ADB Bangladesh

8/3/2019 ADB Bangladesh

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ASIAN DEVELOPMENT BANK RRP: BAN 35225

REPORT AND RECOMMENDATION

OF THE

PRESIDENT

TO THE

BOARD OF DIRECTORS

ON

PROPOSED LOANS AND TECHNICAL ASSISTANCE GRANT

TO THE

PEOPLES REPUBLIC OF BANGLADESH

FOR THE

SMALL AND MEDIUM ENTERPRISE SECTOR DEVELOPMENT PROGRAM

November 2004


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CURRENCY EQUIVALENTS(as of 15 November 2004)

Currency Unit taka (Tk)Tk1.00 = $0.0168$1.00 = Tk59.375

ABBREVIATIONS

ADB Asian Development BankACC Anti-Corruption CommissionBB Bangladesh BankBBS Bangladesh Bureau of StatisticsBDS business development servicesBSCIC Bangladesh Small and Cottage Industries CorporationBSTI Bangladesh Standards and Testing InstitutionCPCU central program coordination unitDFID Department for International Development

EA executing agencyEGBM Enterprise Growth and Bank ModernizationFBCCI Federation of Bangladesh Chambers of Commerce and IndustryFI financial institutionFIL financial intermediary loanGDP gross domestic productIA implementing agencyIDLC Industrial Development Leasing Company of Bangladesh Ltd.IFC International Finance CorporationIMF International Monetary FundIPDC Industrial Promotion & Development Company of Bangladesh Ltd.I-PRSP interim poverty reduction strategy paper

MFA Multi-Fibre ArrangementMIDAS Micro Industries Development Assistance and ServicesMOF Ministry of FinanceMOF-FD Ministry of Finance, Finance DivisionMOI Ministry of IndustriesMSME micro, small, and medium enterprisesNASCIB National Association of Small and Cottage Industries of BangladeshNBFI nonbank financial institutionNBR National Board of RevenueNCB nationalized commercial bankNCID National Council for Industrial DevelopmentNPL nonperforming loan

OECD Organisation for Economic Co-operation and DevelopmentPCB private commercial bankPFI participating financial institutionPRGF Poverty Reduction and Growth FacilityRJSC Registrar of Joint Stock CompaniesRMG readymade garmentSCI small and cottage industrySCITI Small and Cottage Industries Training InstituteSEDF SouthAsia Enterprise Development Facility


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SEF Small Enterprise FundSME small and medium enterpriseSMESDP SME Sector Development ProgramTA technical assistanceUSAID United States Agency for International DevelopmentWB World Bank

NOTES

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

(ii) In this report, $ refers to US dollars.

This report was prepared by a team consisting of H. Y. Hong, R. M. Limjoco, S. N. Oh,S. Thongplengsri, V. T. Velasco, and V. L. You.


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CONTENTSPage

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

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

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

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

A. Benefits and Impacts 30B. Risks 32VI. ASSURANCES 32

VII. RECOMMENDATION 34APPENDIXES1. Program Framework 352. Development Policy Letter and Policy Matrix 403. Sector Analysis and Framework for Small and Medium Enterprise Development 474. List of Ineligible Items 565. Small Enterprise Fund 576. Summary of Due Diligence of Preidentified Participating Financial Institutions

(Deleted Confidential) 58

7. Technical Assistance Loan Components 608. Technical Assistance Loan Cost Estimates and Financing Plan 649. Program Implementation Schedule 6710. Technical Assistance Grant to Support Program Implementation and Coordination

of SMESDP 6811. Summary Poverty Reduction and Social Strategy 71

SUPPLEMENTARY APPENDIXES (available on request)

1. Gender Action Plan2. Environmental Assessment of Policy Matrix3. Bangladesh Bank Circular on Refinance Scheme for Small Enterprises Sector

4. Program Organization Chart5. Terms of Reference for Technical Assistance Loan Components6. Selected Public Institutions Supporting Small and Medium Enterprises


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LOAN AND PROGRAM SUMMARY

Borrower Peoples Republic of Bangladesh

Classification Targeting Classification: General intervention (GI)

Sector: Industry and tradeSubsector: Small and medium-scale

enterprisesThemes: Sustainable economic growth,

private sector developmentSubthemes: Promoting economic efficiency

and enabling markets,policy/institutional/legal/ regulatoryreforms, private sector investment

Environment Assessment Category FI.

Rationale The national poverty reduction strategy of Bangladeshrecognizes that reducing income poverty will require moreconcerted and intensified effort. To meet its goal of halving theincome poverty level by 2015 will require more than doublingthe rate of poverty reduction from the 1.5% per yearexperienced during the 1990s. Accordingly, the Governmentspriority is to accelerate and expand the scope for pro-pooreconomic growth by raising the rate of economic growthquickly and sustainably, with an emphasis on generatingproductive employment. The promotion and development ofsmall and medium enterprises (SMEs) will take center stagefor raising pro-poor economic growth that, being generally

labor intensive, utilizes Bangladeshs factor endowments totheir competitive advantage in the local and global markets.

Recent analysis confirms the important role that the SMEsector plays in reducing poverty in Bangladesh. The morerapid growth of the economy in the 1990s has beenaccompanied by a faster rate of poverty reduction than in the1980s. Significantly, this growth can be traced to nontradableactivities (services, construction, and small-scale industry) thataccounted for about 70% of the incremental growth of the pastdecade relative to the earlier decade. Unlike the 1980s, whenthe rapid shift of labor into the rural nonfarm sector was

largely in the form of self-employment, the 1990s reflected theabsorption of wage labor in greater numbers by enterprisesthat were relatively larger scale and more productive. It is,thus, of critical importance to the poverty reduction effort tobuild on this growth momentum by developing an enablingenvironment conducive to the accelerated growth of the SMEsector over the medium to long term and to adopt policies thatenable the poor to find gainful employment in this sector.


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SMEs account for about 40% of gross manufacturing output,about 80% of industrial employment, and about 25% of thetotal labor force in Bangladesh. However, they have not beenable to realize their full potential due to various constraints:(i) dearth of medium to long-term credit; (ii) limited access tomarket opportunities, technology, expertise, and information,

relative to larger enterprises; (iii) lack of suitable incentives;(iv) inefficient and limited outreach of government services;and (v) weak capacity among SME entrepreneurs inmanaging functional areas of business.

Recognizing the role of SMEs in economic development andthe fight against poverty, the Government formed a nationalTask Force to recommend SME policy guidelines andimplementation strategies, provide the necessaryunderpinnings for public support to the sector, and specifytargeted assistance and a dedicated institutional setup forSME development. The SME Sector Development Program

(SMESDP, the Program) supports the Governments initiativein addressing SME constraints and providing promotionalsupport to facilitate their accelerated growth and development.SMESDP is fully consistent with the strategic priorities of theGovernment and of the Asian Development Bank (ADB)country strategy, and is supported by other developmentpartners. SMESDP also complements the Governmentsagenda of developing the countrys private sector as theengine of growth for the economy, and helps facilitate the flowof private investments into the SME sector in parallel withADBs interventions to promote good governance and thedevelopment of the financial sector, particularly rural credit.

Objectives The goal of SMESDP is to support government efforts tofoster development of the SME sector and enable the sectorto attain its full potential for contributing to sustainableeconomic growth and poverty reduction. SMESDP will supportstrengthening the policy environment for SMEs, and improvingaccess by SMEs to credit and related support services.

SMESDP consists of four parts: (i) a program loan ofSDR9.954 million ($15 million equivalent) supporting policyreforms, (ii) a project loan of SDR19.908 million ($30 millionequivalent) for extending credit to small enterprises, (iii) a

technical assistance (TA) loan of SDR3.318 million ($5 millionequivalent) for improving the effectiveness of governmentassistance to the SME sector and facilitating SMEs access tovarious support services including capacity building andsupport for infrastructure development for SMEs, and (iv) a TAgrant of $600,000 equivalent for assisting the Government toimplement and coordinate the Program and for benefitmonitoring.


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Program Loan SMESDP supports three program outcomes. The first is toestablish an SME policy and development framework toprovide impetus and guidance to the development of thesector. The second is to establish an institutional structure andnecessary mechanisms to support SME development. Thethird is to define government support to SMEs and facilitate

SME access to various services. The latter entails(i) rationalization of government assistance to the SME sector,including credit directly administered by government agenciesand public financial institutions; (ii) provision of tax incentives;(iii) enhancement of SME access to market, governmentservices, capacity building, and product certification, includingupgrading of the current product certification system tointernational standard; and (iv) development of an integratedSME database for improved targeting of assistance.

Cost Estimates The costs of adjustment (excluding the project and TA costs)are estimated at $33.4 million equivalent over the period

FY2005FY2008, reflecting the costs for development andimplementation of the SME policy and developmentframework, tax incentives, establishment of SME supportinfrastructure, and restructuring of concerned agencies underthe Ministry of Industries (MOI) providing services to SMEs.

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

Tranching The program loan will be released in two tranches subject tocompliance with agreed conditions. The first tranche, in theamount of $5 million equivalent, will be released uponeffectiveness of the loan and fulfillment of the first trancherelease conditions. The second tranche of $10 millionequivalent is expected to be released by end-June 2007, uponfulfillment of the second tranche release conditions.

ImplementationArrangements

The executing agency (EA) for the program loan will be theMinistry of Finance, Finance Division (MOF-FD). The EA willconstitute a central program coordination unit (CPCU) in

charge of program monitoring and coordination. Theimplementing agency (IA) for the program loan will be theMOI, except for the tax incentive measures, which MOF-FDwill coordinate with the National Board of Revenue.

Procurement andDisbursement

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


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multilateral and bilateral official sources. Disbursements underthe program loan will be made in line with ADBs simplifieddisbursement procedures and audit requirements. TheBorrower will certify that the value of eligible imports exceedsthe amount of ADBs projected disbursements under theprogram loan in a given period. ADB will have the right to

audit the use of loan proceeds and to verify the accuracy ofthe Borrowers certification.

Project Loan The project loan will be provided to enhance access to creditby SMEs, especially small enterprises referred to inBangladesh as the missing middle. These enterprises aretoo large to qualify for microcredit assistance programs of theGovernment but too small to be within the scope of currentbank lending. The loan proceeds will be used as contributionto the Small Enterprise Fund (SEF), which was set up byBangladesh Bank (BB) as a credit facility available to smallenterprises with fixed assets of less than Tk10 million. The

World Bank has also contributed to the SEF. SEF will beadministered by BB for channeling credit through participatingfinancial institutions (PFIs) to these small enterprises.

Cost Estimates The total project cost including contribution from SMEbeneficiaries and PFIs is estimated at $257.8 millionequivalent, while the fund size of SEF is $56.7 millionequivalent. In addition to the project loan of $30 millionequivalent, SEF will comprise $10 million equivalent from theWorld Bank and $16.7 million equivalent (Tk1 billion) from theGovernment through BB. The Government can increase itscontribution to SEF if there is sufficient demand. The project

loan will be provided in foreign exchange but re-lent by BB toPFIs in local currency at the BB rate.

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

Executing and

Implementing Agencies

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

BB.

Procurement andDisbursement

PFIs will onlend the funds from SEF in taka assubloans/subleases to their SME clients at their prevailingpricing. Activities to be financed through subloans/subleaseswill be carried out in accordance with ADBs procurementrequirements and environmental and other safeguard policies.An imprest account procedure will be used for thedisbursement of the project loan.


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Technical AssistanceLoan

ADB will provide a TA loan of SDR3.318 million ($5 millionequivalent) for (i) the conduct of studies to rationalizegovernment assistance to the SME sector including therestructuring, phaseout, or strategic reorientation of concernedagencies under MOI providing services to SMEs, and toreview and rationalize credit assistance directly administered

by government agencies and public financial institutions;(ii) SME web portal/virtual front office design anddevelopment; (iii) establishment and operation of helplineoutreach centers; (iv) capacity building for SMEentrepreneurs, particularly in rural areas, and for womenentrepreneurs, displaced workers, and credit staff of PFIsdealing with the SME sector; (v) upgrading of the productcertification system; (vi) integrated SME databasedevelopment; and (vii) environmental assessment andmonitoring.

Cost Estimate The total TA loan project cost is estimated at $8.46 million

equivalent, of which $5.00 million equivalent will be funded byADB. The Government will finance $1.84 million equivalentthrough budgetary support, and the remainder of the cost willbe borne by the private business sector through theFederation of Bangladesh Chambers of Commerce andIndustry (FBCCI) and other chamber bodies and industryassociations, SMEs, and PFIs, by payment of fees and cost-sharing arrangements.

Financing Plan ADB will provide the TA loan from its Special Fundsresources, with a term of 32 years, including a grace period of8 years, and with an interest rate of 1.0% per annum during

the grace period and 1.5% per annum thereafter. The TA loancompletion date is expected to be 31 December 2007.

Executing andImplementing Agencies

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

Procurement andConsulting Services

Procurement of goods and services will be in accordance withADB's Guidelines for Procurement. Supply contracts valued at$100,000 equivalent or less may be procured based on localprocedures under the Governments Public ProcurementRegulations, 2003 and acceptable to ADB. All consultingservices that are to be financed from the proceeds of the TA

loan will be engaged in accordance with ADBs Guidelines onthe Use of Consultants and other arrangements for theengagement of domestic consultants satisfactory to ADB.


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Safeguard Policies As IA for the credit facility, BB will monitor compliance of PFIswith ADBs Environmental Policy (2002) and EnvironmentalAssessment Guidelines, and ADBs policies on involuntaryresettlement (1995) and indigenous peoples (1998). PFIs inturn will monitor compliance by subborrowers with ADBpolicies and government regulations.

Technical AssistanceGrant

The TA grant will support program implementation andcoordination to ensure timely compliance with policyconditions and other deliverables to achieve the statedoutcomes. The main tasks under the TA are to assist insetting up and operationalizing the institutional body for SMEpolicy and development framework implementation,strengthen monitoring and reporting, help oversee theimplementation of various components under SMESDP toenable timely corrective action if needed, build up capacity ofthe EA and IAs in implementing the activities and monitoringbenefits of SMESDP, and provide administrative support to

the EA and IAs. The total cost of the TA is estimated to be$750,000 equivalent. ADB will provide $600,000 equivalent ona grant basis from the ADB-funded TA program. TheGovernment will contribute $150,000 equivalent. The TA willbe implemented over the implementation period of SMESDP.Consultants will be recruited in accordance with ADBsGuidelines on the Use of Consultantsand other arrangementsfor the engagement of domestic consultants satisfactory toADB.

Executing andImplementing Agencies

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

Benefits and Impact

Policy SMESDP is central to the formulation and implementation ofpublic policy that focuses on SME development. The SMEpolicy and development framework will make governmentcommitments to the sector explicit, and lay out targeted SMEpolicy measures and institutional structure to guide theconcerned government agencies in providing support to theSME sector. The policy measures will rationalize governmentassistance to SMEs and facilitate SME access to credit,business support services, product certification, and capacitybuilding.

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


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implement the action program to be developed by the SMEAdvisory Panel to support implementation of the SME policyand development framework. Subsequently, over the mediumterm, SMESDP will assist in establishing and operationalizingthe SME Foundation in the form of a public-private partnershipto be a dedicated agency responsible for SME development

on a sustainable basis. Further, the Program will supportstudies for improving the effectiveness, restructuring, andstrategic reorientation of concerned agencies under MOI thatinterface with and provide services to SMEs.

SME Financing Small enterprises will have better access to credit throughSEF. The Program will also enhance capabilities of PFIs inextending credit to SMEs by assisting PFIs in establishing orstrengthening their SME financing operations and trainingabout 1,000 SME credit staff of PFIs as well as other financialinstitutions intending to engage in lending to SMEs, on SMEfinancing, project appraisal and supervision, and credit and

portfolio administration of small loans. Capacity building ofSME credit staff will strengthen their abilities to assess SMEcredit applications as well as facilitate provision of businessdevelopment services (BDS) to SMEs. PFIs are expected tohave more focus on the SME business segment, strengthentheir SME unit, and expand their SME loan portfolio. PFIfinancial assistance will allow the SMEs to strengthen theircompetitiveness and to be commercially viable. It is estimatedthat there will be about 10,000 subloans/subleases that will bemade out of SEF. In addition, lending to SMEs will have astrong linkage impact on BDS providers who would beresponding to generated demand for their services and PFI

referrals.

Beneficiaries SMESDP will contribute to the countrys goal of raising realeconomic growth, generate employment, and therebycontribute to reducing poverty incidence. Overall, during theprogram period FY2005FY2007, employment in the SMEsector is expected to rise by at least 8% per annum.

It is estimated that during the TA loan implementation period,over 8,000 participants from SMEs, including about 2,000women, will undergo training to be conducted by the Small

and Cottage Industries Training Institute in collaboration withFBCCI, and its district chambers and line associations. Over12,000 displaced workers are expected to undergo retrainingprograms and at least 50% are projected to be re-employedduring the program period. It is also expected that about150,000 entrepreneurs or individuals interested in setting upan enterprise will take advantage of the services of thehelpline outreach centers established as public-privatepartnerships under the Program. SMESDP will address


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

Development PartnerCoordination

SMESDP complements ongoing and planned activities ofother development partners, in particular as regards BDS andprivate sector development. The interventions under SMESDPwere closely coordinated with the Local Consultative Groupcomposed of all development partners active in the SMEsector in Bangladesh.

Risks and Safeguards Drawing from past experience, despite possible changes inthe Government, it is presumed that Bangladesh will pursuethe required reforms, based on high-level governmentcommitment.

The program implementation risks have been addressedthrough institutional mechanisms that involve all tiers in theGovernment, including the NCID at the top policy level, theGuidance Committee at the ministerial level, and thededicated SME Cell (over the medium term, the SMEFoundation) at the implementation level. Direct oversight ofspecific program, project, and TA components will be providedthrough the CPCU organized under the EA. The TA grant willprovide capacity-building assistance to strengthen thecapabilities of counterpart staff to implement the policymeasures, and support the EA and IAs in terms of programcoordination and monitoring activities, as well as PFIs in

monitoring benefits from subloans/subleases financed underSEF. On the project loan, both ADB and World Bank staffbased in Dhaka will be closely involved in monitoringutilization of SEF and adherence to relevant policies, and takecorrective measures where needed.

The Program also reduces risk and institutes checks andbalances through the use of participatory consultationmechanisms and public-private partnerships. The SME policyand development framework will be developed throughconsultation and participation of various stakeholders andinformation disseminated to the public through publication in

newspapers of nationwide circulation. The SME Foundationwill have private sector representatives on its board. Theprivate sector through FBCCI, chambers, and associations willbe involved in program implementation and make asubstantial contribution to the total resources, in addition totheir business network, practical knowledge and skills, andlinkages to sources of market information and technology.


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I. THE PROPOSAL

1. I submit for your approval the following report and recommendation on proposed loansto the Peoples Republic of Bangladesh for the Small and Medium Enterprise SectorDevelopment Program (SMESDP, the Program) consisting of (i) a program loan supportingpolicy reforms; (ii) a project loan for extending credit to small enterprises; and (iii) a technical

assistance (TA) loan for improving the effectiveness of government assistance for the small andmedium enterprise (SME) sector and facilitating SMEs access to various support services,including capacity building and support of infrastructure development for SMEs. The report alsodescribes a proposed TA for Supporting Program Implementation and Coordination ofSMESDP, and if the Board approves the proposed loans, I, acting under the authority delegatedto me by the Board, will approve the proposed TA.

II. THE SECTOR: PERFORMANCE, PROBLEMS, AND OPPORTUNITIES

A. Sector Description and Performance

1. Macroeconomic Performance

2. Bangladesh achieved a steady 5% growth rate of real gross domestic product (GDP)during the 1990s, as compared with 4% in the 1980s. The growth of per capita real GDPaccelerated from 1.7% per annum in the 1980s to 3.1% in the 1990s. The growth in the 1990swas attributable to the reforms to move Bangladesh toward an open economy, such as makingthe currency convertible on the current account, reducing import duties, removing controls onthe movements of foreign private capital, and introducing value-added tax. The Bangladesheconomy became more closely integrated with the global economy, with its trade doubling overthe 1990s to reach 31% of GDP by 2001. The industry and services sectors each contributedabout 41%, and agriculture about 18%, to incremental GDP growth in the 1990s compared withthe 1980s. Unlike the 1980s, when the rapid shift of labor into the rural nonfarm sector waslargely in the form of self-employment, the 1990s witnessed the absorption of wage labor in

greater numbers by relatively larger-scale enterprises. These enterprises were at the higher endof the productivity scale compared with the self-employed form of enterprises in the earlieryears.1 Reflecting higher economic growth and increased employment generation, the povertyrate declined from 59% to 50% between 1991 and 2000.

3. The Government has progressively moved away from administered interest rates towardmarket-based rates. The disproportionately high interest rates offered by the National SavingsCertificates2 that crowded out long-term borrowing by financial institutions (FIs) and privatesector borrowers have been reduced toward closer alignment with comparable market rates.Despite these efforts, spreads between lending and deposit rates remain high due to thenonperforming loan (NPL) problem in the banking system, which is being addressed by theGovernment. The Government is also developing a market for government securities and

significantly reduced the withholding tax on income from securities and bonds.3

On the foreignexchange market, the taka was floated in May 2003 and the exchange rate is managed flexibly,with interventions confined to countering disorderly conditions.

1Osmani, S. R., Wahiduddin Mahmud, Binayek Sen, Hulya Dagdeviren, and Anuradha Seth. 2003. TheMacroeconomics of Poverty Reduction: The Case Study of Bangladesh. Dhaka: United Nations DevelopmentProgramme.

2National Savings Certificates are offered to small savers at administered rates, currently in the range of 7.511%for 15 years tenor.

3Reduced from a range of 2545% to a unified rate of 25%, in the current years budget.


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4. To maintain macroeconomic stability and implement structural reforms that willcontribute to improving the investment climate, promoting economic growth, and reducingpoverty, the Government has prepared the National Strategy for Economic Growth, PovertyReduction, and Social Development, the Governments interim poverty reduction strategy paper(I-PRSP), dated March 2003,4 which forms the basis for a 3-year arrangement with theInternational Monetary Fund (IMF) under the Poverty Reduction and Growth Facility (PRGF)

originally approved for SDR347 million (about $505 million). The Government will have toaccelerate economic growth to about 7% per year over the next decade to reduce poverty inhalf by 2015 in accordance with the Millennium Development Goals.5 In comparison, annualGDP growth was 5.3% in FY2003, 5.5% in FY 2004, and is projected at 5% for FY2005. TheIMF PRGF target is 6% for FY2006FY2008. The IMF PRGF together with the DevelopmentSupport Credit I and II projects of the World Bank (WB) also provide policy support in thefinancial sector, including preparation for privatization of and management support for thenationalized commercial banks (NCBs) and issuance of prudential regulations. In July 2004,IMF completed the second review of Bangladeshs economic performance under PRGF andapproved a release of SDR49.5 million (about $72 million) as well as an augmentation of thePRGF, amounting to SDR53.33 million (about $78 million), for the Trade IntegrationMechanism.6

2. Business Environment and Private Sector Development

5. Despite higher economic growth during the 1990s, Bangladesh still lagged behind othercountries in the region such as India, Pakistan, and Sri Lanka. Various studies carried out underAsian Development Bank (ADB) TA in 20027 and 2003,8 an investment climate assessment bythe WB,9 the 2003 National Private Sector Survey of Enterprises in Bangladesh (the 2003Private Sector Survey),10 and surveys by the Federation of Bangladesh Chambers ofCommerce and Industry (FBCCI) have identified major impediments to the countryscompetitiveness and economic growth, including inadequacies in infrastructure facilities(particularly power, gas, and port facilities), corruption and invisible costs, deficiencies in thelegal and regulatory framework, and lack of access to finance by businesses.

6. Nevertheless, the Government has taken several policy initiatives to improve theinvestment climate. The I-PRSP recognizes the private sector as the engine of economicgrowth. The 1999 Industrial Policy eliminated restrictions on private sector participation in all

4The full poverty reduction strategy paper is currently being prepared; its completion is expected by end-2004.

5Poverty reduction targets are set at 35% in 2010 and 25% in 2015 with 2000 as the base year.

6The IMF Trade Integration Mechanism was introduced in April 2004 to assist member countries to meet balance ofpayments shortfalls that might result from multilateral trade liberalization. It is not a special lending facility, butrather a policy designed to make resources more predictably available under existing IMF facilities.

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

Manila).8Report on the SME Enabling Environment, June 2003, prepared under TA 3879 (ADB. 2003. TechnicalAssistance to the Peoples Republic of Bangladesh for Preparing Small and Medium Enterprise Development andExport Expansion Program. Manila.)

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

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


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sectors except defense, nuclear energy, forest plantation, and mechanized extraction ofreserved forests. The foreign direct investment regime is also liberal, although the bulk of directinvestment from abroad has been in the gas and power subsectors. With regard to trade reform,the Government has introduced a three-tier tariff structure with the maximum rate having beenreduced from 30% to 25%. The average tariff and the number of products subject to quantitativerestrictions have also been reduced. Import-licensing requirements have been streamlined. The

Government has introduced export promotion measures and at the same time developed acomprehensive plan to cope with the phaseout of the Multi-Fibre Arrangement (MFA) at end-2004, which will adversely affect textiles and garments, the strategic exports of Bangladesh.

7. Reforms are also under way to create an enabling environment for private sectordevelopment and development partners, including ADB, are providing continuing support forinfrastructure development.11 To tackle the issue of corruption and rent-seeking behavior ofpublic officials, the Government set up the Anti-Corruption Commission (ACC) under the ACCAct passed in February 2004. The WBs Development Support Credit I and II projects as well asthe ADBs ongoing TA12 provide support for the establishment of the ACC. In addition, theGovernment is promoting e-governance and introducing the use of computers and web sites inall ministries and sector corporations to enhance transparency and expedite administrative

processes.

3. Role and Characteristics of the Small and Medium Enterprise Sector

8. It is generally recognized that SMEs have a significant role in generating growth andemployment. SMEs account for about 40% of gross manufacturing output, about 80% ofindustrial employment, and about 25% of the total labor force in Bangladesh. Preliminary figuresbased on the 20012003 Census of Non-Farm Economic Activities (Urban and Rural) [theEconomic Census], which excludes agriculture, fisheries, and forestry, estimate the number ofpersons employed by SMEs at 1.72 million, which is about 45% of the total number employed innonfarm small, medium, and large establishments. The 2003 Private Sector Survey estimatedthat micro, small, and medium enterprises contributed around 2025% of GDP. Given the

critical role of SMEs in economic growth and poverty reduction, it is imperative that theGovernment develop and implement targeted policy measures to address specific constraints toSMEs to enable them to realize their full potential and contribute more effectively to economicgrowth and employment generation.

9. Definition of SMEs. The Industrial Policy 1999 defines SMEs as enterprises employingfewer than 99 workers and/or with a fixed capital investment under Tk300 million. Smallindustry refers to enterprises (excluding cottage units) employing fewer than 50 workers and/orwith a fixed capital investment of less than Tk100 million while medium industry coversenterprises employing between 50 to 99 workers and/or with a fixed capital investment ofbetween Tk100 million and Tk300 million. However, this definition has the second highest upperlimit on fixed assets for SMEs in South Asia and Southeast Asia, after Singapore, and does not

accurately reflect the size of SMEs. The Bangladesh Bureau of Statistics (BBS) classifiesenterprises solely according to total persons employed or engaged (including proprietor) in theEconomic Census. Development partners involved in the SME sector have different definitionsof SMEs. The major commercial banks follow the Industrial Policy definition in terms of

11ADBs projects include among others, construction of roads and transport infrastructure, development of the powerand gas sector, and improvement in efficiency of Chittagong Port.

12ADB. 2003. Technical Assistance to the Peoples Republic of Bangladesh for Supporting Good GovernanceInitiatives. Manila. The TA is progressing well and the Government has requested ADBs assistance in thedevelopment of an implementation plan for the ACC.


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investment capital for lending purposes. The lack of any single standard definition makes itdifficult to interpret data on SMEs and target assistance for SME sector development.

10. Population of SMEs. There are varying estimates of the SME population in line withdifferent definitions of SMEs. Based on the Economic Census, the total number of SMEs 13 isestimated at 79,754 establishments, of which 93.6% are small and 6.4% are medium. The 2003

Private Sector Survey estimated about 6 million micro, small, and medium enterprises definedas enterprises with fewer than 100 employees.

B. Issues and Opportunities

11. Most of the key impediments to the development of the SME sector are linked tostructural problems in the business environment. ADB and other development partners areaddressing issues in private sector and financial sector development. While these problemsaffect all enterprises irrespective of size, SMEs are disproportionately affected due to their smallscale of operations and more limited resources to address the problems. Complementary to thegovernment initiatives and other development partner programs, the proposed SMESDP aims atintroducing policy reforms and creating support infrastructure targeted at SMEs to enhance their

capabilities and facilitate their access to the necessary resources to deal with the regulatory,credit, capacity, and other key issues that they are facing owing to policy and market failures.Sector analysis and framework for SME development, including government initiatives anddevelopment agency-funded programs, are summarized below with details included inAppendix 3.

1. Present Challenges for Small and Medium Enterprises

a. Access to Credit

12. Lack of SME Access to Credit. Financial constraint was cited most frequently as a keyproblem during startup and operations as reflected in the 2003 Private Sector Survey. Problems

are more pronounced for small enterprises predominantly in the informal sector that are in theso-called missing middle. These enterprises, some of which have graduated from microcreditprograms, are no longer considered microenterprises and are ineligible for financing fromnongovernment organizations and microcredit institutions or from government specialassistance programs. On the other hand, they are not large enough to fall within the scope ofcurrent bank lending. Banks view SMEs as relatively higher credit risks, and expected returnsdo not justify the high administrative and servicing costs of small loans. SMEs are normallyrequired to assign real or other immovable properties as collateral to secure their obligation, acondition that most SMEs find difficult to comply with. Further, lack of suitable lendingmodalities, and limited capability of SME credit staff to appraise SMEs cash-flow-generatingcapacity is another reason for the predominance of collateral-based lending.

13. Secured Financing. Lack of ownership of land or immovable property as collateral forbank financing poses a constraint to SME access to credit. Secured financing backed bymovable property (e.g., equipment, vehicles, and other non-land assets) as security wouldgenerally be preferred by SMEs, as they typically own movable property. However, the securedfinancing sector in Bangladesh covering leasing companies is quite small with limited growthpotential due to lack of a legal and institutional framework for secured transactions. Currently,

13In the Economic Census, microenterprises are defined as those with total number of persons employed of lessthan 10, small enterprises with 10 to 49, medium enterprises with 50 to 99, and large enterprises with 100 or more.


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there is no law specifically providing for taking movable property as security for a loan. Securityinterests in movable property are created by contract, creating unnecessary litigation and delay.The current law does not provide for priority of creditor interests; thus, loan recovery typicallyinvolves long and costly litigation to determine interests of creditors. Moreover, there is nocomprehensive registry system in Bangladesh. Not all security interests can be registered,posing a limitation on secured lending. Coverage of the current registry system at the Registrar

of Joint Stock Companies (RJSC), restricted to limited companies, excludes from securedfinancing SMEs that are not in corporate form, although these constitute the majority ofenterprises. The manual registration system results in excessive delay and createsopportunities for corrupt practices.

14. Market Failures in SME Financing. In the absence of a long-term market for debtfunds, availability of medium- to long-term credit is limited. Although there is excess liquidity inthe market, a significant portion is lodged with NCBs that are facing chronic NPL problems andhave been restricted by Bangladesh Bank (BB) to limit their credit portfolio growth to 5%annually in order to contain their losses. In the absence of an effective interbank market, thisexcess liquidity in NCBs does not readily flow to the private commercial banks (PCBs) ornonbank financial institutions (NBFIs). Moreover, NBFIs are limited in their scope for accepting

deposits while PCBs and leasing companies have limited term funds due to an inability toengage in asset/liability mismatches by using short-term deposits for medium- to long-termlending in the absence of liquidity support from BB and without a repo market. In addition, cashreserves are required to be met on a daily basis while the inefficient payments system makesmonitoring and adjusting liquidity positions highly cumbersome and difficult. Furthermore, evenif many NBFIs are keen to engage in SME financing, loans from NCBs are available at ratesthat, owing to the high NPL level, make SME financing unprofitable or marginally profitable.Their relatively high costs of capital limit the expansion of their SME loan portfolio.

b. Need to Rationalize Present Government Support for Small andMedium Enterprises

15. Although SME development has been included in the Industrial Policy, there are neithersignificant specific policy measures nor specific institutional support to establish an enablingframework at a policy level, resulting in costly and inefficient implementation of SMEdevelopment initiatives. SMEs are typically in a disadvantaged position to benefit from neutralbusiness-friendly policies compared with large enterprises. Targeted policy interventions arenecessary to improve access of SMEs to market opportunities, financing, technology, expertise,and information. There is also an evident need to create an institutional mechanism that caneffectively coordinate and implement SME-related policies.

16. The Government provides business support and capacity-building assistance as well asinfrastructure facilities to SMEs, mainly through theBangladesh Small and Cottage IndustriesCorporation (BSCIC). Founded in 1957 by legislation as the principal government organization

mandated to promote the development of countrywide small and cottage industries (SCIs),BSCIC is responsible for (i) allotment of developed industrial estates in 64 districts inBangladesh; (ii) entrepreneurship development training programs conducted by its training arm,Small and Cottage Industries Training Institute (SCITI); (iii) credit arrangement and end-usesupervision; (iv) design, development, and distribution of prototypes through its design center;(v) research and development activities; (vi) management and skills development; and(vii) market study and marketing assistance (e.g., trade fairs).


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17. However, BSCIC has failed to fulfill its mandate due mainly to lack of a clear focus,burden of managing many nonperforming industrial estates, weak management deputed fromthe civil service system with lack of understanding of SMEs, and shortage of well-trainedprofessionals. Currently, there is no cost recovery in the use of public resources in the estatesor in almost all of the services provided by BSCIC, while training participants pay only a nominalfee for its training programs. BSCIC is overstaffed with 3,244 people. In FY2004, the revenue

budget of BSCIC was Tk248 million. Low revenues coupled with high operating costs haveresulted in substantial accumulated operating losses of Tk660 million or about $10.1 million overthe past 10 years. A parliamentary subcommittee was formed to address the issue of operatinglosses while the Ministry of Industries (MOI) has set up a committee to study human resourcerestructuring at BSCIC. To move BSCIC toward a leaner and more effective organization, thecommittee proposed human resource rationalization, including downsizing field offices and thehead office.

18. Since its establishment in 1985, SCITI has conducted training courses for over 24,000participants, mostly existing and potential entrepreneurs and managers of SCI enterprises.However, SCITI has very limited outreach with more than two thirds of its training programsconducted at its premises in Dhaka. Although SCITI has carried out training programs in other

parts of the country in collaboration with BSCICs respective local offices and industrial servicecenters, the implementation of these programs was ineffective due to a meager budget, lack ofqualified faculty members and trainers, and lack of training facilities. There is a need tostrengthen SCITIs capacity to deliver its training services to SMEs on a sustained basis.(Profiles of BSCIC and other public institutions serving SMEs are in SupplementaryAppendix 6.)

19. Public institutions including BB, NCBs, and specialized financial institutions, engaged inextending loans to the agriculture and industry sectors, currently have financing facilities forSMEs, the performance and effectiveness of which have been uneven. These facilities havevarying features and terms. Some are targeted at certain industries or subject to limitedgeographic coverage. BBs Rural-based Agro-Processing Industries Refinancing Facility,

originally set up for Tk1.5 billion, had a low utilization rate owingmainly to the restriction on useof funds to agro-processing industries located outside the major cities; consequently, the size ofthe facility was later reduced to Tk0.5 billion and Tk1 billion was reallocated to set up the SmallEnterprise Fund (SEF).The Entrepreneurship Enterprise Fund was set up by BB in FY2001 as aventure capital fund to co-invest in projects in software, food processing, and agro-basedindustries. Since its establishment, the utilization rate has averaged about one fourth of thebudget allocated in each fiscal year. The Government is exploring an exit strategy for its equityshareholding in the enterprises cofinanced under the Entrepreneurship Enterprise Fund. Somecredit facilities provided by NCBs and specialized financial institutions impose ceiling on loans tosubborrowers in certain sectors, such as agricultural credit, thus distorting interest rates andfurther exacerbating the vulnerable financial position of these entities. There is no indicator tomeasure the effectiveness, outreach, or impact of these facilities. Thus, a study needs to be

conducted to identify ways to rationalize the existing government assistance and to ensureefficient and effective delivery mechanisms.

c. Incentives

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


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exception of very small enterprises classified as cottage industries,14 which are exempted fromvalue-added tax on an extensive list of items, no special tax treatment is given to SMEs. Torelieve the tax burden of newly established enterprises, the Government has provided taxholidays for all manufacturing or service enterprises, irrespective of size, if they are establishedbefore June 2005. These enterprises can register with the National Board of Revenue (NBR) tobe exempted from income tax for 5 years if they are located in major cities such as Dhaka and

Chittagong and for 7 years for those located in other cities. The abolition of the tax holidayscheme, which is expected to be approved by the Government in the next fiscal year, willadversely affect small enterprises to a greater extent than larger enterprises because of theirlimited income-generating capacity to absorb high startup costs. Tax and customs proceduresare also cumbersome and involve high informal payments, reflecting additional compliancecosts and posing a barrier for SME entry into the formal sector.

d. Registration, Licensing, Tax, and Other Requirements

21. The establishment of an enterprise in general requires a trade license from localgovernment bodies, registration under the Factories Act with the Department of Inspection ofFactories and Establishments of the Ministry of Labor, registration for value-added tax and a tax

identification number with NBR, and environmental clearance from the Department ofEnvironment of the Ministry of Environment and Forest. Compliance complexity increases asthe business becomes a legal entity and seeks registration for access to government incentives.If an enterprise is to be incorporated as a company, registration with RJSC is required.Investment registration with the Board of Investments will be required for access to capitalmachinery import incentives in the form of import duty and tax exemptions, and to infrastructurefacilities such as utility (water, electricity, and telecommunications) and land (e.g., industrialestates managed by BSCIC or Bangladesh Export Processing Zone Authority). The processesto meet these requirements usually involve unnecessary delays, harassment, and sidepayments. The information gap has been identified as the key constraint in obtaining certificatesor licenses from any of these regulatory agencies. Awareness and understanding ofdocumentation requirements, steps to be followed, and fees to be paid will help entrepreneurs

to be prepared and make it more difficult for officials or brokers to take advantage of theentrepreneurs lack of knowledge. The delays in the processes are also caused by manualsystems at many of these public service institutions and duplication of procedures.

e. Market for Business Development Services

22. SMEs operating outside the urban centers do not have ready access to businessdevelopment services (BDS) providers. BDS are generally regarded as unaffordable by thissubsector. The BDS market is still fragmented and unorganized with few privately ownedorganizations providing BDS. Some started as projects funded by development partners.15Many of the training and capacity-building programs are neither demand-driven nor specificallytargeted at certain groups of SMEs that are disadvantaged, such as those in rural areas and

those headed by women entrepreneurs. Moreover, retraining programs are also needed for thedisplaced RMG workers due to the phaseout of the MFA by end-2004. It is estimated that at

14Cottage industries in this context are defined by the NBR as enterprises that have (i) investments in capitalmachinery of less than Tk500,000, (ii) annual turnover of less than Tk2 million, and (iii) no production in the nameof any brand belonging to others.

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


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least 200,000 RMG workers, over 85% of whom are women, need retraining to be able toreenter the gainfully employed labor pool. Further, Bangladesh needs to diversify its know-howand technology away from core garment industries to lessen external shocks and better equipthe country to cope with the changing market environment.

23. Some FIs provide basic advisory services to their clients, or make BDS arrangements

with service providers to assist enterprises that they finance.16 Generic training courses oncredit management and core banking and on finance subjects are conducted at the trainingcenter of BB and the Bangladesh Institute of Bank Management. However, to extend FIslending to the SME sector, there is a need to build up capacity of SME credit staff to provide in-house basic advisory services and handholding assistance to SMEs, including preparation ofbusiness plan and bankable proposals.

f. Product Certification System

24. The Bangladesh Standards and Testing Institution (BSTI), an autonomous organizationunder MOI, is responsible for setting national standards for industrial, food, and chemicalproducts; conducting product testing; and issuing product certification. BSTIs certification mark

is mandatory for an extensive list of items to assure quality of products and to protectconsumers. There is no accreditation system to allow for services of private sector accreditationbodies. BSTIs monopoly and lengthy procedures led to the practice of side payments to obtaincertificates. Thus, BSTIs seal of quality has not gained credibility either at home or abroad,impeding the ability of exporters to market their products. To meet importers requirements,enterprises have to go through expensive and time-consuming processes to seek certificatesfrom foreign certification bodies. Many SMEs do not comply with product certificationrequirements due to their ignorance and weak enforcement capacity of BSTI. This limits theirpotential to broaden their client base to overseas markets.

2. Government Policy Support for Small and Medium Enterprise SectorDevelopment

25. Industrial Policy. The promotion of pro-poor growth propelled by the private sector asstated under the I-PRSP will have to be supported by appropriate macroeconomic and sectorpolicies. The new Industrial Policy, in its final draft form, covers (i) roles of MOI and otherrelevant agencies including BSCIC, Board of Investments, and Bangladesh Export ProcessingZone Authority, in promoting the development of industries, particularly those with strong growthpotential; (ii) promotion of exports and foreign direct investment; and (iii) privatization of state-owned enterprises. With renewed interest in SME development, it now highlights the prioritygiven to the development of the SME sector, and, drawing upon the recommendations of thenational Task Force on Development of SMEs [the SME Task Force] (para. 27), outlines theGovernments development strategy for the SME sector. Key elements of the strategy cover,among other things, (i) strengthening the role of public agencies to ensure proper

industrialization of SMEs; (ii) providing tax incentives to SMEs; (iii) simplifying laws andregulations; (iv) using e-commerce to develop production and marketing; (v) establishing aninformation bank to provide market opportunities and trade information; (vi) improving supplychain management to foster subcontracting and linkages between SMEs and larger enterprises;

16BRAC Bank, a PCB, has its own field staff trained to provide advice to its borrowers on basic business plandevelopment and has a partnership with the Job Opportunities and Business Support program of USAID forprovision of BDS, while MIDAS Financing, an NBFI, taps the resources of its parent company, MIDAS, for deliveryof BDS.


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and (vii) conducting a survey to analyze and identify industries with growth potential. The newIndustrial Policy does not provide details for this SME development strategy but refers instead tothe SME policy and development framework. However, the revised definition of SMEs has beenincorporated. According to this definition, to be made generally applicable, (i) for manufacturing,small enterprises are those with fixed investment less than or equal to Tk15 million and mediumenterprises with fixed investment greater than Tk15 million and less than or equal to Tk100

million,17 while (ii) for nonmanufacturing, small enterprises are those with fewer than 25 full-timeemployees, and medium enterprises with between 25 and 100 full-time employees.

26. Preparation of SME Policy and Development Framework. There is global consensusrecognizing the role of SMEs as engines for growth, employment, and poverty reduction, andthe need to design SME policies in the context of a coherent and integrated approach toeconomic growth and social development.18 SME development requires a crosscutting strategythat touches on such areas as macroeconomic policies, business environment, legal framework,and finance, and that is integrated into the broader national development and poverty reductionstrategy.

27. In line with such a consensus and to prioritize specific elements of SME policies from the

Bangladesh perspective, the Government established the SME Task Force on 5 November2003. The SME Task Forcecomprising 16 members from the Government, academia, and theprivate sector, and chaired by the principal secretary, Prime Ministers Officeheld a nationalworkshop on 20 February 2004 and prepared the Report on Development of SMEs.19 TheReport, endorsed by the prime minister and submitted to the Economic Affairs Committee of theCabinet in October 2004, contains policy recommendations with timeframe to create anenabling environment conducive to SME development. Key components are declaration ofSMEs as a priority sector, an institutional framework, various incentives, and capacity buildingand human resource development measures. These recommendations will form the basis forframing the Governments policy vis--vis the SME sector, which will be completed in 2005 andimplemented by an action program (paras. 3940).

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

a. Financial Market Development

28. Reforms in the Banking Sector. The ongoing reforms will help address market failuresin SME financing. The restructuring of NCBs has been initiated and will be supported by theWBs Enterprise Growth and Bank Modernization (EGBM) project, which will assist in preparingstrategies for resolution of problems of NCBs, improve governance arrangements, and divestthe Governments shares in the NCBs. Amendments of relevant laws have been made tostrengthen BBs oversight of the banking sector and ensure its autonomy over monetary and

17Fixed capital assets, valued at replacement cost based on current market prices, include plant, machinery,building, and structures. Land is excluded primarily because in Bangladesh, land values in urban areas aredisproportionately high relative to the other productive assets of enterprises and distort their balance sheet.

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

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


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exchange rate policies. Stricter prudential regulations have been introduced, including increasedcapital adequacy requirements and revisions to loan classification and provisioning guidelines.

29. Development of Capital Market. ADB has provided assistance to strengthen the legaland regulatory framework as well as oversight of the securities markets. It has also been closelyinvolved in reforming the Bangladesh domestic capital market and in enhancing the role of the

Securities and Exchange Commission as a regulator.20 Further, the WBs Financial InstitutionsDevelopment project, which includes a component to facilitate FIs issuance of securities andsecuritization of their loan/lease portfolios, has achieved some progress.21

30. Secured Financing. To support secured financing as part of good governance initiativesas well as SME development, ADB is providing assistance for legal and registry reforms tofacilitate secured transactions. 22 The draft secured transaction law is being prepared and hasbeen discussed among stakeholders, while the registry reform will cover development of anoverall architecture for a transparent, electronic registration system.

31. Financial Reporting. The Government has acknowledged that in the long term it has toimplement recommendations identified in the Report on the Observance of Standards and

Codes23 including simplification of financial reporting standards for SMEs. WB is providingassistance in strengthening accounting and auditing practices in the corporate sector under aneconomic management TA program.

b. Registration, Licensing, and Tax Requirements

32. To facilitate issuance of trade license in Dhaka, Dhaka City Corporation set up a helpdesk at FBCCI and has been working toward developing a simple form of application with fewercertifications required for issuing a trade license. It has introduced automatic annual renewal oftrade license up to 5 years through payment in designated banks. The automation project ofRJSC is ongoing and supported by the Australian Agency for International Development andSouthAsia Enterprise Development Facility (SEDF).24 Further, SEDF also assisted RJSC in

preparing a registration toolkit and an animated television film on how to register a business,and established knowledge centers in Dhaka and Chittagong chambers of commerce andindustry, which maintain a library of SME information and resources including SME toolkitsoffering business software. The development of mechanisms and policies to streamline

20ADB. 1997. Report and Recommendation of the President to the Board of Directors on a Proposed Loan andTechnical Assistance Grants to the Peoples Republic of Bangladesh for the Capital Market DevelopmentProgram. Manila;ADB. 2000. Technical Assistance to the Peoples Republic of Bangladesh for Capacity Buildingof the Securities and Exchange Commission and Selected Capital Market Institutions. Manila; ADB. 2003:Technical Assistance to the Peoples Republic of Bangladesh forFinancial Markets Governance Program. Manila.

21The Industrial Promotion and Development Company of Bangladesh Ltd. (IPDC) is the first to launch asecuritization transaction involving private placement of zero coupon bonds for collateralization of its loan portfolio.The Industrial Development Leasing Company of Bangladesh Ltd. (IDLC) and the United Leasing Company Ltd.

are preparing to issue their own asset-backed debt securities.22ADB. 2003. Technical Assistance to the Peoples Republic of Bangladesh for Supporting Good GovernanceInitiatives. Manila.

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

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


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regulatory constraints on company registration, inspections, and export and import clearancescould be covered under the Regulatory and Investment Systems Improvements for EnterpriseGrowth program of the Department for International Development (DFID) scheduled for 2005. Inaddition, DFID is also providing assistance under its Revenues Administration Reforms projectto streamline and increase transparency in tax procedures by supporting the reform ofadministrative procedures and computerization at NBR and taxpayer education activities,

including tax information leaflets in Bangla and English and a web site containing taxinformation and forms.

c. Business Development Services and Training

33. Under the EGBM project approved in June 2004, WB will provide training on automationapplications to BSCIC and training of trainers to SCITI.25 SEDF provides (i) local serviceproviders and training institutions with the tools and training to develop their capacity to provideBDS, and (ii) SME entrepreneurs and staff with training programs in target subsectors, i.e.,garments, agribusiness, information technology, software, and light engineering.

III. THE PROPOSED SECTOR DEVELOPMENT PROGRAM

A. Objectives and Scope

34. The objective of SMESDP is to support government efforts to foster development of theSME sector by strengthening the policy environment for SMEs and improving SMEs access tocredit and related services. This will enable the sector to attain its full potential for contributing tosustainable economic growth and, through generation of employment, the reduction in poverty.

35. SMESDP consists of: (i) a program loan of SDR9.954 million ($15 million equivalent)supporting policy reforms; (ii) a project loan of SDR19.908 million ($30 million equivalent) forextending credit to small enterprises; (iii) a TA loan of SDR3.318 million ($5 million equivalent)for improving the effectiveness of government assistance to the SME sector and facilitating

SMEs access to various support services including capacity building and support forinfrastructure development for SMEs; and (iv) a TA grant of $600,000 equivalent for assistingthe Government to implement and coordinate the Program and for benefit monitoring. Theprogram framework is in Appendix 1. The development policy letter and the policy matrix are inAppendix 2.

B. Important Features

36. Rationale for Sector Development Program Modality. The sector developmentprogram modality will enable ADB to apply a holistic approach to SME development. Due tomarket failures, targeted policy interventions are necessary to create an enabling environmentfor SME development. The SMESDP policy actions will represent the key and core measures

under the SME policy and development framework that will provide justification for thegovernment interventions in the sector and help relevant agencies focus on SME developmentin an integrated fashion as opposed to past ad hoc interventions.Moreover, the program loancomponent will provide budgetary support for the establishment of an institutional frameworkdedicated to SME development on a sustainable basis and support infrastructure to facilitateSME access to market opportunities, technology, business support services, government

25In addition, the EGBM project also covers additional facilities to modernize BSCICs design center and institutionalcapacity building of the Board of Investments and Bangladesh Export Processing Zone Authority.


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services, and capacity building. The project loan that provides funds for SEF will improve SMEaccess to credit and will be complementary to the ongoing projects of ADB and otherdevelopment partners in the financial sector. The TA loan will support implementation of policyactions, and help carry out the needed assessments, capacity building, and development ofinfrastructure for SMEs.

37. Complementarities to Government Initiatives and Development AgencyInterventions. SMESDP underpins the Governments agenda of developing the countrysprivate sector, particularly the SME sector, which is accorded high priority to serve as theengine of pro-poor economic growth. The interventions under SMESDP will be targeted atremoving obstacles to SME growth and facilitating the flow of private investments into the SMEsector and will complement existing government reform measures and other ADB anddevelopment agency assistance programs in private and financial sector development.Moreover, SMESDP is fully consistent with ADBs country strategy and is complementary toADBs interventions in Bangladesh in rural and microfinance and in financial marketdevelopment, which helps improve resource mobilization and access to credit by SMEs.

C. The Program Loan

1. Components and Outputs

38. The Program is designed to have three policy outcomes:

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

(ii) Outcome 2: Establish Institutional Structure and Mechanisms to Support SMEDevelopment(a) Set up an institutional structure and mechanisms to implement the SME

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

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

restructuring of BSCIC and other concerned agencies under MOI involvedin the sector and rationalization of government direct credit assistancecurrently provided

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

(e) Enhance SME access to product certification and upgrade productcertification system to international standard

(f) Develop an integrated SME database

a. Establish SME Policy and Development Framework

39. Drawing upon the work of the SME Task Force, the Government will, as part of theProgram, formulate an appropriate SME policy and development framework in consultation with


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various stakeholders including SMEs and development partners. The Government will adopt theSME policy and development framework that will, in particular, (i) provide the justification forgovernment assistance to the sector; (ii) map out a government development strategy tosupport the SME sector over the short, medium, and long term; (iii) adopt a single uniformdefinition of SMEs; (iv) identify areas of assistance to SMEs to enhance their access to capital,business support services, capacity building, and technology to improve their product

marketability and competitiveness; (v) delineate the institutional setup to take responsibility forSME sector development; and (vi) incorporate internationally accepted market-based principlesfor SME development. Summary of the SME policy and development framework will bedisseminated to the public through publication in newspapers of nationwide circulation. Further,the development of the SME sector as a priority will be stated in the Industrial Policy and thePoverty Reduction Strategy Paper.

b. Establish Institutional Structure and Mechanisms to Support SMEDevelopment

40. The National Council for Industrial Development (NCID), which is chaired by the primeminister and charged with making policy decisions under the umbrella of the Industrial Policy,

will take responsibility for SME development. The Government will constitute an SME AdvisoryPanel mandated to develop an action program to support the SME development strategy. ThePanel will consist of representatives from MOI and other concerned ministries, industryassociations, and representatives from the private sector and academia, and report to theGuidance Committee,26 set up under the Industrial Policy and chaired by the Minister, MOI. MOIwill be the designated agency for implementation of the Governments SME developmentstrategy and has set up an SME Cell to facilitate operationalization. Over the medium term, theGovernment will draft and approve the memorandum and articles of association that will providethe organizational and operational framework for settingup an SME Foundation, which will haveat least 50% private sector representation on the board and a chief executive officer recruitedfrom the private sector, to assume the responsibilities for implementing the SME developmentstrategy and action program from the SME Cell and to take over, in a phased manner,

management of SME credit facilities currently directly administered by the Government.

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

41. Rationalize Government Assistance to the SME Sector including the Restructuringof BSCIC and Other Concerned Agencies under MOI involved in the sector andRationalization of Government Direct Credit Assistance Currently Provided. TheGovernment will review the effectiveness of existing government assistance to the SME sectorand the efficiency of delivery of such assistance covering various public sector agencies,particularly those under the supervision of MOI including BSCIC, SCITI, and BSTI, as well asvarious forms of credit assistance now being provided to the sector. The study will undertake

detailed diagnostic analysis of the selected agencies activities in terms of need, coverage andscale, impact, cost-effectiveness and sustainability, identification of restructuring alternatives,and preparation of a restructuring plan or a phaseout plan, depending on the studys findings.

26The Guidance Committee has 22 members including the Minister of Industries as chairperson; chairman, Board ofInvestments; governor, BB; secretary, MOI; secretary, Finance Division, MOF; secretaries of other ministries;chairman, BSCIC; representatives of other agencies; and presidents, FBCCI, Metropolitan Chamber of Commerceand Industry, and the major district chambers of commerce and industry.


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42. It is envisaged that BSCIC, SCITI, and BSTI will be restructured, or replaced by moreresponsive institutions. In any event, restructuring or setting up an alternative institution is to beguided by (i) a strengthened governance structure that will introduce public-private partnershipwith private sector representation on the board of the organization; (ii) recruitment ofprofessionals from the private sector, particularly for key positions; (iii) commercialization of theoperations by charging fees at least for cost recovery; (iv) a strengthened performance

evaluation and incentive system; (v) drawing up of a strategic plan with a time-bound road mapfor each product or service group, e.g., market-oriented development and management ofindustrial estates and parks, customer-responsive training, and capacity-building services toSMEs; and (vi) strengthened transparency and accountability, based on defined performanceindicators.

43. The rationalization of concerned agencies under MOI is moving forward. Staffrationalization is currently ongoing at BSCIC as part of human resource restructuring. Staffstrength of BSCIC is 3,244, comprising 1,644 officers (436 in the head office and 1,208 in fieldoffices) and 1,600 employees. It is planned to significantly reduce their strength. The number ofhead office officers will be reduced by half. Staff reduction in the field offices is being workedout. Voluntary retirement will be offered to regular officers and employees. Staff who do not

have properly approved appointments (about 300 persons) will be considered for termination.For improved productivity, training/retraining will be provided. Regardless of whether BSCIC isrestructured or phased out, the Government will have to replenish the employees providentfund and cover special deposit accounts for withdrawals made to bridge BSCICs accumulatedlosses (para. 17). SCITI has been upgraded from a development project to a regular agency ofBSCIC,27 and is recruiting experienced staff and faculty members. SCITI will be restructured tostrengthen its capacity to deliver training and capacity building services to SMEs. In light of theexpected passage of the Accreditation Law that will set up the Accreditation Board, which willaccredit calibration and testing laboratories and certification bodies including those in the privatesector, there is a need to assess BSTIs role in conducting product testing and in certification,and to carry out a study for its strategic reorientation. The Program seeks to resolve theseissues based on the findings of the study.

44. Rationalization of credit assistance will be based on an analytical review of allgovernment-assisted credit programs and facilities for SMEs, including their scope, interestrates, terms and conditions, and implementation arrangements. These include credit programsof government ministries, agencies, and public sector banking institutions funded from thenational budget, refinancing facilities of the BB, and credit programs of NCBs and specializedfinancial institutions funded from their own resources. The issues of directed lending andpolitical considerations, subsidy, and moral hazard will be examined, and, drawing on findings ofthe analytical review and considering international best practices, specific recommendations tomake credit delivery mechanisms more effective and sustainable will be prepared. Thesestudies will be financed by the TA loan (para. 83).

45. Rationalize Incentive and Tax Structure for SMEs. The SME policy and developmentstrategy will include the Governments plan to provide for a suitable incentive and tax structurefor SMEs. To enhance viability of these small enterprises, tax incentives should be given duringtheir initial stage of operations. If the Government abolishes the tax holiday scheme in the nextfiscal year, a 75% income tax rebate and accelerated depreciation allowance for plant andmachinery will be given as a substitute to newly established small enterprises with fixed

27Previously SCITI was a project funded from the annual development program. SCITI is now a permanentgovernment body with budgetary allocation from the annual revenue budget.


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investments excluding land and building of less than Tk3 million. However, these tax incentiveswill not be provided to those enterprises that already take advantage of tax incentives underexisting export incentive schemes. The Government will implement the tax incentives agreedupon to take effect from assessment year FY2006, as provided for in the Finance Act 2005 orother appropriate legislation. The impact of these tax incentives will be minimal initially becausethese enterprises are very small. However, in the long run, these measures are expected to

facilitate the expansion of SMEs and consequently enhance revenue to the Government as theycome out of the informal sector and are captured in the tax net. As stated in the IndustrialPolicy, to encourage the establishment of small firms, assistance will be given by way ofrearranging the tax structure such that taxes and duties are fixed at the lowest level that can be

justified.

46. Enhance SME Access to Market and Government Services. MOI has a program toimplement e-governance, which will involve the development and maintenance of a web site tobe linked to the web sites of other line ministries, and has constituted an e-governancecommittee to spearhead and coordinate this program. The e-governance program is importantfor access and dissemination of information, and enhanced transparency, particularly in crucialareas where corrupt practices prevail, such as procurement and business registration. The

Program will incorporate the development of an SME web portal/virtual front office and theestablishment of SME helpline outreach centers to provide (i) assistance for facilitating accessto government services; (ii) guidance to comply with government requirements includingregistration, product testing and certification; and (iii) dissemination of information about SMEs,market opportunities, and linkages to international markets. The extensive geographic presenceof BSCIC and FBCCI and its member associations could be used to further extend the outreachof government services to SMEs countrywide. MOI, in partnership with FBCCI and its districtchambers and line associations, will establish helpline outreach centers at selected districtoffices of BSCIC, and knowledge centers at the Dhaka and Chittagong chambers of commerceand industry. The helpline and knowledge centers will utilize the SME web portal to provideaccess to information by SMEs in various parts of the country and through the Internet.Assistance for the development of the SME web portal and helpline outreach centers will be

financed under the TA loan (paras. 84 and 85).

47. Enhance SME Access to Capacity Building. Under SMESDP, SCITI will undertake atraining needs assessment and develop appropriate training programs under a public-privatepartnership with FBCCI, district chambers and line associations of FBCCI, accredited womenentrepreneurs associations, and the National Association of Small and Cottage Industries ofBangladesh. The Government has committed to support targeted SME training, particularly for(i) SMEs in rural areas, (ii) women entrepreneurs, (iii) displaced workers in the RMG industry,and (iv) SME credit staff of participating financial institutions (PFIs) under SEF. MOI will presenta plan to restructure SCITI to strengthen its capacity to deliver training services to SMEs. SCITIwill charge for at least cost recovery for those who can afford to pay for the services. The TAloan will provide assistance to SCITI in implementing these training and capacity-building

programs (para. 86).

48. Enhance SME Access to Product Certification and Upgrade Product CertificationSystem to International Standard. To meet SMEs need for credible certification bodies wherethey can obtain a technical evaluation of the quality of their products, BSTI will be strengthenedin conducting product testing and certification. The Program will also support enactment of thedraft Accreditation Law, establishment of the Accreditation Board, and an application by theAccreditation Board for membership of the International Accreditation Forum to ensureworldwide acceptance of certificates issued by accredited certification bodies in Bangladesh. To


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facilitate SME access, a special window for certifying SME products will be set up at BSTI.Assistance in upgrading the product certification system and in promoting product certificationamong SMEs will be provided under the TA loan (para. 87).

49. Develop an Integrated SME Database. For monitoring SME performance anddevelopment, and for targeting assistance, it is essential to have a database that indicates,

among other things, the number of SMEs, their characteristics and economic activities, and typeand number of employees. An initial listing of SMEs will be generated from the EconomicCensus supplemented by other sources. This will serve as a sampling frame for large-scalenationwide sample surveys on attributes of SMEs such as employment (with genderbreakdown) and output. Such data will be captured in an integrated SME database that willfacilitate assessment, particularly as regards impact and effectiveness of government policies.The BBS is completing the processing of the Economic Census and will be publishing apreliminary report by end-2004. It is envisaged that the creation of the SME database will be acollaborative effort with BBS. While BBS continues to prepare the basic statistics regarding theenterprise sector, it is important to have a dedicated unit or institution focusing on informationgathering for SMEs. The SME Cell will assume this function. The TA loan will provideassistance in the development of the database (para. 88).

2. Important Features

50. Internationally Accepted Principles. Policy actions under SMESDP incorporate keyprinciples28 as discussed in paras. 5158.

51. Public-Private Partnerships. To ensure ownership and credibility of policy reforms, thedevelopment of the SME policy and ensuing action program to support the SME developmentstrategy will be a participatory process involving consultation with all concerned stakeholders.The proposed SME Foundation that will eventually take over functions to support SMEdevelopment within the Government will have private sector representation on its board. Thetraining service delivery will be implemented by SCITI in collaboration with FBCCI, chambers,

and associations. The Government will provide, with development agency support, initialinvestments in public goods (e.g., SME database) for the benefit of SMEs, and the associatedservices to maintain such public goods will be contracted to private sector organizations, or runas a joint public-private undertaking. The Government will focus on promoting the developmentof markets for the delivery of BDS by private sector providers. The Government and publicservice institutions will continue to provide services where gaps exist due to market failures, andwill withdraw when markets for these services develop.

52. Demand-Driven Interventions. Training provided under SMESDP will be demand-driven and based on training needs assessment, avoiding duplication with existing trainingprograms.

53. Principles of Cost Recovery. The principle of cost recovery will guide the planning andimplementation of the targeted training programs. There could be exceptions to the principle ofcost recovery in cases that involve very small rural participants who do not have immediatecapacity to pay regular training fees but could influence the direction and pace of SMEdevelopment in their communities. Similarly, employers hiring displaced RMG workers will pay

28These are based on the OECDs Bologna Charter on SME Policies, the Istanbul Ministerial Declaration: Fosteringthe Growth of Innovative and Internationally Competitive SMEs, and current SME policies and legal framework ofADB developing member countries. Market-based principles in finance are discussed in the Project Loan section.


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for their training, but fees will be waived if workers with no ability to pay do not have immediateemployment prospects.

54. Coordination of Government Efforts. The institutional framework for SMEdevelopment will involve all tiers of the Government, including high-level support from theinterministerial committee to be chaired by the prime minister. Moreover, the SME Foundation, a

dedicated institution, will be set up to promote SME development on a sustainable basis.

55. Efficient Resources Utilization and Outreach of SME Programs. Efficiency ofresource use will be maximized by working with SME groups or cells within chambers andbusiness associations, which will coordinate with helpline outreach centers to ensure

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