Catalog

	Table of Contents
p. 5 of 32 BACK | NEXT I. Introduction II. Assessment of Past Performance A. Country and Sector Coverage B. Impact of Private Sector Operations C. Financial Performance D. Risk Exposure E. Portfolio Administration F. Lessons Learned III. Rationale and Role IV. Operational Strategy V. Operational Improvements VI. Resource Requirements VII. Conclusions and Recommendations

Private Sector Operations: Strategic Directions and Review : II. Assessment of Past Performance

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C. Financial Performance

14. Starting with relatively small, stand-alone equity investments in 1983, and followed by larger loans without government guarantee from 1986, ADB has built a private sector portfolio of over $1.24 billion in outstanding disbursements and undisbursed commitments to 100 companies¹² as of the end of 2000. Of this total portfolio, 64 percent is in loans, and 36 percent is in equity investments.

15. Performance of the PSO portfolio was adversely affected by the financial crisis that hit Southeast and East Asia in July 1997, just like the portfolios of commercial banks and other financial institutions operating in the region. The “contagion effect” of currency depreciation and the economic slowdown in other DMCs exacerbated the negative impact (para. 24).

16. The Asian crisis dramatically exposed key weaknesses in the structure and performance of the private sector, and in the role of government with respect to the private sector. In general terms, the crisis showed the failure of government to carry out some of its key roles, particularly financial sector regulation and supervision. At the same time, the crisis was the consequence of poor decisions of individual private sector enterprises, both domestic and foreign. The challenge is to learn lessons from the crisis, while creating conditions to accelerate the role of the private sector in development in a manner that is responsive to the needs of the DMCs.

17. Profitability. The main objective of PSO is to achieve a significant impact on economic development while maintaining profitable operations.¹³ With ADB’s development goals being integrated in PSO, profit maximization is not the main financial objective. However, ADB should generate sufficient profit in PSO to (i) sustain PSO without any cross-subsidy from other ADB activities, and (ii) demonstrate the financial viability of private sector investments in DMCs. Thus, the profitability of PSG operations must be measured adequately and in a transparent manner through a financial reporting system that identifies the costs and income of PSO separately from those of the public sector operations. For a fair measure of PSG’s profitability under this system, costs incurred by PSG for “noncommercial” activities or “semicommercial development” activities would have to be identified and excluded from PSG’s profit calculations, or funded with a separate budget allocation. For example, PSG staff participate in country programming missions, contribute to country strategy formulation, review public sector projects and sector policies, and prepare policy papers, all of which are noncommercial or semicommercial and need to be segregated out of PSG’s “commercial” activities to have a fair accounting. Similarly, the reimbursements received by PSG from project sponsors for out-of-pocket expenses (e.g., mission travel) need to be captured and credited to PSG. To be able to measure the financial performance of PSO independently from the public sector operations, ADB needs to establish an appropriate accounting and financial reporting system for PSO (para. 104).

18. There is also a need to review certain policies that affect the measure of PSO’s profit performance. For instance, an 8 percent general loss provision is booked against all investments which do not have readily available market values and for which no specific loss provision has been made.¹⁴ This fixed charge is made regardless of the actual risk profile of each investment. Such a provisioning policy tends to understate profitability, especially as the portfolio has been growing.¹⁵

19. Loans. Loan collection was adversely affected by the Asian financial crisis. The number of borrowers in arrears increased from 7 to 10 between 1996 and 1997. By 1999, the number increased further to 13 (out of 41 borrowers with outstanding balances) and remained at that level in 2000. All the 13 delinquent borrowers represent projects that were processed prior to the creation of PSG in 1995 (i.e., when PSO projects were undertaken in ADB departments engaged in public sector activities as well) and 10 of them are manufacturing projects (textile, tomato paste, seaweed, chemicals, and rubber tires)—projects that PSG no longer undertakes.¹⁶ The value of loans with arrears has also leveled off by late 2000 at about 21 percent of outstanding loans, as the effects of the crisis diminishes and the measures taken to improve collections takes effect. The loans in arrears are close to fully covered by the 19 percent loss provision on loans outstanding at the end of 2000. The ability of the loan portfolio to absorb loss provisioning is expected to improve significantly with the widening of ADB’s lending spreads, in line increased risk perceptions, for the post-crisis loan approvals. Undisbursed loan commitments of $376 million, mostly to infrastructure projects and accounting for about half of the total loan portfolio at the end of 2000, have such wider spreads.¹⁷ When drawn, these higher-margin loans are expected to improve the profitability of the PSO loan portfolio.

20. Equity Investments. Since 1994, the equity component of the total PSO portfolio has increased steadily, reflecting the increased demand for risk capital in the region. The portfolio share of equity investments¹⁸ increased from 25 percent in 1994 to nearly 42 percent in 1997, but have slowly dropped to 36 percent by 2000 following a deliberate decision by PSG to reduce exposure to equity risk by, for instance, avoiding investments in the equity capital of borrowing infrastructure projects. ADB’s equity investments are often in the currency of the host DMCs but funded mainly with and accounted for in United States (US) dollars, so these investments are vulnerable to exchange rate fluctuations.¹⁹ The rapid depreciation of the local currencies during the Asian financial crisis, coupled with a general decline in market prices of listed securities, adversely affected the value in US dollar of ADB’s equity portfolio (in common with other investors in the region). While the depreciation of local currencies against the dollar has slowed, it is unlikely to reverse significantly in the near term; however, eventually the unrealized exchange losses may be offset by gains in the value of the underlying investment.

21. Overall, losses incurred in weak and failed equity investments have been amply compensated for by substantial capital gains and dividends that ADB enjoyed on its profitable ventures. For instance, during 1983-2000, ADB realized net capital gains of $77 million on divestments²⁰ and received dividends amounting to $67 million from well-performing investee companies. These totaled $144 million, which was more than sufficient to offset the $55 million in net unrealized losses²¹ and $50 million in specific provision on the equity portfolio at the end of 2000. However, against the cost of funding, ADB’s equity investments have so far fallen short of providing sufficient returns.

22. Investment Funds. Based on a review completed in early 2000,²² ADB had achieved a compounded annual rate of return of 6 percent from investment funds up to the end of 1999. This return includes dividends received and net realized capital gains made on redemption or divestment of ADB’s shareholdings, as well as net unrealized gains due to both regional currency movements against the US dollar and asset price fluctuations in capital markets.

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