|Project Rationale and Linkage to Country/Regional Strategy
Pacific island countries face significant and complex development challenges that constrain private sector growth. Challenges include the high cost of doing business, inadequate infrastructure, outdated legal systems, inadequate business and technical advisory services, and land rights issues. The financial sector is underdeveloped, with a low ratio of private sector credit to gross domestic product. Businesses of all sizes have difficulty securing commercial finance in the Pacific. Small and medium-sized enterprises (SMEs) are particularly affected, because commercial banks in the region extend little credit to this segment. Opportunities for businesses to raise additional capital through stock exchanges are also limited. There are no private equity funds in the region and no near-term prospects for new funds. Since 2010, the economic ministers of the Pacific Islands Forum have annually called on development partners to help increase access to finance for SMEs. The Government of Australia expressed interest in working with ADB to design innovative approaches to address the financing constraint faced by SMEs. ADB's Midterm Review of Strategy 2020 emphasizes ADB's intention to expand support for SME finance.
In 2013, ADB reviewed (i) private equity funds and other finance facilities in the Pacific, (ii) the financial sector and supply of and demand for business advisory services by country, (iii) the experience of hybrid risk finance and business advisory support facilities in other regions, and (iv) potential models for the Pacific region. The review found that to ease the financing constraint faced by SMEs, government and development partner efforts should aim to unlock the excess liquidity that commercial financiers have in almost all Pacific island countries. While commercial banks report an interest in increasing lending to SMEs, they remain hesitant. Their credit policies and products favor larger clients and short-term investments. The banks, which are highly risk averse, have expressed concerns over SMEs having weak internal management capacity (including limited financial management skills), as well as insufficient shareholder capital and acceptable collateral. Proposals put to banks by SMEs generally lack the rigor required from a business and financial plan. As a result, credit is often unavailable or unaffordable for SMEs at offered terms.
The TA's impact will be the sustainable growth of the private sector in selected Pacific island countries. The outcome will be commercially successful and sustainable SMEs in Pacific island countries. It is expected that (i) at least $15 million of additional finance will be leveraged from commercial sources; (ii) at least 100 supported SMEs will expand or diversify operations; and (iii) at least 1,000 jobs will be created or saved in supported SMEs.
Tailored business advisory services are needed to reduce financier concerns about SMEs' internal capacities. While these services are available in the larger Pacific island countries, their focus is on large, predominantly foreign-owned enterprises, governments, and development partners. In contrast, business development centers, where they exist, cater to microenterprises and informal sector operators. This leaves SMEs unserved. Building the managerial and technical capacity of these entrepreneurs is essential to improve the business risk profile with financiers. Further, in the underdeveloped Pacific financial markets, innovative financing arrangements are required to leverage and supplement commercial finance. These measures facilitate access to finance for SMEs to expand and diversify, and would absorb excess bank liquidity. They would complement ongoing private sector development and financial sector reforms, including secured transactions reforms, which will increase access to finance by SMEs over time, but will not alone bridge the financing gap.
Business financing and development programs have been implemented in the Pacific and other regions by bilateral development partners, development finance institutions, and private fund management companies for many years. The following lessons have been drawn from these programs: (i) managerial and technical advice to SMEs, pre- and post-finance, is essential for leveraging commercial finance; (ii) SMEs must contribute to the cost of advisory services to ensure buy-in, and must see the advice provided as independent, objective, and confidential; (iii) extensive collaboration with commercial financiers and other stakeholders is vital to achieve the intended impact and lower implementation cost; (iv) SMEs typically demand less than $300,000 in finance, which finance facilities with a commercial mandate have been unable to respond to effectively; (v) where finance is provided, self-liquidating instruments are preferred to prevent exit issues; (vi) expansion of existing businesses is less risky and more likely to succeed than establishment of new ventures; (vii) maintaining an in-country advisory presence in many countries is not cost-effective; and (viii) building in-country advisory capacity is usually not sustainable in the Pacific without continued donor support because of the small market size.