Access to agricultural, microleasing and equity finance in Macedonia

1. United Nations Development Programme Access to agricultural, microleasing and equity finance in Macedonia Almaty, 9-11 November 2005

2. I. UNDP Development Strategy for Macedonia II. About LED projects in Macedonia III. Access to Finance Macroeconomic situation in Macedonia Financial sector in Macedonia Legal and regulatory framework IV. Proposal 1 – Agricultural finance Agricultural Sector Project Strategy and Activities Project Management V. Proposal 2 – micro leasing What is micro leasing and trade-offs between leasing and lending Key Challenges to micro leasing market in Macedonia Project Strategy and Activities VI. Proposal 3 – micro-equity fund Content

3. UN Country Programme Document for Macedonia (2005-2009): Political and social stability Poverty reduction (through economic growth) Job creation Combating corruption Initiatives focus largely on: Creating an improved domestic investment climate, and Upgrading institutions and legal and regulatory frameworks for EU compliance. It is generally recognized that the SME sector is the engine for job creation and growth. I. UNDP Development Strategy for Macedonia

4. Goal Building capacity of the LSG for LED Improved business environment Support to entrepreneurship Poverty reduction Duration:(I) until December 2005; (II) November 2005 – December 2006 Budget (II) 500.000 USD: 200.000 USDfor capacity building and 200.000 USDfor implementation of the LED strategies Donation of the Norwegian Government II. Local Economic Development (LED) Project in Macedonia – Phase I and II

5. Goal Support local economic development Build capacity for local management of project proposals, evaluation and monitoring Prepare municipalities for the upcoming EU structural funds Support multiethnic municipalities to focus on economic development Poverty reduction Duration:until December 2005 Budget 255.000 USD Donation of the OSCE/Norwegian Government Municipal Economic Development Fund (MEDF)

6. Activities: Capacity Building of the LED Staff within the Municipality Creation of LED Partnership (private- public and NGO Partnership) Guiding the LED Partnership and LED Staff to create LED Profile and Strategy The LED Strategy is adopted by the Council of the Municipality Promoting the LED Strategy Municipal Economic Development Fund to support priorities from the LED Strategy (grants vs. revolving or microfinance/equity fund?!?) Build capacity for local management of project proposals, evaluation and monitoring – prepare municipalities for the upcoming EU structural funds Creating sustainable LED capacity: LED Staff employed by the Municipality and registering the LED Partnership as a foundation founded by the Municipality Council Local Economic Development (LED) Project in Macedonia

7. III. Access to Finance - Background • Assessment done by Kiendel Burit, UNCDF • High unemployment (37.2% in 2004, highest in the region) in the Macedonian economy contributes to high levels of poverty (more than 22.6% of the population lives below the poverty line). • Sluggish economic growth and rising unemployment have aggravated poverty levels. • It is widely agreed that the engine of growth for the Macedonian economy and opportunities for employment lay in the development of micro, small and medium enterprises.

8. Fiscal deficits are expected to be slightly less than 1.5% of GDP Debt levels are decreasing and are expected to drop to 42.8% of GDP in 2006 Inflation - single digits 1.9% - 4.2% in 2006 A BB+ local currency rating from Standard and Poors Limited real growth (averaged 1%) and is estimated at a modest 4% in 2005-6 Macroeconomic situation in Macedonia

9. Limited growth, coupled with the dismantling and downsizing of socially owned enterprises over the last decade, has resulted in limited job creation Low FDI (average of $100 million per year) lowest in the region An informal peg of the denar against the euro leads to overvalued currency and is contributing to sluggish economic growth and low competitiveness Low exports and high imports have resulted subsequently in a significant trade imbalance (app. $1 billion in 2004) Macroeconomic situation in Macedonia

10. Low levels of credit and investment capital available to the private sector - gross credit to GDP ratio is 21.5% (compared to rates in emerging market economies in Asia and Latin America of around 63% and over 120% in developed countries) Lending relative to available funds (63.6%) and to total assets (48.5%) has increased in the past few years but remains low Banks hold 1.5 billion Euros in assets, representing 99% of financial sector assets Out of 20 banks, the 3 largest firms hold 65% market share, and the top five firms hold 75% market share. Financial sector in Macedonia

11. The two largest banks, hold 65% of individual savings deposits Seven banks majority-owned by foreign entities, including two of the three largest banks However, none of the strongest EU banks is present in Macedonia Low real competition Banks are too conservative and collateral oriented Financial sector in Macedonia

12. Low know-how in lending to SMEs (cash flow lending vs. real estate collateral lending) Up to 2004 only two microfinance providing institutions existed (Moznosti and FULM) The financial sector is heavily euroized. 50% of deposits and 40% of banks assets are denominated in or linked to foreign currency. Stress tests show that a combined effect of devaluation and credit defaults would have a significant impact on the banking system Interest rates are relatively high nominally (relative to inflation) and there are large spreads between deposit and lending rates, relative to competitive and efficient markets Financial sector in Macedonia

13. Competition is starting to pervade and influence markets – entrance of ProCredit Bank The spread between loans and savings has fallen from 15.7% and 7.8% in 2002 (spread of 7.9%) to 12.5% and 6.4% in 2005 ( a spread of 6.1%). Increased confidence in the banking system saving went from $115 million in 2002 to $494 million when the Euro was introduced. While intermediation remains low at 21.5% now, it is a significant increase from rates of 7.4% in 2003. Finally top-tier foreign EU banks research the market (Raiffeisen, ING) Financial Sector - Improvements

14. Existing entities: Savings Houses, Banks with small domestic license Banks with International license Leasing companies Insurance companies Investment funds (Stock Exchange) Two private mandatory pension funds (80% of the accumulated capital will be invested domestically) The Law on Microfinance which allowed for the establishment of Specialized Microfinance Institutions with 4 million Euro Capital is no longer valid. A New Law on Banks allowing for three (or two?!?) classes of institutions is in the process of development in efforts to bring the banking sector in compliance with the EU Banking Directive. Legal and regulatory framework - Current situation

15. There is a obvious need to diversify the lending and investment institutions: Financial companies Credit Unions Investment funds (not only on the Stock Exchange) Two funds exist offering innovative instruments (Small Enterprise Assistance Fund and the SME Fund) but their unclear legal status makes them vulnerable and creates disincentives of further expansion of innovative financial services Uneven application of tax laws and laws that favor lending over leasing also inhibit the development of markets Laws on enforcement of court verdicts and court independence Legal and regulatory framework – What is missing

16. Stable inflation and budget deficit Hidden fear from devaluation leads to inadequate offer for long-term financing Govt. increases interest rates on Treasury Bills and Govt. Bonds in order to build reserves, keep the peg and finance its operations Increase in the interest rates Banks are lazy, conservative and are just not competitive enough Low level of intermediation opens doors for donor assistance and entrance of top-tier banks Only increased competition will pressure banks to innovate and become more aggressive Macedonia needs development and growth oriented regulatory framework stimulating introduction of new products and new service providers Summary of the financial sector assessment

17. Risk capital (equity, quasi-equity and subordinated debt) Purchase order/trade financing Factoring Start-up finance and TA New products

18. 11.3% of GDP 18% of GDP if processing is included Significant economic development potential in agroprocessing and linked supply chains The potential that the agricultural sector has for job creation is limited due to: Access to finance Poorly equipped companies Weak marketing chains Poor organization of the sector In order to compete with the EU, Macedonia will need to: Standardize output Raise sanitary standards Raise the quality of presentation products All this needs FINANCE! IV. Proposal 1 – Agricultural finance Agricultural Sector

19. the supply of financial services has contracted significantly over the past decade following Macedonia’s independence from the Yugoslav Republic. Prior to independence, credit was provided to state-owned enterprises (AKs) at subsidized rates in the form of inputs and repayment in kind at harvest Most banks are unable or unwilling to manage the production and price risks inherent in agricultural production. Additionally, only 4 of the 21 banks operating in Macedonia have significant infrastructure through which to provide financial services outside of Skopje. Supplier credit and credit from processors or intermediary buyers, extensive in some agricultural economies is virtually absent in Macedonia. IV. Proposal 1 – Agricultural finance Agricultural Sector

20. The demand is estimated at between 30,000 to 60,000 clients in rural markets The current supply of financial services to agricultural households is optimistically estimated at 2,500 loans The bottom line is there is limited supply to meet demand, and the sector is undercapitalized Among the challenges to providing finance to the agricultural sector is developing appropriate products. Potential sources of finance will include not only loans, but potentially leasing products, remittances, and equity instruments. Raising agricultural production will require a range of supportive activities including support for specific value chains for products, access to finance, and adherence to international quality standards. IV. Proposal 1 – Agricultural finance Agricultural Sector

21. This strategy aims to increase access to finance for agricultural markets. Financial services that are attractive to agricultural enterprises include short and longer-term loans, appropriate savings products, remittances, and potentially equipment leasing. Agricultural markets hold significant potential employment opportunities for populations in Macedonia’s most depressed areas. 69% of SME production is in agriculture. IV. Proposal 1 – Agricultural finance Project Strategy

22. Partner with financial service supplier(s) on the ground Work with financial institutions to develop their overall capacities to gain knowledge about the market, develop new products and develop the systems to manage new products Partners selected will have already achieved financial viability and will help them expand into new markets in ways that does not compromise their own viability. For institutions that have not reached viability, reaching viability is a key priority and is a prerequisite for partnership under this initiative. IV. Proposal 1 – Agricultural finance Project Strategy

23. loans for working capital with customized repayment periods leasing products for equipment finance, or insurance to manage price and yield risks associated with agriculture other financial instrument (such as delivery certificates) of vertical supply chain linkages within specific agricultural sectors remittances The project will not only support new market research but will also work with donors/initiatives with considerable experience in this area IV. Proposal 1 – Agricultural finance Project Activities

24. Selecting Technical partners (s) A TSP (s) is paired with a partner financial institutions that has demonstrated experience and track record in the capacity building areas identified by the partner financial institutions. The project will pair selected partner(s) with TSPs that can provide high quality support to meet organizational needs for more effectively and efficiently reaching new market. Previous experience in providing technical assistance to the agricultural sector in Macedonia will be taken into consideration when selecting the TSP. Technical partners will work with partner institutions to develop new products demanded by the market (potential products might be leasing, remittances, insurance, more client responsive loans) and institutional capacities to support the delivery of new products. IV. Proposal 1 – Agricultural finance Project Activities

25. UNDP will ensure the implementation of project activities by acquiring and managing all inputs to the project, monitoring results, and ensuring that knowledge generated by the project is shared with stakeholders in relevant forum Technical Services Provider (TSP) One or more TSPs will be contracted under the project to provide technical expertise identified for a number of project outputs: Carry out market research on agricultural markets Provide capacity building support to better reach agricultural markets UNDP will negotiate a contract (s) with TSP (s) to provide services agreed with Financial Service Providers. IV. Proposal 1 – Agricultural finance Project Management

26. The TSP will Deliver technical support services as agreed in the services contract Report on services provided according to its contract Provide performance data to UNDP on Financial Service Providers and ensure the accuracy of FSP reporting data. Work with FSPs to identify appropriate equipment providers or other contractors or suppliers where necessary to meet capacity building objectives Financial Service Providers The Financial Services Provider will be selected through a selection process. The Providers must demonstrate commitment to the markets to be served through prior track record or Business Plan. IV. Proposal 1 – Agricultural finance Project Management

27. V. Proposal 2 – Microleasing Trade-offs between Microleasing and lending Source: Westley, Equipment Leasing and Lending (A Guide for Microfinance)

28. Cost for lessees Cost of Funds for Suppliers Legal and Regulatory Repossession Tax Code, more particularly: Amortization Profit tax VAT Market Size Resale Market V. Proposal 2 – Microleasing Key Challenges to microleasing market in Macedonia

29. Support the creation of new, long-term jobs through the expansion and establishment of micro and small businesses by supporting the development of new financial instruments. Support to Funds, finance companies that provide “alternative” financing instruments for micro and/or small enterprises Market research for new products (leasing, insurance, remittances, mortgage markets) Piloting new products and approaches Support for legal and regulatory framework Awareness raising: role of non-banking instruments in deepening the financial sector V. Proposal 2 – Microleasing Project Strategy and Activities

30. UNDP will ensure the implementation of project activities by acquiring and managing all inputs to the project, monitoring results, and ensuring that knowledge generated by the project is shared with stakeholders in relevant forum Technical Services Provider (TSP) One or more TSPs will be contracted under the project to provide technical expertise identified for a number of project outputs: Support for NBFI and non-banking lines of business legal and regulatory frameworks Develop risk capital and other “alternative” financial instruments for high yield SMEs Support for determining demand for and piloting new non-banking products (insurance, remittances, etc.) V. Proposal 2 – Microleasing Project Management

31. While extensive research has confirmed the job creation potential of SMEs, there is a class of microfinance borrowers that have the potential to “graduate” into such SMEs if they have access to the necessary capital and business support. Smaller investments to those companies that have begun to formalize their operations and have previously performed satisfactorily as microfinance borrowers. There is ample evidence that such firms are unable to attract larger investments beyond what is available in the microfinance sector and have long since exhausted any personal resources. In effect, there is a financing gap due to a lack of collateral of the type that traditional bank lending requires and the fact that the investment amounts are too small ($30,000-$500,000) to be attractive to traditional equity investors. This is a very challenging market segment to reach and will be labor intensive, but the Facility will provide a unique opportunity to pilot an approach that might form the basis for future support from other donors and private entities. VI. Proposal 3 – Micro-Equity Fund for LED – Concept notes

32. “Risk” capital: Risk capital, generally equity capital or risk capital, refers to money invested by a financial entity into a small business in exchange for partial ownership of the business. The investors share in the business profits as well as the appreciation of the business over time, once all obligations have been met for the firm’s debt. If the investment goes bad, the financial entity can receive some payment from liquidation only after all the other creditors have been met. This investment holds more risk than debt investment, but also opportunity for greater return. Banks are generally reluctant to provide debt financing to new firms, or long term debt that may be required to adequately finance an expansion for a business. For SMEs, a number of new “risk” instruments have been created beyond pure equity investment. These include: Quasi-equity: The financial services firm provides a loan with an unsecured risk portion. The risk associated with the unsecured portion is compensated for by the Financial Services Partner receiving a shareholding in the business. Royalty:The financial entity provides a company with an unsecured loan. In lieu of collateral, the business provides the financial entity with a royalty calculated as a percentage of the value of turnover of the firm for the duration of the loan. VI. Proposal 3 – Micro-Equity Fund for LED - Concept notes

33. Connect LED experience with a fund that can be flexible enough to provide: Equity Quasi-equity Subordinated debt First level of promotion and preparation of the applications will be done with the LED Staff within the Municipalities In this case the fund manager will have an obligation create an revolving fund and make sure that at least 80-90% of the funds are available for the next round of applications This fund will support activities that are stated in the LED Strategies of the Municipalities Matching funds with USAID ($1 mill.) VI. Proposal 3 – Micro-Equity Fund for LED - Concept notes

34. QUESTIONS ?