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p. 8 of 14 BACK | NEXT The need for a strategy The strategy Overview Strategic thrusts Operational priorities Country-specific strategies The required internal changes The implementation plan

Private Sector Development Strategy : The strategy

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Operational priorities

The 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:

1. governance in the public and private sectors;
2. financial intermediation;
3. public-private partnerships; and
4. regional and subregional cooperation.

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

Governance in the public and private sectors

Public sector governance. Effective governance is essential for the encouragement of private sector investment. There is no greater disincentive to business than the added cost and feeling of uncertainty and vulnerability brought about by corruption, abuse of discretion, and bureaucratic interference. Improving the efficiency of public administration and the accountability and transparency of government actions is essential to improve the climate for business and sustain development in the region. Improving public sector governance has been a major development objective of ADB since 1995. Depending on the need of specific DMCs, the areas that ADB can consider for assistance include:

1. strengthening the rule of law through legal and judicial reforms;
2. establishing and maintaining effective and equitable taxation systems;
3. formulating sound and transparent sectoral regulations;
4. strengthening public administration;
5. fighting corruption;
6. removing impediments and reducing transaction costs; and
7. establishing efficient and competitive markets supported by appropriate fiscal, monetary, and trade policies.

ADB TA will also be needed for capacity building to educate and modernize the bureaucracy and agencies that regulate and supervise the private sector in the DMCs. A lesson learned in law and judicial reform is that a holistic, comprehensive approach is crucial as piecemeal interventions do not work. Overall, ADB will help ensure that economic management in the DMCs maximizes and fairly distributes the benefits of economic growth.

Commercialization and privatization. A key dimension of effective public governance relates to the efficient deployment of public funds. Reform of public resource management requires actions to improve efficiency of state-owned enterprises and relieve budgetary pressures from their subsidy and investment needs. This typically involves commercialization (restructuring to achieve cost-recovering operations) as a first step, followed by restructuring the entity into a corporation (giving full financial autonomy under government ownership), and finally privatization (involving private sector participation). Privatization does not always mean divestment of government ownership to the private sector; it can also be done by contracting out enterprise operations, partly or wholly, to the private sector through management contract, asset leasing, or concession.

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

Many DMCs that are inclined to privatize, face severe capacity constraints to meet the challenges of privatization. ADB can help by providing technical advice, particularly in defining sound privatization strategies, establishing and implementing effective privatization programs, designing and operating sound postprivatization regulatory frameworks, and undertaking individual transactions transparently and professionally. But ADB assistance must explicitly require transparency in implementing privatization transactions, establishment of an appropriate tariff policy, protection of workers’ legitimate interests in the transition of ownership, as well as financial market regulations that adequately protect the interests of small investors (including those investing under employee stock ownership plans). As experience has shown, successful privatization requires effective consideration of the interests of all stakeholders. Labor retrenchment, in particular, presents significant social costs, and ADB will help establish social safety nets to address this issue. At the enterprise level, ADB will consider direct financial assistance to the projects resulting from privatization programs supported by ADB and/or other multilateral development banks. Equity investments may also be considered in state-owned enterprises to facilitate or initiate privatization through divestment of government-owned shares or issuance of new shares to broaden ownership.

Corporate governance. Just as good governance is essential in the public sector, so is quality corporate governance essential in the private sector. A systemic failure of corporate governance, as seen in the recent Asian crisis, can have pervasive consequences that place an undue burden on the shoulders of the poor. For individual enterprises, sound corporate governance provides confidence to lenders and investors, and facilitates access to lower cost capital. The development of the domestic capital market often hinges on the existence of a corporate governance culture that ensures voluntary compliance through effective regulatory enforcement. In most of the DMCs, the root causes of poor corporate governance have to be addressed to sustain recovery and growth. Through TA, ADB can help to review commercial laws and regulations and establish:

1. credible accounting and auditing standards;
2. timely and accurate disclosure rules;
3. sound environmental, labor, and social standards;
4. provisions for adequate protection of minority shareholder rights; and
5. effective bankruptcy and foreclosure regimes.

ADB can also help train corporate directors on their duties and responsibilities, and on how they can be effective in balancing the interests of shareholders with those of other stakeholders—employees, customers, suppliers, investors, communities—while maximizing value. In PSO, ADB must invest only in companies that can demonstrate the capacity to establish and maintain sound corporate governance structures and practices. More proactively, ADB must diagnose the quality of corporate governance in its investee companies, 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 promoting corporate responsibility to maximize the opportunity for companies to integrate social and environmental awareness into core business practices and make private investment more sustainable.

Financial intermediation

Well-functioning financial systems are critically needed to promote the private sector. Many DMCs need to strengthen their financial institutions and create diversified financial markets to develop the domestic capacity to finance private sector-led growth. Properly functioning capital markets are needed for effective privatization programs—to facilitate sale of government-divested shares, ensure fair and transparent share pricing, enable wide ownership of privatized shares (thereby enhancing political acceptability), and provide resources for modernization and expansion of privatized enterprises. In a financially integrated world, robust and well-regulated banking systems and financial markets, coupled with sound macroeconomic management, are necessary to reduce the risk of instability associated with sudden outflows of short-term capital. One advantage of the region is that many of the DMCs have substantial domestic savings that, if channeled through well-functioning capital markets, could help the private sector avoid excessive reliance on external finance and the concomitant exposure to exchange risks. ADB has the capability to address intermediation challenges, having undertaken financial sector reform programs through public sector operations and/or direct investments in financial intermediaries through PSO in several DMCs.

Financial institutions and markets. Under the strategy, ADB will continue its support for policy reform and institutional capacity building to strengthen the DMC's financial systems. Using TA and program loans, ADB will focus its assistance on government efforts to enhance regulation and supervision, develop sound banking systems, deepen and broaden securities markets, and create bond markets. Support will also be given for the development of mortgage markets to facilitate housing finance, and the reform of pension and insurance systems to develop sources of long-term capital. In PSO, ADB will complement funding with capacity building and governance strengthening for institutions such as banks, insurance companies, leasing companies, securities firms, and pension fund management companies, incorporating best practices and sound management. ADB can also arrange for the participation of a strategic partner in an institution to facilitate capacity building. The availability of credit information on borrowers and securities issuers is crucial to the functioning of credit markets; this will require establishing rating agencies and credit bureaus, which ADB can promote and catalyze as it has done in India, Malaysia, and Thailand. Preference will be given to supporting institutions that can serve as role models in the process of rehabilitating the financial sector, as in the crisis-hit countries, or in commercializing and privatizing the state-owned banking system, as in the transitional economies.

Progress thus far in bank restructuring in the crisis-hit and other DMCs is encouraging. But corporate sector reforms are lagging. If the banking system is to achieve full recovery, the performance of corporate borrowers must be improved. Progress to date has been achieved mainly in strengthening of insolvency laws, including bankruptcy and foreclosure procedures, which ADB has addressed and will continue to support through its public sector operations. ADB will also support the work of government restructuring agencies using TA. Actual corporate restructuring (through mergers and acquisitions, for example) and corporate debt restructuring have been limited. ADB will selectively catalyze such efforts through PSO in partnership with institutions that have the necessary expertise.

Restructuring the banking system provides an excellent opportunity to transform banks into instruments of effective intermediation in support of labor-absorbing growth. One difficult issue that will need to be addressed in the process is the extent to which targeted or policy lending should be used to channel funds to special needs, especially those of the poor. Most countries have found that it is best to strictly limit such guided credit, to provide it primarily for social purposes, and then at unsubsidized rates. The evidence is strong from many countries that the poor benefit most when they have access to unsubsidized credit. With subsidies, the coverage of credit programs is necessarily quite limited, and the affluent tend to squeeze out the poor for the subsidized funds.

Local currency financing. Foreign borrowings by domestic private firms result in a currency mismatch that cannot be easily hedged if the borrowers earn revenues in local rather than foreign currency. Failure to mitigate the risks associated with such an imbalance was one of the underlying causes of the Asian financial crisis. ADB will continue to address these risks by helping DMCs to develop diversified domestic capital markets, as well as markets for currency swaps and other hedging instruments. But this is a long process. To be more proactive in the interim, ADB will investigate the possibility of raising local currency debt in selected DMCs for its general operational requirements as well as for relending to domestic borrowers (e.g., infrastructure projects and financial institutions supporting SMEs). In addition, ADB will try to provide partial credit guarantees to enable domestic companies and institutions to directly source local currency financing through loans or bond issues and, in some cases, stretch the maturity and reduce the cost of such financing. Local currency bonds issued by ADB and those issued by domestic entities with ADB guarantee will be designed to transfer technology and add value to the domestic bond markets by supplying high-quality debt instruments that conform to global standards for, among others, syndication, pricing transparency, and secondary market liquidity. Similarly, ADB guarantees on local currency loans will help develop a corporate credit pricing curve and foster long-term lending operations among domestic financial institutions.

Investment funds. The potential size of long-term resources that can be mobilized by ADB through funds could be quite large considering its coinvestment experience to date with major pension funds and insurance companies. Investment funds enable ADB to leverage its own scarce capital much more than in other operations. In addition, the accumulated experience from ADB's sizable portfolio of investment funds (29 funds since 1983) represents an important resource base. ADB will tap the firsthand knowledge of its fund managers to identify pressing constraints to private sector development in DMCs where they operate.

Catalyzing funds is a core competence of PSO. To ensure that future funds seeking support are strategically aligned with ADB's development objectives, ADB will take more active involvement in designing investment funds, formulating the funds’ investment objectives in terms of country and sector focus, and working more closely with like-minded, governance-conscious institutional investors. Building on past experience, ADB will explore the possibility of new types of specialized funds to help finance the region’s investment needs, e.g., debt funds, microequity funds, SME funds, environment funds, governance funds, corporate restructuring and recovery funds, agribusiness funds, and internet and technology funds. To be effective in launching new funds, ADB must continue to build contacts with institutional investors from the capital-surplus countries.

Small and medium-sized enterprises. At the user end of financial intermediation, ADB’s focus will be on, among others, SMEs, which are a major generator of employment and income needed to achieve poverty reduction. Assistance to SMEs under credit lines has not been totally satisfactory, and lessons learned will need to be incorporated in the use of financial intermediaries in future SME assistance programs. Direct SME assistance may also be required, for example, in the Pacific and 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 continue to be handled through investment funds and specialized financial institutions that are competent and properly equipped. ADB will also seek to cooperate with existing regional organizations, such as the South Pacific Project Facility, to stimulate private sector investment in the Pacific DMCs. While SMEs require capital, they are also in need of 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 consider technical and business advisory assistance to SMEs and/or continue to collaborate with organizations that are in a position to provide such support. Entrepreneurial education and business incubators will also be supported to help start up new SMEs. TA to governments will be provided to help develop a sound SME environment.

Due to difficulty assessing risks associated with SME credit, SME financing programs often face a dilemma between commercial viability, requiring collateral that most SMEs are unable to accommodate, and social development considerations, such as poverty reduction, that dictate liberal provision of credit to SMEs. One way to resolve the dilemna is to create state-sponsored credit enhancement schemes, such as small loan guarantee facilities for SMEs. ADB can support the establishment of such credit guarantee facilities, which may be partially funded by government and ADB. To ensure that due consideration is given to financial viability and that credit is not extended imprudently, lending institutions availing of guarantees must retain a share of the credit risk.

Public-private partnerships

The public and private sectors should complement each other in the overall development effort. Government efforts to form partnerships with the private sector will lower the risks and costs associated with investments, particularly for infrastructure projects. ADB can help identify the risks and costs associated with the present business environment, and support the development of workable public-private partnerships. The role of government in risk mitigation is crucial for early projects in a sector newly opened to private investment. Care must be exercised, however, in judging where the government’s development function should cease and market mechanisms and institutions can take on the usual project risks, and when continued support to encourage project financing is still warranted.

An effective consultative mechanism can help promote and sustain public-private partnerships in the DMCs to balance social and development goals with commercial interests. ADB will embark on a much more proactive set of initiatives aimed at promoting and brokering such partnerships, particularly in infrastructure development, and advising governments on ways to develop substantive partnerships with the private sector. ADB will also tap into the extensive pool of private sector resources available regionally and globally, and develop networks and relationships with key PSD stakeholders. Respected business leaders from DMCs and countries providing bilateral aid will be invited periodically to a forum to provide ADB with feedback on trends and developments in the private sector and exchange ideas on promoting pro-poor growth.

A big challenge, and opportunity as well, for both the public and private sectors is the effective use of information technology to facilitate development efforts and enhance private sector competitiveness. New computing technologies in telecommunications and multimedia applications, including the Internet, can and do change the competitive advantage of industries and provide new ways to reach out to a broader market. DMC governments can establish partnerships with the private sector to widen the use of information technology in delivering basic social services (e.g., distance education and telemedicine) and to help local enterprises increase their technological development. ADB should help DMCs to develop national policies and programs to accelerate the dissemination of information technology.

Public-private partnerships in physical infrastructure can take the form of BOT projects where there is a sharing of risks between the public and private sectors, with each risk being allocated to the party that can best manage it. The private parties involved in these projects normally assume the commercial risks that are under their control. ADB has achieved some success in using TA facilities to create and develop such BOT-type public-private partnerships in collaboration with DMC governments.⁸

Public-private partnerships can be enhanced when the private sector undertakes a BOT project and the government provides complementary support infrastructure (which may have too long a payback period to be commercially attractive), e.g., a breakwater to protect a BOT container port terminal, or transmission lines to evacuate power from a BOT generating plant. In such cases, ADB can also have a public-private partnership internally, with PSO providing direct assistance to the BOT project and public sector operations funding the 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 with air-side works undertaken by the public sector and land-side works by the private sector; (ii) a railway project with the public sector taking care of squatter relocation and grade separation, and the private sector undertaking the railway rehabilitation and operation; and (iii) a toll expressway undertaken by the private sector, with connecting provincial and rural roads provided by the public sector. Another form of public-private partnership is the export-oriented Theun-Hinboun hydropower project in Lao People’s Democratic Republic (Lao PDR), which was implemented as a joint venture between private sponsors and the Government. The Government’s equity contribution to the project was financed through an ADB public sector loan.⁹ The foregoing approaches to public-private partnership will be an increasingly prevalent way of doing business for ADB and call for close cooperation between public sector operations and PSO.

Catalyzing private infrastructure projects, a core competence of PSO, will be pursued under the strategy. ADB assistance for such projects will be provided through direct financing and risk mitigation, and through investments in specialized financial institutions and investment funds aiming to support private provision of infrastructure services. Priority will be given to those projects that have clear benefits to all segments of the community, including the poor.

Social infrastructure development. ADB will selectively assist DMCs to identify and develop opportunities by which the private sector can help deliver more effective social services such as education, health, nutrition, water supply, wastewater treatment, and solid waste management. An example of public-private partnership in social infrastructure development is where private operators supply in bulk treated water to public waterworks distribution networks. The use of information 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 the private sector to achieve more effective and efficient delivery of essential services, for example, by contracting out to the private sector the provision of publicly funded social goods and services. ADB must recognize, however, that private investors will be attracted to provide social services only if the expected financial returns meet or exceed their cost of capital, regardless of who pays for the services. Aside from education and health, ADB will assist in addressing shelter problems through transparent, efficient, and sustainable private sector-implemented housing and home ownership programs, involving government support where needed.

Agriculture and rural sector development. The DMCs’ agriculture sectors contain the single greatest concentration of private sector production. At the same time, the overwhelming majority of Asia's poor obtain their livelihood from agricultural production. Thus, ADB assistance in promoting public-private partnerships in agriculture can have a tremendous impact on poverty reduction in rural areas. For instance, a project in Papua New Guinea¹⁰ provides support for performance-based agricultural services on a contract basis and shifts the role of government agriculture agencies from directly providing extension services to managing service providers. To stimulate small rural nonfarm enterprises that can help raise incomes and improve the welfare of the poor, particularly for poor women, ADB can support the establishment of viable and sustainable microfinance institutions. ADB will continue to assist DMCs in establishing mechanisms to facilitate market determination of input and output prices; in developing public-private partnerships in the supply of agricultural inputs, particularly in fertilizer distribution and agro-processing industries; and in transferring the management of on-field irrigation systems to farmer groups. ADB can also help strengthen public capacity to deliver rural credit, extension, and research, and manage irrigation and natural resources. Measures to clarify land title and ownership will advance private sector development in rural, as well as urban, areas.

Regional and subregional cooperation

Regional and subregional cooperation has emerged as an increasingly important development strategy in Asia. Such cooperation offers larger markets that allow production economies of scale and efficient division of labor. Whereas in North America and Europe economic integration has involved formal regional cooperation arrangements (i.e., the North American Free Trade Agreement and the European Union), in Asia, economic integration has been driven largely by private sector initiatives, with governments playing an active, if largely informal, facilitating role. One recent example is the Private Sector Forum on Economic Cooperation in the Eastern South Asia Subregion (Bangladesh, Bhutan, Nepal, and 11 eastern states of India), which is being organized by the chambers of commerce and other representatives of the private sector from the concerned countries.¹¹ Indeed, the private sector has been both a prime mover and a prime beneficiary of regional cooperation in a widening network of intraregional investment and trade that is likely to outlive the Asian crisis.

Subregional cooperation, a key area of involvement for ADB, involves encouraging specific, limited linkages of complementary activities across borders to create a region or subregion of economic growth. Economic cooperation can make a subregion, as a whole, relatively more attractive to private investors by extending access to factors of production, production processes, products, and markets beyond national boundaries: it provides wider business opportunities that accelerate development. Since subregional cooperation programs often involve “lagging parts” of participating countries, they can also contribute to poverty reduction.

In this context, ADB will concentrate on facilitating investment in subregional infrastructure projects that provide essential means for trade and investment linkages. For investors, such projects represent new types of business opportunities—and new types of risks: their transborder nature requires appropriate mechanisms to support project preparation and financing. ADB will thus assist in preparing, financing, and providing risk management for subregional projects that involve private sector participation.¹²

Complementing this, ADB will continue to play a significant role by helping to address nonphysical barriers to the movement of goods, services, and people. Examples include initiatives related to trade and investment facilitation, and cross-border training and standards certification and accreditation. This focus will allow the realization of economic 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 excellence and clearinghouse for information and ideas on subregional cooperation at the policy, program, and project levels.

The experience of ADB in promoting regional and subregional cooperation is building up. A program of economic cooperation in the Greater Mekong Subregion, for example, was initiated in 1992 and the effort and resources devoted to the program appear to be paying off. A framework of cooperation in seven priority sectors in the subregion has been established and about 100 subregional projects have been identified and prioritized. ADB is also encouraging cooperation among the governments of People’s Republic of China, Kazakhstan, Kyrgyz Republic, and Uzbekistan. Projects are being designed 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 a subregional securities market.

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