07).

4.4. The institutional arrangements for the T.A. were as follows:

(a) work on Tariff Reform was to be carried out by the newly createdPresidential Tariff commission;

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(b) the study on Industrial Incentives was to be carried out by aconsultant under the Planning Department at the Ministry of Financeand Planning.

(c) work on PMEs was to be carried out by a newly created PublicEnterprise Cell (PEC) in MISA; and

5.0. Project Implementation

5.1. Introduction. The credit component as well as the institutionalstrengthening of the DFIs were implemented as planned. In the area of tradeand industrial policy reform, implementation of the tariff reform module andthe review of industrial incentives were completed with significant benefit.However, implementation of the PME component progressed very slowly and waseventually subsummed under the proposed Public Manufacturing EnterpriseAdjustment Credit. Specific details of component implementation are notedbelow.

5.2. The Credit Component. The credit component of SDR 21.25 millionwas fully committed within the three years envisaged in the SAR (see alsoPart III of the PCR). With a slight increase in the technical assistanceallocation (from the original SDR 1.85 million to SDR 1.865 million), thetotal credit of SDR 23.1 million was fully committed by the credit's closingdate, September 30, 1988. Actual disbursements vis-a-vis SAR estimatesshowed lags both during the initial and closing periods of the credit, withan acceleration midway. The credit was fully utilized by March 3, 1989,nine months behind schedule.

5.3. Subprojects Financed. The credit component was to refinance 100%of the foreign exchange cost of subprojects assisted by the DFIs with -heamounts available to the two institutions determined on the basis of actualcommitments with no pre-allocation by IDA. The actual pattern of subprojectrefinancing (in SDR million) was:

NDB DFCC Total

No. of subprojects financed 46 81 127Average loan size 186.8 160.5 170.0

Commitments 8.6 (40Z) 13.00 (60%) 21.6Disbursements 8.0 (41Z) 12.2 (59%) 20.6

DFCC used 60% of the credit by amount and 64% of the total numberof subprojects approved by both institutions.

5.4. Subloan Sizes. A breakdown of subloans by size (in SDRs) approvedby the two institutions is as follows:

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No. of Subloans

NDB DFCC Total

Below 100,000 26 43 69100,001 - 250,000 16 29 45250,001 - 500,000 - 06 06500,001 - 1,000,000 03 - 031,000,001 - 1,500,000 - 02 021,500,001 - 2,000,000 - 01 01Above 2,000,000 01 - 01

46 81 127

For both DFCC and NDB, the number of large projects requiring prior IDAapproval was smaller than anticipated. This was due in part to sluggishdemand for investment, particularly for large projects, as a result of the1986 disturbances. It was envisaged at appraisal that in the case of NDBsubloans approximately 40% by number and 70Z by amount would be above NDB'sfree limit and, therefore, require prior IDA approval. Only four loansaccounting for 57Z by amount were actually above the free limit. Inclusiveof these four loans, IDA reviewed eight loans approved by NDB. Three of theprojects funded by NDB were in the public sector for replacement ofequipment and modernization. In the case of DFCC's subloans, it wasenvisaged that 30Z by number and 602 by amount would be above DFCC's freelimit of US$250,000. Only nine loans (11%) accounting for approximately 402by amount actually exceeded the free limit.

5.5. Financial Performance of DFCC and NDB. The overall financialperformance of the DFIs continued to improve during the project perioddespite the ongoing disturbances. Both institutions stayed well within thedebt-equity ratios required (8:1 for NDB and 7:2 for DFCC, Statistical Table8). NDB's profits after tax have remained at about Rs 100 million for thepast five years. DFCC's profits before and after tax exceeded appraisalexpectations. However, profits after tax as a percentage of total assetswere lower than the appraisal estimates (Statistical Tables 13 and 14).NDB's return on equity has picked up to 82 in 1988 after a decrease from10.4% to 7.1% in 1987 while both institutions have also maintainedsatisfactory collection ratios (not covenanted under IDP) over the pastthree years (Statistical Tables 9 and 10). Although arrears for subprojectsfinanced under IDP is not serious for either DFI (Statistical Tables 7 and8), arrears in NDB's total portfolio have however increased significantlyover the past few years.

5.6. The T.A. Component. In the area of trade and industrial policyreform, the main area of the policy reform program, an advisor worked withthe Presidential Tariff Commission to update estimates of effectiveprotection, done in an earlier study financed under the first SMI Project.This study highlighted three major problems in the tariff system: (i) highlevels of protection for import-substitution industries and low incentivesfor export products; (ii) a number of consumer essentials with loweffective incentives and high protection for several luxury goods; and (iii)62 product lines (about 202 of the sample) with negative value-added atworld prices. Members of the Commission visited the Tariff Commissions in

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the Philippines and Australia to review tariff reform programs in thosecountries.

5.7. The second module of the trade and industrial reform program - thestudy of Industrial Incentives was completed, although in a modified form,focusing upon export policy and incentives and changes needed in theindustrial regulatory framework. The work done provided the substantivebasis for the 1987 Industrial Policy Statement (IPS), the Government'sExport Development Strategy and its Export Policy and Incentive Structure.The review of related industrial incentives for more export-orientedindustries was not carried out, although the findings of the task forcesinvolved in the preparation of the IPS (fLnded under the project) werereflected.

5.8. Implementation of the component to improve the efficiency of PMEsquickly highlighted the complexity of the component, the lack ofimplementing capability in MISA and the lack of support for the programwithin MISA. The scope of the program was too broad-ranging from firm levelstudies for a number of large corporations, to formulating and implementingpilot schemes to facilitate the privatization of the ownership and themanagement of selected PMEs. Eventually implementation of the subcomponentwas taken over by the Presidential Committee on Privatization established inJuly 1987 under other ongoing IDA projects.

5.9. Central to the poor performance of MISA and the PMEs was weakmanagement. Firm level problems such as the lack of financial planning,existence of an irrational product mix, absence of corporate planning andmanagement information systems were symptoms of this weak management. Theproject recognized this and tried to address it indirectly by creating apublic enterprise cell within the MISA to initiate, implement and monitorthe public enterprise development program. However, the cell was staffedfrom within MISA and did not have delegated authority to enforceimplementation.

5.10. Of the proposed firm-level studies, only three materialized, viz.those relating to the Ceramics, Mineral Sands and the Plywood Corporations.The study on ceramics proved useful in making cost saving improvements inproduction, but the Corporation rejected the recommendations on marketing.The study on mineral sands resulted in some minor organizationalrecommendations which were accepted. The recommendations of the study onplywoods are still under consideration by GOSL. The corporate planningprocess was introduced into all PMEs with the assistance of externalconsultants and all corporations have now prepared corporate plans, althoughtheir quality varies widely from excellent (Tyre Corporation) to incomplete(Hardware and Ceramics).

5.11. A review of existing systems of controls over public enterprises byMISA was initiated with considerable delay in December 1986. Therecommendations from the review were examined and approved by MISA as wellas by the Government Committee of Development Secretaries (a committeecomprising of Secretaries of key ministries). Changes recommended to theprocurement procedures were approved by the Cabinet in December 1988, butsubsequently reversed in January 1989. Guidelines on performancecontracting were also prepared by the Consultants and approved by the

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coordinating committee, but no further discussion of the proposals tookplace. Performance contracts for two public corporations (Tyre and Leather)are to be implemented this year.

5.12. Risk Assessment. The SAR correctly identified the risk that asufficient number of subprojects might not materialize in time fordisbursement. The 1986 insurgency did result in sluggish demand forinvestment in all sector, and slowed disbursements. The SAR also correctlyidentified the risk of poor implementation of the Public EnterpriseDevelopment Program which was the case, due primarily to MISA's weakenedcommitment during implementation and GOSLs diverted attention to the moreimportant problems of resolving the current security situation.

6.0. Major Project Results

6.1. Objectives. The project was successful in meeting the objectivesof fostering industrial investment by providing credit and assisting in thedevelopment of the appropriate policy environment. In this regard thefundamental objective of the trade and industrial reform program wereachieved, although the benefits expected from the PME component were notachieved.

6.2. Credit Component. The credit line was fully disbursed with 127subprojects financed in widely diversified manufacturing industry. The 15"A" Subprojects financed by DFCC showed economic rates of return (ERRs)ranging from 15% for battery manufacture, to 502 for textiles and packing.Post-evaluation reestimated ERRs are not available. During implementation,DFCC supervision indicated that 58 of the 72 completed subprojects areoperating satisfactorily and meeting loan repayments. NDB had three "A"subprojects. For one of them (Lanka Tiles) there is a large discrepancybetween the appraisal ERR (25Z) and reestimated ERR (7.34%). The second(Colombo Drydocks) has close appraisal and reestimated ERRs of around 8%.The third (Ceylon Tobacco) had a high appraisal ERR of 21.32 but areestimated ERR is not available. Of the 46 loans approved by NDB, eightwere in arrearb as of December 1, 1989.

6.3. The T.A. Program. Overall the TA component achieved verysatisfactory results. In the area of tariff reform, the Presidential TariffCommission updated its Effective Protection Rate (EPR) measurements, takingaccount of changes in tariff rates. This resulted in the introduction ofappropriate changes in the nominal tariff rates. Major elements of thestudy on Industrial Incentives were completed with the most useful aspectsrelating to export incentives. In the area of public sector efficiency aPublic Enterprise Cell was established to implement a planned program ofreform but it has not functioned effectively (para 5.6). Studies of severalPMEs were completed but the impact on the enterprises was limited. Ameasure of success has however been achieved in installing and operating auniform system of performance reporting. Monthly performance reports arebeing received on average 18 days after the end of each month. Consultancyassistance has also been extended to seven public corporations to increasethe market orientation in their activities, although the effectiveness ofthis consultancy assistance has been marginal. The consultancy on the twoDFIs' operations resulted in significant institutional and operational

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improvements and both institutions are now well equipped to compete in themore opened financial sector.

6.4. Impact of Project. A sectoral analysis of the projects financedreveals that the metals, chemicals (pharmaceuticals and others) andengineering products accounted for about 50% of total credit; other majorsectors were food processing which accounted for I?Z of total credit, andthe service sector, 152. The majority of the subprojects are located inurban areas as a result of poor infrastructure in rural areas. The directemployment generated from the subprojectz was 3,128 jobs, compared with2,500 jobs estimated in the SAR. The cost per job created, was aboutUS$12,833 equivalent (RS 385,903), compared with US$15,000 estimated in SAR.

6.5. Improving Financial Sector Efficiency. The innovations (to SriLanka) of introducing competitive access to funds created a healthycompetition between the two DFIs, as envisaged in the SAR. This modusoperandi has been followed in later industrial credit projects and is nowstandard practice. Earlier IDA assistance to the DFIs was institution-specific. The DFIs have also secured the participation of commercial banks,especially the indigenous commercial banks, in syndicate financing where theDFIs have taken the lead role, sharing their appraisal expertise with thecommercial banks. Consortium lending has been effectively introduced intothe financial sector, and commercial banks participation in syndicated termloans for the larger projects has become routine. The consultancies to theDFIs have improved the quality of appraisals and helped streamline internalprocedures. Project identification and promotion units were set up in bothDFIs and these units have completed several sector studies.

6.6. The consultant funded under the project helped draft the charter ofthe Equity Fund (the Capital Development and Investment Co. Ltd.--(CDIC))and formulate its initial operational policies and guidelines. CDIC startedfunctioning as an autonomously managed company in February 1986 and hassince established its own identity as a source of equity and quasi financingsource as well as an underwriter. It works closely with the DFIs incofinancing projects. At present it has a marketable (listed) shareportfolio of approximately Rs 65 million (at cost) and direct investments ofapproximately another Rs 100 million.

7.0. Project Sustainability.

7.1. General. Overall, except for the PME subcomponent, the project hasa high degree of sustainability, both in terms of investment 'subprojects)and policy/institutional development. The approach of including significantpolicy components in an investment project was found to be effective inachieving dialogue and policy reforms, especially since the government wasreluctant to engage in a highly visible sectoral adjustment operation. Interms of overall policy objectives, the approach of successive SMI projectsand IDPs, each following the other with an average lag of about eighteenmonths, has been effective in incrementally improving Sri Lanka's trade,industrial, and financial policy environment and sustaining policy reform.

7.2. Investment. Supervisions by the DFIs report favorably on mostsubproject operations. Although ex-post ERRs were not available for allsubprojects, the ERR of the subprojects studied was generally in the range

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of 15-50%, and the high collection ratios of the institutions provide afurther measure of these investments' viability. The building up of theDFIs institutional capabilities and the use of multiple channels in a singleproject was an innovation that was to become an entrenched standard featureof subsequent credit operations in Sri Lanka.

7.3. Policy/Institutional Reform. A major aspect of this project'ssustainability is related to institution and policy reform. ThePresidential Tariff Commission supported by this project and the first SMIproject is a good example of institutional sustainability and tariff reformis an ongoing exercise by GOSL. Dialogue on Public Enterprise Policy Reformis being sustained by the recently appraised Public Manufacturing EnterpriseAdjustment Credit.

8.0. IDA's Performance

- 8.1. In order to change the project design from a structural adjustmentoperation to a more traditional development project, IDA devoted aconsiderable amount of direct and indirect staff time to projectdevelopment. This proved to be effective as the project was successful inachieving the fundamental objective of supporting much needed, significantpolicy changes although possibly at a slower pace than under a fast-disbursing adjustment operation.

8.2. In most supervision missions, a trade economist was included toensure that the tariff reform program was maintained properly under the T.A.However, despite the considerable effort devoted by IDA staff to it, the PMEprogram had design and implementation problems (see Lessons Learned) andproject supervision should have been more appropriately staffed and focusedto enable staff to maintain an effective dialogue with the consultants sothat remedial action required to put the component on course could have beentaken sooner.

9.0. Borrower's Performance

9.1. Too optimistic an assumption was made regarding the capability ofDFIs' staff to appraise large industrial projects, particularly thoseproposed by large state or multinational corporations. NDB evidenced a lackof commercial orientation, although both institutions gradually developedthis. Eventually, commercial banks becane participating credit institutionsunder subsequent projects.

9.2. Among the elements identified as pre-requisites for the success ofthe program to improve the performance of PMEs was a strong commitment bythe relevant Ministries. Although this commitment was given during theproject preparation, it was not sustained during the implementation stage.The risk in this regard due to the entrenched nature of existing controlswas recognized in the SAR. The detailed implementation plan worked outduring negotiations, reflected apparent commitment by the agencies of theborrower for concrete action. This, however, did not materialize.

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10.0. Project Relationship.

10.1. The overall relationship between IDA and the DFIs in theimplementation of the project was very good. Under the credit component,there was an ongoing dialogue between IDA and the DFIs on policy andprocedural issues and IDA worked closely with both institutions to helpimplement needed changes. This situation was fostered by a continuity ofpresence of both IDA and DFI officers.

10.2. In the area of trade and industrial policy reform there was alsoclose collaboration with the Borrower, reflected in both the degree offormal and informal contacts between the Tariff Commission, EDB and IDA.This relationship has continued under subsequent projects. Relationshipbetween MOF and IDA was also good and in turn this fostered an atmosphere ofconstructive review of reform proposals.

10.3. Notwithstanding the limited success of the PME componentrelationship with MISA also grew and this enabled IDA to make suggestionsfor industrial policy reform which 'eventually appeared in the IndustrialStrategy Statement.

11.0. Consulting Services.

11.1. The quality of the work under the T.A. component varied. ThePublic Sector Corporation Performance Contract and Monitoring Systemproposed by consultants was complicated for implementation, and one of thethree PHE productivity studies was not useful. The work on trade and tariffreform was of good quality. The effectiveness of the consultancies was alsolimited by the difficulties encountered in the implementation of therecommendations. Many of these difficulties are traceable to a lack ofcommitment by the relevant authorities.

12.0. Project Documentation and Data

12.1. For the preparation of PCR, data related to the credit componentwas available from the DFIs. Considerable difficulty was experienced inobtaining data from other agencies regarding the project's other components.The SAR, which could have provided a useful framework for implementation,was not used extensively by the Borrower in the implementation of theproject.

13.0. Conclusions and Lessons Learned.

13.1. The project has two parts: (a) the credit component which met theobjective of providing finance for import of machinery and equipment tolocal industry; and (b) the T.A. program which was successful instrengthening the DFIs and accelerating the impetus of trade reform but lesssuccessful in public enterprise reform. The coverage of the study onIndustrial Incentives was more limited than anticipated in the SAR.

13.2. In general, the project results show that the project format waseffective in achieving significant policy changes through a phased programwhen there is an understanding between IDA and a Borrower regarding long-term goals and firm commitment by the Government and concerned agencies.

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This was the case of trade policy reform. In the area of public enterpriseswnere there was only a limited commitment to reform, more up-frontimplementation of policy reform should have been required prior to theproject. Project performance in this area would also have been enhanced ifsupervision missions had included specialists in enterprise restructuring.

13.3. Central to the poor performance of the PMEs was their weakmanagement. The project sought to initiate measures to improve thisperformance within the existing political and procedural constraints.However, the scope of the efficiency improvement program was too wide, andit was to be implemented by existing, weak firm-level managements supportedby committees at Ministry level. Against this background more emphasisshould have been devoted to the strength ning of MISA's structures andpersonnel.

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Table 1 - RELATED BANK LOANS

No. Loan/Credit Title Purpose Year of StatusApproval

942-CE Small and Medium Industries Promote private 1979 CompletedProject (SMI) industrial development, 12/80

focusing on SMI'sassistance to developthe National DevelopmentBank (NDB) technical andmarketing services to keySMI sectors, and policy studieslimited to reforms in tariffsand export Incentives

1182-CE Second Small and Medium Provide term funds to viable SMI*, 1991 CompletedIndustries (SMI-2) Project emphasizing exports, through SMI 6/87

Fund of NDB; training andconsultancy for SMI Fund andparticipating credit institutions(PCIs), -Improvements In theIndustrial Development Board (IDB),and assist the Export DevelopmentBoard (EDS)

1860-CE Third Small and Medium Provide credit to private SMIs, 1987 OngoingIndustries (SMI-8) Project make further contribution to policy

reform in the areas of tariff,administration, export promotion,and financial sector operations

1692-CE Second Industrial Development Provide term credit to finance 1988 Ongoing(IDP-2) Project

rehabilitation and expansion (BMRE)by private firms and selectedpublic manufacturing enterprises;assist Implementation of reforms intrade policy, industrial incentives,export promotion, public enterpriseefficiency, industrial finance, andfinancial po!icy; technical assistanceto development finance contributions,performance monitoring oystem forPMEs, and industrial strategydevelopment

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Table 2 - PROJECT TIMETABLE

PLANNED ACTUAL

Preparation April 1981 April 30, 1981Preappraisal August 1481 September 8, 1981Appraisal November 1981 November 24, 1981Loan/Credit Negotiations May 1983 Hay 24, 1983Board Approval July 1983 July 12, 1983Loan/Credit Signing October 1983 October 12, 1983Loan/Credit Effectiveness January 1984 January 4, 1984Loan/Credit Closing September 30, 1988 September 30, 1988Loan/Credit Completion March 31, 1988 March 31, 1988Full Disbursement June 30, 1988 March 31, 1989

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Table 8 LOAN/CRrDIT DISBURSEMENTS

A. CUMULATIVE ARD ACTUAL DISBURSEMENTS

(US$ million)

Appraisal Estimates Actual

Fiscal year Quarterly Cumulative X of Estimated Quarterly Cumulative X of Actualand quarter Disbursements Diabursements Total Disbursements Disbursements------- -----------------------------------------------------------------------------------

FY 842 0.2 0.2 0.8 - -3 0.3 0.5 2.0 0.5 0.5 1.94 0.6 1.1 4.4 1.1 1.6 6.1

FY 1 0.7 1.8 7.2 0.4 2.0 7.72 1.0 2.8 11.2 1.4 8.4 18.08 1.2 4.0 16.0 1.6 6.0 19.24 1.3 5.3 21.2 1.2 6.2 28.4

FY 1 1.7 7.0 28.0 1.2 7.4 28.42 1.8 8.8 85.2 6.1 12.6 47.98 2.0 10.8 48.2 4.6 17.1 66.64 2.2 13.0 32.0 0.9 18.0 09.0

FY 1 2.4 16.4 61.6 0.6 18.6 70.92 2.5 17.9 71.6 2.0 20.5 78.68 2.8 20.2 80.8 0.9 21.4 82.04 2.0 27.2 88.8 0.8 22.2 86.1

FY 1 1.8 28.6 94.0 0.3 22.5 86.22 0.9 24.4 97.6 C.6 28.1 88.58 0.4 24.8 99.2 0.2 28.8 89.84 0.2 25.0 100.0 0.2 28.6 90.0

FY 1 - 26.0 100.0 1.4 24.9 95.42 - 25.0 100.0 0.4 75.8 98.98 - 26.0 100.0 0.8 28.1 100.04 - 25.0 100.0 0.0 28.1 100.0

a/ The disbursements were in SDR. Actual disbursements werein historical US$ equivalents, which totalled more thanthe USS equivalent at appraisal.

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Table 4 : INDICATORS OF PROJECT IMPLEMCNTATION AND RESULTS

INDICATORS APPRAISAL ESTIMATE ACTUAL OF X OFPCR ESTIMATE ACHIEVEMENT

Indicators 1 NDB and DFCC subprojects All subprojects are In 9OXwere to be in manufacturing, manufacturing and theypublic sector or private are wall diversified.sector, but not in serviceor commercial undertakings.

Indicators 2 Credit was to be disbursed Full disbursement was sofully by June 80, 1988 delayed by nine months

Indicators 8 Generation of direct Incomplete data show a 1001employment was to be 2,500 generation of 2,029 jobsjoba with cost per job of and a cost/job ofUS816,000 equivalent US812,983 equivalent

Indicators 4 Technical assistance was Implementation of this 60%to help start reform of - component was only par-public enterprises tiolin general areas.

Indicator 5 Technical assistance to Strategy Studies - Staff 90%improve development banks trained In DFCC, NDBsubector analysis andproject promotion efforts

Indicator 6 Estabilshment of new equity Capital Development and In- 100%fund to be administered by dustrial Company establishedNOS

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Table 5. STATUS OF COVENANTS

COVENANT StJECT STATWIIN COMLAHM

NDWA 2.01 NOB hall carry out part A and Part 3.1 of N0S retained W.D. Scott tothe Project NDB shall employ consultants for prepare corporate strategy.Institutional strengtheninag and train Itsstaff .

NDBPA 2.03(s) NDB shall submit to IDA first three subloons in compliancefor approval for public and privateInvestment, respectively.

MDBPA 2.08 (b) NDS shall submit subprojects above free In compliancelimit for IDA approval with the followingInformation sumary description ofsubproject term and conditions,amortization schedule and g and rconomicImpact calculation

NOWA 2.03(c) NDB shall submit free limit subproject for In complianceIDA approval with the following Information:

sumaary description of subproject, term endconditions, and amortization schedule.

NOWA 2.08(d) NmOrl amortization schedule shall not exceed In compliance.16 years, with appropriate grace period,with e qualI periodic payments and followlimited ICB procedures for procurementcontracts above 112 million equivalent.

M)BPA 2. 03 (e) NDB shall not submit subprojects for IDA In complianceapproval until It has etlihg ablpromotion unit with suitably qualified staff

NOWA 2.03(f) NOB shall not submit subprojects after In compliance with IDA

Septmer 0, 1N concurrence, Projectdiwbureements extended byone year due to politicaldisturbances In 1906.

NDWPA 2.04 NDB shall enter Into lending greements with In compliance D entered

Ito subborrowere with sufficient safeguard Into legal agreements with

for Itself and for IDA. Project Completion It. subborrowersReport - submission delayed until March1og0.

NDBPA 2.05 ND8 shall submit to IDA promptly upon their Partial compliance. ancpreparation, the plans, report., training maintained proper MIS andprogram, contract documents and schedules submitted reports generallyrelating to Part 8.1 of the Project. NDB on time. Projectshall prepare project completion report six completion reportmonths after Project completion of Part 9.1 submission delayed tillof the Project. March 1990.

NDOPA 2.06 N0B shall fulfill Its obligations under the In compliance.NDB subsidiary Loan Agreement

NDBPA 2.07 NDB shall cae It. subsidiaries to obeerve In compliance.and perform the obligations of af under theNDB Project Agreement.

NDOPA 2.04 NDB shall, at IDAo request, exchange vie In compliance.with IDA regarding the Project's progress,and promptly Inform IDA of major conditionswhich may threaten attainment of Projectobjectives.

NDBPA 2.01 NDB shall manage its operations and conduct In compliance.Its affairs well and maintain a competentoafP.

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Table 5

PaeiTrT

NDPA 8.02 NDB shall not sell or transfer ***ets In compliance.without prior IDA consent except In theconduct of ordinary business, and NDB willtake all actions to maintain Its corporateexistence

NDWA 8.03 NDS *hall Insure Itself appropriately. In compliance.

NDBPA 8.04 NDS *hall adopt policy and strategy In compliance.statements satisfactory to INa and establishand maintain a project unit for projectIdentifcation and promotion staffed withqualified personnel.

NDSPA 8.05 NDS *hall complete staffing of Its project In compliance.Identification and promotion unit by March31, 184

NDSPA 4.01 NDS *hall maintain proper proceduresIrecords and accounts adequate to monitor and I apIlnerecord the progress of Part 8.1 of theProject, as well as of each subproject.

NDBPA 4.02 NDO shall have Its accounts audited annually In compliance.and furnish IDA copies of Its auditedstatemeunts no later than six months afterend of the fiscal year. Also NDS shallfurnish periodic reports to IDA.

NDBPA 4.08 5DS's debt to equity shall not exceed 8:1. In compliance.

NDBPA 4.05 NDS *hall not prepay any of Its borrowings In compliance.without,ZDA's agreement.

DPA 4.06 1DB shall not bear foreign exchange risks In compliance.under the Project.

DFCCPA 2.01 DFCC shall carry out Its pert of Part A and In compliance.Part B.2 of the Project.

DFCCPA 2.02 DFCC shall employ consultants fr In compliance. DFCCInstitutional strengthening and train Its retained Morgan Gr*.nfeltBuaff. to conduct Institutional

study.

DFCCPA 2.08 DFCC shall suoit subproject above and In compliance.belo frot limit to IDA for authorization ofwithdrawal undar the credit with theaproprate documentation. oFCC subloanesall not exceed 1 years In maturity and

shal shave equal periodic rofpyments, ofintfrest and principal. DIFCC hall adopt apoli cy statement and strategy statement byMarch 81, 194.

DFCCPA 2.04 DFCC shall enter into lending goreements In compliance.with Its subborrowere with sufficientsafeguards for Itself and for IDA and followlimited IC procedures for procurementcontracts above US2 million equivalent.

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Table 6

DPCCPA 2.06 DFCC shall maintain proper procedure. and Partial compliance. DFCCrecords to monitor progress of Part 0.2 of maintains generallythe Project and submit to IDA promptly upon adequate MIS and reportstheir completion the plans, reports, were submitted generally ondocuments and schedules relating to Part 8.2 time. Project completionof the Project. DFCC shall submit a Project report on Part 8.2 will notcompletion report for Part 8.2 of project be submitted until Aprilsix months after Its completion. 1900.

DFCCPA 2.06 DFCC shall fulfill It. obligations under the In compliance.DFCC subsidiary loan agreement

DFCCPA 2.07 DFCC shall cause Its subsidiaries to observe In compliance.and perform the obligations of the DFCCunder the DFCC Project Agreement.

DFCCPA 2.06 OFCC shall, at IDA's request, exchange views In compliance.with IDA regarding the Project** progress,and promptly inform IDA of major conditionswhich may thretn the attainment of Projectobjectives.

DFCCPA 8.01 DFCC shall manage Its operatione and conduct In compliance.Its affairs well and maintain a competentstaff.

DFCCPA 8.02 DFCC shall not **ll or transfer assets In compliance.without prior IDA consent except In theconduct of ordinary business and DFCC,shall take all actions to maintain itscorporate existence.

DFCCPA 8.08 DFCC shall Insure itself appropriately. In compliance.

DFCCPA 8.04 DFCC shall adopt a Policy Statement and a In compliance.Strategy Statement and establish andmaintain a unit for project Identificationand promotion staffed with qualifiedpersonnel.

DFCCPA 8.05 DFCC shall complete staffing of its project In compliance.identification and promotion unit by March81, 1984.

DFCCPA 4.01 DFCC shall maintain proper procedures, In compliance.records and accounts adequate to monitor andrecord Part 8.2 as well as of eachsubproject.

DFCC 4.02 DFCC shall have It. accounts audited In compliance.annually and furnish IDA copies of itsaudited statements no later than six monthsafter the end of the fiscal year. Also DFCCshall furnish periodic reports to IDA.

DFCCPA 4.08 DFCCOs debt to equity shell not exceed 7:1. In compliance.

DFCCPA 4.06 DFCC shall not prepay any of its borrowings In compliance.without IDA's agreement.

DFCCPA 4.00 DFCC shall not bear foreign exchange risks In compliance.under the Project.

- 109 -

Table 6PaeTW

OCA 8.08 The borrower shall employ advisors and Partial compliance. Delaysconsultants to carry out Part C and 0 of the In recruitment of eseProject. advisors and consultants;

non-recruitment of someadvisors and consultants.

OCA 8.08 The borrower shall cause all goods and In compliance.services financed from the credit to be usedfor the exclusive purposes of the Project.

DCA 8.04(a) The borrower shall furnish IDA promptly, Partial compliance.

plan*, reports, training programs, contracte Frequent delays Inand scheduals on Parts CA 0 of the Project. submission of Information.

OCA 8.04(b) The borrower shall maintain adequate records Partial compliance.and submit periodic reports to IDA on Parts Borrower MIS system oftenC and D of the Project. Inadequate and timing of

reports frequently late.

DCA 8.06(C) The borrower shall furnish IDA copies of In compliance.contrasts.

OCA 8.06(d) The borrower shall furnish a Project Not In compliance.Cotion Report on Parts C and 0 of the

DCA 8.06 The borrower shall by November 80, 1OU and Partial compliance.by November 80 of each year thereafter, Borrower and IDAfurnish IDA with an annual plan to imp;ove collaborated closely inpublic Industrial enterprise performance. preparing a Public

Ent--op!*-Roticturi noproject.

DCA 8.06 The borrower shall bear the foreign exchange In compliance.risks under the Project.

OCA 4.01 (a) The borrower shall maintain procedures, Partial compliance.records, and separate accounts to monitor Borrowers MIS systm weak.and record procrres of Parts C and D of theProject.

DCA 4.01(b) The borrower shall have annual audits of Partial compliance.Project accounts and submit reports. Reports submitted often

late.

OCA 4.02 The borrower shall furnish IDA a phased Partial compliance.program of tariff reform and begin Delayed Implementation.Implementation by September 80, 1964.

OCA 8.01 (a) The borrower to carry out Parts C and r of Partial compliance.the Project with due diligence and Program to Improve publicoff iciency. enrerprIoo performance

C and Incomplete dueto lack of borrowerconsensus and conviction;review of IndustrialIncentives was done In themore, limited scope.

DCA 3.01(b) The borrower shall cuse NDB and DFCC to In compliance.fulfill obligations under the NDO ProjectAgreement and DFCC Project Agreement.

DCA 3.01(c) The borrower shall onlend Credit proceeds to In compliance.ND and oCC under subsidiary LoanAgreements satisfactory to IDA.

- 110 -

Table 6

OCA 8.01(d) The borrower shalI not assign amend, In cepiance.abrogate, or waive subsidiary LoanAgreements on any provisions thereof withoutIDA agreement.

- 111 -

Table 0. USE OF BANK RESOURCES

A. STAFF INPUTS

Stags of Project Cycle Actual

(Staff Weeks)

Through appraisal 76.5Appreal 18.4EffectivenessSupervision 79.7

Total 169.6

MISSIONS

Month/Year No. of Persons Days in Specialization Rating Type offelld represented problems

Preappraisal 9/81 4 15 Economist, FinancialAnalyst

Appraisal 11/81 4 15 Economist, FinancialAnalyst

Post-appraisal 8/88 2 14 Economist, FinancialAnalyst

SUPERVISION

Mission 1 16/88 1 4 Financial Analyst 1, 2 Technical, PoliticalMission 2 4/84 2 14 Financial Analyst/ 1, 2 Technical, Political

EconomistMission 8 7/84 8 18 Financial Analyst/ n.a Technical

EngineerMission 4 9/84 1 4 Financial Analyst n.a TechnicalMission 6 10/84 1 10 Financial Analyst 2, 2 Political, TechnicalMission 6 1/85 1 7 Engineer na TechnicalMission 7 2/88 2 7 Economist n.a TechnicalMission 8 11/65 1 14 Financial Analyst 2, 1 TechnicalMission 9 8/96 1 8 Financial Analyst 2, 1 TechnicalMission 10 7/86 2 15 Financial Analyst 2, 1 TechnicalMission 11 11/88 4 15 Financial Analyst/ Technical

EconomistIndustry Specialist

Mission 12 5/87 7 15 Financial Analyst, 2, 1 Financial, TechnicalEconomist, MarketSpecialist, TariffSpecialist

Misvion 18 8/87 5 15 Financial Analyst, 2 TechnicalEconomist, Engineer

Mission 14 10/88 1 10 Economist 2 Technical

- 112 -Page 1 of 2

TABLE 7

DEVELOPMENT FINANCE CORPORATION OF CEYLON (DFCC)CR.1401-CE

ARREARS OF SUBPROJECTS AS OF MARCH 81, 1989(Re '000)

Loan Balance Interest Instalment Interest andName of Client as at in Arrears in Arrears Instalment in

81/2/89 as at as a Arrears as N81/8/89 81/8/89 of Loan Balance

----------------------------------- ------------ --- ---------- ---------------

1. Acme Aluminium Co. Ltd. 9,652 - - 02. Acme Aluminium Co. Ltd. 8,589 - - 08. Aitken Spence and Co. Ltd. 079 - - 0

4. Aitken Spence (Garments) Ltd. 286 - - 05. Aitken Spence (Garments) Ltd. 468 - - 06. Aitken Spence (Printing) Ltd. - - - -7. Alexandra Industries 2,198 - 08. Allied Industries Ltd. 110 - - 09. Amico Industries 1,080 - 116 11

10. Amico Ind. (Coy.) Ltd. 2,095 - 288 1111. Asiaknit Lt. - - - -12. Asiaknit Ltd. - - - -18. Associated Motorways Ltd. 1,019 18 85 1014. Associated Motorways Ltd. 277 4 40 1816. Associated Traders 119 - - 016. Band* Metal Industries 166 - 017. boto Shoe Company of Ceylon 498 - - 018. Beligala Oil Mills 1,907 629 1,192 9519. C. W. Mackie 1,120 - - 020. Ceylon Biscuits Ltd. 897 - - 021. Ceylon Glass Co. Ltd. 124 - - 022. Ceylon Match Co. Ltd. 1,226 - - 028. Ceylon Paint Ind. 1,060 868 446 7724. Ceylon Papr Sacks Ltd. 1,727 596 880 8525. Ceylon Tobacco Co. Ltd. 128 - - 026. Ceylon Tobacco Co. Ltd. 272 - - 027. Ceymac Rubber Co. Ltd. 84 - - 028. Chemical Industries 180 - - 029. Chemical Industries 256 - - 080. Chemical Ind. (Colombo) Ltd. 416 - - 081. Colmane Garments Ind. (Pvt.) Ltd. - - - -82. D.K.W. Plastic Industries 850 - - 088. Daintee Industries Ltd. 179 - - 084. Dointee Industries Ltd. 8,288 - - 086. 0. Samson and Sons Ltd. - - -86. Eastern Merchants Ltd. 2 - - 087. Elephant Lite Corp. Ltd. 28,760 - 8,126 1188. Glaxo Ceylon Ltd. 184 - - 089. Glaxo Ceylon Ltd. 410 - - 040. Olaxo Ceylon Ltd. 181 - - 041. Oranex (Pvt.) Ltd. 6,900 104 - 242. Harris (Ceylon) Ltd. 119 - - 048. Harris (Ceylon) Ltd. 99 - - 044 Hyluck Garments Ind. Ltd. 1,750 - - 045. Hyluck Garments Ltd. 668 - 046. Hyluck Garments Ltd. 694 - - 047. Jinesena Ltd. 74 - - 048. J.B. Fishing Ind. Ltd. - - - -49. K*lni Cables Ltd. 1,422 - - 050. Kundanwals Industries Ltd. 1,867 - 216 1661. Lake House Investments Ltd. 20 - - 052. Lanka Colourphoto Proc. Ltd. 617 - - 068. Lanka Spice Ltd. 8,181 85 1,639 5454. Lanka Tiles Ltd. 40,286 1,027 - 855. Lanks Ceylon Ltd. 8s - 0

113 -

Table 7/Page 2 of 2

Loan Balance Interest Instalment Interest andName of Client as at In Arrears in Arrears Instalment in

81/2/89 as at as at Arrears as X81/8/89 81/8/09 of Loan Balance

68. Lever Brothers (Ceylon) Ltd. - - -67. Little Lion Associates 678 - - 068. Maharaja Organisation Ltd. 8,888 - 91 869. Maharaja Organisation Ltd. 6,689 - 178 860. Metal Packaging Ltd. 6,688 - 618 861. Metal Packaging Ltd. 2,968 - 841 1262. Moosajee Ltd. 2,985 - - 063. MSL Computer Services Ltd. 604 - - 064. Negindes Industries Ltd. 8,967 - 456 1165. Nissof Corrugated Cartons 148 - 066. Nissol Corrugated Cartons 1,277 - - 067. Orient Garments Ltd. -- - 068. Orient Garments Ltd. - - - -69. Penpals Ltd. 790 - - 070. Penpals Ltd. 442 - - 071. Perera and Sons Bakers Ltd. 280 - - 072. Polypak Industries Ltd. - - - -78. Polypak Industries Ltd. 228 - - 074. Precious Ind. (Pvt.) Ltd. 6,847 - - 076. Pure Beverages Co. Ltd. 18,488 - - 076. Pure Beverages Co. Ltd. 19,497 - - 077. Quick Tea (Pvt.) Ltd. 971 - - 078. Ravi Industries 1,077 - - 079. Regency Garments 708 - - 080. Sri Lanka Asbestos Products 2,777 - 176 081. Theranga Textiles Ltd. 1,685 - - 1182. The Ceylon Brewery Ltd. - - 083. Uni Walker Packaging Ltd. 8,890 - - 084. United Tractor and Equipment 215 - - 08o. Uswatte Confectionery Works 88 - 84 1286. Vac Pac Service (Pvt.) Ltd. 2,971 - 162 687. Verna Ltd. 1,946 - - 088. Varna Ltd. 1,928 - - 089. W.A. Perera and Co. Ltd. 2,198 - 68 2890. Wickremasinghe Polythene 2,124 50 2

218,477 2,874 10,540 6.28

- 114 -

Page 1 of 2TABLE 8

NATIONAL DEVELOPMENT BANK (NDB)Cr.1401-CE

ARREARS OF SUBPROJECTS AS OF MARCH 81, 1989

Loan Balance Interest in Instalment in Int. and Instal.Client's Name as at Arrears as at Arrears as at In Arrears/Loan

81/8/89 81/8/89 81/8/89 Balance (S)

1. Ceylon Tobacco 15,000,000.00 -2. Ceylon Tobacco 787,600.00 -3. Tyre Corporation 16,676,626.00 -4. Colombo Drydocks 92,011,686.00 7,820,998.28 -6. Lanka Tiles 26,000,000.00 489,760.01 -

Sub Total (A Subprojects) 149,374,810.00 8,260,748.24 6.68

6. Ceylon Leather 1,748,400.00 -7. Lanka Cement 286,600.00 -8. Freight Services 176,000.00 - -9. Sea Lion Express 1,228,615.89 24,769.47 71,131.88

10. Deveo Shows I 66,774.00 - -11. Deveo Shows II 491,700.00 -12. Richard PeIrls I - --18. Tootal Thread - - -14. Elephant Lite - - -15. Tropical Foliage and Flower - - -16. Alpha 1,067,800.00 - -17. Singslanka - - -18. Qunaratna 146,500.00 - -19. Tieara Garments 8,100,000.00 8,868,082.56 8,100,000.0020. Richard Peirie II 1,674,760.00 -21. Sirirl I 777.16 11.01 777.1622. Colombo Oss Co. - -28. Modern Tea Packers 1,810,868.64 124,984.64 102,616.8824. Furnifits 2,200,000.00 48,478.45 -25. Universal 1,500,600.00 - -26. Elastomeric III 1,618,702.00 107,674.76 479,695.0027. Parquet 680,000.00 - -28. Kelani Printers 5,000,000.00 2,050,818.07 5,000,000.0029. Asian Electricals 1,107,000.00 -80. Kandy Tyre House 1,174,000.00 -81. Naleem Hadjior 6,000,000.00 -82. Ceylon Leather II 6,671,422.00 -88 Wijaya Offset 850,000.00 5,287.87 60,000.0084. Samson Industries I 688,400.00 - -86. Leatherette 1,895,480.00 -86. W.M. Mendis 1,820,000.00 22,760.00 850,000.0087 Huejay Multiflora 4,500,000.00 -38. Print Care 524,700.00 -39. Freight Services II 98,100.00 -40. Sungold 1,760,000.00 -41. Sigirt I - - -42. Hettiarachchi 660,000.00 46,750.00 12,600.0048. SD&CC II 5,616.8d 6,616.8844. Mascon Industries 1,748,000.00 - -46. Premedesa Bros. 2,184,000.00 92,820.00 812,000.0046. Richard Peiris III 166,646.00 - -47. Central Industries 2,460,116.01 - 20,116.01

Sub Total 8 Subprojects 59,663,467.57 6,887,766.82 14,604,861.80 84.18

TOTAL 209,088,277.57 14,148,509.56 14,504,861.80 18.71

- 115 -

Table 8

Page 2 of 2

SRI LANKA

NATONAL DEVELOPMENT BANK (NDB)Cr.1401-CE

All projects under Cr.1401-CE have been completed and are operatingsatisfactorily except for the following:

(a) Colombo Drydocks - A letter of demand has been sent to the company.Foreigh collaboration is being sought for managementand/or equity investment in project. The governmenthas appointed a Committee headed by the Chairman/NDBto hold discussion with a Dockyard in Singapore whichhas experience/interest in taking up an equity positionin the local company and managing/evaluating the dock.

(b) Tisara Garments - Project recently rehabilitated by Bank. Company isadhering to revised repayment program.

(c) Modern Tea Packers - Factory closed. There is to be a negotiated settlementbetween the Bank and the client for the sale of theassets to a third party.

(d) Furnifits - Due to constraints in financing working capital, theCompany is unable to service the loans. A freshproposal for rescheduling the loan is being worked out.

(e) Hettiarachchi & Co. - The factory was gutted by fire in December 1988 and hasnot been in operation since then. The Bank came to asettlement with the Company where approximately 50% ofthe amount due to the Bank was paid and the balance waswritten off.

- 116 -

TABLE 9NATIONAL DEVELOPMENT BANK OF SRI LANKA (NOD)

CASH COLLECTION PERFORMANCE FOR FY 1988-FY 1988

Re Mn.

12 Months to 81 Dec. 1988 1984 1985 1986 1987 1988

Arrears as at beginning(A)

- Principal - 21.51 89.27 86.79 66.87 66.87- Interest 6.95 27.87 61.69 47.87 69.55 59.77

Total 6.95 48.88 100.96 84.18 124.92 116.14

Current dues (B)- Principal 68.74 96.66 152.24 219.28 846.62 440.89

- Interest 95.69 128.66 169.12 216.05 258.66 887.49

Total 169.88 226.82 821.86 485.88 605.28 778.88

Total collectibles(C) = (A+B)

- Principal 68.74 118.17 191.51 256.07 411.99 496.26

- Interest 102.54 168.08 289.81 288.42 818.21 897.26

Total 166.28 274.20 481.82 519.49 780.20 898.62

Cash collections (D)- Principal 42.28 77.65 182.79 174.56 229.87 298.18

- Interest 76.17 94.84 144.41 162.87 282.92 244.97

Total 117.40 171.99 277.20 886.98 462.29 588.10

Write-off- Principal (E) - - - - - 70.46

- Interest - - - - - 56.85

Total 126.81

Rescheduled (F)

- Principal - 1.25 21.98 16.14 127.26 47.07

- Interest - - 89.08 41.50 25.62 7.61

Total - 1.25 60.98 57.64 152.77 54.68

Arrears at end

(C)-(D+E+F)

- Principal 21.51 89.27 86.79 65.87 65.87 85.60

- Interest 27.87 61.69 47.87 69.66 59.77 88.88

48.88 100.96 84.16 124.92 116.14 178.98

Collection Ratio

(D/(C-E-F) 70.8 88.01 78.71 72.95 80 76

-117 -

TABLE 10

DEVELOPMENT FINANCE CORPORATION OF CEYLON (DFCC)CASH COLLECTION PERFORMANCE

FINANCIAL YEAR 1 1982/8 1988/84 1984/86 1986/88 1988/87 1987/88 1988/89

(1) Balance 8/F:Interest 1 19.89 24.61 88.74 17.28 28.78 29.54 64.06

Instalment 17.85 24.46 88.14 28.97 88.88 81.29 47.92

--------------------------------------------------------TOTAL 87.24 49.27 71.68 41.20 67.11 60.8 111.97

--------------------------------------------------------(2) Due for the Year:

Interest 82.06 98.62 100.67 121.59 166.62 216.79 221.68

Instalment I 68.89 80.88 74.18 110.66 210.10 296.94 869.80

TOTAL I 140.45 182.88 174.70 282.24 878.72 512.78 690.99

--------------------------------------------------------(8) Tota I Dues:

Interest 101.45 118.88 188.81 186.82 192.85 248.88 285.68

Instalment I 76.24 118.82 112.27 184.82 248.48 827.28 417.28

TOTAL I 177.69 281.05 248.08 278.44 485.88 678.568 702.96

------------------------------------------------- ---(4) Adjustments for: I

Write-off of Interest I 8.67 16.29 8.21 1.48 10.19 2.71 18.56

Write-off and Reached. of Int. ( 2.85 9.08 27.29 2.12 17.02 8.28 0.87

------------------------------------------------ --TOTAL 6.02 26.97 80.60 8.55 27.21 6.94 19.28

------------------------------------------------------(5) Cash Collection: I

Interest I 72.97 68.80 118.87 118.68 162.82 179.67 194.45

Instalment I 49.48 85.60 61.01 99.12 195.17 276.08 842.91

TOTAL I 122.40 134.80 174.88 212.78 847.79 455.86 587.86

--------------------------------------------------------(6) Balance C/F:

Interest I 24.81 38.24 17.28 23.73 29.64 64.05 72.67

Instalment I 24.46 38.14 28.97 33.38 31.29 47.92 78.70

--------------------------------------------------------TOTAL I 49.27 71.88 41.20 57.11 60.83 111.97 146.87

(7) Collection Ratio:

Interest - X I 66.90 68.20 88.80 82.70 83.80 78.70 72.80

Instalment - X ( 74.80 67.40 71.80 74.80 88.20 85.20 82.80

0A--1. 1. 180 66-----------------------------------------------TOTAL - U 141.50 180.60 158.60 157.50 170.00 158.90 155.10

-----------------------------------------------------------------------------------------------------------------I---

- 118 -

Table 11 - BALANCE SHEET FY84-FY88, NATIONAL DEVELOPMENT SANK

Re MnFY ended December 1984 1936 1988 1987 1988

Assets

Current AssetsCash & bank balance 428.5 467.1 422 481.4 884.2Accrued Income 28.3 28.8 29.7 82.5 39.2Current maturities of

loan portfolio 191 276.9 866.7 688.9 819.1Promissory Notes 150 160 150 150 150Others 56.8 67.9 109.8 126 226

Total Current asets 358.8 979.2 1078.2 1278.9 1898.8Loan Portfolio net of

current maturities 809.8 1058.8 1612.9 1989.7 2888.9Equity Investments 67.9 71.8 78.2 88.8 126.8

Total long termPortfolio 887.7 1124.9 1691.1 2078 2612.7

Lose: Provision for losse -68.8 -121.4 -177.8 -286.8 -828.8Net Portfolio 800.9 1008.5 1418.8 1842.2 2188.9Net Fixed assets 5.9 10.4 17.8 46.4 84.1Invest. In associate

companies 10 80 55 86 100

Total assets 1870.4 2028.1 8564.8 8250.6 8771.8

Liabilities A Equity

Current liabilitiesCurrent maturities

of Long term debts 22.4 49 72 61 195.8Accrued Interest 68.1 90.2 49.8 78.7 190.9Others 28.8 82 67 87.8 68.1

Total current liabilities 118.8 171.2 178.8 172 449.8Net Term liabilities 447.1 662.8 1070.7 1681.8 1846.8

Total liabilities 680.9 888.5 1249.6 1868.8 2295.9

Equity

Paid up share capital 600 600 600 600 600Reserves & retained

earnings 609.6 689.6 714.8 797.2 876.4

Total equity 1109.6 1189.6 1814.8 1897.2 1476.4Total liabilities

and equity 1607.4 2028.1 2664.8 8250.6 8771.8

Ratios

Current 7.6:1 5.7:1 6.1:1 7.4:1 3.1:1Long term debt to equity 0.4:1 0.6:1 0.8:1 1.2:1 1.2:1Provisions as X of loan 7.7 10.8 11.2 11.4 12.8

and equity portfolio %

- 119 -

Tab~e 12DEVELOPMENT FINANE CORPORATION OCEyLON (DFCCV>

Prolsered and Audited Balane s~.eta, FY 1983 -19

Yøw Ending Mrh 31 FY 1983 FY 94 FY lff FY 1986 FY 1987 FY 1988 FY 198pm__ _Aud Pro Aud Prøj Aud Proj Aud Pro Aud Aud AudLoane 40.3 529.0 603.7 518.8 001.6 778.9 013.2 1.030.7 Ø33.7 1.425.2 1,83.7 2.048.2Ofinay haEe 25.2 27.7 30.4 36.7 37.7 48.9 44.2 53.1 51.0 61.6 70.0 75.8Prefernc ~Sharg 32.6 35.1 26.0 30.6 19.5 27.1 13.0 21.4 6.5 20.0 18.5 17.0FnanclalLeses - - - - - 1.5 - 13.1 - 38.8 61.7 61.8Subtotal 607.1 501.8 660.1 658.1 658.8 Ø54.4 70.4 1,127.3 601.2 1.544.5 1,834. 2,203.7Leas Provilons 28.4 23.4 31.1 35.7 32.7 45.2 34.5 0.8 36.6 20.2 37.6 57.1578.7 568.4 629.0 620.4 62.1 80U.2 835.9 1.126.5 053.O 1.524.3 1.796.9 2,146.6Current Ase

Debtore ost & Acrued Inome 27.6 20.3 36.2 36.8 38.3 11.0 42.7 16.8 47.6 17.1 33.2 3.7Temporary Inv*stment 4.0 0.2 24.0 70.0 24.0 40.0 14.0 284.0 4.0 321.0 240.0 270.3Cash~øank Balanes 16.8 6.0 18.5 10.8 27.9 3.3 41.6 14.8 56.8 21.4 52.1 54.0Current Agst Subtotal 48.4 98.5 78.7 123.6 90.2 54.3 98.3 316.5 108.4 359.5 334.3 360.0Total Aest 643.3 683.5 738.7 719.1 747.8 898.2 766.4 1.485.2 808.3 1.034.9 2,190.3 2,566.4LIABILITIES&hwCaptal 60.0 94.8 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0Special Resrv 13.9 15.0 13.9 15.0 13.9 15.0 13.9 15.0 13.9 15.0 15.0 15.0General and Bulding Re~ev 30.0 33.5 47.0 38.0 62.0 44.5 78.0 81.0 85.0 110.0 161.0 221.0Profit and Los Blanc 1.3 0.3 1.1 Q.3 0.6 0.5 1.6 0.5 1.5 1.0 0.8 1.2Total Equity8ubtotal 105.2 143.6 162.0 153.3 176.0 160.0 103.5 196.5 212.4 232.0 276.8 337.2Lan frm Government 13.0 14.9 12.8 12.8 11.7 11.7 10.7 10.7 9.0 10.7 8.6 7.5Central Bank Relinan~ 213.0 210.8 238.5 227.0 231.8 219.8 222.4 254.3 211.3 200.9 239.9 233.7Development Bank - - - - - - - 343.1 - 398.7 398.7 308.7Bank Lons 21.9 21.4 18.0 14.4 14.2 10.9 10.2 7.6 0.2 5.0 1.2 0.4IBRD Lons 1.8 1.8 1.1 - 0.7 - 0.4 - 0.3 - - -IDA Lan 122.4 123.3 103.0 119.1 81.9 180.9 01.8 307.4 48.1 409.6 534.0 657.9ADB First Loan 143.2 142.7 165.8 175.9 148.4 207.2 123.8 186.1 102.1 278.5 297.9 380.9New FC Loan - - - 35.3 - 60.7 - 62.1 - 64.0 63.9 254.9IDA/SMI Røinanoe - 0.5 - 0.3 - 8.0 - 44.1 - 131.1 228.0 242.2Total Long-trm Oebt Subtol 516.8 521.4 539.2 584.8 488.7 099.2 429.1 1.215.4 374.6 1,558.5 1.773.6 2.155.2Taxes Payable 8.6 - 7.8 2.4 7.3 0.5 7.9 3.1 8.5 7.0 9.4 17.0SundryCreditore 12.0 17.9 14.7 18.0 16.6 28.5 10.9 58.2 17.5 124.5 116.5 42.0OMdnd 3.1 0.0 7.2 10.0 7.2 12.0 7.2 12.0 7.2 12.0 14.0 15.0Current Lablltfe Subtoali 21.3 18.5 29.7 31.0 31.1 36.0 32.0 73.3 33.2 144.4 139.9 74.0Total UabillI.e 643.3 683.5 73.7 769.1 747.8 8905.2 768.4 1.485.2 800.3 1,934.9 2.190.3 2,568.4ebtquity Rao 4.91:1 3.63:1 4.48:1 3.81:1 3.9:1 4.37:1 3.52:1 0.19:1 3.10:1 6.72:1 0.41:1 6.3:1

- 120 -

Table 18 Income Statements FY 1984-1988, NO

FY ending 81 Dec. 1984.0 1985.0 1986.0 1987.0 1980.0

Revenue

Interest on loans 134.1 178.9 181.8 209.4 264.6Interest from SMI loans 18.1 14.1 23.0 41.7 58.7Interest from fixed

deposits 60.8 66.7 54.0 41.6 50.9Income from equity

Investments 0.4 1.6 2.9 1.7 1.9Other Income 6.9 9.2 11.6 16.0 17.1

285.8 286.6 268.6 809.8 898.2

Operating Expense

Interest on borrowings 89.2 62.9 - 84.2 128.9 16.6Administrative expenses 20.1 24.8 27.7 29.2 88.6Provision for doubtful

accounts 64.8 61.0 82.7 69.6 97.8Depreciation 0.6 0.6 0.6 0.7 1.6

124.7 169.8 146.2 228.6 269.8

Net income 110.6 106.2 108.4 865.7 108.9

Lees taxNet profit after tax 110.6 106.2 106.4 85.7 108.9

Ratios

Return on averageequity V a/ 10.4 9.2 9.6 7.1 6.0

Return on average totalassets X 6/ 9.6 8.6 8.9 7.5 7.7

Administrative Ageneral expense/average total assets 1.8 1.8 1.2 1.0 1.0

Interest spread c/ 1.8 2.8 2.4 2.0 8.4Earnings spread d/ 9.0 7.8 6.8 6.4 6.0

s/ Return on average equity a Net Income before tax & dividend

Average equity (without pro note)

6/ Return on overage total assets a Net income # Int. on borrow.

Average totel assets

c/ Interest spread a Interest from loan - Financ. exp.-- se--m-mem-----m---e---------m-mm------

Avg.loon portfolio Avg.Iong term liab.

d/ Earnings spread m Int.from total portfolio - Financ.exp.#Div.

Avg.& Invst.portfoi Avg.Iong tore

- 121 -Table 14

CVELM~r FNANCE cCMPA7IGN 0P CEYLO (DFCC)

Projected and Audited Ince~ Ste6eenta, FY 1981-1989

(Re. Million)

Yar ended Merch 81 FY 1983 FY 1984 Fy 1985 FY 1986 FY 1987 FY 1988 FY 1999

Proj Aud Proj AU4 Proj Aud Pro Aud Proi Aud Aud Aud

Interesl an Le 91.6 82.1 99.4 84.8 108.3 18.0 109.2 114.5 116.5 158.9 192.9 202.0

Leasing Inces - - - - - 0.1 - 1.2 - 4.9 9.6 9.5

Dividend.:

Ordinary sheroa 8.4 1.3 8.9 1.8 4.8 3.7 8.7 4.4 6.7 7.7 7.8 10.1

Prøførenu hes 2.7 2.7 2.2 8.0 1.7 1.8 1.2 0.9 0.7 0.8 0.8 0.1

L~Gai feø~ Å *~it~.n% fes 1.2 1.4 10.2 2.2 1.8 2.1 1.4 2.2 1.4 1.9 1.9 1.8

Piued Å cmIl 0pli Intereal 8.8 1.2 8.9 18.1 4.8 18.0 4.S 82.2 5.8 89.6 87.8 55.6

Miacellenee. £no~. 0.4 4.2 0.8 0.6 0.5 1.2 0.7 2.8 0.9 6.9 8.4 18.7

102.6 92.9 111.1 107.2 115.9 111.4 12.0 18M.2 181.5 217.2 259.7 294.$

Intere~6 an:brrolngo fro Ome~le eur~ce 24.6 24.6 80.7 80.2 81.9 29.2 81.1 44.8 80.0 60.8 67.6 57.8

Borvings froe Noaein Souro*s 22.9 23.1 29.7 26.1 22.4 85.9 18.8 41.7 18.4 58.7 78.1 86.9

47.8 47.7 55.2 8M.8 61.7 65.1 61.6 86.8 62.8 119.2 140.7 144.4

11888 FRPZ88.1 45.2 M8.9 50.9 84.2 44.8 81.4 71.7 69.0 98.0 119.0 180.4

Overhadu 7.5 104.0 9.4 9.0 11.7 10.0 14.7 12.1 18.8 14.1 16.8 25.8

Opraciatlon 0.8 0.8 0.8 0.5 1.0 0.4 1.0 2.7 1.1 2.4 6.8 6.0

Pr~ioion/vriff of DtoufulL~»ne mnd 1nVstV n% 22.8 18.1 2.7 21.2 1.6 18.1 1.8 19.8 2.1 25.8 27.1 28.2

Pr~ls bforg Te 24.8 19.4 49.8 20.2 89.9 22.0 48.9 87.4 47.6 86.2 68.8 92.4

Inmeme Tøm 12.8 4.4 19.8 8.7 18.2 8.8 19.8 8.4 21.8 8.6 10.2 17.1

W I E 12.0 18.0 24.0 14.8 21.7 11.7 24.1 82.0 26.1 47.6 88.8 75.3

Statury neserve 1.8 8.0 - - - - - - - - - -

0~her Rumerv. 1.0 9.5 17.0 4.8 18.0 6.6 16.0 20.0 19.0 88.0 45.0 60.00IVIdendø (Ca~) .1 2.8 7.2 10.0 7.2 10.0 7.2 12.0 7.2 12.0 14.0 18.0

R47l06

Adeløl~lrevo Eapen~/Avørag

Teel mests (M) 1.8 1.8 1.4 1.8 1.4 1.8 2.1 1.2 2.6 1.0 1.8 1.4

Pr~e Prefi/Aversee fuIty (I> 18.9 18.5 21.1 18.6 16.8 14.0 18.8 21.0 16.0 26.2 29.1 82.8

Rate of Dividende (0) 12.0 2.6 12.0 10.0 12.0 10.0 12.0 12.0 12.0 12.0 14.0 18.0

Dividond s Per~ent.s. Me

remse (P~l Ratio) 25.1 16.7 80.0 69.0 83.1 89.9 29.9 87.8 27.6 25.2 2.9 19.9

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