· Contents iii The need for a strategy 1 Why a strategy now 1 Why a comprehensive strategy 2 Private sector and poverty reduction 3 The strategy 9 Overview 9

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March 2000

© Published by Asian Development Bank 2000

The Asian Development Bank (ADB) encourages use of the materialpresented herein, with appropriate credit given to ADB. Pleaseaddress inquiries for copies to the Chief, Office of External Relations,Asian Development Bank, P.O. Box 789, 0980 Manila, Philippines.

All rights reserved.

Contents

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The need for a strategy 1Why a strategy now 1Why a comprehensive strategy 2Private sector and poverty reduction 3

The strategy 9Overview 9Strategic thrusts 10Operational priorities 16Country-specific strategies 31

The required internal changes 33Operational orientation, skills, and processes 33Operating principles 35Instruments 37

The implementation plan 39Communicating the strategy 39Implementing the strategy 39Monitoring implementation 40

Appendixes 41

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Abbreviations

ADB - Asian Development BankBOT - build-operate-transferCOS - country operational strategyDMC - developing member countryPRG - partial risk guaranteePSD - private sector developmentPSO - private sector operationsSME - small and medium-sized enterpriseTA - technical assistance

NOTEIn this report, "$" refers to US dollars.

The need for a strategy

Why a strategy now

Support for private sector development (PSD) is an integral partof the Poverty Reduction Strategy1 recently adopted by AsianDevelopment Bank (ADB). Development of a strong and

dynamic private sector is crucial to long-term, rapid economic growth,a necessary condition for sustained poverty reduction. ADB now needsto articulate a strategy to define how it can more effectively promoteprivate sector-led growth in support of its vision of an Asian and Pacificregion free of poverty.

Articulation of a PSD strategy is also timely as the region is facingserious challenges that require immediate attention. For instance, therecent financial crisis has discouraged private capital flows into theregion at a time when the need for private capital is increasing. Thecorporate and financial sector restructuring now beginning in the regionis a resource-intensive exercise. Privatization programs, planned andunderway, cannot be funded from domestic sources alone. Newmarkets are beginning to open up, as barriers to entry are lowered inthe previously highly protected banking, securities, and insurancesubsectors, as well as pension fund management—as in the People’sRepublic of China and India. A pressing challenge for the region isthe need to regain the confidence of investors and lenders, foreign aswell as domestic. ADB’s developing member countries (DMCs) needassistance to catalyze resumption of private investment in the region.

1 R179-99: Fighting Poverty in Asia and the Pacific The Poverty Reduction Strategy of theAsian Development Bank, 9 November.

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In the wake of the crisis, there has been renewed appreciation ofthe private sector’s development role as an engine of growth.Experience has shown that, when properly regulated and operatingunder competitive market conditions, the private sector can generallyuse resources more efficiently than the public sector. Private sectorentities can deliver goods and services to meet growing demandsand create job opportunities in the process. Public sector involvementin the productive sectors is often unsustainable, especially if it is atthe expense of social sectors where it is truly needed. Whilegovernment should shift away from commercial business, it has todevelop a strong capacity to create and sustain the legal and marketinstitutions needed to enable and regulate private sector activities.Creating the enabling environment for domestic and foreign privateinvestors and shifting the role of government from owner-producerto facilitator-regulator, and the large adjustment costs associated withsuch a shift, are big challenges for which the DMCs need ADB’scontinued and intensified support.

Why a comprehensive strategySupport for PSD is not new to ADB (Appendix 1). ADB's first loanwas a line of credit to a Thai development finance institution foronlending to small and medium-sized enterprises (SMEs) in the privatesector. The indirect financing of private enterprises throughgovernment-guaranteed loans to development finance institutions hasincreased over the years and has been an important mode of ADBassistance for PSD. In addition, other modes of ADB public sectorassistance have contributed significantly to PSD. In most DMCs, policydialogue, technical assistance (TA), and project and program loanshave been used to help create a conducive environment for the privatesector. Such support for PSD has covered a range of sectors: financeand capital markets, agriculture, industry, trade, and infrastructure. Inthe 1980s, ADB added direct private sector operations (PSO) toprovide direct assistance to private enterprises through equityinvestments2 and loans without government guarantees.3

2 R38-82: Revision 2, Final: Equity Investment Operations by the Bank, 10 February.3 R93-85: Lending to the Private Sector Without Government Guarantees, 9 September.

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Two lessons have been learned from the direct and indirectfinancing of private enterprises. First, the right policy environment isvital for the long-term viability of these businesses. While ADB hasassisted DMCs in developing an enabling environment for the privatesector, the Asian financial crisis has called for more comprehensiveDMC efforts with ADB support. Second, ADB assistance, if combinedthrough the public and private sector windows to address developmentchallenges, can provide synergistic solutions resulting in greaterbenefits for the host DMC. Such a combination requires public sectorassistance to pay more systematic attention to private sector interestsand concerns, and private sector assistance to promote developmentimpacts in their activities.

These lessons indicate the need for ADB to articulate acomprehensive, bankwide PSD strategy. ADB’s existing private sectorstrategy focuses mainly on its direct nongovernment-guaranteedassistance through PSO. The strategy proposed in this paper goesbeyond that and addresses the more complex challenge of how ADB'spublic and private sector operations can both better promote privatesector-led growth. This strategy articulates, for the first time, asystematic and coherent framework for ADB’s PSD efforts. However,detailed discussion of PSO-specific operational issues (e.g., approvalprocesses, prudential limits, local currency financing, and TA for PSO)are not included in this paper. These issues will be addressed in aseparate Board paper.

Private sector and poverty reductionIt is widely accepted that the private sector is needed and better suitedfor sustaining rapid growth. And the Asian experience shows thatgrowth is the most powerful weapon in the fight against poverty.Growth creates jobs that use labor, the main asset of the poor. Asgrowth proceeds, private sector employment becomes the majorsource of economic support for the majority of workers and theirfamilies. Thus, improving labor market operations is an importantelement of strategies to promote pro-poor growth and reduce poverty.It also helps allocate a country’s human capital resources to their mostproductive uses, enhancing general economic welfare, andencouraging further growth and development. Well-designed labor

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market policies help societies make growth more equitable bysmoothing income fluctuations and broadening access to human capitaldevelopment and employment opportunities. However, it is alsoimportant to recognize the linkages across factor markets (labor,capital, and land). Thus, an integrated approach to the removal ofdistortions in different factor markets is essential for sustained successin the fight against poverty.

Growth also increases the tax base that enables government, actingon good governance principles, to finance labor market programsand provide basic social services. Health and education services, inparticular, give the poor a better chance to increase their productivityand earning capacity. Transparency and accountability in governmentare crucial to ensure that such social expenditures are effective andcan reach the poor.

Data for several developing regions in the world illustrate thatpoverty incidence at any point in time is largely a reflection of acountry's previous economic growth performance (Box 1). Thisimportant relationship between poverty reduction and growth isexemplified more clearly by the experiences of developing countriesin Asia. In East Asia, for example, poverty incidence decreasedfollowing growth acceleration in the 1980s and early 1990s. Bycontrast, also in East Asia, the negative growth resulting from the 1997financial crisis led to a rise in poverty incidence in the affectedcountries. Indeed, no country or region in the world has successfullyreduced poverty in a no-growth environment.

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In all countries, where direct poverty reduction and social safety netprograms are necessary to address poverty, budgetary spending typicallyinvolved in these programs would be difficult without economic growth.Poverty support programs have a stronger constituency when theeconomic pie is growing. Alternative funding from foreign aid orborrowing could help, but is not sustainable in the long run.

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Of course, both the level of growth and its pattern (or how thebenefits of growth are distributed) matter for poverty reduction. Theextent of participation of the poor in a growing economy is key.However, East Asian countries have shown that growth can lead to adecline in poverty despite a rise in inequality. During 1993–1998 inViet Nam, for example, poverty declined substantially due to rapidgrowth, and despite a rise in inequality (Box 2). The case is clear thatthe contribution of growth to poverty reduction was significant androbust. There are, of course, cases where the rise in inequalityexceeded growth and the poverty situation worsened, as in Thailandduring 1975–1986 and rural People’s Republic of China during 1985–1990. The ideal case was seen in Malaysia (1973–1989) and Indonesia(1978–1984), where the growth and distributional effects reinforcedeach other and led to an even stronger impact on poverty reduction.

The private sector can also affect poverty in other ways. Forexample, private investment in infrastructure projects that are properlyregulated can relieve pressure on public budgets and, thus, enablegovernments to redirect more resources to social spending. Privatesector participation in infrastructure can also improve the deliveryefficiency of essential services and extend these to the poor.Experience has shown that efficiency gains from privatizing utilitiescan benefit all income classes. But with effective regulation thatensures appropriate tariff policy, lower-income groups tend to gainrelatively more than higher-income groups, improving the distributionof income.4 Concessions can be designed such that bidders are requiredto provide service to poorer areas (e.g., through public standpipescharging low lifeline tariffs for water supply), with the associatedcost to be borne by government in the form of lower concessionrevenues. Public-private partnerships with features such as this canhelp address poverty, as governments recognize that such activitiesmust be underwritten by the public budget, and as private companiesrealize the value of collaborative investing, both in terms of communityrelations and financial returns. Such an approach makes the subsidyto the noncost-recovering activity transparent and best represents good

4 Chisari, O., A. Estache, and C. Romero 1997. The Distribution of Gains from UtilityPrivatization and Regulation in Argentina. Public Policy for the Private Sector 12(December): pp. 33-36.

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public policy. Cross-subsidies are neither transparent nor sustainable.Although they can be useful for helping the poor in situations wherebetter means of transferring resources to the poor do not exist, therecan and should be better instruments that, over time, can be developedand used to replace cross-subsidies.

Private provision of goods and services with public financing canalso be well-suited to the social sectors, as another form of supportfor poverty reduction, where the private sector can sometimes beengaged on a contractual basis to operate not-for-profit social facilities,like schools and health clinics. With proper regulation, private sectormanagement is often more efficient than public administration andcan deliver better and more innovative service at a lower cost. Inmany countries, health services are provided by the private sectorbut with public financing. In addition, the private sector can, and oftendoes, supply for-profit social services to the higher income groups—for-profit hospitals, higher education, etc.—freeing up governmentresources for the needs of lower income groups. Clearly, the privatesector can play some modest role in poverty reduction. However, itis neither in a position to provide noncost-recovering social serviceson its own balance sheet, nor to engage in not-for-profit activitieswithout compensation. Thus, the private sector cannot be expectedto undertake extensive poverty interventions on its own.

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The strategy

Overview

Identifying the private sector as the key to sustainable, rapidgrowth, the PSD strategy aims to help expand and strengthenprivate sector participation in the development of the DMCs. The

strategy is designed to provide a systematic and coherent frameworkwithin which ADB will seek to promote the private sector to supportgrowth and reduce poverty. Comprising the strategy are three thrustsof ADB’s PSD efforts. These will be pursued primarily in four priorityoperational areas that can make the greatest impact on the privatesector’s contribution to pro-poor growth. While the strategy will guideADB’s PSD activities across the region, it will be operationalized atthe country level as part of ADB’s operational strategy for individualDMCs. To make the strategy work, ADB will need to institute internalchanges relative to its operational orientation, its mix of staff skills,and its processes and procedures.

In formulating the strategy, five factors have been considered:(i) ADB’s overarching objective of poverty reduction; (ii) thedevelopment challenges facing the region; (iii) the private sector-related activities of other multilateral development agencies,particularly those operating in the region and with which ADB mustcoordinate its activities (Appendix 2); (iv) ADB’s own institutionalstrengths (Box 3); and (v) lessons learned from ADB's existing PSDactivities. The strategy recognizes that ADB's financial and humanresources are limited, so that its PSD assistance must look for leveragedinterventions and must be selective and strategically focused.

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Strategic thrustsUnder the strategy, ADB will utilize the capabilities of both its publicand private sector operations to deliver synergistic solutions toproblems that impede private sector growth in the DMCs and thecontribution of the private sector to poverty reduction. In public sectoroperations, the strategy has two thrusts: (i) to support DMCgovernments in creating enabling conditions for business, and (ii) togenerate business opportunities in ADB-financed public sectorprojects. The third thrust is in PSO: to catalyze private investmentsthrough direct financing, credit enhancements, and risk mitigationinstruments. All of ADB's instruments for advice and financing willbe used to pursue PSD outcomes targeted by the three strategic thrusts(Table 1).

The three thrusts of the strategy are mutually reinforcing whenbrought to bear on a development challenge. Such has been theexperience of ADB. In Bangladesh, for example, there was a need todevelop fresh power supply without relying on government funding.ADB responded by providing TA, first, to create the right environmentfor the entry of private investment (sector restructuring, regulatoryframework, tariff reform), and then, to prepare a build-operate-transfer

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(BOT) power-generating project for international competitive bidding.The winning bidder was to be supported by ADB with direct loan,cofinancing, and guarantee facilities to catalyze the project.

ADB’s experience has shown that creating the enabling conditionsto open a sector to private investment may not be sufficient to attractentrants. Sometimes, a model project is needed to providedemonstration effects, and funds have to be catalyzed to actually makethe project happen. By the same token, a single private sector project,made possible with ADB support, may achieve little if it cannot bereplicated without ADB support because the enabling conditions arenot in place. ADB recognizes the two sides of this equation and willhave to tackle the twin challenges in tandem.

Creating enabling conditionsADB uses public sector operations to help DMC governments establishthe right conditions for business and a policy environment conduciveto pro-poor growth. Reforms that spur entrepreneurial developmentand stimulate foreign and domestic private investment are designedto enlarge the private sector’s role in the economy. As the transitionoccurs, the government must reduce its presence as owner-producerand concentrate more on facilitating and regulating private sectoractivities to ensure markets work and to protect public interest. Thisshift in the government’s role will make government a neutral andobjective regulator, and free public resources (such as those used tosupport loss-making state enterprises) that can then be redirected tobasic education, health services, and social safety nets. In many DMCs,growth and, ultimately, poverty reduction depend on such a shift.

One of ADB’s strengths lies in conducting policy dialogue withgovernment on needed reforms. Under the PSD strategy, the reformagenda will seek to achieve the following: stable macroeconomicmanagement; investment, trade, and price liberalization; reducedbarriers to competition; well-functioning financial and capital markets;flexible labor and land markets; good physical, social, andtechnological infrastructure; equitable tax systems; and legal andjudicial systems that protect property rights, enforce contracts, andprovide for dispute resolution. Improving the business environmentfor SMEs will be part of the reform agenda. In addition, the policy

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agenda will include measures to enable DMCs to maximize the benefitsof globalization (e.g., increased trade and capital flow) and minimizethe risks associated with it (e.g., sudden and disruptive movementsof short-term capital). This will require, for instance, the introductionof regulatory frameworks to strengthen market institutions andestablish social protection programs, including social safety nets andlabor laws that protect workers. Measures may also be considered toregulate short-term speculative capital flows and encourage morestable, long-term investment.

Specific policy advice on these areas of reform will be based oneconomic and sector work. In addition, TA will be provided togovernments to formulate the regulatory and institutional frameworksneeded to make markets work better and to build the capacity ofmarket regulatory authorities. ADB will also support policy andinstitutional changes to encourage private sector participation in keysectors through program and sector development loans as well as bylinking project investments to progress in needed reforms.

An adequate physical environment is also important for the privatesector. ADB will help governments build infrastructure facilities suchas ports, roads, telecommunications, and power plants needed toenable the private sector to undertake business efficiently. Wherefound desirable based on benefit-cost analysis, the location of suchfacilities can deliberately be chosen to influence the flow of privateinvestment to less-developed (and poverty-stricken) areas of a country.

Recent events in the region underscore the need for greaterattention to labor market issues. The Asian financial crisis bared thevulnerability of people living close to the poverty line. Indeed, astable macroeconomic environment is important for the welfare andprotection of the poor. This justifies ADB’s involvement in financialsector reform issues from a poverty perspective. Experience in someDMCs indicates that distorted and fragmented labor markets generateinequality of labor incomes. To address this problem, ADB and theDMCs must be committed to effective labor market policies to generateprivate sector-led employment. Improved labor market policies canbe achieved through policy dialogue and project interventions inactive and passive labor programs. Dialogue on labor market policiesmay include the elimination of labor distortions, and the reform of

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discriminatory codes and practices. Active labor market programsinclude employment services (e.g., job brokerage and counseling)and redeployment and training programs. Passive labor marketprograms cover unemployment, injury and disability insurance, incomesupport, and labor standards. Through these labor market interventions,ADB can enhance the role of the private sector in promotingemployment and contributing to poverty reduction in the region.However, some labor protection policies (e.g., occupational safetylegislation) may, in the short run, lead employers to substitute capitalfor labor on the margin, or to move production facilities to countrieswith less stringent labor laws. The situation should improve ascorporate responsibility becomes more widely accepted and theplaying field for labor becomes more even across countries.

Generating business opportunitiesADB’s public sector projects can be formulated in such a way thatthey provide specific opportunities in which the private sector canparticipate. Such opportunities may include model private sectorprojects that are designed to include poverty reduction impacts.Indeed, ADB has long been involving the private sector as suppliersand contractors in the implementation of its public sector investmentprojects. Under the PSD strategy, ADB will take deliberate steps toensure that, in its public sector projects, where appropriate, businessopportunities are generated for the private sector, particularly for thedomestic private sector. This will be done in various ways. Whenpreparing a public sector project, ADB will explicitly consider thescope for private sector participation, and include the nature and timingof this participation in the project design. For example, a state-ownedsewerage treatment plant being processed for ADB financing can berequired to subcontract its operation and maintenance to a qualifiedprivate sector entity to be selected on a competitive basis. Investmentopportunities may also be created by considering the private sectoralternative to a government-proposed investment project, as was thecase with the Colombo port project approved in 1999.5 In support ofgovernment efforts to encourage private sector participation in key

5 Loan 7153/1689-SRI: South Asia Gateway Terminals Private Ltd. for the Colombo Port,loan for $35 million and equity investment of $7.4 million, approved on 11 May 1999.

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sectors in more DMCs, ADB will continue to support privatizationprograms and prepare model BOT-type infrastructure projects thatcan be competitively bid to the private sector. As a rule, ADB mustensure that its public sector investments do not crowd out the privatesector, and that ADB and DMC governments explore all possibleopportunities to ensure private sector participation where this can bedone effectively and efficiently.

Catalyzing private investmentsADB provides direct financial assistance to private sector projectsthrough PSO. While ADB’s participation is usually limited, it leveragesa large amount of funds from commercial sources to finance theseprojects.6 ADB is viewed as a neutral long-term investor committedto the highest standards of corporate conduct; its presence is seen asa source of comfort by other lenders and investors. To facilitatemobilization of commercial debt finance for cofinancing, ADB willintensify the use of two instruments to mitigate perceived sovereignrisks: the complementary financing scheme and the partial riskguarantee (PRG).7 ADB’s role in sovereign risk mitigation is now muchmore critical as the crisis-affected DMCs try to regain the confidenceof foreign investors and lenders. Where appropriate, ADB’s partialcredit guarantee, which provides comprehensive protection tolenders, will also be used to mitigate credit risks and stretch the maturityof commercial loans in local currency for long-gestating private sectorprojects. Aside from contributing finance that is not available onreasonable terms elsewhere and catalyzing funding from otherfinanciers, ADB’s involvement can, more importantly, exert influenceon project design and implementation so that environmental and socialconcerns are addressed more effectively. ADB can also selectivelyattempt to encourage sponsors to incorporate project componentsthat, for instance, extend essential services to the poor withgovernment support.

6 The leverage achieved in PSO is around $8 of funding commitments from others forevery $1 committed by ADB.

7 A paper on PRG is under preparation for consideration by the Board during the firstquarter of 2000.

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ADB will seek to catalyze private sector projects that deliverspecific development impacts and related demonstration effects inline with ADB’s strategic priorities and country-specific operationalstrategies. While ADB’s participation helps ensure successful projectlaunches, ADB also benefits from the insights it gains into the workingsof the private sector and the constraints the sector faces. The resultinginstitutional learning at the project level provides an importantcomplement to ADB's macroeconomic and sector policy work to createenabling conditions. The individual ADB-assisted private sectorprojects themselves are also a potentially important influence on andinput to policy. They can (i) pilot test the sufficiency of the enablingenvironment in a sector and open the sector to private sectorinvolvement by providing demonstration effects, (ii) provide atemplate for other investors to replicate, and (iii) pioneer experimentalprojects that could provide the basis for a policy framework for privateinvestment in a new sector.

As a multilateral development institution, ADB does not financeprivate sector projects based solely on their financial viability. Projectsmust have clear development impacts and/or demonstration effectsthat go beyond the benefits captured in the financial rate of return.ADB assistance to the project, whether in the form of offshore orlocal currency financing, must be (i) catalytic (leveraging ADB’sfinancial resources by attracting other investors and lenders), or(ii) additional (complementing, not substituting for commercial sourcesof finance), or (iii) adding value (influencing project design or structureto make it more environmentally or socially friendly, create morejobs, impart better skills or technology, or raise the standards ofcorporate governance).

Operational prioritiesThe pursuit of the three strategic thrusts (creating enabling conditions,generating business opportunities, and catalyzing private investments)will be focused primarily on four priority areas of operation:

(i) governance in the public and private sectors;(ii) financial intermediation;

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(iii) public-private partnerships; and(iv) regional and subregional cooperation.

These four areas of operational focus represent the key vehiclesfor promoting private sector development and pro-poor growth inthe Asian context. They involve activities in which ADB has theunderlying strength based on its track record and for which the threestrategic thrusts can achieve significant PSD outcomes (Table 2).

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Governance in the public and private sectorsPublic sector governance. Effective governance is essential for theencouragement of private sector investment. There is no greaterdisincentive to business than the added cost and feeling of uncertaintyand vulnerability brought about by corruption, abuse of discretion,and bureaucratic interference. Improving the efficiency of publicadministration and the accountability and transparency of governmentactions is essential to improve the climate for business and sustaindevelopment in the region. Improving public sector governance hasbeen a major development objective of ADB since 1995. Dependingon the need of specific DMCs, the areas that ADB can consider forassistance include (i) strengthening the rule of law through legal andjudicial reforms; (ii) establishing and maintaining effective andequitable taxation systems; (iii) formulating sound and transparentsectoral regulations; (iv) strengthening public administration;(v) fighting corruption; (vi) removing impediments and reducingtransaction costs; and (vii) establishing efficient and competitivemarkets supported by appropriate fiscal, monetary, and trade policies.ADB TA will also be needed for capacity building to educate andmodernize the bureaucracy and agencies that regulate and supervisethe private sector in the DMCs. A lesson learned in law and judicialreform is that a holistic, comprehensive approach is crucial aspiecemeal interventions do not work. Overall, ADB will help ensurethat economic management in the DMCs maximizes and fairlydistributes the benefits of economic growth.Commercialization and privatization. A key dimension of effectivepublic governance relates to the efficient deployment of public funds.Reform of public resource management requires actions to improveefficiency of state-owned enterprises and relieve budgetary pressuresfrom their subsidy and investment needs. This typically involvescommercialization (restructuring to achieve cost-recoveringoperations) as a first step, followed by restructuring the entity into acorporation (giving full financial autonomy under governmentownership), and finally privatization (involving private sectorparticipation). Privatization does not always mean divestment ofgovernment ownership to the private sector; it can also be done by

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contracting out enterprise operations, partly or wholly, to the privatesector through management contract, asset leasing, or concession.

Privatization in its various forms is currently not pursued with equalvigor and conviction in all DMCs, and there remain divergent politicalviews on the extent to which it should be promoted. ADB will thusneed to carefully consider how and in what form and time frame topromote the privatization alternatives in the context of specific DMCs.ADB can also help governments analyze options available, andformulate general principles for the appropriate mix of public andprivate sector activities. In the transitional economies, large parts ofthe economy are still in public hands, including most heavy industriesand utilities. In South Asia and the Pacific DMCs, there are also manypoorly performing state-owned enterprises in a wide range of sectors.Even Southeast Asia still has many state-owned or controlledenterprises and financial institutions. It is clear over the next fewyears that privatization (through management contract, asset leasing,concession, or divestment) will continue to be an important part ofoverall economic reform programs in many DMCs. The success ofprivatization efforts will depend heavily on the government's politicalwill and on whether or not domestic investors are in a position tobecome owners of the privatized assets.

Many DMCs that are inclined to privatize, face severe capacityconstraints to meet the challenges of privatization. ADB can help byproviding technical advice, particularly in defining sound privatizationstrategies, establishing and implementing effective privatizationprograms, designing and operating sound postprivatization regulatoryframeworks, and undertaking individual transactions transparently andprofessionally. But ADB assistance must explicitly requiretransparency in implementing privatization transactions, establishmentof an appropriate tariff policy, protection of workers’ legitimateinterests in the transition of ownership, as well as financial marketregulations that adequately protect the interests of small investors(including those investing under employee stock ownership plans).As experience has shown, successful privatization requires effectiveconsideration of the interests of all stakeholders. Labor retrenchment,in particular, presents significant social costs, and ADB will help

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establish social safety nets to address this issue. At the enterpriselevel, ADB will consider direct financial assistance to the projectsresulting from privatization programs supported by ADB and/or othermultilateral development banks. Equity investments may also beconsidered in state-owned enterprises to facilitate or initiateprivatization through divestment of government-owned shares orissuance of new shares to broaden ownership.Corporate governance. Just as good governance is essential in the publicsector, so is quality corporate governance essential in the privatesector. A systemic failure of corporate governance, as seen in therecent Asian crisis, can have pervasive consequences that place anundue burden on the shoulders of the poor. For individual enterprises,sound corporate governance provides confidence to lenders andinvestors, and facilitates access to lower cost capital. The developmentof the domestic capital market often hinges on the existence of acorporate governance culture that ensures voluntary compliancethrough effective regulatory enforcement. In most of the DMCs, theroot causes of poor corporate governance have to be addressed tosustain recovery and growth. Through TA, ADB can help to reviewcommercial laws and regulations and establish (i) credible accountingand auditing standards; (ii) timely and accurate disclosure rules;(iii) sound environmental, labor, and social standards; (iv) provisionsfor adequate protection of minority shareholder rights; and (v) effectivebankruptcy and foreclosure regimes. ADB can also help train corporatedirectors on their duties and responsibilities, and on how they can beeffective in balancing the interests of shareholders with those of otherstakeholders—employees, customers, suppliers, investors,communities—while maximizing value. In PSO, ADB must invest onlyin companies that can demonstrate the capacity to establish and maintainsound corporate governance structures and practices. More proactively,ADB must diagnose the quality of corporate governance in its investeecompanies, benchmark this against best practice, and develop a time-bound action plan to remove deficiencies and introduce enhancements.ADB’s initiatives on corporate governance should extend to promotingcorporate responsibility to maximize the opportunity for companies tointegrate social and environmental awareness into core business practicesand make private investment more sustainable.

21

Financial intermediationWell-functioning financial systems are critically needed to promotethe private sector. Many DMCs need to strengthen their financialinstitutions and create diversified financial markets to develop thedomestic capacity to finance private sector-led growth. Properlyfunctioning capital markets are needed for effective privatizationprograms—to facilitate sale of government-divested shares, ensurefair and transparent share pricing, enable wide ownership ofprivatized shares (thereby enhancing political acceptability), andprovide resources for modernization and expansion of privatizedenterprises. In a financially integrated world, robust and well-regulatedbanking systems and financial markets, coupled with soundmacroeconomic management, are necessary to reduce the risk ofinstability associated with sudden outflows of short-term capital. Oneadvantage of the region is that many of the DMCs have substantialdomestic savings that, if channeled through well-functioning capitalmarkets, could help the private sector avoid excessive reliance onexternal finance and the concomitant exposure to exchange risks.ADB has the capability to address intermediation challenges, havingundertaken financial sector reform programs through public sectoroperations and/or direct investments in financial intermediariesthrough PSO in several DMCs.Financial institutions and markets. Under the strategy, ADB willcontinue its support for policy reform and institutional capacity buildingto strengthen the DMC's financial systems. Using TA and programloans, ADB will focus its assistance on government efforts to enhanceregulation and supervision, develop sound banking systems, deepenand broaden securities markets, and create bond markets. Supportwill also be given for the development of mortgage markets to facilitatehousing finance, and the reform of pension and insurance systems todevelop sources of long-term capital. In PSO, ADB will complementfunding with capacity building and governance strengthening forinstitutions such as banks, insurance companies, leasing companies,securities firms, and pension fund management companies,incorporating best practices and sound management. ADB can alsoarrange for the participation of a strategic partner in an institution tofacilitate capacity building. The availability of credit information on

22

borrowers and securities issuers is crucial to the functioning of creditmarkets; this will require establishing rating agencies and creditbureaus, which ADB can promote and catalyze as it has done in India,Malaysia, and Thailand. Preference will be given to supportinginstitutions that can serve as role models in the process of rehabilitatingthe financial sector, as in the crisis-hit countries, or in commercializingand privatizing the state-owned banking system, as in the transitionaleconomies.

Progress thus far in bank restructuring in the crisis-hit and otherDMCs is encouraging. But corporate sector reforms are lagging. If thebanking system is to achieve full recovery, the performance ofcorporate borrowers must be improved. Progress to date has beenachieved mainly in strengthening of insolvency laws, includingbankruptcy and foreclosure procedures, which ADB has addressedand will continue to support through its public sector operations. ADBwill also support the work of government restructuring agencies usingTA. Actual corporate restructuring (through mergers and acquisitions,for example) and corporate debt restructuring have been limited. ADBwill selectively catalyze such efforts through PSO in partnership withinstitutions that have the necessary expertise.

Restructuring the banking system provides an excellentopportunity to transform banks into instruments of effectiveintermediation in support of labor-absorbing growth. One difficultissue that will need to be addressed in the process is the extent towhich targeted or policy lending should be used to channel funds tospecial needs, especially those of the poor. Most countries have foundthat it is best to strictly limit such guided credit, to provide it primarilyfor social purposes, and then at unsubsidized rates. The evidence isstrong from many countries that the poor benefit most when theyhave access to unsubsidized credit. With subsidies, the coverage ofcredit programs is necessarily quite limited, and the affluent tend tosqueeze out the poor for the subsidized funds.Local currency financing. Foreign borrowings by domestic private firmsresult in a currency mismatch that cannot be easily hedged if theborrowers earn revenues in local rather than foreign currency. Failureto mitigate the risks associated with such an imbalance was one of theunderlying causes of the Asian financial crisis. ADB will continue to

23

address these risks by helping DMCs to develop diversified domesticcapital markets, as well as markets for currency swaps and otherhedging instruments. But this is a long process. To be more proactivein the interim, ADB will investigate the possibility of raising localcurrency debt in selected DMCs for its general operational requirementsas well as for relending to domestic borrowers (e.g., infrastructureprojects and financial institutions supporting SMEs). In addition, ADBwill try to provide partial credit guarantees to enable domesticcompanies and institutions to directly source local currency financingthrough loans or bond issues and, in some cases, stretch the maturityand reduce the cost of such financing. Local currency bonds issuedby ADB and those issued by domestic entities with ADB guaranteewill be designed to transfer technology and add value to the domesticbond markets by supplying high-quality debt instruments that conformto global standards for, among others, syndication, pricingtransparency, and secondary market liquidity. Similarly, ADBguarantees on local currency loans will help develop a corporatecredit pricing curve and foster long-term lending operations amongdomestic financial institutions.Investment funds. The potential size of long-term resources that canbe mobilized by ADB through funds could be quite large consideringits coinvestment experience to date with major pension funds andinsurance companies. Investment funds enable ADB to leverage itsown scarce capital much more than in other operations. In addition,the accumulated experience from ADB's sizable portfolio ofinvestment funds (29 funds since 1983) represents an importantresource base. ADB will tap the firsthand knowledge of its fundmanagers to identify pressing constraints to private sectordevelopment in DMCs where they operate.

Catalyzing funds is a core competence of PSO. To ensure thatfuture funds seeking support are strategically aligned with ADB'sdevelopment objectives, ADB will take more active involvement indesigning investment funds, formulating the funds’ investmentobjectives in terms of country and sector focus, and working moreclosely with like-minded, governance-conscious institutionalinvestors. Building on past experience, ADB will explore thepossibility of new types of specialized funds to help finance the

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region’s investment needs, e.g., debt funds, microequity funds, SMEfunds, environment funds, governance funds, corporate restructuringand recovery funds, agribusiness funds, and internet and technologyfunds. To be effective in launching new funds, ADB must continue tobuild contacts with institutional investors from the capital-surpluscountries.Small and medium-sized enterprises. At the user end of financialintermediation, ADB’s focus will be on, among others, SMEs, whichare a major generator of employment and income needed to achievepoverty reduction. Assistance to SMEs under credit lines has not beentotally satisfactory, and lessons learned will need to be incorporatedin the use of financial intermediaries in future SME assistance programs.Direct SME assistance may also be required, for example, in the Pacificand Central Asian DMCs. However, this is a very difficult and time-consuming task. It requires specialized teams that ADB does not have,and is not expected to have. So ADB financing for SMEs will continueto be handled through investment funds and specialized financialinstitutions that are competent and properly equipped. ADB will alsoseek to cooperate with existing regional organizations, such as theSouth Pacific Project Facility, to stimulate private sector investment inthe Pacific DMCs. While SMEs require capital, they are also in needof advice and training for various aspects of their operations, e.g.,business planning, accounting and finance, management capacity,and environmentally clean production. Hence, ADB will also considertechnical and business advisory assistance to SMEs and/or continue tocollaborate with organizations that are in a position to provide suchsupport. Entrepreneurial education and business incubators will alsobe supported to help start up new SMEs. TA to governments will beprovided to help develop a sound SME environment.

Due to difficulty assessing risks associated with SME credit, SMEfinancing programs often face a dilemma between commercialviability, requiring collateral that most SMEs are unable toaccommodate, and social development considerations, such as povertyreduction, that dictate liberal provision of credit to SMEs. One way toresolve the dilemna is to create state-sponsored credit enhancementschemes, such as small loan guarantee facilities for SMEs. ADB cansupport the establishment of such credit guarantee facilities, which

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may be partially funded by government and ADB. To ensure that dueconsideration is given to financial viability and that credit is notextended imprudently, lending institutions availing of guarantees mustretain a share of the credit risk.

Public-private partnershipsThe public and private sectors should complement each other in theoverall development effort. Government efforts to form partnershipswith the private sector will lower the risks and costs associated withinvestments, particularly for infrastructure projects. ADB can helpidentify the risks and costs associated with the present businessenvironment, and support the development of workable public-private partnerships. The role of government in risk mitigation iscrucial for early projects in a sector newly opened to privateinvestment. Care must be exercised, however, in judging where thegovernment’s development function should cease and marketmechanisms and institutions can take on the usual project risks, andwhen continued support to encourage project financing is stillwarranted.

An effective consultative mechanism can help promote and sustainpublic-private partnerships in the DMCs to balance social anddevelopment goals with commercial interests. ADB will embark on amuch more proactive set of initiatives aimed at promoting andbrokering such partnerships, particularly in infrastructuredevelopment, and advising governments on ways to developsubstantive partnerships with the private sector. ADB will also tapinto the extensive pool of private sector resources available regionallyand globally, and develop networks and relationships with key PSDstakeholders. Respected business leaders from DMCs and countriesproviding bilateral aid will be invited periodically to a forum to provideADB with feedback on trends and developments in the private sectorand exchange ideas on promoting pro-poor growth.

A big challenge, and opportunity as well, for both the public andprivate sectors is the effective use of information technology tofacilitate development efforts and enhance private sectorcompetitiveness. New computing technologies in telecommunicationsand multimedia applications, including the Internet, can and do change

26

the competitive advantage of industries and provide new ways toreach out to a broader market. DMC governments can establishpartnerships with the private sector to widen the use of informationtechnology in delivering basic social services (e.g., distance educationand telemedicine) and to help local enterprises increase theirtechnological development. ADB should help DMCs to developnational policies and programs to accelerate the dissemination ofinformation technology.Physical infrastructure development. The DMCs’ public sectors willcontinue to play a major role in the provision of infrastructure.However, private sector participation in partnership with the publicsector can facilitate financing, construction, and operation ofinfrastructure facilities; improve efficiency; deliver much-neededservices cost effectively; and release resources from public budgetsat all levels. Through public sector operations, ADB will intensifyassistance to DMC governments to create enabling conditions forprivate sector participation in areas such as energy, transport, andtelecommunications. ADB will help establish an effective regulatoryframework for private participation in infrastructure, build capacityof concerned regulatory agencies, strengthen state utilities dealingwith the private sector as output offtaker or input supplier, and trainand develop skills of public officials responsible for infrastructuredevelopment. In addition, ADB will develop sectoral templates forappropriate risk-sharing arrangements that would allow the privatesector to earn reasonable rates of return, ensure equitable access toquality services, and save on the transaction costs of the lengthyprocesses involved. These approaches will be designed to helprationalize each sector and identify an effective role for the privatesector in the provision of infrastructure services. ADB will ensurethat the process of transferring infrastructure responsibilities to theprivate sector is transparent and competitive, and produces greaterefficiencies and better service to consumers.

Public-private partnerships in physical infrastructure can take theform of BOT projects where there is a sharing of risks between thepublic and private sectors, with each risk being allocated to the partythat can best manage it. The private parties involved in these projectsnormally assume the commercial risks that are under their control.

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ADB has achieved some success in using TA facilities to create anddevelop such BOT-type public-private partnerships in collaborationwith DMC governments.8

Public-private partnerships can be enhanced when the privatesector undertakes a BOT project and the government providescomplementary support infrastructure (which may have too long apayback period to be commercially attractive), e.g., a breakwater toprotect a BOT container port terminal, or transmission lines to evacuatepower from a BOT generating plant. In such cases, ADB can alsohave a public-private partnership internally, with PSO providing directassistance to the BOT project and public sector operations fundingthe related public investment. Other examples of such partnerships,with both the public and private sectors involved in financing,implementation, and operation, would be (i) an airport project withair-side works undertaken by the public sector and land-side worksby the private sector; (ii) a railway project with the public sector takingcare of squatter relocation and grade separation, and the private sectorundertaking the railway rehabilitation and operation; and (iii) a tollexpressway undertaken by the private sector, with connectingprovincial and rural roads provided by the public sector. Another formof public-private partnership is the export-oriented Theun-Hinbounhydropower project in Lao People’s Democratic Republic (Lao PDR),which was implemented as a joint venture between private sponsorsand the Government. The Government’s equity contribution to theproject was financed through an ADB public sector loan.9 Theforegoing approaches to public-private partnership will be anincreasingly prevalent way of doing business for ADB and call forclose cooperation between public sector operations and PSO.

Catalyzing private infrastructure projects, a core competence ofPSO, will be pursued under the strategy. ADB assistance for such

8 Loan 7152/1669-PRC: Chengdu Generale des Eaux-Marubeni Waterworks CompanyLtd., for $26.5 million, approved on 11 February 1999.TA 2338-BAN: Private Sector Implementation of Meghnaghat Power Rural Electrifica-tion, for $211,000, approved on 30 May 1995.TA 2730-PRC: BOT Changsha Power Project, for $597,000, approved on 23 December1996.

9 Loan 1329-LAO: Theun-Hinboun Hydropower, for $60 million, approved on 8 November1994.

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projects will be provided through direct financing and risk mitigation,and through investments in specialized financial institutions andinvestment funds aiming to support private provision of infrastructureservices. Priority will be given to those projects that have clear benefitsto all segments of the community, including the poor.Social infrastructure development. ADB will selectively assist DMCsto identify and develop opportunities by which the private sector canhelp deliver more effective social services such as education, health,nutrition, water supply, wastewater treatment, and solid wastemanagement. An example of public-private partnership in socialinfrastructure development is where private operators supply in bulktreated water to public waterworks distribution networks. The use ofinformation technology, as in distance learning and telemedicine,presents opportunities to extend the reach of these services,especially to the poor. There are also opportunities to involve theprivate sector to achieve more effective and efficient delivery ofessential services, for example, by contracting out to the private sectorthe provision of publicly funded social goods and services. ADB mustrecognize, however, that private investors will be attracted to providesocial services only if the expected financial returns meet or exceedtheir cost of capital, regardless of who pays for the services. Asidefrom education and health, ADB will assist in addressing shelterproblems through transparent, efficient, and sustainable private sector-implemented housing and home ownership programs, involvinggovernment support where needed.Agriculture and rural sector development. The DMCs’ agriculturesectors contain the single greatest concentration of private sectorproduction. At the same time, the overwhelming majority of Asia'spoor obtain their livelihood from agricultural production. Thus, ADBassistance in promoting public-private partnerships in agriculture canhave a tremendous impact on poverty reduction in rural areas. Forinstance, a project in Papua New Guinea10 provides support forperformance-based agricultural services on a contract basis and shiftsthe role of government agriculture agencies from directly providingextension services to managing service providers. To stimulate small

10 Loan 1652-PNG: Smallholder Support Services Pilot Project, for $7.6 million, approvedon 10 December 1998.

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rural nonfarm enterprises that can help raise incomes and improvethe welfare of the poor, particularly for poor women, ADB can supportthe establishment of viable and sustainable microfinance institutions.ADB will continue to assist DMCs in establishing mechanisms tofacilitate market determination of input and output prices; indeveloping public-private partnerships in the supply of agriculturalinputs, particularly in fertilizer distribution and agro-processingindustries; and in transferring the management of on-field irrigationsystems to farmer groups. ADB can also help strengthen publiccapacity to deliver rural credit, extension, and research, and manageirrigation and natural resources. Measures to clarify land title andownership will advance private sector development in rural, as wellas urban, areas.

Regional and subregional cooperation.Regional and subregional cooperation has emerged as an increasinglyimportant development strategy in Asia. Such cooperation offers largermarkets that allow production economies of scale and efficientdivision of labor. Whereas in North America and Europe economicintegration has involved formal regional cooperation arrangements(i.e., the North American Free Trade Agreement and the EuropeanUnion), in Asia, economic integration has been driven largely byprivate sector initiatives, with governments playing an active, if largelyinformal, facilitating role. One recent example is the Private SectorForum on Economic Cooperation in the Eastern South Asia Subregion(Bangladesh, Bhutan, Nepal, and 11 eastern states of India), which isbeing organized by the chambers of commerce and otherrepresentatives of the private sector from the concerned countries.11

Indeed, the private sector has been both a prime mover and a primebeneficiary of regional cooperation in a widening network ofintraregional investment and trade that is likely to outlive the Asiancrisis.

Subregional cooperation, a key area of involvement for ADB,involves encouraging specific, limited linkages of complementary

11 The forum received a small TA grant from ADB (TA 5890-REG: First Meeting of thePrivate Sector Forum on Economic Cooperation in the Eastern South Asia Subregion, for$30,000, approved on 23 December 1999).

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activities across borders to create a region or subregion of economicgrowth. Economic cooperation can make a subregion, as a whole,relatively more attractive to private investors by extending access tofactors of production, production processes, products, and marketsbeyond national boundaries: it provides wider business opportunitiesthat accelerate development. Since subregional cooperation programsoften involve “lagging parts” of participating countries, they can alsocontribute to poverty reduction.

In this context, ADB will concentrate on facilitating investment insubregional infrastructure projects that provide essential means fortrade and investment linkages. For investors, such projects representnew types of business opportunities—and new types of risks: theirtransborder nature requires appropriate mechanisms to support projectpreparation and financing. ADB will thus assist in preparing, financing,and providing risk management for subregional projects that involveprivate sector participation.12

Complementing this, ADB will continue to play a significant roleby helping to address nonphysical barriers to the movement of goods,services, and people. Examples include initiatives related to tradeand investment facilitation, and cross-border training and standardscertification and accreditation. This focus will allow the realization ofeconomic benefits from investment in subregional infrastructure and,more broadly, will facilitate subregional economic linkages, integration,and development. In addition, ADB will serve as a center of excellenceand clearinghouse for information and ideas on subregionalcooperation at the policy, program, and project levels.

The experience of ADB in promoting regional and subregionalcooperation is building up. A program of economic cooperation inthe Greater Mekong Subregion, for example, was initiated in 1992and the effort and resources devoted to the program appear to bepaying off. A framework of cooperation in seven priority sectors inthe subregion has been established and about 100 subregional projectshave been identified and prioritized. ADB is also encouragingcooperation among the governments of People’s Republic of China,

12 An example of such a subregional project is Loan 1329-LAO: Theun-Hinboun HydropowerProject, for $60 million, approved on 8 November 1994.

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Kazakhstan, Kyrgyz Republic, and Uzbekistan. Projects are beingdesigned to lay the foundation for economic growth through cross-border cooperation among these four countries. For the Pacific DMCs,ADB has provided assistance in examining the feasibility of asubregional securities market.

Country-specific strategiesThe stage and status of private sector development differs widelyamong the DMCs. Thus, while the strategic actions proposed in thestrategy are designed to be applicable across the region, they have tobe tailor-made at the country level to meet the diverse conditions andchanging needs of individual DMCs and to maximize the contributionto growth and poverty reduction. Country-specific PSD strategies willbe formulated within the framework of the PSD strategy and as anintegral part of ADB’s operational strategy for individual DMCs.Depending on the country setting, the country strategy for PSD mayrequire, (i) a primary focus on facilitating the emergence of domesticentrepreneurs by supporting related microenterprises and SMEs; or(ii) support for rural nonfarm enterprises or agri-business; or(iii) formulation and implementation of programs to supportprivatization and financial sector reform; or (iv) assistance with broad-based reform of enterprise ownership and private property laws,particularly in the transitional economies. Special consideration willneed to be given to the small size of the Pacific DMCs and the greatdistances between them. A theme that is likely to run through allcountry strategies for PSD is improving the legal environment andthe governance regime.

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The required internalchanges

Operational orientation, skills, and processes

For the strategy to be successful, ADB must make a commitmentto change its operational orientation, its mix of staff skills, and itsprocesses and procedures. Such internal change is at the heart

of the strategy.

Operational orientationIn support of its primary objective, ADB must place poverty reductionas the centerpiece of all its operations. ADB as a whole must recognizethe essential contribution of the private sector to pro-poor growth,which is needed to achieve sustained poverty reduction. With thisrecognition, ADB will need to institute a systematic process to ensurethat public sector projects are designed to incorporate, to the extentpossible, elements that promote a better business environment and/or provide appropriate scope for private sector participation inprojects. In PSO, on the other hand, there will be a need to ensurethat ADB pursues private sector projects with specific developmentimpacts and/or demonstration effects.

Staff skillsThe strategy will require new staff skills from PSD specialists (asdistinguished from PSO investment officers). Such skills will constitutea core of intellectual capacity in ADB to address public policy issues

34

related to private sector participation in development (similar to theapproach used for social development and environment issues). ThesePSD staff will prepare working guidelines to implement the strategyand sensitize other staff to PSD issues through training and consultation.PSD specialists will help identify areas for public-private partnerships,lead dialogue with governments on PSD issues, review ADB projectsfor private sector potential, and review government policies vis-a-vis the private sector. Skills relating to legal aspects of PSD, e.g.,regulation of privatized utilities, will also be required.

Processes and proceduresA country-specific PSD strategy should be made an integral part ofthe country operational strategy (COS) to ensure that development ofthe private sector is explicitly targeted in ADB’s programs for anygiven DMC. This operational integration should not be difficult asADB's public and private operations are under the same charter,management, and institution. PSO should support the developmentgoals of the COS. In this context, catalyzing private investments underPSO may be needed even in sectors that are not prioritized for publicsector operations.13 The country assistance plan14 should, at the earlieststages, proactively consider private sector alternatives to, and/orcommercial cofinancing of, prospective public sector projects or partsof these projects. Such private sector alternatives need not involveADB support through PSO, but may be considered for direct ADBassistance only if they can contribute to pro-poor growth. The Inter-American Development Bank systematically asks why the privatesector is not taking up some of the burden in a public sector projectwhen designing, selecting, and processing projects.

PSD specialists, as well as PSO investment officers, will need towork as part of the now largely public sector country teams that are

13 For example, telecommunications may no longer be justified for public sector funding incertain DMCs, but ADB may have a role to play in catalyzing private investment intelecommunications projects in lesser developed DMCs. This is clearly evidenced by theGrameen Phone Project in Bangladesh, which addresses dimensions of poverty reductionand gender and development, while stimulating domestic entrepreneurship.

14 As a result of the recently approved redesign of ADB’s operational business processes, in2001 the COS and country assistance plan for any given DMC will be combined to formthe country strategy and program.

35

responsible for country-level strategies and programs. PSD specialistswill provide advice on PSD from a public policy perspective, whilePSO investment officers will represent the private sector view basedon their hands-on experience with private sector projects. Additionally,PSO investment officers will be included on project teams on a case-by-case basis where their skills are required in processinginfrastructure and other projects involving public-private partnershipsand public sector projects that have potential for private sectorparticipation. Country and sector specialists in the programs andprojects departments may support the processing of private sectorprojects, but because of the nature of risks involved and potentialconflict of interest (Box 4), the lead responsibility will be with PSOinvestment officers.

ADB-assisted private sector projects will be screened for theirdevelopment impact and poverty reduction contribution. The successor failure of any given private sector project will, from ADB’s pointof view, be evaluated on how well it meets the development impactareas identified at appraisal, in addition to its financial performance.The impact of ADB’s public sector operations on PSD should likewisebe benchmarked and tracked in terms, for example, of a public sectorloan's contribution to creating a policy and/or physical environmentconducive to private investment or to generating investmentopportunities for the private sector. Scorecards will be developed,based on the rudimentary illustrations in Appendix 3, with each impactarea in the scorecards to have specifically defined criteria.

ADB will need to enhance and institutionalize partnershipsbetween public sector operations staff and PSO staff to achievesynergy across the organization, while keeping in mind the possibilityof conflict of interest (Box 4). Networking and sharing of professionalexpertise will be encouraged. Disincentives to close collaborationwill be removed.

Operating principlesTo implement these fundamental changes required by the PSDstrategy, two important operating principles are proposed to guidethe delivery of assistance and concentrate ADB’s efforts on where itcan contribute best.

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“Think PSD” in public sector operations. This entails deliberateefforts by public sector operations to improve the enablingenvironment for the private sector and to use the experiences of PSOas inputs to these efforts. The new operational orientation calls fordisciplined, sequenced examination of private sector alternatives atkey stages of ADB projects: (i) at project preparation, asking whetherthe private sector can undertake the project without governmentassistance or, if not, whether a public-private partnership is feasible,or whether parts of the project can be undertaken by the private sector;or (ii) after project completion when construction and implementationrisks no longer exist, asking whether the private sector can step in bytaking over management and/or ownership, partially or wholly, orby refinancing government debt. The deliberate pursuit of privatesector approaches to ADB’s public sector operations does notnecessarily mean less public sector lending. It will, however, meanthat public sector operations should focus more on projects (i) thatinvolve direct poverty interventions and/or (ii) that private investorsare not prepared to undertake.

“Think development impact” in private sector operations. PSO’sorientation will be to achieve greater development impact and/ordemonstration effects, and work with governments to take deliberatesteps to reduce poverty. At concept clearance and due diligence stagesof any private sector project, due consideration should be given toensuring development impact through, for example, employmentopportunities, cleaner environment, access to public services,effective competition, and better corporate governance. At the sametime, clarity and transparency should be observed in dealing withprivate sector partners to retain their confidence. Demonstration andcatalytic effects are also important in PSO, and these will be pursuedby seeking private sector projects that can be replicated if successful.To broaden the impact of PSO in the region, there may be a need toextend the reach of PSO to smaller DMCs or to sectors other thanfinance and infrastructure, which constitute PSO’s present corecompetence.

37

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38

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39

The implementation plan

Communicating the strategy

ADB will communicate the strategy to its internal and externalstakeholders by various means:

(i) ADB-wide seminars will be conducted to increase staff awarenessof the strategy.

(ii) The strategic thrusts, areas of operational focus, and operatingprinciples will be codified and disseminated to staff through staffinstructions or the Operational Manual.

(iii) External seminars and a media campaign will be organized topromote awareness of the strategy among government officials,international investors, local entrepreneurs, and the public.

Implementing the strategyEffective implementation of the strategy will require the followingpostapproval actions:

(i) A core staff of PSD specialists will be recruited to focus on PSDissues, with interface functions between the public and privatesector operations of ADB.

(ii) Country-specific strategies for PSD will be prepared as part ofCOS and country assistance plan for individual DMCs.

(iii) Scorecards for public sector operations and PSO will bedeveloped and operationalized.

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Appendixes

Page Cited on(page)

1 Taking stock of ADB assistance forprivate sector development throughpublic sector operations 42 2

2 Private sector activities of othermultilateral agencies 52 9

3 Scorecard concepts 62 35

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Taking stock of ADB assistance for private sectordevelopment through public sector operations

Credit line operationsTraditionally, the Asian Development Bank’s (ADB) assistance forprivate sector development has been through its public sectoroperations. Through Article 14 (i) of ADB’s Charter,1 ADB has beenextending credit lines to selected state-owned and private financialintermediaries of its developing member countries (DMCs) throughthe government or with government guarantees specifically to supportinvestments in productive private small- and medium-sized enterprises(SMEs). The credit lines were a quick and cost-effective mode forADB assistance to these private enterprises, which otherwise may nothave had any access to foreign exchange needed for investment. ADBhas approved 110 credit lines totaling about $4.4 billion for use by 65intermediaries in 23 DMCs. These have benefited over 22,000 SMEs.

Experience with these operations was varied. Several ADB-assisteddevelopment finance institutions (DFIs) have developed into profitable,mature, strong, and diversified institutions that play important roles intheir countries’ economic progress. These include, for instance: ChinaDevelopment Corporation (Taipei,China); ICICI Ltd. (India); KoreaDevelopment Bank and Korea Long-Term Credit Bank (Republic ofKorea); Development Bank of Singapore, and Industrial FinanceCorporation of Thailand. At the same time, several other DFIs, particularlystate-owned ones, have encountered major problems resulting fromexcessive state control and regulation of their lending policies andoperations; directed lending to specified enterprises or target groups;major changes in official trade and investment policies affecting clientperformance; substantial depreciation of the local currencies resultingin large exchange losses that destabilize clients and, in turn, theintermediaries’ own stability; inadequate capitalization that cannotwithstand substantial portfolio losses; inefficiencies arising from lackof competitive motivation and institutional weaknesses; absence ofeffective prudential oversight; and failure to develop alternative

1 Asian Development Bank. 1995. Agreement Establishing the Asian Development Bank.Article 4, para.1.

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sources of long-term funding. Many of these weak DFIs becamevirtually bankrupt. To keep ailing DFIs afloat, some governments havecontinued to sustain them with subsidized funding, straining limitedbudgetary resources. The credit line operations have clearly shownthat ADB's focus on the intermediaries alone will not ensure viability.Success depends to a large extent on the policy, legal, and regulatoryenvironment in which the intermediaries function. Even strong andmature institutions may fail if the policy and regulatory environmentis not conducive to efficient performance. The focus in theseoperations is, therefore, increasingly on broader financial sectorreforms and wider institutional policies as much as on the soundnessand suitability of the intermediaries chosen to channel ADB funds.

Historically, the credit line operations relied largely on state-ownedDFIs. Since the 1990s, a number of private financial intermediaries(including commercial banks and leasing companies) have been used tochannel ADB funds under umbrella credit lines. This has led toexpeditious and competitive use of ADB funds. Credit line operationshave also (i) enhanced ADB’s contributions to institutional enhancement,capacity building, and human resource development in the financialsector; and (ii) reinforced ADB’s policy dialogue with DMC authoritieson financial sector reforms and capital market development issues.

Enabling environmentA range of ADB interventions has focused on improving the policy,legal, institutional, and regulatory environment of the private sectorin the DMCs. Through policy dialogue with DMC authorities, technicalassistance (TA), and since 1987, program lending, ADB hasencouraged and assisted DMCs in formulating and implementingreforms that promote private sector development by removing marketdistortions, strengthening domestic financial markets, and promotinggood governance standards. Program loans, in particular, have beenused to support policy and institutional reforms in the financial sector(India, Indonesia, Lao People’s Democratic Republic [Lao PDR], SriLanka, Thailand, and Viet Nam), agriculture (Bangladesh, Lao PDR,Nepal, Pakistan, Papua New Guinea, Philippines, Samoa, and SriLanka); industry (Bangladesh, Mongolia, Nepal, and Pakistan),hydrocarbon (India), trade (Indonesia), and road transport (Philippines).

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Cognizant of the DMC’s stage of development, and the fact thatmost DMCs had weak markets overshadowed by public interferenceoffering poor incentives to private investors, ADB has supported thecreation of an enabling environment for private investment. ADBprovided support aimed at stable macroeconomic management;investment, trade, and price decontrol; well-functioning financial andcapital markets; flexible labor markets; good infrastructure; and a legalsystem protecting and enforcing contractual and property rights. Solid,but partial, progress has been achieved in most DMCs. With programlending playing a key role, investment deregulation has been thearea of greatest success, as DMCs have opened up closed sectors toprivate investment, both local and foreign. ADB support has played arole in India, Lao PDR, Nepal, Pakistan, Philippines, and Viet Nam,where prices were partially decontrolled. Although ADB has not yetexplicitly undertaken labor reforms, its efforts to reform publicenterprises and deregulate investment have indirectly supported theintroduction of flexibility in labor markets. ADB has also providedassistance for legal system reform.

Physical infrastructureIn the 1990s, ADB began to address the weaknesses of public agenciesin key sectors. These weaknesses appeared to be rooted in thestructural characteristics of public ownership, a persisting obstacle toimproving sector management in the 1980s. Growing recognition wasbeing given to the effectiveness of competition to achieve efficientmanagement of sectors that had originally appeared to be naturalmonopolies, and to lower costs despite the economies of scale thatappeared to support monopoly structures. Privatization of state-ownedenterprises (SOEs) in the physical infrastructure sectors became aprincipal objective of ADB. In DMCs with underdeveloped marketsor constraints derived from their political economies, SOEcorporatization became the alternative means of improving theefficiency of sector management.

ADB efforts to support the Philippines install new powergenerating capacity through private sector participation have beenhugely successful, ending the brownouts that were the main obstacleto the Philippines’ efforts to improve its investment environment. The

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thrust of ADB’s efforts in privatization has been substantially tocommercialize state-owned utilities, with notable success in People’sRepublic of China (PRC), Indonesia, Philippines, Sri Lanka, andThailand, and with ongoing efforts with good potential for success inIndia, Lao PDR, and Viet Nam. An important lesson learned is thatpowerful vested interests frequently seek to subvert privatization totheir own ends; transparency and competitive bidding are keyelements of sound privatization, but are not easily secured.

ADB has also supported several DMCs’ efforts to pursue anintegrated approach to transport development, with a focus on theroad subsector. ADB has helped DMCs privatize road subsectormanagement through road construction and maintenance and throughtollways, which are commercially viable only on a few road sectionsin several DMCs. ADB has made successful progress with roadconstruction and maintenance in nearly all the DMCs in which it hasbeen active in the sector. ADB has improved sector management bytransferring it from government line ministries to autonomous roadauthorities. ADB continues to seek ways to improve the funding ofroad construction and maintenance—a key issue—as revenuesgenerated through vehicle and fuel taxes are significant, but tend toaccrue to the budget rather than to the sector.

ADB has also been utilizing TA to help DMC governments identifythe scope of private sector participation in infrastructure development,and formulate appropriate policy and regulatory frameworks tofacilitate private investment. In 1998, ADB approved a TA for thestudy of private sector participation in gas transmission in Bangladesh,and port development in the Maldives. ADB also funded a study,completed in 1998, in the PRC road subsector that concluded that,although construction risk is best left to the public sector, once trafficvolume increases to a sufficient level, leasing or securitization is afeasible option for mobilizing private capital for the transport sector.

Financial sectorIn parallel, recognition was also being given to the fact that ifinfrastructure services are properly priced, they can be self-financingin their capacity to generate capital and to service debt, and do notneed to be financed by government. This strengthened the need to

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develop strong markets to support the financing requirements ofprivate sector-led growth. With this aim, ADB shifted its financialsector operations from a narrow focus on the resource needs of DFIs,to a broader effort of developing financial and capital markets in theDMCs. In support of this second objective to develop DMC financialmarkets, ADB undertook the following range of activities: recourseto market pricing of funds and introduction of competition amonglenders to reduce funding costs; decontrol of lending to allow fundsto move to activities offering the highest returns; introduction ofmarket-based funding of public sector borrowings; widening the rangeof instruments mediating between savers and borrowers; strengtheningpublic supervision of deregulated markets; and improving DMC accessto global capital markets. Primarily through program lending, ADBhas made good, but partial, progress in financial sector and capitalmarket reform in India, Pakistan, Philippines, and Sri Lanka.

Agriculture sectorAn important part of ADB’s agenda in the 1990s was thecommercialization of agricultural production, as most of the DMCswere subject to heavy public intervention in the sector during the1970s and 1980s. These interventions consisted of support pricesand input subsidies for producers, and price controls on itemsconsumed by the poor. In most DMCs, the balance of subsidiesprovided adequate production incentives, which combined withtechnological innovation, led to Asia’s green revolution. Povertyreduction provided the rationale to redistribute through subsidies. But,what resulted were distorted incentives, misallocated resources,escalating fiscal deficits, and the dead weight of public bureaucracies.ADB has attempted to undo this by providing assistance to dismantlecomplex state interventions to allow markets to determine input andoutput prices; open the market for agricultural produce and inputsupply to the private sector; and develop rural infrastructure with asubstantial focus on farm-to-market roads, rather than input supply.ADB also promoted wider participation by beneficiaries,nongovernment organizations (NGOs), and the private sector in thedesign and implementation of ADB projects.

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A complementary objective in commercializing the agriculturesector was to reduce or reform the role of public agencies. ADBprovided support to eliminate the public sector’s role in the marketingof inputs and outputs in favor of the private sector, and assisted intransferring the management of on-field irrigation systems to farmergroups. Given the weak markets inhibiting the private supply of ruralcredit, extension, and research, ADB strengthened public capacity inthe delivery of these support services and in the management ofirrigation and natural resources.

The most notable impacts on the commercialization of theagriculture sector were made in the transition economies in Indochina,1

the Central Asian republics (CARs), and Bangladesh. Through programlending, which has influenced policy changes, ADB has helped toinduce impressive increases in output and productivity in Bangladeshsince 1992. ADB program and project loans that have supplementedInternational Monetary Fund-supported interest rate, exchange rate,and pricing reforms; and have helped Lao PDR and Viet Namimplement sector policies that have reversed years of stagnatingagricultural output and increased rural incomes. Program loans havealso begun to facilitate the CARs in their transition from collective toprivate farming, and privatization of plantations has made goodprogress in Sri Lanka.

ADB’s record in improving the delivery of support services hasbeen mixed. Its support for agricultural research in internationalagencies and in DMCs has generated high returns in terms ofdeveloping new technologies and applying them on the ground.However, its record on improving rural credit has been poor, with theexception of microcredit, which is a relatively newer initiative thathas shown good initial results and holds promising potential,particularly in its role in the development of women. This is due, inlarge part, to the weak performance of agencies ADB supports tomanage irrigation, forestry, and fisheries. These problems are rootedin the structural characteristics of public management and negligiblebudget support.

1 Indochina includes Cambodia, Lao PDR, and Viet Nam.

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Social infrastructure sectorADB has been partly successful in improving the management capacityof public agencies entrusted with the delivery of health and education.Where feasible, management has been entrusted to beneficiaries andNGOs, or contracted out to the private sector (e.g., maintenance ofvehicles, construction, or accounting and billing). However, as theactual delivery of health and education services remains in the publicsector, ADB has provided significant amounts of capacity building,principally through training, to address weaknesses in delivery. ADBis increasingly providing support to DMCs through program and projectloans to assist them in shifting budget funds from sectors that are self-financing, such as physical infrastructure, to those that are not,primarily health and education.

In urban development, ADB has shifted from discrete financingof urban water supply systems to a more integrated approachencompassing the financing and management of urban development.This has included (i) delineating boundaries between urban andprovincial or national authorities to separate responsibilities andestablish accountabilities; (ii) financing frameworks that facilitaterevenue collection, revenue sharing, and cost recovery, and allowthe development of borrowing capacity and self-financing municipalbudgets; (iii) contracting out municipal services and privatization wherepossible (e.g., ADB-supported privatization of Manila and Colombowater supply); and (iv) capacity building of municipal bodies. Theseissues have recently become part of ADB’s policy agenda.

Postcrisis assistanceFollowing the Asian financial crisis, ADB has taken significantmeasures to help its crisis-affected DMCs. In 1998, to help Indonesiastrengthen its financial sector and assure a sustainable flow of resourcesto the private sector, ADB approved a $1.5 billion loan to supportreforms of governance in the financial sector to assist in sectorrestructuring, and to restore its ability to effectively mobilize andefficiently allocate resources for investment. With physicalinfrastructure bottlenecks constraining growth, ADB has been helpingDMC governments encourage private sector participation in the

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provision of physical infrastructure services. ADB approved a $300million loan to the Philippines for a power sector restructuring andprivatization program, designed to transfer ownership of powergeneration to the private sector.

Catalyst for informationADB has played a pivotal role as an intermediary and catalyst ofinformation flows. ADB sponsored a regional workshop in Manila inDecember 1998 that brought together government officials, bankers,and private sector developers to discuss best practices for promotingprivate investment in power, ports, airports, expressways, and watersupply development.

Regional and subregional cooperationADB has played a significant role in the emergence of several initiativesaimed at regional cooperation. It nurtured and sustained the effort,launched in 1992, of six countries in the Greater Mekong Subregionto develop norms of cooperation that have now reached the level ofpreparation of specific subregional projects in transport and energy,with the participation of the private sector. Two other subregionalgroupings (Indonesia-Malaysia-Thailand, and Brunei Darussalam-Indonesia-Malaysia-Philippines) have requested ADB assistance toprepare subregional growth centers. More recently, the South AsiaGrowth Quadrangle (Bangladesh, Bhutan, India, and Nepal) has askedfor ADB assistance, and ADB has already undertaken a similar initiativein the CARs.

Good governanceAlthough ADB formally adopted good governance as a developmentobjective only in 1995, sector level governance interventions haveformed part of its operations since its inception. These have focusedmainly on the governance dimensions of private sector developmentand public sector reform, but good governance comprises keyelements that cut across sectors and require a macro frameworkapproach: public administration, public finance management,subnational governance, and development of sound judicial and auditframeworks. In the past two years, ADB has initiated work in all these

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areas in several DMCs, and will continue to do so, with the additionalelement of improving information technology.

Commercial cofinancingCommercial cofinancing (i.e., private capital) has been mobilized forpublic sector institutions. In the Philippines, for example, ADB usedits partial credit guarantee to enable the National Power Corporationto tap the Japanese capital market for 20-year yen financing. Inaddition to facilitating capital market development in the Philippines,this transaction helped the corporation increase its exposure to market-based sources of financing. Commercial cofinanciers typically requireadherence to agreed financial ratios, generally accepted accountingprinciples, and other market-related requirements. The financialdiscipline associated with commercial cofinancing complementsfinancial reforms in public sector institutions. In addition, theinvolvement of private capital through commercial cofinancing canhelp set the stage for successful restructuring and/or privatizationefforts.

Lessons learnedA lesson learned for the use of credit lines, both in relation to thefinancial intermediaries and assisted private enterprises, is that theright policy, legal, and regulatory environment, and good governanceare vital for effective functioning. While ADB has helped DMCs addressthe enabling environment, the Asian crisis showed that concertedefforts are required by DMCs and, in turn, by ADB. This underliesADB’s rationale in reducing its DFI lending in the 1990s, as most DFIswere inextricably linked to public interference in resource allocation.ADB support for employment-generating investment has shifted tocreating an enabling environment for market-based financing, ratherthan directly providing investment funds, to promote more inclusiveand sustainable growth toward the ultimate goal of poverty reduction.

The rise in economic growth rates in Asia, up to the financialcrisis, was the most important event of the 1990s. The market-drivenand private sector-oriented framework that enabled this transformationwas mostly put in place by the DMCs themselves. However, manyDMCs turned to ADB for assistance, notably in South Asia, the

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transitional economies, and the Philippines. In these cases, ADB canclaim credit for successful efforts in this area. ADB’s efforts in thePacific DMCs were less fruitful, as structural constraints remain difficultto overcome in these small states. In the Pacific DMCs, ADB assistancehas shifted to improved aid coordination, rather than additional aid,with a focus on supporting policy frameworks and private investment.

ADB has used several approaches to reduce poverty. The firstwas to consider how to relate growth-oriented projects. Growth is thesingle most important contributor to poverty reduction; increasingemployment and access of the poor to productive resources arerecognized tools to this end. However, ADB has learned that growthin the DMCs must be labor intensive. One of the most crucialcomparative advantages of ADB’s DMCs lies in their inexpensive laborforces. Policies that have facilitated labor-intensive, rather than capital-intensive, production have been the key to generating realemployment, typically in industrial and service SMEs and throughforeign direct investment. ADB is keeping these lessons in mind andbringing them to bear in establishing links between its growth, led bythe private sector, and poverty reduction objectives.

A third lesson learned is that ADB’s public and private sectorwindows should have worked more closely together to increasebenefits to the DMCs, and optimize development impacts. Public sectorassistance pay systematic attention to private sector interests andconcerns. ADB will draw on this experience in reviewing its approachto private sector development.

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Private sector activities of othermultilateral agencies

The World Bank GroupWorld Bank (WB)Support by the World Bank Group—The World Bank (WB),International Finance Corporation (IFC), and Multilateral GuaranteeAgency (MIGA)—for private sector development to promote growthand efficiency, and thereby to reduce poverty, has undergonesubstantial evolution. Early project lending focused on creating theinfrastructure base to complement industrial and agriculturaldevelopment. Adjustment lending in the 1980s expanded the focusby working to establish a macroeconomic framework for private sectordevelopment and appropriate relative prices. Since 1989, a strategyhas been incorporated that focuses on improving the businessenvironment, restructuring the public sector and supportingprivatization, and reforming and developing the financial sector indeveloping countries. Together, the components of this strategy arehelping to nurture a healthy private sector, a prerequisite for attractingprivate capital flows.

Efforts to improve the business environment focus on necessarypolicy, regulatory, and legal reforms. These activities have an increasinglysharper focus through a program of private sector assessments, initiatedin fiscal year 1992 and carried out in conjunction with IFC.

Promotion of public sector restructuring has tended to focus ontrimming overextended public sectors and supporting privatizationof state-owned enterprises (SOEs) and private sector delivery of publicservices. However, the focus has shifted to complement privatizationwith efforts to upgrade areas of public administration that have thepotential to profoundly affect the growth and efficiency of the privatesector: tax and customs administration, trade and investmentpromotion, enterprise-support services, court administration, andinfrastructure planning and provision. WB is also involved with issuesrelating to the importance of transparency, dealing with the potentialdirect social costs of privatization, and establishing a postprivatizationenvironment that stimulates competition, promotes equity, and inhibitsavoidable concentrations of ownership and economic power.

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WB provides support for the private provision of infrastructure,focusing on (i) privatization of public utilities; (ii) development ofregulatory frameworks to provide appropriate mechanisms for pricingprivately delivered infrastructure services, encouraging competitionand, where appropriate, removing barriers to entry; and (iii) provisionof WB financing or partial guarantees to attract additional privatecapital for infrastructure projects.

In the financial sector, WB focuses on creating the appropriatelegal, regulatory, and supervisory structures to realize the full benefitsof financial sector reform. WB emphasizes the need for policy reformin conjunction with macroeconomic reform, improvements in thefinancial infrastructure, and strengthening of specific financialinstitutions.

WB is improving its capacity to support governments design andimplement private sector development reforms by understanding thedynamics of the environment affecting private sector developmentand devising ways to eliminate or work around obstacles toimplementation; forging links between various local institutions criticalto private sector development to build capacity so that local institutionscan deepen and sustain progress initiated through WB; and learn fromsuccessful country experiences internationally, and tailor these to aspecific country’s needs.

In recent years, WB’s efforts to support private sectordevelopment have accelerated rapidly. Typically, about two thirdsof all WB operations include components that explicitly supportprivate sector development. WB has a vice president under who acritical mass of highly competent professionals has been assembledto provide technical support for financial and private sectordevelopment, and the industry and energy sectors. WB has alsoinitiated major efforts to promote small- and medium-sized enterprises(SMEs) and the entrepreneurial role of women, encouraging the privatesector in the poorest of developing countries and supporting thenecessary underpinnings of public sector reform.

Recently, WB started reaching out to, and conducting dialoguewith, multinational corporations (MNCs) in an effort to promote privateenterprise in developing countries. WB has noted that in manycountries where it operates, the industry sector consists mainly of

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export-oriented enterprises, such as textiles and electronics, overwhich the host country has little influence on market and productiondecisions: the MNCs are in control. Without this dialogue with MNCs,multilateral development banks run the risk of providing incorrectadvice if they do not understand the decision-making processes ofmultinationals.

WB and IFC recently began working together to create synergies.They are undergoing an organizational change at the corporate leveland a merger of offices is being orchestrated in the field. Colocationof offices has already been accomplished in a number of countries tobetter coordinate IFC and WB efforts in private sector development.There has been a recent merger of the positions of the WB countrydirector with the IFC resident representative. In a recent move toincrease its presence and operations in the Asian region, a joint WB-IFC regional office is being established in Singapore.

International Finance Corporation (IFC)IFC was established in 1956 as a member of the World Bank Group. Itis a legally and financially independent multilateral agency that fosterseconomic growth by promoting private sector investment in itsdeveloping member countries (DMCs). IFC combines aspects of amultilateral development bank with that of a private merchant bank.In its project financing, IFC provides loans without governmentguarantees, makes equity investments, and seeks to mobilizeadditional project funding from other investors and lenders throughloan syndications, parallel financing, and guarantees. IFC prices itsfinancing and other services in line with the market, and seeksprofitable returns. In addition, IFC sponsors and funds selectedfinancial intermediaries.

IFC offers a range of advisory services and technical assistance (TA)in such areas as capital market development, corporate restructuring,risk management, and project preparation and evaluation, and advisesmember governments on creating an environment that encourages thegrowth of private enterprise and foreign investment. IFC maintainsan emerging markets database, functions as an adviser to severalprojects that it finances, and frequently joins large MNCs and leadingDMC business groups in its operations.

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IFC’s general policy guidelines are quite similar to and, in somerespects, identical with those of ADB for direct private sector financing.IFC views development, not profits, as its primary goal. But, it seesthe aim of profitability as consistent with the development objectiveand not in conflict with it. IFC seeks to strike a proper balance betweenits profitability and risk-taking in its investment activities. It makes amajor contribution to development when its involvement makes acritical difference to investors intending to proceed with largeinvestments that have an important impact on a country’s economy.IFC tries to ensure that its participation makes a special contributionthat supplements or complements the role of market operators.

IFC has been quite active in private sector financing in Asia, aidedby its representative offices in Bangkok, Beijing, Islamabad, Jakarta,Manila, and New Delhi, and now by the newly opened joint IFC-WBoffice in Singapore. IFC’s assistance to projects in Asia covers a widerange of industry and infrastructure sectors. It has financed projects inthe oil refining, petrochemical, cement, textile, automobile,electronics, and agro-processing industries, as well as in energy,transport, telecommunications, tourism, and health. Some of theseprojects have been jointly financed by ADB. IFC has also supportedseveral financial intermediaries in commercial banking, leasing, andhousing finance. As part of its Foreign Investment Advisory Servicesprogram, IFC has provided advice on investment policy andprocedural aspects to several Asian countries, including Bangladesh,People's Republic of China (PRC), India, Lao People’s DemocraticRepublic (Lao PDR), Malaysia, Mongolia, Nepal, Philippines, Sri Lanka,Thailand, and Viet Nam. In addition, IFC has been providing adviceon corporate financial restructuring and on privatization. To helpentrepreneurs in the region’s smaller economies establish newbusinesses or expand and diversify existing ones, IFC has establisheda South Pacific Project Facility based in Australia.

In the past, IFC focused mainly on sectors rather than on countries.This is, however, beginning to change as the planning exercise isnow being driven by country considerations. However, when a projectis cleared for processing, the concerned sector department takes thelead and drives the process. IFC’s strategy currently focuses on threeareas: (i) key sectors that were originally in the public sector but are

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now moving to the private sector, i.e., infrastructure, oil and gas,transport, utilities, and education; (ii) financial sector, with emphasison domestic financial market development; and (iii) SMEs. In its workto support SMEs, IFC has established a business advisory unit thatprovides capacity building and advice on producing viable businessplans as well as accounting, financial, and credit analyses, and riskassessment skills to help SMEs and start-ups in their operations.

IFC used to prepare country assistance strategies (CAS) separatelyfrom WB. Currently, the IFC works closely with WB to prepare jointcountry strategies, particularly for activities in capital marketdevelopment, foreign direct investment (FDI) promotion, and SMEdevelopment. This has been institutionalized in the sense that the Boardis aware of the process. For countries classified as high priority due toIFC’s large investment program or where significant opportunities havebeen identified, IFC prepares a detailed private sector strategy as anannex to the CAS to supplement what is included in the text. There are20 such countries. For lower-priority countries, the private sector strategywill only be included in the text. For countries classified as hostile to theprivate sector, IFC does not participate in the CAS. IFC signs off on theCAS and the Board presentation is done jointly.

To facilitate a division of labor and to prevent a conflict of intereston the advisory side, IFC will normally provide advisory services onissues such as FDI or regulatory frameworks, whereas WB adviseson policy issues. IFC discloses its investments in projects so hostgovernments are fully aware of the dual role played by IFC. In caseof jeopardy, if IFC is a lender and/or investor, it acts as representativeof other investors and lenders, whereas WB would advise on policyissues. This is where the “firewall” must be put up between the twoentities to prevent a serious conflict of interest.

For the guarantee instrument, WB’s guarantee program has not beenused extensively, but IFC has issued $100 million as guarantees. Tomitigate risks, IFC shares guarantees with the local banks, and the localbanks price the loan based on the percentage IFC is guaranteeing.

Multilateral Investment Guarantee Agency (MIGA)MIGA was established in 1988 to reduce poverty through FDI to andamong DMCs, by offering political risk investment insurance coverage

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to private investors, and providing promotional and advisory servicesto help its DMCs attract and retain FDI. MIGA estimates that 55 out of1,400 projects are submitted to their Board, and of the 1,400 projectsreceived annually worldwide, 400 are from Asia. Twenty percent ofMIGA's portfolio comes from Asia. Projects have been guaranteed inBangladesh, PRC, and Pakistan. A constraint faced by MIGA in doingmore work in Asia is the fact that some of their host countries are notMIGA members, e.g., Cambodia and Thailand.

MIGA recently raised its capital to $2 billion, its project limits to$200 million (project size of up to $1 billion) and country limits to$620 million. In 1998, it provided 73 guarantees worth $1.3 billion,mainly to power projects, charging 50 to 150 basis points. MIGA hasissued 60 guarantees related to infrastructure projects. High investorconfidence in the past made obtaining political risk insurance for waror insurgency a low priority. The trend, however, has reversed. Mostof the policies underwritten by MIGA provide coverage to investorsin the event of war in the host country.

MIGA would like to collaborate with ADB in the following areas:(i) providing guarantees to projects where ADB is an investor;(ii) coinsuring in ADB projects with ADB; and (iii) relying on ADB’sdue diligence on projects that MIGA insures, as similar standards (e.g.,environmental and labor) set by ADB are also required by MIGA.

Inter-American Development BankThe Inter-American Development Bank (IDB) has traditionally followedpolicies similar to those of WB for private sector development. In recentyears, private sector development has begun to occupy a moreprominent position in its activities. IDB has set up the Inter-AmericanInvestment Corporation (IIC) to support SMEs in Latin America andthe Caribbean with loans, guarantees, and equity investments. IDBalso administers the Multilateral Investment Fund (MIF), which wasestablished in January 1993 to finance programs for policy change,training, and improved access to credit to help member countriesstrengthen their private sectors. The MIF consists of a technicalcooperation facility that helps identify and implement policy changesto promote the private sector, a human resources facility that helpsretrain displaced workers and strengthen worker productivity, and a

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small enterprise development facility that helps broaden economicparticipation by the poor, women, and minorities.

Over several years, IDB has made a conscious effort to promoteinstitutional change in mindset and work processes. This has resultedin much closer collaboration between its public and private sectordepartments to successfully develop private sector projects in itsDMCs. IDB established a management review process wherebyjustification must be made systematically as to why the private sectoris not participating in a public sector project. This review process isproving to be an incentive for the public sector departments tocoordinate with the private sector departments to identify projectsthat have the potential of being undertaken and/or funded by theprivate sector.

To facilitate the coordination of activities for private sectordevelopment, the president of IDB created a private sectorcoordination committee. The committee is comprised of the vicepresident and individuals from MIF, IIC, the Private Sector Department,and the Legal Department. The key to the committee’s success relieson agreements in internal processes.

To promote the development of the private sector, during its eighthreplenishment in 1994, IDB raised its private lending limit from5 percent of annual lending commitment to 10 percent. Project limitswere also increased to $75 million or 25 percent of total project cost,except for smaller countries where a limit of up to 40 percent ofproject cost applies.

Inter-American Investment CorporationThe Inter-American Investment Corporation (IIC) is a multilateralinvestment corporation that promotes the economic development ofits regional member countries by stimulating the establishment,expansion, and modernization of private SMEs in the Latin Americanand Caribbean region. IIC began operations in 1989 with subscribedcapital of $200 million; this was recently increased to $700 million.IIC provides long-term loans and guarantees to, and makes equityinvestments in, private enterprises that have difficulty raising financefrom other sources on reasonable terms. It provides lines of credit tofinancial intermediaries. By Charter, IIC can only provide corporate

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lending or project financing; it is prohibited from accepting sovereignguarantees. IIC mobilizes additional capital for assisted projects throughsyndication and underwriting operations, by identifying joint venturepartners and facilitating transfer of technology. IIC also provides fee-based advisory services to private firms and advisory services tomember governments on their investment policies, and assists themin privatizing SOEs, particularly those of medium size.

IIC supports projects that, in addition to providing potentiallyprofitable investment opportunities, have a development impact onthe host countries. Particular attention is paid to mitigating adverseenvironmental impacts. IIC is currently developing a new product—an agency line of credit—that will enable them to lend directly to aproject sponsor with a financial institution counterpart. The risk willbe borne by IIC and the financial institution to the extent of theirrespective exposures.

European Bank for Reconstruction and DevelopmentThe European Bank for Reconstruction and Development (EBRD)was established in 1991 with a unique mandate to foster the transitionto open market economies and to promote private and entrepreneurialinitiatives in the Central and Eastern European countries committedto, and applying, the principles of multiparty democracy, pluralism,and market economics, thereby assisting their economies to integrateinto the international economy. EBRD seeks to help the countrieswhere it operates to establish the framework of a market economy,implement restructuring and privatization, create moderninfrastructure, strengthen financial institutions and legal systems, anddevelop the local private sector. EBRD has 55 members, and likeADB enjoys a strong triple-A credit rating that reflects its strong capitallevel and membership, and conservative fiscal policies.

EBRD has merged its merchant banking with its developmentbanking. Not less than 60 percent of its funding is to be directed toprivate enterprises and/or SOEs that are implementing programs toachieve private ownership and control. Not more than 40 percent ofEBRD’s funding is to go into public infrastructure and other projects.In reality, 85 percent of EBRD’s operations benefit the private sectordirectly or indirectly, but 50 percent of these deals involve government

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risk. In all its projects, EBRD must follow three principles: transitionimpact, sound banking and investment, and additionality.

EBRD’s Banking Unit is organized into six business groups, threeof which are country groups and the other three sector groups. Thecountry groups include (i) the Russia Federation and the Central Asianrepublics (CARs), (ii) Central Europe, and (iii) South and SoutheastEurope, and the Caucasus. The sector groups include financialinstitutions, infrastructure, and industry and commerce. The sectorgroups normally take the lead and, currently, are lending 80 percentof the business, but there is an effort to push more business to thecountry groups. The country groups take care of sectors not coveredby the sector groups, but overall, a country team approach is used.EBRD does not do programming work with governments as ADBdoes, and they also do not do advisory work.

Currently, their strategy is to focus on the following: (i) supportingbanks and other financial institutions that have an institutionalcommitment to SMEs; (ii) providing a full range of financing structuresin infrastructure operations including private, sovereign, subsovereign,and public-private partnerships; (iii) supporting the restructuring ofpotentially viable large enterprises, by carefully selecting a fewprojects that have a strong demonstration effect; (iv) continuing equityinvestments; and (v) promoting a sound investment climate andstrengthening institutions that are important for the functioning ofmarkets, by working closely with its foreign investment advisorycouncils.

EBRD’s Risk Management Unit is located outside of the BankingUnit. The Risk Management Unit is responsible for reviewing everytransaction, and signs off on all private sector projects. The OperationsCommittee helps coordinate the country and sector groups. In itsproject work, both the concerned country and sector groups get fullcredit regardless of which group originates or leads the deal. Thisprovides an incentive for the country and sector teams to worktogether. The Operations Committee is cochaired by the vice presidentand deputy vice president of the Banking Unit, and is comprised ofthe head of finance, the chief economist (who ensures the transitionimpact), the general counsel, and the head of risk management.

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EBRD is doing work with municipalities, given the trend towarddecentralization of governments. They treat the municipality as anonsovereign entity, i.e., a private sector entity, as a municipalitydoes have its own sources of funding and does not depend solely ongovernment transfers. An important criteria adhered to by EBRD isthat all of its projects must be self-sustaining and, over time, the projectrevenues must be able to service the debt.

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Scorecards Concepts

Private Sector Operations: A Scorecard for Greater Development ImpactA scorecard can “score” all prospective private sector projects against a set of development impacts desired inthe developing member countries (DMCs). These development objectives will be defined in terms of theAsian Development Bank's (ADB's) strategic development and private sector development objectives. ADB-assisted private sector projects should have development impacts as defined by these objectives. Table A3.1presents a conceptual illustration of the scorecard concept, using ADB's existing private sector projects asexamples. Further refinement and elaboration will be needed to implement such an approach.

The scorecard will enable ADB to strengthen the development focus of its private sector operations becauseit will have defined upfront what the objectives of these operations are.

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Public Sector Operations: A Scorecard for Greater Private Sector Development EffectA scorecard can also be developed to track the contributions of ADB’s public sector projects to private sectordevelopment, where public sector loans help to create enabling conditions or generate investment opportunitiesfor the private sector (Table A3.2).

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Documents

· Contents iii The need for a strategy 1 Why a strategy now 1 Why a comprehensive strategy 2 Private sector and poverty reduction 3 The strategy 9 Overview 9