Special Evaluation Study

Reference Number: SST: REG 2006-06

May 2007

Private Sector Development and Operations:

Harnessing Synergies with the Public Sector

Operations Evaluation Department

 ABBREVIATIONS

ADB – Asian Development Bank

ADF – Asian Development Fund
AFTA – ASEAN Free Trade Area
ASEAN – Association of Southeast Asian Nations
BOT – build-operate-transfer
CAPE – country assistance program evaluation
CBP – country business plan
CEP – credit enhancement products
CFS – complementary financing scheme
CLASS – Comprehensive Loan Administration Servicing System
COSO – Central Operations Services Office
CPS – country partnership strategy
CSP – country strategy and program
DEC – Development Effectiveness Committee
DFI – Development Finance Institute
DFID – Department for International Development
DMC – developing member country
EBRD – European Bank for Reconstruction and Development
EIRR – economic internal rate of return
EVN – Electricity of Viet Nam
FDI – foreign direct investment
FIRR – financial internal rate of return
FSU – former Soviet Union
GCI – global competitiveness index
GDP – gross domestic product
GOCC – government-owned and -controlled corporation
HCMC – Ho Chi Minh City
ICT – information and communications technology
IEI – innovation and efficiency initiative
IFC – International Finance Corporation
IFI – International Finance Institution
IPP – independent power producer
LTSF – long-term strategic framework
MIC – middle-income country
MTS – medium-term strategy
MWSS – Metropolitan Water Systems Services
NAIA – Ninoy Aquino International Airport
NBFI – nonbank financial institution
NPL – nonperforming loan
OCO – Office of Cofinancing Operations
OCR – ordinary capital resources
OED – Operations Evaluation Department
OGC – Office General Counsel
PCG – partial credit guarantee
PCR – project completion report
PFI – private finance initiative
PIATCO – Philippine International Air Terminal Company
PPER – project performance evaluation report
PPP – public-private partnership
PRC – People’s Republic of China
PRG – political risk guarantee
PRISM – private investment securities management system
PSA – private sector assessment
PSCC – private sector credit committee
PSCM – Capital Markets and Financial Sectors Division
PSD – private sector development
PSDS – private sector development strategy
PSIF – Private Sector Infrastructure Finance
PSO – private sector operations
PSOC – operations coordination unit
PSOD – Private Sector Operations Department
PSP – private sector participation
RMU – Risk Management Unit
RR – risk rating
RSDD – Regional Sustainable Development Department
SAPE – sector assistance program evaluation
SES – special evaluation study
SEZ – special economic zone
SIDBI – Small Industries Development Bank of India
SME – small and medium-sized enterprise
SOE – state-owned enterprise
SPD – Strategy and Policy Department
TA – technical assistance
UK – United Kingdom
VAT – value-added tax
VCF – venture capital fund
VFM – value for money
WTO – World Trade Organization

WEIGHTS AND MEASURES

km – kilometer
MW – megawatt

NOTE

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

 Key Words
asian development bank, central asia, development impact, east asia, financial performance,
financial sector, india, infrastructure, investment climate, pacific, performance evaluation,
philippines, policy review, portfolio quality, private sector development, private sector
operations, public-private partnership, south asia, viet nam

Director General : B. Murray, Operations Evaluation Department (OED)

Director : R.B. Adhikari, Operations Evaluation Division 2, OED

Team Leader : B. Finlayson, Senior Evaluation Specialist,

Operations Evaluation Division 2, OED
Team Members : J. Dimayuga, Evaluation Officer, Operations Evaluation Division 2, OED
: R. Perez, Senior Operations Evaluation Assistant,
Operations Evaluation Division 2, OED

Operations Evaluation Department, SS-74

 GLOSSARY

Affermage – Concessionaire receives all the revenue and costs of the operation to
service their costs before passing residual on to owners. Managers
are provided with a relatively high degree of freedom to determine the
commercial strategy.
Complementary financing – CFS (or B loan) is available for private sector projects in which the
scheme (CFS) Asian Development Bank (ADB) is a direct participant by way of an A
loan. CFS loans are a form of syndication, which are funded by
commercial lenders with ADB acting as "lender of record." Although
CFS loans do not provide cofinanciers with recourse to ADB, these
loans enjoy the same privileges and immunities given to the ADB A
loan.
Development impact – In accordance with the Operation Evaluation Department’s guidelines
for evaluating nonsovereign operations, development impact is
evaluated according to (i) private sector development; (ii) business
success; (iii) economic development; and (iv) environment, social,
health, and safety performance.
Mezzanine finance – Mezzanine finance can be unsecured debt, or preference shares. This
type of funding offers a higher return than debt due to higher levels of
risk. However, returns are less than equity where returns are treated
as residual payments. Mezzanine finance tends to be used when
bank borrowing limits are reached and the firm cannot or will not issue
more equity.
Partial risk guarantee – The partial risk guarantee covers part of a lender’s outstanding debt
service against specific political risks. ADB’s Charter does not
authorize coverage of equity risks. Risks potentially can cover issues
such as breach of contract and currency inconvertibility.
Risk exposure – Risk exposure = probability of risk occurring x total loss if risk occurs.
Secured versus – The two main types of loans are secured loans and unsecured loans.
unsecured loans For secured loans, the borrower pledges some sort of collateral. The
bank may repossess the collateral if the loan is not repaid according
to the terms agreed to when the loan was taken out. Unsecured loans
do not require any collateral. Money is borrowed on the strength of the
borrower’s credit standing and ability to repay the loan using cash
flows from the project or from an independent source.
Subordinated debt – Subordinated debt, a form of mezzanine finance, is a term used to
describe debt that is unsecured or has a lesser priority than other debt
claims on the same asset. If the party that issued the debt defaults on
repayments, people holding subordinated debt get paid after the
holders of the senior debt. A subordinated debt carries more risk than
a normal debt, and earns a higher expected rate of return than senior
debt due to the greater inherent risk.
Syndication – Syndication is the private placement of debt (or equity) securities to
third parties. By employing debt syndication, several banks,
investment firms, or other companies share the profits and diversify
the risk of making a large loan. For ADB, syndications are used to
transfer some or all of the risk associated with its loans and
guarantees to its cofinancing partners, and include fronting (CFS),
non-funded risk participations, and sell-down arrangements.
Underwriting – In banking, underwriting encompasses detailed credit analysis
preceding the granting of a loan, based on credit information furnished
by the borrower. Underwriting also can refer to buying corporate
bonds, commercial paper, or government securities by a dealer bank
for its own account, or for resale to other investors.
 CONTENTS
Page

EXECUTIVE SUMMARY ii

I. INTRODUCTION 1
A. Background 1
B. Study Objectives, Scope, and Methodology 1
C. Report Structure 3

II. CONTEXT OF SUPPORT FOR THE PRIVATE SECTOR 4

A. Assessment of Trends in Private Sector Development 4
B. Objectives of ADB’s Private Sector Development Assistance 8

III. COUNTRY STRATEGIES AND ASSISTANCE 9

A. Strategic Objectives 9
B. Public Sector Operations 9
C. Private Sector Operations 22

IV. EVALUATION FINDINGS 36

A. Overview 36
B. Development Impact 37
C. ADB’s Investment Profitability 44
D. ADB’s Effectiveness 46
E. ADB’s Additionality 52

V. ISSUES AND RECOMMENDATIONS 54

A. Overview 54
B. Issues 55
C. Recommendations 64

APPENDIXES
1. Literature Review 65
2. Project Evaluation Reports 75
3. Country Case Studies: Comparison of Investment Climates 78
4. Country Case Study: Philippines 85
5. Country Case Study: India 95
6. Country Case Study: Viet Nam 106
7. PSOD Operational Review 114

Attachments: Management Response

DEC Chair Summary

The guidelines formally adopted by the Operations Evaluation Department (OED) on avoiding conflicts of
interest in its independent evaluations were observed in the preparation of this report. Before joining
OED, the director general of OED managed the Asian Development Bank’s operation in the People’s
Republic of China for 11 years; the director, OED2, was responsible for country strategy and
programming for Viet Nam (2003-2005); and the OED team leader responsible for preparing this
evaluation was a private sector development specialist for Central Asia. Rolf Westling and Cherry Ann
Santos, the consultants, might not necessarily agree with all of the views and conclusions presented in
the study. To the knowledge of the management of OED, potential conflicts of interest of the persons
preparing, reviewing, or approving this report were managed adequately.
 EXECUTIVE SUMMARY

Introduction. Research confirms a strong link between poverty reduction, economic

growth, improvements in the investment climate, and levels of private sector investment. In
2005, the Development Effectiveness Committee recommended that the Operations Evaluation
Department (OED) assess the strategic direction and performance of the Asian Development
Bank’s (ADB) private sector development and investment operations. OED has prepared this
Special Evaluation Study to determine: (i) the extent to which ADB is pursuing the correct
objectives; (ii) whether the efficiency and effectiveness of its operations to support the private
sector can be improved; and (iii) the extent ADB has been creating value in its private sector
development activities.

Context of ADB’s Private Sector Support. Over the last four decades, there has been
a dramatic shift in the way multilateral development banks operate. In the mid 1960s, there was
a lack of foreign currency capital in the Asia Pacific Region. Multilateral agencies such as ADB
were established to mobilize this capital from members of the Organization for Economic Co-
operation and Development and make it available through sovereign loans to developing
member countries. There is now tens of trillions of dollars in funds available in international
capital markets and regional banks. The main problem mobilizing funding in the Asia Pacific
Region is finding investment opportunities of an acceptable quality that balance risks and
rewards. Also, governments are withdrawing from direct provision of services and focusing on
strengthening the policy and regulatory environment for private sector. These developments
have meant that private sector is becoming an increasingly important client of ADB, and this is a
trend that is expected to continue for the foreseeable future.

In many cases, money is no longer the core product being sought from ADB.
Increasingly, what is being sought from ADB is support for building the enabling environment for
the private sector (e.g., rule of law; access to finance; appropriate police/legal/regulatory
frameworks) and lowering the risk associated with individual transactions through ADB’s
involvement. As a result, there has been a shift within ADB to create value for transactions by
providing more intangible services such as private sector development, knowledge transfer and
risk management. ADB is uniquely placed to provide this combination of services through its
base in the region, and presence of public and private sector operations under one roof,
creating a “one stop shop” for private sector development and commercial risk management
services. Fully exploiting this potential comparative advantage requires development of strong
synergies between the public and private sector parts of ADB.

ADB’s Strategic Direction. Given these developments, the promotion of the private
sector is an important strategic objective for ADB. It was one of three crosscutting themes
identified in the Long-Term Strategic Framework for 2001–2015. ADB’s Board of Directors
approved the Private Sector Development Strategy in 2000 to improve the integration of ADB’s
public and private sector operations. The 2001 Private Sector Operations: Strategic Directions
and Review recommended broadening the scope of private sector operations, increasing the
level of resources, and establishing a Private Sector Operations Department (PSOD).

The Private Sector Development Strategy defines ADB’s overarching framework for
private sector operations. It has three strategic thrusts: (i) creating enabling conditions for the
private sector and improving the investment climate, (ii) generating business opportunities by
considering the scope for public-private partnerships in ADB projects, and (iii) catalyzing private
investment through direct (equity and debt) and indirect (guarantees) financial participation in
 iii

private sector projects. ADB’s public sector operations were responsible for the first two
strategic thrusts, whereas PSOD took the lead in directly catalyzing investment. ADB’s country
strategies were meant to identify private sector development bottlenecks and issues that
needed to be addressed to facilitate public private partnerships. At the earliest stages of the
country strategy development process, private sector commercial cofinancing options were to
be considered as an alternative to the public sector as a means of funding prospective projects.

An important feature of the Private Sector Development Strategy was the need for
regional departments to use ADB’s country strategies to interlink public and private sector
planning and operational activities. Country-specific Private Sector Assessments were required
to be prepared to support that process. The evaluation found that, except in a few countries,
private sector development road maps were not included in country strategies, and the Private
Sector Assessments did not appear to have influenced significantly the preparation of country
strategies. OED has prepared nine Country Assistance Program Evaluations since 2000. A
review of these documents indicates that at the strategic level, ADB has failed to develop clear
programs in the country strategies for the development of synergies between public sector and
private sector operations. The vision of strong synergies between the public and private sides of
ADB set out in the Private Sector Development Strategy remains unfulfilled.

While the general lack of synergy between public and private sector operations is
disappointing, there have been some successes and progress is being made. ADB’s experience
in the power sector provides some examples of good practices that should be used in other
sectors. ADB has supported the restructuring of the power sector in many countries. An
important element of power sector reform is the creation of opportunities for private sector
participation in areas such as generation. Although reforms in most countries have been slower
than originally envisaged, progress is being made. Private sector investment in the power
sector, including in projects supported by ADB, has increased in the Asia and Pacific region.
PSOD financed energy projects have been successful. In some cases where problems arose
with tariffs for private financed projects, ADB was able to use its access to policy makers to
mitigate some of the negative financial consequences for its private sector clients through policy
dialogue. In comparison to the energy sector, apart from India, where the government is scaling
up private financing for airports and roads, progress on private sector participation in the
transport and water sectors has been limited.

In the finance sector, country evaluation studies indicate that small and medium
enterprise credit lines issued by government-owned development finance institutions have been
a common feature of ADB’s private sector enabling environment efforts. An analysis of OED’s
database on the performance of such institutions found that, excluding loans to Republic of
Korea and Singapore, the success rate was a low 38%. The OED analysis concluded that
generally ADB should not lend to government owned development finance institutions, and any
exceptions would need to be strongly justified.

In regard to individual projects processed by PSOD, a review of OED’s performance

evaluation reports from 1992 through to 2006 indicated a highly satisfactory project success rate
of 92%, which substantially exceeds the average success rate of evaluated public sector
projects of 64%. The success rate for private sector projects exceeds the 80% standard that
ADB uses as a benchmark defining satisfactory performance of projects. The OED evaluations
of private sector projects highlighted a range of issues such as lack of coordination between
public and private sector; lack of competition; tariff problems; need for foreign currency;
difficulties with exit; and, more recently, resettlement issues. A review of project completion
iv

reports prepared by PSOD found a similar set of issues. Most of these issues are related to
problems with the enabling environment and could only be resolved by policy dialogue
undertaken by ADB’s regional departments and the host country governments. Despite these
problems, the overwhelming majority of PSOD’s projects have been successful.

The ADB Task Force review of the Private Sector Development Strategy in 2006
reported on a wide range of problems implementing the strategy, including lack of focus in
ADB’s country strategies, weak screening and monitoring mechanisms at the strategic level,
and lack of development performance standards. The Task Force made recommendations to
address these issues. In response to these proposals, the Strategy and Policy Department
prepared a new set of guidelines for producing country partnership strategies in 2007. These
guidelines seek to reinforce the requirement that private sector alternatives be considered by
regional departments when preparing country strategy programs based on sector road maps.
While these changes are positive developments, the results of the evaluation suggest that, by
themselves, such procedural changes alone may not be sufficient to develop strong public and
private synergies within ADB. Organizational reforms within ADB may be needed if the rapid
realization of these synergistic benefits does not materialize.

Private Sector Operations. ADB began its Private Sector Operations in 1983 and
since 2003 the volume of PSOD transaction has grown substantially. Private sector transactions
are now an important feature of ADB’s operations, rising from 6% of ADB approvals in 2000 to
17% in 2006. A total of 22 private sector projects were approved in 2006 with a combined value
of $1.42 billion, including a $455 million complementary financing scheme facility. In recent
years, growth in private sector lending has been greatest in Bangladesh, India, Indonesia, the
PRC, and Sri Lanka. The sector orientation has changed as opportunities in infrastructure have
emerged. The share of infrastructure in ADB’s private sector portfolio increased from 25% at the
end of 1995 to 42% at the end of 2006. Power projects dominate ADB’s private sector
infrastructure portfolio. Most transactions have been in the form of senior debt (47%), equity
(20%), and complimentary financing scheme instruments (21%). ADB has made virtually no use
of subordinated debt instruments. The market demand for complimentary financing schemes
(where ADB acts as lender of record for third party commercial lenders) and guarantees has
been limited, although these are signs that demand appears to be recovering, at least for
complimentary financing schemes.

PSOD’s portfolio is profitable and quality appears to be satisfactory, although it is not yet
rated by an independent third party such as Risk Management Unit. The capacity of the Risk
Management Unit is still limited as it was only made independent in 2005. It is still in its initial
period of operations and procedures and there is insufficient skilled staff to meet the volume of
transactions. The Risk Management Unit requires further strengthening. PSOD has performed
well in growing its portfolio in recent years in response to increasing demands throughout the
Asia Pacific Region for non-sovereign support from ADB. While PSOD has been allocated
additional budgetary resources and the number of staff has increased, these changes do not
reflect growth in transaction volumes. In 2006, OED conducted a benchmarking review of PSOD
relative to International Finance Corporation and European Bank for Reconstruction and
Development, which confirmed that PSOD is significantly understaffed based on transaction
volumes and the size of the portfolio. The limited human resources constrain PSOD’s ability to
increase the volume and development effectiveness of its transactions, particularly in small
countries and in countries with challenging operating environments.
 v

Evaluation of Private Sector Development and Operations. Following the criteria in

ADB’s Guidelines for Preparing Performance Evaluation Reports on Nonsovereign Operations
approved in 2007 (the Guidelines), private sector development and operations was evaluated
under four main criteria: (i) development impacts, (ii) ADB’s investment profitability, (iii) ADB’s
effectiveness, and (iv) ADB’s additionality (the extent to which it is creating value). The
evaluation applies to both ADB’s private sector development activities and PSOD transactions.
Thus the evaluation ratings encompass both the activities of regional departments that took the
lead on the enabling environment and PSOD which pursued transactions. The evaluation draws
upon the results of a literature review, OED’s general body of evaluation evidence, an
assessment of ADB’s processes to formulate country strategies a review of the PSOD portfolio
and operations, and the findings of country studies in the Philippines, India and Viet Nam.

Private Sector Development and Operations was rated “satisfactory”. Investment

profitability and ADB’s additionality were rated “satisfactory”, while development outcomes were
rated as being on the margin of “satisfactory”. ADB’s effectiveness was “partly satisfactory”. The
lower ratings reflect the fact that ADB has not realized its full potential to create synergies
between its public and private sector operations, rather than systemic problems with the PSOD
portfolio. ADB must strive hard to create these synergies to make full use of its potential to help
mobilize private sector resources to support socio economic development and to create the jobs
that are necessary to reduce poverty in the Asia and Pacific region.

Development Impact was evaluated using the following sub-criteria: (i) private sector
development, based on “beyond company impacts” (i.e., impacts of regional department
supported reforms on the enabling environment) and “direct company impacts” (i.e. impacts on
private investments supported by PSOD); (ii) business performance; (iii) economic
development; (iv) contribution to living standards; and (v) environmental sustainability.

Private Sector Development Impact was rated as “satisfactory”. In the 2006 Task Force
Review of the Private Sector Development Strategy was found to have not been successfully
implemented and this evaluation confirms those findings, especially in regard to ADB’s support
for the creation of an enabling environment for the private sector. While the regional
departments took the lead in this area, responsibility for this outcome rests with both the public
and private sides of ADB. They have not worked together sufficiently to develop the synergies
necessary to achieve a better development rating. The generality of the country private sector
assessments and country strategies and lack of specific sector road maps and performance
targets in the country strategies prepared by regional departments meant in many cases they
were not operationally relevant for private sector development initiatives or private sector
transactions. There was a general lack of coordination between the public and private sides of
ADB. Apart from the power sector, where unbundling reforms pursued by regional departments
created opportunities for private sector, a large proportion of public sector operations focused
on sovereign loans designed to provide outputs in response to perceived market failures, rather
than strengthening markets and creating entry points for PSOD transactions. Lack of feedback
from PSOD to regional departments on critical enabling environment constraints did not provide
a counterweight to this development. There was virtually no evidence that efforts were made
early in the country strategy process to consider commercial financing options as an alternative
to public funding. This was an explicit objective in the Private Sector Development Strategy.

More success has been apparent achieving positive direct company impacts in PSOD
projects, which were rated as “satisfactory”. The size of the PSOD portfolio has grown
substantially in recent years and it has diversified operations to some frontier countries,
vi

rebalanced operations towards infrastructure projects, and created alliances with other
agencies. Offsetting these results, the volume of PSOD operations is still low and concentrated
in a small number of countries, relative to the International Finance Corporation. Weaknesses in
the enabling environment, where reform was under the control of the regional departments,
meant there has been a lack of progress diversifying into sectors such as roads and water due
to a shortage of well designed concessions issued in competitive markets. There has been
limited progress on the use of non traditional finance instruments such as complimentary
finance scheme instruments and guarantees. Project evaluations and annual and quarterly
PSOD reports confirm projects are profitable, deriving a business success rating of
“satisfactory”. Where available, self and independent project evaluation reports have indicated
that, in general, the social and environmental impacts results of PSOD infrastructure projects
were favorable, both leading to a “satisfactory” rating.

The second main evaluation criterion, ADB’s Investment Profitability was rated
“satisfactory” based on the good overall financial performance of the PSOD portfolio. Profitability
is essential for an investment to be sustained, as well as to protect ADB’s balance sheet. While
the portfolio is profitable, there is need to ensure that quality is protected over the medium term.
ADB’s non-sovereign portfolio exposure at the end of 2006 to equity was 35.4%, which appears
to be high for a bank. The portfolio exposure to the power sector was more than 40%, which
exceeds the new 30% sector exposure limit adopted in 2007. Following the Asian financial crisis
in 2000, 37% of the PSOD portfolio was rated as marginal or worse indicating that ADB should
not be complacent when it comes to risk management, particularly now that the size of the
PSOD portfolio is growing. Unexpected developments which are beyond ADB’s control can
affect the quality of the portfolio. While PSOD has informally applied a ceiling of 30% of the
PSOD portfolio for equity, consideration should be given to determining whether explicit
exposure limits should be adopted for types of funding modalities such as equity that are based
on formal risk management principles.

The third evaluation criterion, ADB’s Effectiveness, was rated “partly satisfactory”. This
result was due to partly satisfactory performance in (i) ADB’s corporate project screening,
appraisal, and structuring procedures, (ii) monitoring and supervising practices, and (iii)
satisfactory performance in its role and contribution in supporting private sector.

In regard to screening, private sector investments could have been targeted more
precisely to fit within clearly defined sector reform programs identified in country strategies. This
result arose due to weaknesses in the planning process led by the regional departments and a
lack of cooperation with PSOD which was meant to participate and help prioritize private sector
development activities and sectors of intervention during the formulation of country strategies.
The lack of full PSOD engagement at the country strategy and programming level meant that
public sector-led country programming missions were not subjected to any significant internal
pressure to consider alternative private sector modalities. ADB did not take any steps to
introduce project appraisal techniques to assess the value for money arising from public versus
private sector provision. These features, coupled with concerns about the uneven
concentrations in the PSOD portfolio, lead to the conclusion that a defined business planning
process would have helped the PSOD transactions better support ADB’s private sector
development objectives at a country level.

Between 1996 and 2005 there were a high number of project cancellations, especially in
countries such as India. Problems arose due to factors such as ADB’s high cost of funds and
problems with regulatory approvals. This experience indicates that there may be issues with due
 vii

diligence procedures. While these procedures do not appear to be resulting in projects with a
high level of credit risks, the large number of cancellations undermines the efficiency and
effectiveness of PSOD’s operations. Some sponsors interviewed by OED voiced concerns
about the lengthy turn around time ADB needed to complete all required internal procedures,
document transactions, and reach financial close and disbursement. These problems appear to
be arising due to the nature of ADB’s business processes that largely reflect a public sector
mentality and a lack of harmonization with other international finance institutions in areas such
as safeguard policies.

There are concerns about structuring projects, both in terms of the type of assets that
are selected by ADB and the financial structures that are provided. This problem is primarily due
to ADB’s lack of involvement in advisory work at the initial industry restructuring and project
design stages, and preparation of bid documents. These activities have been the responsibility
of the regional departments, and it has had the effect of dislocating PSOD’s business process.
Following the Asian financial crisis, it became apparent that concession agreements in sectors
such as power, roads and water have sometimes allowed excessive levels of risks to be
transferred to the private sector in areas such as tariff, traffic and currency movements. Project
failures have effectively reduced the supply of private capital in these sectors. Because the
enabling environment has not been improved in the road and water sectors, PSOD has had
limited engagement in these sectors. Similar to infrastructure, PSOD does not have control over
necessary entry points in the financial sector, that could strengthen targeting and delivery of its
services. PSOD has not been provided with the mandate or the resources to introduce reforms
to ensure property and financial rights are capable of being enforced and provide a catalyst for
financial intermediation.

In regard to funding structures, high levels of equity, and limited use of subordinated
debt and guarantees do not appear to be optimal structures. Hybrid forms of finance such as
subordinated debt would help address the risk capital needs of clients without compromising
ADB’s exit options and the need to earn an acceptable return. A fundamental issue is the lack of
use of complementary financing scheme and guarantee instruments that can be used to
mobilize private resources by mitigating political and credit risks. Guarantee instruments can
potentially utilize ADB’s capital far more efficiently than conventional debt and equity to mobilize
private investment. While PSOD must respond to the demands from its clients when structuring
funding facilities the use of guarantees should be encouraged wherever possible. While PSOD
is investigating ways of strengthening its guarantee capacity, there has been insufficient
progress to date.

PSOD, and more generally ADB, have made progress developing sources of local
currency finance. However, there continue to be concerns about pricing of ADB’s private sector
funding facilities as there is a lack of information on the costs of doing business. PSOD’s
financial instruments are priced exclusively by reference to the market. It is difficult to achieve
an efficient result with this procedure as there is often a lack of market comparators, there are
yield curve effects, and risk return effects. The lack of cost data means it is difficult to determine
when prices are genuinely market based and financially sustainable for ADB.

Monitoring and supervision have suffered from weaknesses in the organization structure,
which is an area that is largely beyond the control of PSOD and responsibility sits with ADB
Management. The organization structure, where PSOD reports to Vice-President (Operations
1), does not facilitate effective and efficient project design and administration. The current
arrangements introduce unnecessary geographic and administrative barriers and distort
viii

management incentives. The combination of project origination and project monitoring

responsibilities within PSOD distorts incentives and despite an increase in staff, there is
insufficient staff to perform its responsibilities. The lack of an in-country presence for PSOD in
most resident missions undermines business development opportunities and places ADB at a
competitive disadvantage vis-à-vis other multilateral agencies. PSOD’s interface with the Office
of Cofinancing Operations (OCO), which reports to a different Vice-President has been
problematic.

PSOD would benefit from additional staff with skills in areas needed to define
and monitor developmental and socioeconomic impacts of transactions, portfolio management,
and management reporting capacity. Reporting systems do not provide a clear indication of
development and financial performance or critical risks. Similar to public sector projects, virtually
all the private sector project approval documents evaluated during the review period lacked
performance indicators. Although PSOD introduced annual reports for monitoring projects in late
2005, only a small proportion of projects has been subject to a full review at this stage due to
staff shortages and weakness’ in portfolio management systems. Additional investment is
required in information systems as the existing systems are manual in many cases, based on
distributed systems, and are not secure, creating risks of errors and omissions.

Role and Contribution is concerned with the extent projects complied with ADB’s
strategies, policies and standards. The rating for this criterion was satisfactory. ADB’s presence
in transactions is clearly valued by private sector. PSOD was complimented by sponsors on a
number of occasions on its efforts to establish standards of high corporate governance in both
infrastructure and financial sector projects. In cases when projects encountered difficulties
related to government actions, sponsors particularly appreciated ADB’s ability to access senior
decision makers, in the role of an honest broker, to help resolve the problem. In discussions
with various sponsors, they valued the endorsement of project quality that arose through ADB
participation, especially in areas such as social and environmental safeguards. At the same
time, there was sometimes a lack of clarity in ADB’s documentation about why PSOD was
involved in particular transactions and the development results that were to be achieved.
References to the country strategy for project justifications are often based on general
statements such as a need to increase private sector participation in infrastructure, or
strengthen financial intermediation. Reports and Recommendations of the President on project
proposals present multiple objectives. There is also a lack of clarity on what is required from
ADB’s safeguard policies and standards which have been changing over time and are not
harmonized with other international financial institutions or local government regulations.

The fourth evaluation criterion, ADB’s Additionality, has been evaluated along two
dimensions: (i) ADB’s contribution to improving design and functioning of the private sector
projects; and (ii) the extent ADB helped support the realization of the projects and mobilized
private finance, either directly or indirectly. Additionality was present to a material degree in the
majority of the ADB-supported private sector projects that were reviewed. However, a rating of
“satisfactory” rather than “excellent” has been assigned to this criterion due to the lack of ADB
involvement in project design. Given staff shortages, PSOD must largely respond to proposals
submitted by project sponsors. Although there have been a few noteworthy exceptions,
generally neither the public nor private sides of ADB are involved at the very early phase of the
project cycle to identify and design transactions that maximize development impacts. Due to
PSOD’s limited capacity to pursue enabling environment reforms it operates in a reactive rather
than proactive fashion. PSOD would benefit by scaling up its market presence in resident
missions, and strengthening its access to technical assistance resources to initiate enabling
 ix

environment reforms on its own account. In terms of supporting investment, sponsors provided
encouraging feedback about the benefits of their involvement with ADB. Some sponsors
considered ADB’s involvement essential as a means of enhancing creditworthiness and
catalyzing commercial funding. ADB’s relatively long maturities and grace period were well
suited to infrastructure financing. ADB participation provided an important means of ameliorating
political risk, especially for tariffs in the power and energy sectors. While private sector projects
demonstrate high leverage relative to public sector projects in terms of mobilizing $6.70 dollars
of private investment over the period 1996 – 2006 per dollar of ADB funds invested or loaned,
the level of resources mobilized to date seems modest relative to the potential.

Issues and Recommendations. Despite strong growth in the size of the PSOD
portfolio, many DMCs are complaining that ADB is not responding adequately to this demand. In
most countries in the Asia Pacific Region, the private sector’s role in financing, managing, and
delivering services has increased, particularly in sectors such as finance, energy, transport, and
water utilities. Governments are shifting their operational focus to policy and regulatory
functions. This trend requires changes in the scope of ADB’s operations, as well as greater
synergy between public and private sector operations. As discussed in the ADB’s Medium-Term
Strategy II, for 2006–2008, and the presentation of the Private Sector Development Strategy
Task force to the Board in 2006, PSOD’s role within the context of ADB’s overall operations is
expected to grow substantially over the next 5 years. The final report of the 2007 Eminent
Persons Group confirmed this view. It highlighted the importance of economic growth, public
private partnerships in infrastructure, and the need to strengthen financial intermediation. This
vision requires changes in the roles, products, responsibilities, and organization structure; the
level and type of resources; and ADB’s organizational structure related to private sector
operations. This type of change will not be straightforward. ADB has struggled to find ways of
merging public and private sector operations since the early 1980s as it requires changes in
culture, organization structures and strong leadership from Management. It is a particular
challenge to graft a private sector culture into an organization like ADB that is dominated by a
public sector culture. Many corporations involved in merger and acquisition activities have found
that merging different corporate cultures is a difficult exercise. It is not surprising that ADB is no
exception in this regard.

This evaluation is the first of four related studies. It will be followed by OED reviews of (i)
investments in private equity funds, starting in 2007, (ii) private infrastructure portfolio in 2008,
and (iii) the effectiveness of strategies for developing an enabling environment for the private
sector in 2009. Together, these four evaluations will provide a comprehensive assessment of
ADB’s private sector operations, and its efforts to improve the business climate in DMCs. Within
this context, this evaluation has found that at the corporate level, ADB needs to look at the
organizational effectiveness to ensure optimal efficiency in its business procedures and delivery
of services. At the departmental level, ADB needs to develop country level business plans within
the framework of country partnership strategy for its private sector operations and medium term
strategic plans. There are opportunities to further harmonize operations with other similar
multilateral development agencies in developing/fine-tuning guidelines and practices for
preparing country and departmental level business plans and implementing environment and
social safeguard policies and procedures. ADB’s aspirations for expanded private sector
operations should be accompanied by the resources required to achieve this goal. The following
key recommendations are put forward for Management consideration. Further details on these
recommendations are presented in the main text of the report (Chapter V).
x

Recommendation Responsibility Timing

1. Corporate Level:
(i) Assess the need for changes in organizational structure BPMSD with SPD, 2009/10
supporting Private Sector Operations and Private Sector RDs, OCO, and
Development activities such that the potential synergies of PSOD after
the public and private sectors working together are more completion of the
effectively captured. LTSF review

(ii) Establish a permanent unified credit committee that is VPs and Managing 2008
supported by a permanent independent secretariat. Revise Director General
credit committee operations so that it considers risks and
returns of transactions. Encourage a more direct and frank
exchange of information by meeting on a regular basis, and
review projects from concept clearance stage.

(iii) Strengthen the Risk Management Unit in anticipation of a VPs and Managing 2008 and onwards
significant increase in non-sovereign lending. Director General

(iv) Develop a corporate management plan covering a five PSOD, RDs, SPD, 2009
year period that aligns resources with aspirations to expand and BPMSD
private sector operations, including details on necessary
administrative budget, technical assistance resources, staff
skill mix, and strengthening supporting functions of risk
management and commercial co-financing. Introduce
balanced scorecard framework for assessing achievements in
private sector operations, drawing on the experience of other
similar multilateral development agencies.

2. Department Level:
(i) Prepare country business plans for delivering private PSOD and RDs Beginning in 2008
sector operations and private sector development related
outputs in the country partnership strategy framework

(ii) Develop and implement a medium term strategic plan, PSOD and BPMSD 2008
including new products for supporting private sector and non-
sovereign clients, monitorable results indicators, and
resource requirements.

(iii) Prepare and implement integrity due diligence guidelines PSOD and OAGI 2008
for private sector operations that form part of ADB’s
anticorruption policy framework encompassing various
aspects of corruption, including fraud, money laundering, and
financing for terrorism.

ADB = Asian Development Bank; BPMSD = Budget, Personnel and Management Systems Department; LTSF =
Long-Term Strategic Framework; OCO = Office of Cofinancing Operations; OAGI = Office of the Integrity Division;
OED = Operations Evaluation Department; RD = Regional Department; RMU = Risk Management Unit; SPD =
Strategy Policy Department; VP = Vice President.
Source: Operations Evaluation Department Staff Evaluation.

Bruce Murray
Director General
Operations Evaluation Department
 I. INTRODUCTION

A. Background

1. The private sector is widely regarded as the engine of economic growth and job creation,
and thus a major contributor, albeit indirectly, to poverty reduction in the Asia and Pacific region.
The growing recognition of the important role of the private sector in reducing income poverty
has led to strategic changes within international financial institutions, including the Asian
Development Bank (ADB). International Financial Institutions (IFIs) realize that to provide better
services to their clients and increase the probability of achieving development results, they must
move away from providing funding to the private sector through state-owned development
finance institutions, sharpen the focus of their private sector strategies on strengthening the
enabling environment, and increase investments funded through their private sector operations
(PSO).

2. ADB designed its 2000 Private Sector Development Strategy1 to help catalyze private
investment. The growth of ADB’s private sector transaction volumes has accelerated, especially
since 2003, reaching $1.5 billion in 2006—more than five times the annual average level of
approvals during the 1990s. For 2007, $1.87 billion in transactions are planned. The
Development Effectiveness Committee recommended in 2005 that the Operations Evaluation
Department (OED) assess the strategic direction and performance of private sector operations.
This evaluation is the first of four related studies. It will be followed by reviews of (i) investments
in private equity funds in 2007, (ii) the private infrastructure portfolio in 2008, and (iii) the
effectiveness of strategies for developing an enabling environment for the private sector in
2009. Together, these four evaluations will provide a comprehensive assessment of ADB’s
private sector operations, and its efforts to improve the business climate.

B. Study Objectives, Scope, and Methodology

3. The Private Sector Development Strategy was meant to help realize ADB’s pro poor
growth objectives and catalyze private sector development (PSD) and private sector investment.
To capture the effects of this strategy, operations were evaluated over the period 1995 to 2005,
five years before and five years after the policy was adopted. This evaluation is designed to
determine: (i) the extent ADB is producing the right outputs in its enabling environment and
related investments activities to achieve private sector development outcomes; (ii) whether
there are opportunities to improve the efficiency and effectiveness of its operations; and (iii) the
degree to which ADB’s private sector activities are adding value. The conceptual framework for
the evaluation is illustrated in Figure 1.

1
ADB. 2000. Private Sector Development Strategy. Manila.
2

Figure 1: Conceptual Evaluation Framework

Activities Outputs Outcomes Impacts

External Context Objective

Political will for reform, resource
endowments, macro stability, Is ADB doing the right To what extent is
openness to trade, extent of thing? ADB adding value?
privatization etc.

Implement Public
Sector Loans/TA –
Policy and Lower
Improve Enabling
Institutional transaction costs
ADB Prioritization Environment
Reform and risks Increased
Strategic selection of Competition
Direction PSD and Private
for PSD Projects Implement Non Investment
Sovereign PSO - Strengthen Better firm
Direct Firm Capacity decisions
Investment

Marketing and project origination Internal Context

capacity, project administration
systems, risk management and Is ADB doing things
reporting arrangements, skills and
number of staff etc. right?

ADB = Asian Development Bank; PSD = Private Sector Development; TA = technical assistance
Source: Operations Evaluation Department.

4. This conceptual framework forms the basis of the OED’s Guidelines for Preparing
Performance Evaluation Reports on Non-sovereign Operations (the Guidelines).2 The way the
evaluation issues map onto the criteria and sub-criteria defined in the Guidelines is presented in
Table 1.

2
The Guidelines are based on the harmonized Good Practice Standards for Evaluation of Private Sector Investment
Operations prepared by the Multilateral Development Bank-Evaluation Cooperation Group and were approved in
2006. Available: http://www.ADB.org.
 3

Table 1: Evaluation Framework and the OED Evaluation Guidelines

Key Questions of the SES: Evaluation Criteria based on the Guidelines:

Is ADB doing the right thing? Development impact:
• Sustainable private sector development
• Business performance
• Economic development
• Contribution to living standards and environmental
sustainability
Is ADB doing things right? ADB’s investment profitability, measured by returns from projects
ADB’s operational effectiveness:
• At entry screening, appraisal and structuring work
• Monitoring and supervision quality
• Role and contribution
Is ADB adding value? ADB’s additionality in terms of improving design and functioning of
private sector operations and finance mobilization
Source: Evaluation Approach Paper, Operations Evaluation Department.

C. Report Structure

5. Chapter II provides the context for the evaluation. The findings of a broad-based
literature review are presented, identifying trends in private sector investment in ADB’s
developing member countries (DMC) and important issues. The objectives of ADB’s overall
assistance program are presented to help clarify the scope of private sector development
activities generally.

6. Chapter III reviews trends in ADB’s technical assistance (TA) and public sector lending
programs, and levels of private sector development activities. ADB’s process for coordinating
policy dialogue, and preparing private sector assessments and country strategies, is reviewed.
Issues that have emerged from previous ADB evaluation studies at the country, sector, project,
and thematic levels are discussed. The operations of the Private Sector Operations Department
(PSOD) within ADB is reviewed, identifying strategic objectives, trends in approvals, geographic
and sector coverage, use of various financial instruments, and portfolio quality. Organization
structure, level and type of resources, and reporting and risk management systems are
reviewed.

7. Chapter IV appraises ADB’s private sector development program, investments and

loans, using the four private sector evaluation criteria: (i) development impacts; (ii) ADB’s
investment profitability; (iii) ADB’s effectiveness; and (iv) ADB’s additionality. Chapter V
summarizes the issues arising from the analysis and provides recommendations for
strengthening ADB’s operations to help develop the private sector in the future. The detailed
findings of the literature review, project evaluation reports, country case studies and the
operational review of PSOD undertaken by OED in 2006 are presented in the appendixes.
4

II. CONTEXT OF SUPPORT FOR THE PRIVATE SECTOR

A. Assessment of Trends in Private Sector Development

1. Background
8. A literature review (Appendix 1) found that over the past decade important shifts have
occurred in the views on the best ways for IFIs to support (i) economic development, especially
in middle-income countries; and (ii) the private sector. Poverty reduction became the primary
objective of many IFIs. The important role that economic growth, job creation, and private sector
participation play in reducing poverty has been increasingly recognized.

9. In the mid-1990s, the World Bank presented evidence on the substantial costs that
state-owned enterprises (SOEs) impose on countries due to poor incentives, monopoly powers,
and preferential access to finance that crowded out private sector. Further, it highlighted the
importance of privatization as a means of supporting economic growth.3 Subsequent studies4
found that aid in the form of money has a material impact only if it is provided in the context of
good institutions and economic policies. Studies5 have confirmed the central role that the private
sector plays in supporting growth, generating jobs and tax revenue to fund the provision of
essential public goods. Evidence demonstrated strong links between poverty reduction,
economic growth, and private sector development.6 Studies found that countries with higher
levels of private sector investment experience higher rates of growth.7 In 2006, a British report
confirmed the validity and importance of these objectives, and published findings showing the
high correlation between growth and poverty reduction. The report noted the private sector is a
key driver of growth by creating jobs and higher wages. A vibrant private sector increases
national savings, enhances the national tax base, allows higher public spending on basic
services such as health and education, strengthens civil society, and encourages broader
participation in national development.8

10. The encouragement of private investment from foreign and domestic sources has been
an important feature of development since the early 1990s. In the 1990s, foreign direct
investment (FDI) in infrastructure projects with private participation grew dramatically—in Latin
America, sub-Saharan Africa, and Asia and the Pacific. Private investment in projects totaled
almost $500 billion from 1990 to 1998, peaking in 1996 and 1997.9 Developing countries
benefited from project finance as a means of financing mining, oil, and gas projects. The use of
project finance applications was broadened in the 1990s to include infrastructure, particularly
power and telecommunications projects, and a small number of water, sewerage, and transport
projects. The type of private participation varied by region. In Latin America and Central Asia,
divestiture, often accompanied by market structure and regulatory reforms, was the preferred
option. In contrast, new project investments were more common in East and South Asia—for

3
World Bank. 1995. Bureaucrats in Business. The Economics and Politics of Government Ownership. Washington,
DC.
4
World Bank. 1998. Assessing Aid—What Works, What Doesn't, and Why. Washington, DC.
5
Dollar D. and A. Kraay. 2001. Growth Is Good for the Poor. World Bank Development Research Group
mimeograph. Washington, DC.
6
United Nations Development Program. 2004. Unleashing Entrepreneurship. Commission on the Private Sector and
Development. New York.
7
Bouton, L. and S. Mariusz. 2000. Trends in Private Investment in Developing Countries: Statistics for 1978–1998.
Discussion Paper 21. International Finance Corporation. Washington, DC.
8
House of Commons, International Development Committee. Private Sector Development, Fourth Report of Session
2005-06, Volume 1. London.
9
PPI Project Database in Roger, N. 1999. Recent Trends in Private Participation in Infrastructure. Private Sector
Viewpoint Note No. 196. World Bank. Washington DC.
 5

example, pursuing independent power producers—without associated market reforms to

stimulate competition.

Box 1: Private Sector Participation and Poverty Reduction

Privatization has been a common modality used to promote economic growth and poverty reduction. However,
critics often have argued that restructuring and movements to cost recovery unfairly affect the poor. Conversely,
proponents of reform have argued that resources need to be freed up and used efficiently to allow them to
contribute to job creation, tax payments, and economic growth. Similarly, improvements in cost recovery will
enhance service delivery and access to critical services, and targeted payments can support the poor. A recent
review of privatization experience found the major infrastructure privatizations in Latin America generally
increased access to power, telephone, and water services, particularly for the poor. Privatization freed up 1–2%
of gross domestic product, providing governments with 5–10% additional revenue. On the other hand,
privatization generally was carried out without considering its potential to reduce inequality. Reform focused
mainly on reducing the burden of losses to the state, and on attracting new investment. In the transition and Asian
economies, the experience has been more mixed, and distributional debates typically focus on infrastructure. In
many cases, independent, accountable regulatory regimes were lacking. Evidence indicates that better regulatory
regimes—in law and in practice—produce better distributional outcomes of privatization. A practical implication of
this finding is that selling governments should spend more time upfront creating and reinforcing regulatory
capacity, taking into account the distributional implications of privatization.

A recent Asian Development Bank (ADB) publication examined ways that public-private partnership (PPP)
financing modalities can work for the poor. Governments first need to create the appropriate enabling
environment for PPPs to work, and then ensure that pro-poor benefits of infrastructure provision are put in place.
PPPs can range from service and management contracts to privatization, with many variations in between. Using
ADB’s experience, the paper suggests four key steps to make PPPs work for the poor: (i) integrate PPPs into the
government’s poverty reduction strategies, interpret these strategies as forms of “market research”, and use
them as “marketing opportunities”; (ii) build poverty considerations into the policy setting and process by
establishing a PPP framework that includes universal service obligation payments to private providers for delivery
of noncommercial services, competitive service delivery, and careful pro-poor tariff policy design (e.g., lifeline
tariffs); (iii) put in place pro-poor regulatory designs and enforcement mechanisms; and (iv) design a financing
structure that does not asymmetrically allocate financial risks that can weigh heavily on the poor.

a
Center for Global Development. 2005. Privatization Reality Check: Distributional Effects in Developing
Countries, N. Birdsall and J. Nellis. Washington, DC: Center for Global Development.
b
Panggabean, A. T. P. 2006. Expanding Access to Basic Services in Asia and the Pacific Region: Public-Private
Partnerships for Poverty Reduction. ERD Working Paper Series No 87. Manila: ADB November 2006.
Source: Operations Evaluation Department staff compilation.

11. In addition to providing finance for capital-intensive infrastructure, FDI is an important

source of technology, innovation, and international links.10 FDI has been a major source of
capital in East Asian countries such as the People’s Republic of China (PRC) and Viet Nam,
where it has been encouraged through the creation of special economic zones. While FDI has
many benefits, it is a volatile source of funding. Exchange rate risks are created when foreign
loans are used to finance projects that generate revenues in domestic currencies. Following the
macroeconomic turbulence of the Asian financial crisis, the availability of private infrastructure
financing declined dramatically. It is still recovering almost a decade after the event.

12. Delays in the recovery of FDI flows in DMCs have been coupled with an increasing
recognition of the value of mobilizing local private resources to support development. Studies11

10
World Economic Forum. 2000. Building on the Monterey Consensus: The Untapped Potential of Development
Finance Institutions to Catalyze Private Investment. New York.
11
De Soto, H. 2000. The Mystery of Capital: Why Capital Triumphs in the West and Fails Everywhere Else. New
York, Basic Books.
6

indicate the potential value of land and other domestic forms of property held by small and
medium enterprises is substantial. These assets provide a far larger pool of resources to
finance investment than official development assistance. Studies have found that domestic
competition and productivity are potentially more important drivers of growth than investment
alone.12

13. Traditional official development modalities, such as public sector credit lines for small
and medium enterprises (SMEs), often have experienced problems because of inappropriate
incentives for lenders and borrowers. Loans can be politically motivated and directed to
noncommercial operations. Many state-owned development finance institutions have weak
project appraisal and credit risk management systems. Credit lines were often denominated in
foreign currency, while SME receipts were in local currency. Frequently, these constraints
resulted in high levels of nonperforming loans and poor financial performance of the financial
institutions.13 Similar issues arose with direct public sector provision of monopoly infrastructure,
including utilities, due to (i) conflicts of interest between regulatory and commercial functions, (ii)
tariffs that are below the cost of providing services, (iii) inefficient operations, (iv) poor
maintenance, (v) lack of staff incentives, and (vi) limited access to finance. Lack of competition
also can lead to problems with corruption.14 Many public providers are financially distressed and
lack resources to meet demands for expanding access.15 Because of these issues,
development priorities shifted toward helping create or strengthen competitive markets and
improve the investment climate to support local investment, rather than directly providing foreign
funding support to SMEs through state-owned financial institutions or state-owned and operated
infrastructure.

14. Despite the potential offered by market liberalization, coupled with improved access to
FDI and local private capital, the persistent shortage of funding for private SMEs and a gap in
infrastructure investment have continued in many developing economies. Investment climate
studies show that SMEs consistently rate access to finance as a major constraint. For
infrastructure, efforts to encourage private investment in telecommunications, power generation,
and ports have yielded some success. However, limited investment by private sector in roads
and water continues. The UN Millennium Project estimated the current financing gap for
businesses at $73 billion per year in low-income countries and $10 billion per year in middle-
income countries.16 A joint 2005 study by ADB17, Japan Bank for International Cooperation, and
World Bank estimated the infrastructure investment needs in 21 developing countries in East
Asia at $200 billion per year over the next 5 years, with the PRC accounting for 80% of this
total. Financing at these levels is beyond the capacities of governments. Private sector capital
must be mobilized.

12
World Bank Economic Review. 2000. It’s Not Factor Accumulation: Stylized Facts and Growth Models.
Washington, DC.
13
OED evaluations have found that the success rates of loans to government owned development finance institutions
have been low relative to other sectors. These findings raised questions about whether ADB should continue to
finance such loans as most government-owned financial institutions would not meet the criteria specified in Section
D of ADB’s operations manual.
14
Moran, T.H. 2007. Harnessing Foreign Direct Investment: Policies for Developed and Developing Countries.
Washington, DC: Center for Global Development.
15
World Bank. 2005. Infrastructure Development: The roles of public and private sectors, World Bank Group’s
approach to supporting investments in infrastructure. Washington, DC.
16
World Economic Forum. 2006. Building on the Monterey Consensus: The Untapped Potential of Development
Finance Institutions to Catalyze Private Investment. New York.
17
ADB. Japan Bank for International Cooperation, and World Bank. 2005. Connecting East Asia: A New Framework
for Infrastructure. Washington, DC.
 7

15. While there continues to be serious levels of underinvestment within DMCs, it is

apparent this result is not arising due to a shortage of capital in the region. Over the last four
decades, there has been a dramatic shift in the way multilateral development banks operate. In
the mid 1960s, there was a lack of foreign currency capital in the Asia Pacific Region.
Multilateral agencies such as ADB were established to mobilize this capital from members of the
Organisation for Economic Co-operation and Development and make it available through
sovereign loans to developing member countries. There is now tens of trillions of dollars in
funds available in international capital markets and regional banks. The main problem mobilizing
funding in the Asia Pacific Region is finding investment opportunities of an acceptable quality
that balance risks and rewards. Also, governments are withdrawing from direct provision of
services and focusing on strengthening the policy and regulatory environment for private sector.
These developments have meant that private sector is becoming an increasingly important
client of ADB, and this is a trend that is expected to continue for the foreseeable future.

16. In many cases, money is no longer the core product being sought from ADB.
Increasingly, what is being sought from ADB is support for building the enabling environment for
the private sector (e.g., rule of law; access to finance; appropriate police/legal/regulatory
frameworks) and lowering the risk associated with individual transactions through ADB’s
involvement. As a result, there has been a shift within ADB to create value for transactions by
providing more intangible services such as private sector development, knowledge transfer and
risk management. ADB is uniquely placed to provide this combination of services through its
base in the region, and presence of public and private sector operations under one roof,
creating a “one stop shop” for private sector development and commercial risk management
services. Fully exploiting this potential comparative advantage requires development strong
synergies between the public and private sector parts of ADB.

Figure 2: Public Sector Strategy and Operations within ADB

P U B L IC S E C T O R
G o v e r n m e n t D ia lo g u e

P r iv a te S e c to r D e v e lo p m e n t

P R IV A T E S E C T O R
O n th e G r o u n d E x p e r ie n c e

Source: Private Sector Operations Department.

8

B. Objectives of ADB’s Private Sector Development Assistance

1. ADB Strategies

17. In line with market trends, ADB’s strategies have assigned an important role to the
private sector since the late 1990s. Apart from a stable and predictable macroeconomic
environment, DMCs need policies, regulations, and institutional capacity that support
competitive private investment. While scaling up the number and volume of private sector
investments, ADB has sought to strengthen its internal planning processes to address more
effectively the multitude of factors that affect the business environment.

18. ADB prepared its first formal private sector strategy paper in 1985.18 Despite gradual
growth throughout the 1990s, private sector operations remained modest in size, with limited
internal and external market recognition. Following the Asian financial crisis, the need to
mobilize private capital to help build the foundation for economic recovery became apparent.
ADB began to recognize private sector development as a strategic priority. In 1999, ADB
approved its poverty reduction strategy,19 which acknowledged the importance of a strong and
dynamic private sector for achieving long-term, rapid economic growth and reducing poverty.

19. Promotion of the private sector was one of three crosscutting themes in the Long-Term
Strategic Framework for 2001–2015. A Medium-Term Strategy for 2001–2005 was prepared to
implement the long-term strategy. In 2000, ADB prepared the Private Sector Development
Strategy20. Under that strategy, ADB’s public sector operations were to increase their orientation
toward private sector development, and private sector operations would focus more on
development impact. In 2001, a Review of the Strategic Direction and Operations21 of ADB’s
direct private investment activities recommended the scope of private sector operations be
broadened, the level of resources increased, and that a PSOD be established.

20. In 2006, ADB concluded a review of the Private Sector Development Strategy,22 which
found that demand for private sector development in the Asia and Pacific region was increasing
with the rise of globalization and international integration. A central challenge for ADB was
transforming itself from an institution focused broadly on public sector lending into a more
regionally focused and agile institution that could meet its overall objective of poverty reduction.
Actions to help ADB achieve these objectives included: (i) using more rigorous diagnostic
analysis that supported a series of strategic, sequenced interventions based on sector road
maps, supported by changes to ADB’s policies and procedures to screen and monitor projects;
(ii) revising the organization structure; (iii) increasing the level of private sector-related skills in
ADB; and (iv) clarifying reporting arrangements. The roles of the Office of Co-financing
Operations (OCO) and the Risk Management Unit (RMU) were to be strengthened.

21. The Medium-Term Strategy II, approved for 2006–2008,23 identified five corporate
priorities, one of which is catalyzing investment. Private sector operations were upgraded to be
a core business activity. In July 2006, ADB’s Strategy for Middle-income Countries reconfirmed

18
ADB. 2005. Strategy for the Bank’s Assistance for Private Sector Development. Manila.
19
ADB. 1999. Fighting Poverty in Asia and the Pacific–The Poverty Reduction Strategy of the Asian Development
Bank. Manila (R179-99).
20
ADB. 2000. Private Sector Development Strategy. Manila.
21
ADB. 2001. Private Sector Operations: Strategic Directions and Review. Manila.
22
ADB. 2006. Private Sector Development: A Revised Strategic Framework. Manila.
23
ADB. 2006. Medium-Term Strategy II, 2006–2008. Manila.
 9

the importance of strengthening PSOD.24 For much of the past decade, while public sector
lending has been stagnant, the demand for private sector operations has been rising. ADB
needs to be able to service this demand.

22. The final report of the Eminent Persons Group, issued in April 2007,25 highlighted the
importance of economic growth, public-private partnerships in infrastructure, and the need to
strengthen financial intermediation in the Asia Pacific Region.

III. COUNTRY STRATEGIES AND ASSISTANCE

A. Strategic Objectives

23. The Private Sector Development Strategy (2000), which defines the framework for
ADB’s private sector operations, has three strategic thrusts: (i) creating enabling conditions for
the private sector and improving the investment climate, (ii) generating business opportunities
by considering the scope for private sector participation in ADB projects, and (iii) catalyzing
private investment through direct (equity and debt) and indirect (guarantees) financial
participation in private sector projects. ADB’s public sector operations were responsible for the
first two strategic thrusts, whereas PSOD took the lead in directly catalyzing investment. PSOD
would support the formulation of the development goals in ADB’s country strategy by helping to
identify private sector development bottlenecks, as well as issues that needed to be addressed
to facilitate private sector participation. The strategy anticipated private sector alternatives and
commercial cofinancing alternatives to prospective public sector projects or parts of such
projects would be considered at the earliest stages of the development of ADB’s country
strategies and program.

24. An important feature of the Private Sector Development Strategy was the use of ADB’s
country strategies to link public and private sector planning and operational activities. The
country-specific private sector development strategies were to be based on private sector
assessments. Their preparations became a formal requirement following the reorganization of
ADB on regional lines and introduction of ADB’s New Business Processes on 1 January 2002.
Country strategies were to be implemented using a balanced scorecard and a set of
development indicators. Private sector operations would benefit from a country strategy in which
the public sector regional departments would try to improve the business environment. Private
Sector Development Specialists were to be recruited and placed in the regional departments to
provide advice on private sector development from a public policy perspective. Investment
officers in PSOD were responsible for representing the private sector view in country strategy
formulation based on their hands-on experience.

B. Public Sector Operations

1. Technical Assistance and Public Sector Lending

25. Public sector operations encompass the provision of technical assistance (TA) and
sovereign guaranteed loans. Many of these activities are directly or indirectly supportive of the
private sector. TA is used to support a broad array of policy, advisory, and capacity building
services. Almost 25% of TA over the period 1996-2006 was allocated to law, economic and
24
ADB. 2006. Enhancing Asian Development Bank Support to Middle Income Countries and Borrowers from
Ordinary Capital Resources. Manila.
25
ADB. 2007. Towards a New Asian Development Bank In a New Asia, Report of the Eminent Persons Group to the
President of the Asian Development Bank. Manila.
10

public policy reforms, all of which should have had positive implications for private sector
development. Various public sector loans were designed to (i) strengthen the policy, legal and
regulatory environment in the financial sector to improve the efficiency of financial
intermediation for banks, non-bank financial institutions, and the capital markets; (ii) remove
infrastructure bottlenecks to reduce the cost of transport and provide more reliable supplies of
electricity and water; (iii) address externalities associated with air and water pollution; (iv)
support policy reforms to improve governance; and (v) improve education and health to
strengthen the workforce.

26. All of these types of interventions should have helped to improve the enabling
environment for the private sector, although evidence indicates that private sector development
was often not a priority. In terms of thematic classification, 9.4% of the public sector loans in
2006 were targeted directly at private sector development reforms. This figure is volatile, being
only 3.5% in 2005. Offsetting this result, there are conceptual problems with ADB’s loan
classification system. Project classifications do not fully capture the indirect private sector
development support provided by interventions funded by sovereign loans. For example,
programs that support state owned enterprise reforms, governance reforms, privatization, and
sector unbundling, all have important indirect private sector development impacts. These types
of loans would not generally be recorded as private sector development related interventions in
the classification system.

27. To understand what level of public sector operations was dedicated to creating enabling
conditions for the private sector and creating investment opportunities for PSOD in accordance
with the Private Sector Development Strategy, it is necessary to review the individual country
level private sector assessments, country strategies and loans and TA programs.

2. Private Sector Assessments

28. The Private Sector Development Strategy included a requirement that country-specific
private sector development strategies be produced as part of the preparation of ADB’s country
strategies. Guidelines for Private Sector Assessments were produced in 2003.26 These
documents were designed to be the primary means to develop ADB’s private sector strategies
and to guide operations at the country level. The guidelines indicated that a private sector
development road map would be integrated with the country strategy sector road maps. Private
Sector Assessments would be prepared prior to finalizing country strategies discussed with the
government, and treated as supplementary appendices of the country strategies that could be
obtained on request. In practice, consultation with governments was often limited to a
presentation of the related research without any follow up discussion on how changes might be
implemented. The assessments were primarily treated as internal ADB documents. OED was
able to locate only 14 Private Sector Assessment documents that were published and in the
public domain via ADB’s web portal (Table 2).

26
ADB. 2003. Private Sector Assessment Reference Guide. Manila.
 11

Table 2: Availability and Scope of Private Sector Assessments

Country Year Scope

Macro Privatization Infrastructure FDI SME Access to
Economy and Property Public-Private Reform Reform Finance
and Rights Partnerships
Competition
PRC 2003 Yes No Yes Yes Yes Yes
India 2003 Yes No Yes Yes Yes Yes
Cambodia 2003 Yes Yes Yes Yes Yes Yes
Vanuatu 2003 Yes Yes Yes Yes Yes Yes
Papua New 2003 Yes Yes Yes Yes Yes Yes
Guinea
Marshall 2003 Yes Yes Yes Yes Yes Yes
Islands
Samoa 2003 Yes Yes Yes Yes Yes Yes
Pacific 2004 Yes Yes Yes Yes Yes Yes
Islands
Mongolia 2004 Yes Yes Yes Yes Yes Yes
Viet Nam 2005 Yes No Yes Yes Yes Yes
Uzbekistan 2005 No Yes No Yes Yes Yes
Philippines 2005 Yes Yes Yes Yes Yes Yes
Solomon 2005 Yes Yes Yes Yes Yes Yes
Islands
Fiji Islands 2006 Yes Yes Yes Yes Yes Yes
FDI = foreign direct investment, PRC = People’s Republic of China; SME = small and medium-sized enterprise.
Source: www.adb.org (While Private Sector Assessments were prepared for Viet Nam in 2002 and Indonesia in
2004, they were not published and placed in the public domain.)

29. Half of the Private Sector Assessments that were published were issued in 2003. Six of
the 14 Private Sector Assessments were prepared for small Pacific island economies, where the
potential for private sector investments in absolute terms is limited. Five additional assessments
were only published in 2005 and 2006. Private Sector Assessments are not available for some
DMCs in which ADB had substantial operations (e.g., Bangladesh, Lao People’s Democratic
Republic, Nepal, Pakistan, and Sri Lanka). Only one Private Sector Assessment was available
for a Central Asian country (Uzbekistan). Despite the provision of guidelines, the structure of the
reports varied widely, although typically the scope encompassed the six main aspects (Table 2)
of private sector development. This is not surprising, given the complexity of the subject.
Constraints are dynamic and difficult to measure, and ADB instruments have varying degrees of
influence on objectives. The main weaknesses were a lack of precise data and the generality of
the recommendations. In many cases the lack of road maps meant it was not clear what
resource requirements were envisaged, when events should occur, or who was responsible.
 12

3. Country Strategies and Programs

30. Country strategies27 are the primary mechanism for defining public sector advisory and
lending activities. Table 3 provides a summary of country strategies prepared since 2000, and
the extent to which they explicitly referred to Private Sector Assessments and private sector
road maps. In most cases the Private Sector Assessments did not appear to play any material
role in the country strategies. Assessments were mentioned in only five of the 20 country
strategies (Cambodia, Papua New Guinea, the PRC, Uzbekistan, and Viet Nam). With the
exception of Papua New Guinea, private sector development road maps were not included in
the country strategies. The public sector side of ADB prepared the Private Sector Assessments,
typically by the governance and finance division concerned, often with little input from other
public sector divisions or PSOD. The level of discussion on private sector development and the
amounts of public sector assistance identified in the country strategies that would support the
development of the private sector was quite high in some cases (e.g., India). However, the
assistance to support the necessary reforms identified in the country strategies was absent from
project and TA pipelines.

31. In many cases, project descriptions indicate that private sector development-related
projects were concerned primarily with constructing state-owned facilities or state-guaranteed
credit lines to provide services and funding to the private sector. Few examples were found of
specific reforms to the enabling environment to support sustained private sector investment in
areas such as competition policy, privatization, or definition of property rights. Similarly, there
were limited cases where entry points were created for PSOD transactions. The overall
conclusion is that Private Sector Assessments were not used effectively to position ADB
strategically to support the development of the private sector in a particular country, or to create
synergies between the public and private sector sides of ADB.

Table 3: Country Strategies and Private Sector Development, 2000–2006

Private Public
Reference to Sector Sector
Private Road No. of Funding
Sector Map/ Projects/TAs ($ million)
Assessments Strategy with Private with Private
Country in the in the Sector Sector
Strategy Country Country Development Development Sectors with References
Country Period Strategy Strategy Orientation Orientation to Private Sector
Philippines 2000–2002 No No 2 175 Finance (Capital Market),
Transport
Afghanistan 2000–2002 No No — — —
Viet Nam 2002–2004 Yes (2001) No 2 135 Finance (SMEs)
Maldives 2002–2004 No No — — —
Lao PDR 2002–2004 No No 4 75 Agriculture, Finance, and
Communications
2003–2005 No No 7 115 Agriculture, Transport,
Power, Communications,
and Finance
Pakistan 2003–2005 No No 4 650 Finance (SMEs,
Infrastructure),Energy

27
Country strategies were known as country operational strategies and country assistance plans before January
2002, country strategies and programs from 2002 to 2006, and currently as county partnership strategy.
 13

Private Public
Reference to Sector Sector
Private Road No. of Funding
Sector Map/ Projects/TAs ($ million)
Assessments Strategy with Private with Private
Country in the in the Sector Sector
Strategy Country Country Development Development Sectors with References
Country Period Strategy Strategy Orientation Orientation to Private Sector
Indonesia 2003–2005 No No 10 990 Energy, Transport, Social,
Trade, Governance
India 2003–2006 No No 23 5,210 Agriculture, Finance,
Energy, Transport,
Governance, Regional
Cooperation
Kyrgyz 2004–2006 No No 3 35 Trade, Education, Finance
Republic (capital markets)
Kazakhstan 2004–2006 No No 4 190 Agriculture, Transport,
Water
PRC 2004–2006 Yes No 8 — Agriculture, Finance,
Energy, Transport, Urban
Services
Tajikistan 2004–2006 No No 1 15 Agriculture
Sri Lanka 2004–2006 No No 4 290 Industry, Transport,
Finance (SMEs)
Cambodia 2005–2009 Yes (2003) No 2 25 Agriculture, Finance
Nepal 2005–2009 No No 0 0 Agriculture, Finance
Bangladesh 2006–2010 No No 1 315 Energy
Uzbekistan 2006–2010 Yes (2005) No 1 30 Agriculture
Indonesia 2006–2009 No No 8 2,437 Agriculture, Education,
Law & Economic Mgt,
Transport, Finance
PNGa 2006–2010 Yes (2003) Yes — — —
— = not available, Lao PDR = Lao People’s Democratic Republic, PNG = Papua New Guinea, PRC = the People’s
Republic of China, SME = small and medium-sized enterprise, TA = technical assistance.
a
The Country Strategy Program has only one nonlending project for a energy project with a private sector theme (as
shown in concept paper), amounting to $500,000.
Source: Asian Development Bank records.

4. Private Sector Development

a. Country Assessments

32. OED has produced nine country assistance program evaluations (CAPEs) since 2000
(see Box 2). A review of these documents indicates a number of common themes related to
private sector operations: (i) the country programs did not have a clear strategy that positioned
ADB to have a strategic impact in this area; (ii) the public and private sector sides of the ADB
did not work together effectively to develop niches and create synergies; (iii) while the regional
departments undertook some activities to improve the enabling environment, these efforts were
scattered across sectors, not systematic, and generally unrelated to PSOD; (iv) ADB’s success
in improving the business climate was mixed; and (iv) ADB’s indirect contributions to generating
business opportunities by considering the scope for private sector participation was largely
absent from the country strategies.
14

Box 2: Country Assistance Programs Evaluations

a
The 2002 Mongolia country assistance program evaluation (CAPE) found that the Asian Development Bank (ADB)
had supported privatization, trade liberalization and competition reforms, and sector restructuring and unbundling
(e.g., power, telecommunications, airports, and air navigational aids). Further, the CAPE found ADB had provided
extensive technical assistance (TA) support to reform the financial sector. While private sector development support
was quite extensive, coordination was a problem due to a lack of guidance on how thematic assessments should be
incorporated in programs. The Papua New Guinea b and Bangladeshc CAPEs found the main form of private sector
development assistance had been credit lines for small and medium-sized enterprises (SME), and both programs
had been unsuccessful. There had been limited progress in Bangladesh on privatization and there was an intention
d
in the future to strengthen banks. The Cambodia CAPE noted TA had been provided to strengthen the tourism
industry, and that the private sector assessment examined strategic options to facilitate SME development. The
Nepal CAPEe indicated private sector development should become a future ADB priority.
f
The CAPE for Bhutan indicated that private sector development initiatives needed to be based on a more practical
approach, where support is targeted at improving SME access to finance and ways are considered to strengthen
data collection, especially in the informal sector. The Indonesia CAPEg found that ADB’s public sector assistance for
private sector development had been directed toward privatization and financial sector reform to help resolve
nonperforming loans that had arisen because of the Asian financial crisis. The CAPE noted that further work was
required to address enabling environment issues, and recommended the next country strategy identify ways to
catalyze private sector investment through regulatory and governance reforms and an increase in the number of
ADB’s private sector transactions, which had ceased following the Asian financial crisis. An increase in private
transactions could be achieved by using risk mitigation instruments and local currency bonds more often.

The Uzbekistan CAPEh concluded that, while the country operational strategy identified many possibilities for private
sector development, prioritization and specificity on what ADB would seek to achieve were lacking. The country
strategy implied that assistance would be limited to ADB-funded private sector transactions. The Uzbekistan private
sector assessment had concluded that major impediments to growth of the private sector related to undeveloped
financial markets and directed lending through state-owned banks had crowded out the private sector. ADB’s
private sector support in Uzbekistan had consisted primarily of the provision of credit lines to SMEs, plus a revolving
credit facility in the education sector to support the private production of textbooks. Some of these sovereign
guaranteed credit lines were not successful, with only 22% repaid as agreed in the original loan agreements, 45%
rescheduled, and 25% written off, with the balance being frozen. SME borrowers did not repay loans due to a
combination of factors, such as adverse foreign exchange movements and operational problems. ADB had not
financed any nonsovereign transactions in Uzbekistan.
i
The Lao People’s Democratic Republic CAPE concluded that ADB’s private sector development strategies needed
to be strengthened at the sector level, and should encompass both issues within a sector and related factors such
as the impact of trade liberalization and access to finance. Private sector development was linked primarily to
financial sector assistance targeted at SMEs. Programs focused on strengthening monetary policy; bank regulation
and operations; and underlying financial drivers such as land registration and bankruptcy provisions. These
programs had limited impact, and were rated partly successful.

a
ADB. 2002. Country Assistance Program Evaluation, Mongolia. Manila.
b
ADB. 2003. Country Assistance Program Evaluation, Papua New Guinea. Manila.
c
ADB. 2003. Country Assistance Program Evaluation, Bangladesh. Manila.
d
ADB. 2004. Country Assistance Program Evaluation, Cambodia. Manila.
e
ADB. 2004. Country Assistance Program Evaluation, Nepal. Manila.
f
ADB. 2004. Country Assistance Program Evaluation for Bhutan. Manila.
g
ADB. 2005. Country Assistance Program Evaluation for Indonesia. Manila.
h
ADB. 2006. Country Assistance Program Evaluation for Uzbekistan. Manila.
i
ADB. 2006. Country Assistance Program Evaluation for Lao PDR. Manila.
 15

b. Sector Assessments

1) Power and Energy

33. While the general lack of synergy between public and private sector operations is
disappointing, there have been some successes and progress is being made. ADB’s experience
in the power sector provides some examples of good practices that should be used in other
sectors. In 2006, OED evaluated28 the achievements of ADB’s Energy Policy Review (2000).
Among other things, ADB operations in the energy sector were designed to support: (i)
unbundling public sector monopolies; (ii) supporting hydrocarbon and power sector
restructuring; (iii) reforming energy pricing policies, tariffs, and energy management; and (iv)
strengthen sector governance. The evaluation found: (i) significant progress had been achieved
across the Asia and Pacific region unbundling the power sector, a critical first step in creating an
enabling environment for the private sector; (ii) restructuring the power sector was often more
difficult, and required more time than originally envisaged; (iii) ADB contributed positively to
sector reforms in several countries (e.g., Bangladesh, India, Pakistan, Philippines); (iv) after the
Asian financial crisis, the availability of project finance from international commercial banks
declined due to efforts of some DMCs to renegotiate power purchase agreements and concerns
about risks of currency mismatches; (v) despite a decline in international project financing, the
level of interest from local private investors and financial institutions has increased; and (vi)
ADB’s lending priorities have shifted, with nonsovereign lending for generation supplanting
public sector lending, which shifted into providing loans for transmission and distribution
systems.

34. The Evaluation of ADB’s Energy Policy concluded: (i) ADB-funded projects and
programs in the power sector have enjoyed a considerable degree of success; (ii) the work of
the public side of ADB in supporting power sector reform helped to create business
opportunities for the private sector; (iii) in many countries, the private sector responded to these
new opportunities by investing in the power sector; and (iv) while ADB’s nonsovereign power
projects have been successful, other private sector energy-related investments have
experienced difficulties. These problems included allegations of corruption, particularly in cases
of noncompetitively bid concessions, and difficulties with tariff adjustments, especially when the
currency had experienced large fluctuations.

35. OED has evaluated ADB operations in the energy sectors in Bangladesh,29 India,30 and
Philippines.31 Overall, while the programs were generally successful in unbundling and
establishing independent regulators, progress on privatization was slower than expected,
especially in transmission and distribution. In the Philippines, the restructuring program and
establishment of independent regulators took longer than expected to complete, and some of
the bidding processes to privatize assets failed. While the private sector financed many of the
independent power producer generation projects in the late 1980s and early 1990s, these
concessions were awarded through negotiation rather than transparent competitive bidding
procedures. This practice raised concerns in some quarters about the possibility of corruption.
The long-term nature of the contracts has delayed sector restructuring to introduce competition,

28
ADB. 2007. Evaluation of ADB Energy Policy 2000 Review. Manila. (forthcoming)
29
ADB. 2003. Sector Assistance Program Evaluation of Asian Development Bank Assistance to Bangladesh Power
Sector. Manila.
30
ADB. 2007. Sector Assistance Program Evaluation of Asian Development Bank Assistance to Indian Energy
Sector, Manila (ongoing).
31
ADB. 2005. Sector Assistance Program Evaluation of Asian Development Bank Assistance to Philippines Power
Sector. Manila.
16

and created substantial stranded costs that contribute to the financial burden of consumers. The
Philippines has honored its contracts with independent power producers, although they are a
major contributor to the high cost of power in the country.

36. OED has examined several private sector power and energy projects in Bangladesh, the
PRC, and Sri Lanka, and they were all found to be successful. However, some of these projects
encountered difficulties. For example, in one transaction, ADB could not fulfill its role as a
catalyst for further build-operate-transfer projects, because: (i) it lacked a system-wide technical
due diligence program, and (ii) the availability of local financing and generation capacity
changed. Subsequent to construction, the public sector purchaser threatened to renege on the
tariff, and ADB played a key role negotiating with the government on behalf of cofinanciers and
mitigating political risks associated with the project. The quality of ADB’s due diligence in more
recent nonsovereign projects in the energy sector has improved, particularly in generation and
fuel transmission-related projects. Despite issues of this nature, the energy policy evaluation
found the benefits of ADB’s involvement in private sector power projects had extended far
beyond its financial contribution. ADB’s involvement had supported progress on reform, given
confidence to other investors, encouraged the adoption of best practice, and provided important
demonstration and risk mitigation effects.

Box 3: Strategies for Mitigating Risks of Corruption

The Operations Evaluation Department’s (OED) Energy Policy Reviewa discussed the potential for corruption in the
power sector, and concluded the Asian Development Bank (ADB) can help to address problems of this type by
improving governance in sector operations. The introduction of competition can harness the power of markets to
promote good governance. The regulator, in its capacity as an independent legal authority that balances the needs of
the consumers and the viability of the suppliers, has a critical role to play in enhancing accountability and limiting risks
of corruption. For private sector infrastructure projects the greatest risks of corruption occur at the time of award of
concession bids, and then possibly through the tariff adjustment mechanism. These risks can be managed by creating
an enabling environment with a transparent process leading to contract award and regulatory functions that are
subject to public scrutiny and independent audit.

On a wider scale, ADB addresses corruption through its Policy on Anticorruption and associated integrity principles
and guidelines that all staff are expected to follow, irrespective of whether they work in the public or private sector.
Identical provisions apply to sovereign and nonsovereign loans. The Integrity Division has been established within
ADB’s Office of the Auditor General to enforce these corruption principles. To date, no cases of corruption associated
with nonsovereign loans and investments have been reported.

a
ADB. 2007. Evaluation of ADB Energy Policy 2000 Review. Manila.

2) Transport

37. Compared to power and energy, ADB has been less successful catalyzing private sector
participation in the transport sector, although some progress has been made in the Philippines
(Box 4). India has made the most progress developing transport related public-private
partnership programs. In other countries, such as Pakistan and the PRC, where OED has
prepared transport sector assistance program evaluations (SAPEs), ADB has supported few or
no non-sovereign transactions in the transport sectors in these countries. This result is broadly
consistent with worldwide experience. While private sector investments have been substantial in
airports and seaports—transport modes where ADB has limited to no involvement in most
countries—few private transactions have been seen in roads and railways, the modes that
dominate ADB’s public sector transport portfolio.
 17

Box 4: Manila North Tollways Corporation

In October 2000, the Asian Development Bank (ADB) approved a loan of $45 million without government
guarantee, and a $25 million loan under the complementary financing scheme (CFS) for the Manila North
Tollways Corporation (MNTC), a special purpose vehicle established to rehabilitate, expand, and operate 83.7
kilometers of the North Luzon Expressway and other related tollways. The sponsors for the project were (i) First
Philippine Infrastructure Development Corporation; (ii) Egis Projects S.A., France; and (iii) state-owned Philippine
National Construction Corporation, which has exclusive rights to develop road concessions. The Toll Regulatory
Board approved the investment proposal in 1996, and MNTC was formed in 1997. Lenders were ADB,
International Finance Corporation (IFC), Export Finance and Insurance Corporation, and commercial banks under
cover provided by ADB, Compagnie Francaise d’Assurance pour le Commerce Exteriur, Multilateral Investment
Guarantee Corporation, and a commercial bank letter of credit.

The project was carried out on a rehabilitate-operate-transfer basis, and the construction contract was
competitively bid internationally. The agreement covers Phase 1 and there are two additional phases envisaged,
but they did not form part of the project. The project was classified as environmental Category B, as impacts were
limited because it was an expansion of an existing road and noise and pollution effects could be mitigated. The
project had relatively few social impacts, as most land was already in government possession. The project started
operations in February 2005, and financial performance has been in accordance with expectations.

The loans were based on market-derived margins that were acceptable given the risks attached to the project.
ADB’s operational effectiveness was high, as it was the coordinating bank, leading the technical, financial, and
legal due diligence. ADB also conducted contract negotiations under what proved to be difficult conditions. IFC’s
extensive global experience with tollway projects helped ensure the financing facility was designed well. Traffic
risks were mitigated by the shortage of alternative routes and available data on existing traffic flows. Tariff risks
were addressed through provisions in the agreement to make automatic tariff adjustments independent of any
administrative or public hearing processes. Local currency risk was addressed partially through the tariff
mechanism, and some of the debt was intended to be refinanced locally once construction was complete. Overall,
the level of ADB additionality was rated excellent.

Source: Operations Evaluation Department Staff compilation.

38. OED’s transport SAPE in India32 focused on roads and railways. The evaluation
concluded that transport investment needs substantially exceed the fiscal capacity of the
national and state governments. Creating an enabling environment for private investment in the
transport sector, particularly for roads, has been a key strategic objective for ADB. Private
sector participation has been growing in the Indian road sector. ADB’s public sector operations
have supported this development by promoting both public private partnerships projects and
private sector participation in rehabilitation and maintenance. ADB encouraged private sector
involvement by providing sovereign guaranteed funding assistance to private and state owned
development banks for on-lending to private sector infrastructure such as roads.

39. A Private Sector Infrastructure Facility was designed by ADB to help support public
private partnership schemes in India. An OED evaluation33 of this project identified a range of
issues limiting effectiveness of the facility including: lack of realistic traffic forecasts; resistance
to tolls; inappropriate models for public private partnerships; a lack of domestic and international
private sector interest; and poorly designed financial structures. One of the participating state
owned development banks became insolvent. It proved difficult to find viable projects. Loans
were denominated in foreign currency while revenues were in domestic currency, creating a
mismatch that reduced demand for these funds.

32
ADB. 2007. Sector Assistance Program Evaluation of the Transport Sector in India. Manila.
33
ADB. 2006. Project Performance Evaluation Report on the Private Sector Infrastructure Facility in India. Manila.
18

40. Overall, the Indian transport sector evaluation found the government had moved to
address issues undermining the effectiveness of private sector participation in infrastructure by
establishing: (i) annuity based public private partnerships contracts; and (ii) a viability gap
funding scheme. These mechanisms will help avoid problems with inappropriate allocations of
risks to the private sector such as traffic flows and foreign currency movements. The
government no longer intends to guarantee facilities such as the Private Sector Infrastructure
Facility and the focus will be on non sovereign guaranteed public private partnerships that will
be used to finance future roads. Private sector participation has not been a feature of ADB’s
railway operations in India.

41. In comparison to India, Pakistan is only starting to consider ways of stimulating private
sector participation in the transport sector. An OED evaluation of ADB’s operations in Pakistan’s
road sector34 found that to date private sector participation had been limited to consultancy and
construction contracting, and greater private sector involvement was needed as investment
requirements exceed the fiscal capacity of the government. Constraints that need to be
addressed include the inability of the private sector to obtain long term local finance, political
constraints imposing tolls, and lack of capacity within government to design, procure and
administer public private partnerships.

42. The findings of the evaluation of ADB’s operations in the PRC transport sector35 were
similar to those in Pakistan. While identification of alternative financing mechanisms, including
private sector, was a sector priority, private sector participation was limited. The PRC had
financed most of its road development programs (70%) by borrowing debt at the local
government level, secured against projected toll revenues. Only 1–5% of the financing for
expressways was sourced from the private sector, despite significant private sector interest in
the first half of the 1990s. ADB’s attempts to formulate public private partnership road projects in
the PRC were not successful due to problems forecasting traffic volumes. For this reason, the
government decided to bear construction and start-up traffic flow risks by financing initial stages
of development, and then leasing or securitizing the completed expressways. In line with this
model, two publicly financed ADB road projects were part of a package of expressways
securitized in the capital markets, and two early local railways financed by ADB were listed on
the stock exchange.

5. Finance

43. Country evaluation studies indicate that credit lines for SMEs and infrastructure issued
by development finance institutes have been a common feature of ADB’s private sector
enabling environment efforts. OED has collected data on the performance of development
finance institutions36 and found that excluding loans to Republic of Korea and Singapore, the
success rate of ADB supported development finance institutions projects was 38%. Poor
performance was due to a range of factors including: (i) weak ownership incentives; (ii) poor
assessment of demand for credit; (iii) governance issues including directed lending, weak credit
assessment, corruption, and inadequate monitoring. The OED analysis concluded that generally
ADB should not lend to government owned development finance institutions, and any
exceptions would need to be strongly justified.

34
ADB. 2006. Sector Assistance Program Evaluation of the Transport Sector in Pakistan. Manila.
35
ADB. 2007. Sector Assistance Program Evaluation of Asian Development Bank Assistance for Roads and
Railways in the People’s Republic of China. Manila.
36
ADB, 2005 Annual Evaluation Review, Operations Evaluation Department
 19

6. Private Sector Operations Performance Evaluations

44. While weaknesses remain in the enabling environment for the private sector throughout
the region, especially in transport, water, and the financial sectors generally, results from the
limited number of OED assessments of individual private sector projects usually have been
positive. OED has only prepared 13 independent Project Performance Evaluation Reports for
private sector projects between 1992 and 2006. The summarized evaluation results are
presented in Appendix 2. The evaluations covered power, cement, fertilizer, steel and textile
plants, funds, and various financial institutions across seven countries. The transactions
evaluated were not selected using random sampling techniques. As a result, the evaluations are
not necessarily representative of the full set of private sector projects. The structure of the
evaluation reports has varied over time further limiting their usefulness as a reliable indicator of
performance. Despite these concerns, the results of the independent OED evaluations indicated
most projects were successful and profitable. Of the 13 private sector projects that have been
evaluated, 12 were rated “successful” and one (a power plant in the Philippines) was rated
“partly successful”.

45. This success rate (92%) far exceeds the average success rate for public sector projects,
which was 64%.37 The success rate for private sector projects exceeds the 80% benchmark that
ADB has established for successful operations. The evaluation findings reflect a common set of
issues, including lack of coordination between public and private sectors; lack of competition;
tariff problems; need for foreign currency; difficulties with exit; and, more recently, problems with
resettlement. Most of these issues related to problems with the enabling environment and could
only be resolved by policy dialogue undertaken by ADB’s regional departments and the host
country governments. Despite these problems, the overwhelming majority of PSOD’s projects
have been successful.

46. In 2002, OED undertook a special evaluation study to assess the impact of investment
fund operations. The report concluded that 18 of the 29 investment fund operations covered by
the study had high or medium impacts at the fund level. For every dollar of ADB investment, the
investment fund investments had mobilized $9.00–$41.40 from other sources. While resource
mobilization had been high, financial performance had been modest due to the negative impact
of the Asian financial crisis. OED intends to begin updating this study in 2007 for completion in
2008.

47. From 1995 through to 2006, PSOD prepared 35 Project Completion Reports that
provided self assessments of private sector transactions (see Appendix 2). Of the 35 self
evaluation studies, 20 covered financial institutions and the transactions occurred in 10
countries. Project self evaluation studies are slightly different to the OED project evaluation
reports as the focus tends to be on lessons learned rather than rating absolute levels of
performance. The project self evaluation studies identified problems similar to those set out in
the OED project evaluations, although there was greater variability in financial and economic
performance. Issues included (i) PSOD’s lack of influence over regulatory reform, (ii) lack of
independent regulation, (iii) need for reforms to support sector restructuring, (iv) lack of exit
mechanisms, (v) foreign exchange risks, (vi) weaknesses in corporate governance
arrangements for fund managers, (vii) weaknesses in judicial systems, and (viii) inadequate
minority shareholder rights. Similar to the findings of the OED analyses, most of these issues
were derived from the enabling environment and could only be resolved by working with the
regional departments and the public sector.

37
ADB, 2006, Annual Evaluation Review, Manila
20

48. The available evaluation reports account for only a small number of ADB’s total private
sector transactions. This coverage is expected to increase in the future. The following PSOD
targets have been set for preparing project self evaluation studies: (i) an increase from 25%
coverage in 2005 to 40% in 2006; (ii) 60% in 2007; and (iii) 100% in 2008. In 2007 OED issued
Guidelines for Preparing Performance Evaluation Reports for Nonsovereign Operations that will
guide the preparation of both PSOD project self evaluation studies and independent OED
evaluations.38 The Guidelines will help to improve consistency over time, and across both OED
evaluations and PSOD self assessments. Supporting draft Project Administration instructions
have been prepared for project self evaluation studies that are based on the Guidelines.

7. Private Sector Development Strategy Review

49. An ADB-wide review of the Private Sector Development Strategy in 200639 concluded
that its objectives were valid and continued to be important. However, a range of internal
problems had prevented ADB from fully implementing the strategy. Contributing factors included
(i) weak leadership, (ii) lack of readiness within ADB due to insufficient understanding of issues
and “buy in” on reforms, (iii) lack of performance indicators and targets, (iv) incomplete
operational framework that did not emphasize clearly the role of public goods to create enabling
conditions for private sector investment, and (v) confused operational priorities within programs
that did not focus clearly on sectors. A wide range of problems are associated with
implementation, including: (i) a lack of screening and monitoring mechanisms to check the
private sector development content of programs and monitor results, (ii) a lack of focus in
country strategies on private sector development, (iii) policies and procedures designed to
support the public sector that did not provide entry points for nonsovereign transactions, (iv)
weak skills and a lack of incentives to pursue private sector development as public sector staff
are rewarded based on the level of public sector loans, (v) inadequate attention to performance
management, (vi) a lack of clear accountabilities, and (vii) a lack of collaboration and teamwork
across public and private sector operations.

50. These are a formidable list of problems and, together with findings reported earlier about
the lack of impact of Private Sector Assessments in ADB’s country strategies, they indicate ADB
has failed to fully exploit the synergies of having both public and private sector operations in one
organization. The logical conclusion from this review is that in the area of private sector
development, ADB is not providing the types of services that DMCs, particularly middle income
countries, are demanding. To help resolve these issues, the Task Force recommended that: (i)
private sector development be established as a core business theme in ADB’s Second Medium
Term Strategy40; (ii) country strategy formats and processes be revised to include sector road
maps that explicitly recognize private sector; (iii) policies and procedures be revised so private
sector development impacts are identified much earlier in the project review process; (iv)
review, and where appropriate remove, operating restrictions on nonsovereign lending; (v)
clarify internal and external reporting arrangements for sovereign, nonsovereign, and
cofinancing operations, and clearly define accountabilities; (vi) develop more market-oriented
products and services in areas such as cofinancing; (vii) rebalance skills mix and realign
incentives to increase the capacity and willingness to identify and process nonsovereign
transactions; (viii) increase independent risk management capacity; and (ix) strengthen client
and relationship management responsibilities. These points are generally consistent with many

38
ADB. 2007. Guidelines for Preparing Performance Evaluation Reports on Non Sovereign Operations. Manila.
Available: http://www.adb.org
39
ADB. 2006. Private Sector Development: A Revised Strategic Framework. Manila.
40
ADB. 2006. Medium-Term Strategy II, 2006–2008. Manila.
 21

of the findings of this evaluation. The Board reviewed the Task Force’s recommendations, and
the President requested senior management in May 200641 to implement the proposed actions
on an interim basis.

8. Country Partnership Strategies

51. Following the Task Force’s recommendations, the President approved new guidelines in
February 200742 for enhancing country partnership strategy processes. The new guidelines
presented the following proposals for strengthening the link between private sector development
and non-sovereign transactions: (i) clearly defining ADB’s assistance for private sector
development in country strategies, (ii) ensuring synergies between public and private operations
by incorporating private sector development in sector road maps, (iii) pursuing private sector
transactions within agreed sector road maps on a broad sector basis, and (iv) covering
sovereign and nonsovereign operations in business plans. The new country strategies will be
results-oriented to support design, monitoring, and evaluation of country strategies using an
outcome and output results chain linked to individual interventions. The country strategies will
be based on sector assessments that identify constraints and opportunities, including those in
thematic areas; and estimate medium-term investment and TA requirements.

52. Whether these recommendations will be implemented successfully and the

consequential changes result in the delivery of improved private sector development services
that clients are demanding remains to be seen. The main areas of concern are the lack of detail
regarding what sector road maps will encompass and achieve. The guidelines do not mention
development concepts such as transition, liberalization, competition, independent regulation,
property rights, supply chains, private sector participation, or use of quantifiable screening
measures such as value for money. Concerns remain that the public sector investment
objectives of the regional departments responsible for preparing the country strategies will
continue to drive the program. No obvious incentives or reasons exist for a regional department
to pursue private sector initiatives, given that staff is rewarded for making regional department
transactions.

53. PSOD does not have sufficient staff to fulfill the proposal that its staff participate
extensively in country strategy processes. The interface between PSOD and regional
departments to develop private sector development strategies lacks clarity. The governance and
finance divisions in regional departments have traditionally been responsible for private sector
development. However, they have limited interaction with infrastructure sectors, where enabling
environment reforms such as privatization and public-private partnership designs are meant to
be put into effect. The Second Medium Term Strategy approved in 2006 has further complicated
the situation as it has sought to prioritize sectors, but these priorities appear to be more relevant
to the public sector in low income countries rather than private sector operations in medium
income countries. For example ADB is expected to exit from telecommunications, airports and
sea ports. There would be opportunities for private sector transactions in these areas even if
public sector lending was not deemed appropriate. Reforms in key areas for private sector such
as law and judiciary, public finance and economic management, and communications, are now
categorized as second or third tier priorities.

41
ADB. 2006. Implementing the Revised Strategic Framework for Private Sector Development—Interim Measures.
Manila.
42
ADB. 2006. Further Enhancing Country Strategy and Program and Business Processes. Manila.
22

54. Given that the Private Sector Development Strategy was approved seven years ago, as
well as the concerns about the likely success of these reforms to strengthen country
programming, more concrete actions need to be taken to ensure the realization of synergies
between public and private sectors. At a minimum, a mechanism to monitor progress is needed.
Organizational reforms may be needed if the rapid realization of these synergistic benefits does
not materialize.

C. Private Sector Operations

1. Strategic Objectives

55. The 2001 Private Sector Operations: Strategic Directions and Review Paper 43 is the
defining strategic document for private sector transactions under ADB’s Private Sector
Development Strategy. The review paper recommended: (i) focusing on infrastructure and
capital markets; (ii) developing new areas, such as information communication technology and
social infrastructure on a pilot basis; (iii) continuing to focus on middle-tier and larger DMCs,
while seeking to extend ADB’s reach, where feasible, to transition and smaller economies; (iv)
making wider use of innovative financial instruments, such as guarantees; (v) developing
strategic alliances and partnerships with other international financial institutions; and (vi)
revising ADB’s internal controls to increase the maximum amount of capital allocated to PSOD,
raise project limits, and streamline procedures for approving restructuring proposals. PSOD staff
numbers were to be increased to support more activity, strengthen risk management
procedures, and upgrade financial reporting systems. The Private Sector Operations Group was
upgraded to a department (PSOD), headed by a Director General who reports to Vice-President
(Operations Group 1).

2. Portfolio Evolution

a. Historical Trends

56. ADB’s private sector operations began in 1983. The level of activity increased during the
latter part of the 1980s following the establishment of a private sector division in 1986 within the
Industry and Development Banks Department. The Development Finance Division within the
department handled financial sector business, while the Private Sector Division focused on
direct investments in manufacturing, agribusiness, infrastructure, and services. In 1989, the two
divisions were transferred to a new Private Sector Department, which had three divisions with a
geographic focus. Traditional credit lines to government-owned development finance institutions
were the dominant business product for this department. In 1994, the Private Sector Division
was renamed the Private Sector Group and placed under the Director General leading the
public sector-focused Infrastructure, Energy and Financial Department (West).

43
ADB. 2001. Private Sector Operations: Strategic Directions and Review. Manila.
 23

57. During 1983–1990, the Board approved private sector transactions totaling $519.2
million. In the following 5-year period (1991–1995), approvals increased by 48%, reaching $758
million for 61 projects. During 1996–2000, 34 projects with a total value of $1.352 billion were
approved—a 78% increase in volume, although the number of projects decreased by 44%. Until
the end of 1995, 11% of approvals on average were canceled. The cancellation rate rose to
24% during 1996–2000 (Figure 3). The high level of cancellations during 1996–2000 reflected
the impact of the Asian financial crisis and the waning business drive of Private Sector Group
following the departmental downgrading. Changes in the organizational arrangements
contributed to a lack of focus and an unclear functional identity.

Figure 3: Approved Private Sector Transactions (1983–2000)

$ million
2,000
1,800
1,600
1,400
1,200
1,000
800
600
400
200
0
1983-1990 1991-1995 1996-2000
Approvals Cancellations Net Approvals
Source: Asian Development Bank Records.

58. Following the approval of the Private Sector Development Strategy44 and establishment
of PSOD in 2001 as a department reporting directly to a Vice-President, a new PSOD
management team was appointed. The department was restructured and new staff recruited,
primarily people from the private sector with commercial banking experience. Not unexpectedly,
some time was required before there was a visible impact on business volume. Renewed
momentum in transaction volumes was evident by 2003 with the approval of nine projects
totaling $462.6. In 2004, 16 projects were approved with a total value of $605.2 million. While a
large proportion of approvals from these two years were canceled later, the improved
performance indicated a new vigor in PSOD’s business activities. The sustainability of the trend
was confirmed by the 17 project approvals, totaling $821.5 million45, in 2005 (Figure 4).

44
ADB. 2000. Private Sector Development Strategy. Manila.
45
ADB’s own account (excluding CFS loans).
24

1200 Figure 4: Approved Private Sector Transaction (2001–2006)

1000

800
$ million

600

400

200

0
2001 2002 2003 2004 2005 2006

Approvals Cancellations Net Approvals

Source: Asian Development Bank records.

59. Approvals in 2006 increased to 22 projects with a total value of $1.42 billion, including a
$455 million complementary financing scheme (CFS) facility. Private sector lending is now an
important feature of ADB’s total operations. In 2006, PSOD accounted for 17% of total ADB
approvals. The corresponding figures, based on net approvals, was 5% in 1996 and 6% in
2000. Cancellations are not a feature of approvals in 2005 and 2006. This result does not mean
that projects are no longer being canceled. PSOD is responsible for informing Controllers
Department when projects are canceled and recorded as such in PSOD’s financial reports. This
process can take many years. For this reason, IFC and EBRD focus on committed funds when
reporting on performance, although cancellations are an important indicator in its own right.

b. Geographic Trends

60. Details on the distribution of the private sector portfolio across countries are presented in
Figure 546. Growth has been greatest in recent years in Bangladesh, India, Indonesia, the PRC,
and Sri Lanka.

46
Disbursed and outstanding at the end of year at market value on ADB’s own account.
 25

Figure 5: Distribution of the Private Sector Portfolio Among Countries,

1995, 2000, and 2006
25

20

15
Percent

10

am
ia

lia
tan

ia

ka
R
n

l
f

t an

d
h

sia

es
.o

pa

na
.o
ut a

an
PD
es

Ind

ys

an
pi n

tN
p
nis

Ne

gio
e
ep

kis
ng
la

ail
lad

Bh

Re
on

iL
o,

Ma

Vie
ilip
a

Mo
's R

Pa

Re
Th
Ind
ng

La
Afg

Sr
,
rea

Ph
Ba

ple

Ko
eo
,P
i na

1995 2000 2006

Ch

Source: Asian Development Bank records.

61. In 1995, the Philippines had the largest share of the nonsovereign portfolio (20%),
followed by India (19%), and Pakistan (18%). By the end of 2006, the PRC had the largest
share (23%), followed by Bangladesh (10%), India (10%), Indonesia (9%), and Sri Lanka (9%).
The portfolio shares of Philippines and Pakistan (and, until 2006, Indonesia) fell significantly as
these countries experienced political or economic difficulties during part of the period under
review. In addition to country-specific operations, ADB also supports regional funds. The size of
the regional fund portfolio has fallen proportionately and in absolute terms.47 Under ADB’s credit
risk exposure limits the maximum country exposure is 25%, indicating that this exposure at any
one time tends to be quite high, although over time it has shifted from middle income countries
such as Philippines and Thailand to the PRC.

62. PSOD has not made investments in middle-income countries such as Malaysia and
Republic of Korea for many years. In 2006, the private sector portfolio was concentrated in a
few countries—six accounted for 67% of the portfolio. Many of the smaller DMCs had no
transactions. This raises the issue of whether this level of achievement was an adequate
response to the Private Sector Development Strategy objectives, which called for the expansion
of private sector operations to smaller frontier countries with the aim of eventually reaching out
to most, if not all, DMCs. The geographic distribution suggests that PSOD concentrated on a
few countries with a higher demand to achieve volume priorities, rather than maximize
development impacts across DMCs. This conclusion is reinforced by a comparison of the scale
of investments and range of countries has approved nonsovereign transactions relative to IFC
(Table 4).

47
From $131.7 million in 2000 (14.1% of the portfolio) to $101.2 million at the end of 2006 (5.3%).
26

Table 4: IFC and ADB Commitments

($ million)
ADB ADB ADB
IFC b IFC
Exposure Portfolio Exposure
Commitmentsa Commitments
as of Exposure as of
as of June as of June
December (% of December
2005 2005
Country 2006 Total) Country 2006
Azerbaijan 240.5 4.0 0.2 Cambodia 24.2 0.0
India 3,833.7 326.2 12.6 Fiji Islands 27.6 0.0
Indonesia 2,789.8 364.8 14.1 Kyrgyz 52.6 0.0
Republic
Kazakhstan 540.2 226.3 8.8 Maldives 72.3 0.0
Lao PDR 7.2 91.9 3.6 Nepal 109.7 0.0
Malaysia 60.3 0.1 0.0 Papua 14.5 0.0
New
Guinea
Mongolia 10.2 4.5 0.2 Tajikistan 28.0 0.0
Nepal 109.7 28.0 1.1 Uzbekistan 77.9 0.0
Pakistan 1,869.8 21.2 0.8
Philippines 2,054.4 64.0 2.5
PRC 2,217.7 546.5 21.1
Samoa 1.5 0.4 0.0
Sri Lanka 227.9 177.8 6.9
Thailand 2,979.3 72.6 2.8
Viet Nam 444.5 128.0 5.0
Regional 4,668.3 249.3 9.6
Total 22,055.0 2,305.6 406.8 –
a
Cumulative commitments composed of disbursed and undisbursed balances.
b
Exposure is outstanding Private Sector Operations Department portfolio and undisbursed commitments.
ADB = Asian Development Bank, IFC = International Finance Corporation, Lao PDR = Lao People’s Democratic
Republic, PRC = the People’s Republic of China.
Source: ADB. 2005. IFC Annual Report 2005. Quarterly Report on Private Sector Operations. Manila.

63. Table 4 indicates that, in theory, more could have been done to diversify the portfolio.
While PSOD has some operations in “frontier” countries such as Afghanistan, Bhutan, Lao PDR,
and Mongolia, there have been virtually no private sector transactions in the South Pacific.48
The Central Asian Republics were absent from the portfolio until 2006. Given the opportunities
to collaborate with EBRD, which has more than 10 years experience operating in Central Asia,
and with IFC, which has also been active in the region, there might have been opportunities for
private sector operations in countries such as Azerbaijan and Kazakhstan earlier than 2006.

64. PSOD’s sizeable portfolio of regional funds and financial institutions does not mitigate
the narrow DMC coverage as the fund managers tend to avoid risky frontier markets unless it
has been agreed as a specific fund objective. The limited geographic coverage of the portfolio is
linked to staffing constraints. In terms of efficiency of use of staff and volume of transactions,
which is the primary incentive for staff on both the public and private sides of ADB, it is more
efficient for PSOD to respond to requests for financing from clients operating in traditional
countries. Frontier countries can require considerable staff resources to develop transactions
that are inherently more costly and risky for PSOD to pursue and subject to much higher failure

48
There is an ongoing Kula Fund investment for $3.0 million approved in 1997 and a Kula Fund II investment for $4.0
million approved in 2006.
 27

rates. Given the constraints on staffing, it is understandable that PSOD concentrated on building
up the size of the portfolio rather than aggressively expanding into frontier countries, although it
will inevitably have offset potential development impacts.

c. Sector Reorientation

65. Until the mid-1990s, private sector transactions primarily targeted the financial and
manufacturing sectors. Apart from the power sector, infrastructure received relatively little
emphasis. The financial and capital markets in many countries in the Asia and Pacific region
were undeveloped, offering few opportunities to mobilize local currency financing.
Consequently, apart from investments in equity funds and financial institutions that needed
convertible international currencies for their operations, business development focused on
manufacturing industries and services with export potential. These direct investments were
inherently risky, as they followed ongoing economic liberalization programs where the
manufacturing firms became subject to increasing levels of international competition and they
lost the benefits of protectionist policies. Further difficulties arose as foreign currency export
earning targets could not always be assured. The depreciation of local currency could adversely
affect firms, leading to difficulties with currency mismatches and servicing of foreign currency
obligations. Several project failures and financial losses were seen in the early stages of ADB’s
private sector operations, especially following the Asian financial crisis.

66. As opportunities for private sector participation in infrastructure emerged, the portfolio
was gradually restructured, a process that accelerated following the approval of the Private
Sector Development Strategy in 2000. Figure 6 shows the sectoral distribution of ADB’s private
sector transactions at the end of 1995, 2000 and 200649. The proportion of agri-business,
manufacturing and other industries fell from 26% at the end of 1995 to 6% by the end of 2006.
While Funds and Capital Market instruments grew in absolute terms, its share of the PSOD
portfolio declined slightly. In line with the new strategic emphasis, the share of infrastructure
increased from 25% at the end of 1995 to 42% at the end of 2006, with most of these
transactions being directed to power generation projects. This exposure to the power sector of
42% is high from a risk perspective, although the figures reported by PSOD are slightly distorted
due to recent changes in ADB’s non sovereign risk management practices. In April 2007, the
Board approved a recommendation50 that the sector credit limit be raised upwards from 15% to
30% and a new sector classification system be introduced for risk rating purposes. Under the
new risk rating system, PSOD is no longer in breach of sector credit limits although it is at the
upper limit for power.

49
Disbursed and outstanding at end of year on ADB’s own account.
50
ADB. 2007. Review of Prudential Exposure Limits for Nonsovereign Operations. Manila.
28

Figure 6: Distribution of PSOD Portfolio Across Sectors

100% 9% 6%
24 % 20 % 12 % 10%
80%
12 % 14 %
60% 29% 42%
39 % 28 %
40%
20% 38 % 50% 42%
25 %
0%
1995 2000 2005 2006

Agri-business, Manufacturing, other Industries

Funds and Capital Markets
Financial Sector
Infrastructure
PSOD = Private Sector Operations Department.
Source: Asian Development Bank records.

67. An important positive development that has emerged in ADB’s private sector portfolio is
the substantial shift away from manufacturing and agribusiness towards infrastructure. This
change in sector mix seems appropriate because: (i) financing for manufacturing and industrial
facilities can best be left to commercial sources as much of Asia’s considerable foreign direct
investment occurs in this area; (ii) the long maturities of ADB loans are well suited to
infrastructure; (iii) since infrastructure dominates much of ADB’s public sector lending, it should
be easier to develop synergies between the operations of the public and private sides of ADB;
(iv) ADB’s ongoing policy dialogue in some infrastructure sectors addresses issues such as the
legal and regulatory framework, tariffs and cost recovery and commercialization, all of which
help to improve the enabling environment for the private sector; and (v) the access of the public
sector side of ADB to senior government decision makers in most infrastructure sectors can be
used to help reduce risks and resolve disputes that are commonly associated with infrastructure
projects.

68. While good progress has been made in the power sector, there have been limited
developments in other sectors such as telecoms, ports, roads, water, and social sectors. The
Second Medium Term Strategy51 states that ADB should exit from activities such government
administration, telecommunications, and ports. Strengthening of public sector administration
would seem to be a core private sector enabling environment initiative to reduce transaction
costs and corruption in areas such as taxation, the award of concessions and issuance of
licenses through e-government programs. PSOD has made several investments in
telecommunications projects in countries such as Bangladesh and Afghanistan. There are few
ports in the PSOD portfolio but they would seem to be natural business. These types of facilities
are subject to regulatory risks, have large sunk costs, long term funding requirements, and can
generate some revenue in foreign currency, partly offsetting foreign exchange risks. Since
project evaluation ratings in these sectors are generally satisfactory, presumably the Second
Medium Term Strategy concluded that ADB should exit from these activities because there has
been limited demand in low income countries for public financing in these sectors for the past
decade. This approach does not provide a justification for PSOD to withdraw, particularly if it
develops capacity to create value by developing entry points for private sector transactions
through provision of advisory services in areas such as privatization.

51
ADB. 2006. Medium-Term Strategy II, 2006–2008. Manila.
 29

69. The share of the financial sector in the private sector portfolio grew from 28% in 2000 to
42% in 2006. This change is due to the $75 million Bank of China transaction approved in 2005,
and two further bank related transactions in Kazakhstan approved in 2006. Other related
activities such as housing and trade finance continue to remain at low levels. The finance sector
can potentially play a central role in development. Equity investments in banks have been
important components of the development strategies of EBRD, where it is coupled with
extensive assistance in the area of legal reform. In ADB this potential does not yet appear to be
realized. A critical weakness in the private sector operation for the financial sector is PSOD’s
dependency upon regional departments to create coherent reform programs, especially in
regard to developing credible mortgage, bankruptcy and credit rating systems. Such activities
are often not included in the country strategies.

70. There has been a quite rapid growth in the size of the funds and capital markets portfolio
over the last three years although ADB’s outstanding balance to these types of investments as a
proportion of the portfolio in total has fallen from 12% in 1995 to 10% in 2006. Most of this
investment has occurred in venture capital funds targeting SMEs. While growth in capital
markets was an objective of the Private Sector Operations Review (2001), investments in this
area continue to be controversial within ADB, including some Board members, due to problems
identifying and measuring development impacts and lack of ADB control. OED intends to
conduct an evaluation of equity funds in 2007 to help shed some light on this issue. The
evaluation of PSOD funds will draw upon the findings of an ongoing OED evaluation of capital
markets and an evaluation of ADB’s financial sector program loans.

d. Financial Instruments

71. ADB has used eight types of instruments to finance its private sector transactions (Table
5). Senior debt and equity account for two thirds of the portfolio.

Table 5: Cumulative Investment Approvals by Instruments (end of 2006)

Instrument Amount % of Total
($ million)
Senior Debt 3,268 47.1
Direct Equity 1,407 20.3
Complementary Financing Scheme 1,433 20.7
Partial Risk Guarantee 714 10.3
Currency Swap 0 0.0
Underwriting 46 0.7
Line of Equity 35 0.5
Subordinate Debt 31 0.4
Total 6,934 100.0
Source: Asian Development Bank records.

72. The complimentary finance scheme (CFS) instrument accounted for 20.7% of the total
portfolio at the end of 2006. This modality, based on IFC’s “B Loan,” was developed in the
1980s to strengthen the catalytic impact of private sector operations by mobilizing commercial
funds to complement ADB’s project funding. ADB acts as the lender of record for the
commercial loan, passing on its preferred creditor status benefits without taking responsibility for
any repayment shortfalls the cofinancier might experience. The envisaged benefits, apart from
catalyzing additional investment, were improvements in the terms of the loan by sharing ADB
benefits with commercial lenders. The complimentary finance scheme provided tax benefits for
lenders in some countries. Offsetting these factors, this instrument is not equally favored by all
30

co-financiers as they loose their ability to foreclose on a client if ADB does not want to pursue
this option and it can create inter-creditor problems. While these issues are important, the main
reason for the limited use of this instrument was the reduction in demand for project finance
following the Asian financial crisis and the need for greater certainty on risk coverage that could
be obtained from other forms of guarantees.

73. Partial guarantees for mitigating political and credit risks have been provided by PSOD
since 2000.52 These credit enhancement instruments have been only moderately successful. By
the end of 2006, $714 million, or 10% of cumulative approvals, had been issued in the form of
guarantees. In 2004, an innovative $200 million currency swap was pursued with the Central
Bank of the Philippines in an effort to access local currency funding. Although ADB approved
the facility, the government subsequently decided not to proceed and the swap was canceled.
Underwriting is another potential way to leverage fundraising from commercial sources, but it
has only been used on a small number of occasions, all of them prior to 1990. The limited level
of underwriting services provided by PSOD reflects a lack of incentives and capacity for ADB to
sell down new and existing loans and, for that matter, equity investments.

74. Experiments with lines of equity were discontinued in 1991, as ADB had become a direct
shareholder with high-risk exposures in many enterprises. ADB had to deal with each of these
enterprises individually, especially when problems arose, as occurred frequently. ADB has used
almost no quasi-equity products, such as subordinate debt, convertible loans, or other
mezzanine instruments. ADB has extended subordinate debt in only three cases for a total of
$31 million. This approach might have been taken in part because most infrastructure projects
typically rely upon debt, whereas financial sector transactions use equity. Nevertheless,
numerous examples are available, especially in infrastructure, of PSOD providing both debt and
equity. If ADB provides debt and equity to a single project, it risks a conflict of interest in cases
where the views of equity shareholders and lenders differ. If the project experiences difficulties,
this divergence of views might be significant. Investors in some of the ADB financed power
projects expressed concerns about ADB taking both a debt and equity position. Hybrid
instruments can help strengthen the capital base of projects, while allowing ADB to avoid
conflicts of interest, and providing it with protection against foreign currency movements and an
exit mechanism. This funding modality allows for a more certain pricing structure that is
commensurate with the higher risk profile.

75. Figure 7 presents the outstanding portfolio by loan, equity, and guarantee exposures53.
At the end of 2006, the portfolio was $1.91 billion. Of this amount, $881.9 million (46%) was in
the form of loans, $655.8 million (34%) was equity, and $374.2 (20%) guarantees.

52
Following the Credit Enhancement Policy Paper in 2006, ADB no longer refers to “partial guarantees”. It uses the
term “guarantees”, which can cover limited risks or be comprehensive.
53
Disbursed and outstanding at end of year at market value on ADB’s own account.
 31

Figure 7: Evolution of the PSOD Portfolio by Financial Instrument

2,500

2,000
$ million

1,500

1,000

500

0
1995 2000 2005 2006
Loan Equity Guarantee Total
PSOD = Private Sector Operations Department.
Source: Asian Development Bank records.

3. Portfolio Quality

76. Seven risk rating (RR) categories, ranging from RR-1 (strong) to RR-5 (substandard)
and RR-7 (outright loss), are used to classify sector transactions. Figure 8 presents the portfolio
quality by risk category at the end of 1995, 2000, and 2006.

Figure 8: Distribution of the Portfolio by Risk Categories (1995, 2000, and 2006)
90
80
70
60
50
%

40
30
20
10
0
l)

d)
)

d)

l)

s)
)
ng

na
ry

fu

os
oo

ar
to

bt
tr o

gi

nd

(L
(G

ac

ou
ar
(S

ta

-7
f

(M
-2

(D
is

-s
-1

R
at
R

ub
-4

-6

R
R

(S
R

R
(S
R

R
-3

-5
R

R
R

1995 2000 2006

RR = risk rating.
Source: Asian Development Bank records.

77. The quality of the portfolio deteriorated from 1995 through to 2000, reflecting the impact
of the Asian financial crisis and the nature of the transactions in the portfolio. In 2000, 23% of
investments were rated as good or strong, 37% were marginal or worse, and 41% satisfactory.
Following the recommendation of the Private Sector Operations Review, in 2001 PSOD
established the Risk Management Unit, which began cleaning up the portfolio. These efforts
were successful, and the portfolio quality had improved significantly by the end of 2006. The
proportion of projects that were satisfactory or better increased to 93%, with only 7% of the
portfolio rated as marginal or worse. While this improvement in portfolio quality is encouraging,
32

concerns about the rigor of this categorization process remain, as PSOD prepared the credit
risk ratings for the projects in the portfolio. In line with normal banking practice, where risk
management and provisioning is separated from the asset booking unit, the Risk Management
Unit was shifted out of PSOD in 2005. However, due to lack of staff the Risk Management Unit
does not yet have the responsibility or the capacity to (i) review negotiated projects before
signing, (ii) perform post-disbursement project analyses, or (iii) conduct portfolio reviews until
loan repayment or equity divestment.

78. As shown in a recent external review of ADB’s risk profile,54 these arrangements vary
substantially with those at peer institutions, such as IFC, EBRD, and the African Development
Bank. This lack of authority and capacity of an independent risk assessment function, combined
with the rapid increase in the size of the non sovereign guaranteed portfolio, represents an
important risk exposure for ADB.55 The external review concluded operational factors
constituted the most important risks to ADB. Operational risks relate to issues within a country
such as political instability and corruption in procurement agencies, and within ADB to
inadequate resources and lack of information to allow decision making in a way that it can
manage risks. ADB’s risk management functions were lacking in multiple dimensions including
weaknesses in risk oversight from the Board by the Audit Committee, misaligned credit risk
assessment procedures, and lack of data and portfolio reports. Risk Management Unit was
understaffed and lacked certain skill sets.

4. Organization Structure

79. PSOD’s organization structure is headed by a Director General. There are two
operational divisions consisting of Private Infrastructure Finance and Capital Markets and
Financial Sectors. In 2006, the structure of PSOD was revised by: (i) dividing the infrastructure
financing division into two subdivisions to mirror the geographic coverage of operations regions
1 and 2 for better alignment with regional departments; (ii) formalizing the operations
coordination unit to facilitate increased coordination and collaboration internally (and externally);
and (iii) creating a deputy director general position. These changes were designed to support
the growth of ADB’s private sector transactions, allow PSOD to carry out new initiatives, and
support the increasing geographic diversification in frontier and under served countries.
Subsequent to this realignment, a safeguard specialist was transferred to PSOD to improve
compliance with safeguard environmental and social standards as part of project preparation.

80. Despite reforms to PSOD’s organization structure, issues associated with the current
arrangements continue to limit the efficiency and effectiveness of its operational performance.
The Vice-President (Operations 1), who is responsible for PSOD, also heads the operations of
two of five public sector regional departments.56 This arrangement confuses the setting of
priorities and areas of responsibility when considering private sector operations, and introduces
geographic constraints. It is not clear that private sector initiatives are pursued with the same
vigor in Operations Groups 1 and 2. At the end of 2006 countries in Operations Group 1
accounted for 41% of PSOD’s total exposure compared to 59% for DMCs in Operations Group
2. These results are distorted in the Operations 2 region by a small set of large transactions in
2005-2006 in Indonesia, Kazakhstan, and the PRC. In Indonesia, there were no transactions

54
Ernst and Young. 2006. Development of An Enterprise-Wide Risks Management Capability, Risk Profiling
Benchmarking-Implementation Planning. United Kingdom.
55
The requirement for risk monitoring capacity is lower for ADB’s public sector operations as governments bear the
financial risks on transactions. Consequently, regional departments focus on operational aspects and generally do
not monitor projects after the project completion report is finalized.
56
This includes India, PRC, and Thailand resident missions as of end 2006.
 33

from 1998 through to 2005. In Kazakhstan (and more generally Central Asia) there were no
transactions approved until 2006 when a former PSOD staff member was made Head of
Resident Mission. While the PRC accounted for 21% of the portfolio at the end of 2006, 40% of
this amount was related to two investments that occurred in 2005-2006.

81. Lack of in-country representation across all regions compounds these difficulties, with
only three PSOD staff being located within resident missions. There are issues associated with
the internal organization structure of PSOD and the way in which it manages risk. The rapid
growth in transaction volumes since 2003 has placed increasing pressure on PSOD staff and
their ability to manage the portfolio. Few PSOD professional staff works exclusively on portfolio
administration and restructuring problem accounts in the portfolio. Instead, staff is typically
responsible for both project preparation and management, and there is no independent back
office function. PSOD is responsible for categorizing and managing distressed assets and
financial restructurings. This structure creates a potential conflict of interest. Because PSOD is
an integrated part of ADB it does not produce standalone reports covering all aspects of its non-
sovereign guaranteed operations, making it difficult to determine the quality and performance of
the portfolio.

Figure 9: PSOD Organization Structure

Managing
Vice President
Director (Operations 1)
General

Risk
Management
Unit

Office of the
Director
General Private Sector
Operations
Operations
Department
Coordination
Unit

Private Infrastructure Capital Markets and

Finance Financial Sector

Project Origination and Project Project Origination and Project

Management Administration Unit Management Administration Unit
-Private Infrastructure -Trade Finance
Finance 1
-Capital Markets
-Private Infrastructure
- Financial Institutions
Finance 2

PSOD = Private Sector Operations Department.

Source: Asian Development Bank records.
34

5. Resources

82. The total number of staff in ADB rose from 1,920 in 1995 to 2,405 in 2006, an increase
of 25%. Over the same period the number of PSOD staff positions more than doubled from 29
in 1995 to 67 in 2006 (see Figure 10), an increase of 131%. While the change in PSOD staff
numbers was positive, PSOD’s volume of approved transactions quadrupled over the same
period (and if guarantee instruments were included in this figure it would rise to 717%). The
implication that PSOD is understaffed relative to the volume of business and demands from
clients was confirmed by a peer comparison with EBRD and IFC undertaken by OED in 2006.57
The benchmarking study found that PSOD remains understaffed in terms of both processing
new transactions and performing portfolio management and administration functions. This result
was robust after allowing for differences across institutions in product mix, average project size,
overall volumes, and organization structure. PSOD lacks administrative support functions in
areas such as planning, legal counsel, treasury, financial control, information and
communications technology and human resources. In addition to not maintaining parity with
changes in transaction volumes, insufficient staff has been allocated to meet the additional
demands of DMCs.

83. As noted in ADB’s Middle Income Countries Initiative58 several DMCs have complained
that PSOD is under resourced. ADB’s traditional approach of tightly controlled, annual
incremental budgeting based on historical precedent is not appropriate in a context where there
is strong demand. If a strategic choice is made to grow PSOD more rapidly than other parts of
ADB, a longer term strategic plan is needed to better align ADB’s staff resources with significant
changes in corporate priorities. There is a need to address constraints on the likely growth in
ADB staff numbers in PSOD and its ability to redeploy positions within the organization between
public and private sector operations.

Figure 10: Evolution of PSOD Staffing Numbers

70
4
60
50
34
40
1
30 1 19
20 14
29
10 16
14
0
1995 2000 2006
National Staff International Staff Department Management

PSOD = Private Sector Operations Department.

Source: Asian Development Bank records.

57
ADB. 2006. Annual Report on Loan and Technical assistance Portfolio Performance for the Year Ending 31
December 2005. Manila. Although, new positions were added in PSOD after that analysis was undertaken, these
new positions do not alter the overall conclusions.
58
ADB. 2006. Enhancing Asian Development Bank Support to Middle Income Countries and Borrowers from
Ordinary Capital Resources. Manila.
 35

84. The skill mix in PSOD raises concerns. Most PSOD staff does not have experience in
sectors such as transport and water, application of guarantee instruments, and economic policy
and institutional reforms required to support programs such as privatization. PSOD has few staff
with experience analyzing development impacts or the socioeconomic benefits of private sector
operations. PSOD has had difficulties accessing safeguard specialists although one person with
skills in this area joined PSOD in 2006. Limited attention to these issues, and difficulties
preparing coherent Design and Monitoring Frameworks for projects has created tensions
between some Board members and PSOD. The departmental annual budget figures reflect a
similar trend of under-resourcing (Table 6). The budget for 2006 increased 148% over 1995.
ADB’s total actual budget increased over the same period by 171% indicating the PSOD budget
was adjusted at a slower rate than funding elsewhere in ADB. This result occurred despite the
fact that changes in new transaction volumes and transactions under PSOD management were
increasing at a much faster rate than the rest of ADB. In 2006, PSOD’s staff consulting budget
was less than $1.0 million although it did gain access to a $5.0 million TA allocation, an increase
from the $3.0 million allocated for the first time in 2005.

Table 6: PSOD Budget Figures (1995, 2000, and 2006)

($000)
Resources 1995 2000 2006
Total PSOD Budget 3,479 4,285 8,637
Of which, Staff Consulting 250 na 950
Technical Assistance Allocation - - 5,000
na = not available; PSOD = Private Sector Operations Department.
Source: Asian Development Bank budget, 1995, 2000, 2005.

6. Reporting and Risk Management59

85. In 2006, PSOD initiated a system for preparing annual reports on infrastructure projects.
This arrangement will be extended to financial sector investments in 2007. There is a
consolidated set of annual financial statements prepared for PSOD by Controllers Department
but the quality of the information is diminished as the system does not accurately allocate items
such as overhead operating costs to PSOD or identify the risk adjusted cost of capital of its
projects. The main source of data on PSOD performance is the Private Sector Investment
Management (PSIM) Notes that are consolidated in a quarterly report that is appended to a two
page covering commentary by PSOD Management. These notes and the annual report do not
compare budgets against actual. The project data in the PSIM notes is incomplete, and
substantial additional data processing is required to support management decision making.
PSOD does not report on development impacts at the country level or in departmental reports.
Apart from the PSOD project self assessment reports, formal feedback mechanisms to the
Board, Management, and regional departments are not in place. PSOD does not formally report
on private sector development constraints that are undermining the performance of projects and
identify areas of future reform to strengthen the enabling environment.

86. Reporting arrangements for safeguards appear to be ad hoc, and primarily relate to
project processing and approvals. As is the case on the public side of ADB, post-project
monitoring to ensure no adverse impacts on environment, livelihoods, resettlement, and
indigenous peoples is limited. Credit risk management and reporting arrangements are being
revised within ADB; and new risk ratings, exposure limits, and provisioning arrangements are

59
Further details on these issues are in ADB. 2006. Annual Report on Loan and Technical Assistance Portfolio
Performance for the Year Ending 31 December 2005. Manila.
36

being prepared. However, these reforms are only in the early stages.60 While changes are
positive, the Risk Management Unit is experiencing difficulties due to: (i) problems attracting
staff; (ii) time required to develop new nonsovereign guaranteed risk management systems from
scratch; and (iii) working within procedures that were designed for public sector operations.
Progress has been lacking in consolidating and upgrading information systems and preparing
reports that help support management decision making regarding performance, risks, and
issues requiring corrective action. The Office of Information Systems and Technology plans to
consolidate and strengthen ADB’s computerized management information systems. However,
the program is not clear at this stage, and a detailed assessment of management information
needs for PSOD does not appear to have been undertaken.

IV. EVALUATION FINDINGS

A. Overview

87. ADB’s private sector development and operations was evaluated following the
Guidelines for Nonsovereign Operations and conceptual framework presented in Chapter 1. The
overall rating is “satisfactory” (see Table 7).

Table 7: Evaluation of ADB’s Private Sector Development and Operations

Partly
Item Unsatisfactory Satisfactory Excellent
Satisfactory

1.0 Development Impact X

1.1 Private Sector Development X
- Beyond company impacts
(improving enabling
environment) X

- Direct company impacts

(catalyzing investment) X
1.2 Business Success X
1.3 Economic Sustainability X
1.4 Contribution to Living Standards X
1.5 Environmental Performance X
2.0 ADB’s Investment Profitability X
3.0 ADB’s Effectiveness X
3.1 Screening, Appraisal, and
Structuring X
3.2 Monitoring and Supervision X
3.3 Role and Contribution X
4.0 ADB’s Additionality X
5.0 Overall Rating X
ADB = Asian Development Bank.
Source: Asian Development Bank Operations Evaluation Mission.

60
ADB. 2007. Review of Prudential Exposure Limits for Nonsovereign Operations. Manila.
 37

88. Investment profitability and ADB’s additionality were rated “satisfactory”, while
development impacts of private sector operations were rated as being on the margin of
“satisfactory”. ADB’s effectiveness was rated “partly satisfactory”. The lower ratings reflect the
fact that ADB has not realized its full potential to create synergies between its public and private
sector operations, rather than systemic problems with the PSOD portfolio.

B. Development Impact

89. Development impact was evaluated using the following criteria: (i) private sector
development including beyond company impacts (i.e., impacts on enabling environment) and
direct company impacts (i.e., impacts of private investment); (ii) business performance; (iii)
economic development; (iv) contribution to living standards; and (v) environmental sustainability.
Overall the development impact of private sector operations was rated as satisfactory.

1. Private Sector Development

a. Beyond Company Impacts

90. This criterion refers to factors such as expansion of the private sector, increasing
competition, strengthening industry linkages, improving laws and regulations and creating sound
contractual frameworks. There is a lack of data on the linkage between outputs and their impact
on the private sector operations. ADB reports, including OED evaluations, PSOD reports and
country case studies, were the main sources for information for the evaluation. The rating for
this criterion is partly satisfactory as the evaluation found that ADB has not realized its full
potential to create synergies between its public and private sector operations to improve
enabling environment and to mobilize private sector resources to support socio economic
development in DMCs. Table 8 presents some examples of where there was good cooperation
between regional departments and PSOD. Cooperation is most apparent in the power and
energy sectors and in these circumstances the results were often very successful. However, in
general, regional departments and PSOD have not worked together sufficiently to develop the
synergies necessary to achieve a better development rating.

Table 8: Examples of PSOD Projects Originated by Regional Departments

Country Project
Bangladesh AES Meghnaghat Power Project

India LNG Petronet

Dahej Liquified Natural Gas Terminal
Tala Delhi Transmission Project

Mongolia Trade and Development Bank

Pakistan SME Guarantee Facility

PRC Chengdu Water Supply Project

LNG = Liquefied Natural Gas; PRC = People’s Republic of China; PSOD = Private Sector Operations Department;
SME = small and medium-sized enterprise.
Source: Operations Evaluation compilation.
38

91. As discussed in Chapter III, OED’s review of country strategies indicates that private
sector was not generally a material feature. Private Sector Assessments and country strategies
were meant to be the main instruments guiding the implementation of the Private Sector
Development Strategy and identifying ways to improve enabling conditions. These reports were
found to be ineffective instruments to achieve this objective. The lack of focus on road maps
and private sector alternatives meant country strategies and private sector assessments often
had little relevance for private sector operations. The 2006 Task Force Review of the Private
Sector Development Strategy found the strategy had not been successfully implemented and
this evaluation confirms those findings, especially in regard to creation of an enabling
environment for the private sector.

92. A review of private sector project evaluation reports found that PSOD had limited
influence on the enabling environment. This result is not surprising as the Private Sector
Development Strategy formally assigned responsibility for strengthening the enabling
environment to regional departments and PSOD did not have the mandate or the resources to
perform this task. There are a number of examples where problems arose with tariffs in ADB-
supported transactions, and PSOD and regional departments were able to work together to gain
access to policy makers to mitigate some of the negative financial consequences for private
sector clients. Mechanisms were not put in place to systematically feedback PSOD’s experience
at the transaction level to broader policy dialogue undertaken by the regional departments to
improve the business environment.

93. The country case studies (see Table 9 and Appendixes 4, 5 and 6) indicated there was
insufficient activity strengthening the enabling environment for the infrastructure and finance
sectors. There was a lack of activity in areas such as establishing public private partnership
procurement capacity in sectors such as roads and water. In many cases the realization of
ADB’s private sector development and poverty reduction objectives seemed to be equated with
trying to improve SME access to finance by providing credit lines to government owned financial
institutions rather than strengthening the enabling environment and supporting PSOD
participation in a wider range of transactions. Alternatively, the focus was on capital market
development, even when banks continued to suffer serious problems securing debt and bond
markets were years away from being likely sources of private finance. While there were
exceptions, this is a narrow focus, especially when non performing loans continue to be a
fundamental constraint for banks across Asia.

94. Despite bankruptcies following the Asian financial crisis, limited work was done by the
public sector side of ADB in areas such as property rights, secured transaction registries, and
mortgage and bankruptcy laws. These areas are fundamental to building an enabling
environment for the private sector and providing the basis to moving to capital market
development. An important exception was Viet Nam, but it is not clear what level of success has
been achieved and there was a lack of follow through in the form of financial sector investments.
In the India and Philippines, PSOD has sought to catalyze programs to address the non
performing loan problem, although these efforts were not supported by any prior enabling
reforms put in place by the regional departments.
 39

Table 9: Private Sector Development Operations in Case Study Countries, 1995-2005

Activity Philippines India Viet Nam

Public Private Public Private Public Private
Public - - Some reform to - Strengthened -
a judiciary and executive.
Administration
executive at BOT Law. No
state level. No direct
assistance on involvement in
privatization, or privatization or
strengthening strengthening
property rights. the Public
Private
Partnerships.
Unit or
property rights.

Power and Extensively Funded Extensively Transactions Involved in Two

energy involved in Independent involved in in sector pioneering
unbundling Power unbundling and generation, restructuring power
and Producers regulatory and a and projects
regulatory Several reform in some liquefied transmission. contracts.
reform. Private states. natural gas
Sector project.
Operations
transactions
pending.
Transport Limited Manila road Substantial - Substantial -
activity tollway. involvement in involvement in
Tried to road programs road programs.
support and some rail.
Private
Manila air
terminal.
Water and Unbundling Tried to Substantial Small Developed Tried to
Urban Manila Water participate housing number water resource participate
Development to create two unsuccess- assistance housing management unsuccess-
concessions. fully in programs. projects system. fully in water
Maynilad unrelated to concession
Water. public sector
operations.
Finance Capital Small Capital markets Banks and Financial -
markets number of reform, and Equity Fundssector reform
reform and Non infrastructure main focusing on
SME credit Performing and SME credit activities. restructuring
lines. Loan lines. TransactionsBanks and
transactions unrelated toNon Bank
unrelated to Regional Financial
Regional Department Institutions and
Department operations. providing rural
operations. credit lines.
SME = small and medium-sized enterprise.
a
Refers to activities such as fiscal and judicial reform, competition, privatization, property rights, foreign direct
investment and public private partnership capacity building.
Source: Operations Evaluation Department staff compilation.
40

b. Direct Company Impacts

95. Direct company impacts are concerned with assessing the influence of ADB’s private
sector investments and loans on private sector development by stimulating investment due to
factors such as demonstration impacts and transfer of technology. The rating for this criterion is
satisfactory.

96. The independent country, sector and project evaluations conducted by OED and self
assessments by PSOD are the primary source of data on individual project impacts. The results
of these studies indicate the projects have generally been successful once they have been
implemented. An overall project success rate of 92% is high compared to public sector success
rates. A review of the project evaluations in Appendix 2 indicates that demonstration effects
were an important feature of many projects. Projects such as Petronet LNG Limited, Nghi Son
Cement Limited, Fujian Pacific Electric Limited were all able to demonstrate the introduction of
new technologies and approaches in areas such as governance, marketing, production,
complying with social and environmental standards and good community relations. Foreign
sponsors were able to bring in new skills and help train up local workforces.

97. PSOD’s self evaluations report similar findings. Projects such as Grameen Phone and its
role in bringing telecommunication services to the poor have had an international impact in
terms of demonstrating what can be achieved by bringing these services to the poor. The
Colombo Port is helping revive critical infrastructure that will potentially have spill over effects for
the whole economy, and could not easily be financed by the government due to fiscal
constraints. The National Development Bank Housing Bank project provided important
demonstration effects in the area of improving access of the public to housing, although the
project has suffered from weaknesses in the enabling environment due to problems enforcing
mortgage laws. The Bhutan Bank project brought international financial services to a remote
and under-developed economy.

98. While these impacts were positive, there were some issues, especially among the
financial sector projects. These problems appear to have been associated with the Asian
financial crisis and arose in areas such as legal property rights that undermined development
potential. Similarly, the early industrial sector investments often ran into financial difficulties and
did not have a sustained positive influence on development. PSOD has, appropriately, exited
from the latter line of business.

99. As part of this evaluation, rapid project assessments over the period 1995-2005 were
conducted in the three case study countries. Table 10 provides a summary of performance.
Overall the results were positive. Further details on the projects are presented in Appendices 4,
5, and 6.
 41

Table 10: Project Performance in Country Case Studies (1995–2005)

Country Number Number Number Number Total Number
Projects Projects Projects Projects of Projects
Canceled Unsatisfactory Satisfactory Excellent

Philippines 3 2 3 3 11
India 9 1 9 3 22
Viet Nam 2 0 2 3 7
Source: Operations Evaluation Department staff compilation.

100. The Manila North Tollway Corporation project was the only infrastructure project in the
Philippines approved and implemented over the period of analysis. The complimentary financing
scheme was successfully used to catalyze additional funding for the project, which contributed
to overall development impact. The success of the project helped demonstrate the feasibility of
public private partnership structures in the road sector. The transaction is replicable and further
private road projects are being processed by the government. Given the limited amount of
successful public private partnerships in the road sector worldwide, this outcome is positive. The
majority of private sector transactions pursued in the Philippines was in the finance sector,
encompassing a peso swap that was cancelled, three investments that together were designed
to help resolve the non performing loan problems of PCI Equitable Bank and National Housing
and Mortgage Company, and establish a credit bureau. While these transactions were small
and have only recently been put in place, it appears likely they will have important positive
developmental impacts and will help to demonstrate the non performing loan problem in the
Philippines can be resolved.

101. In India, the emphasis on infrastructure in ADB’s country strategy was not fully reflected
in the level of private sector operations. The country strategies repeatedly called for innovative
infrastructure financing solutions to help catalyze additional investment using mechanisms such
as credit enhancement facilities and financing public private partnership infrastructure projects.
In practice, ADB was not directly involved in these types of transactions over the period of
analysis as few projects were developed that were financially viable. PSOD focused on financial
institutions in India, and in some cases the purpose of this funding was to develop infrastructure.
The performance of individual projects in India was generally satisfactory, with three projects
being ranked excellent, nine satisfactory and only one small investment ranked as
unsatisfactory (see Table 10). ADB made an equity investment in Petronet LNG Limited, the first
private sector LNG terminal in India. Other investors have replicated this type of project,
indicating the project model is robust and it had an important demonstration effect. A local
currency loan made to Tala Delhi Transmission Limited supported a project transmitting electric
power from Assam to Delhi. The transmission project was pioneering as it was the first private
power transmission project in the Asian region. Private sector transactions in the capital market
were developmental and investments appeared to have a positive impact on the enabling
environment.

102. In Viet Nam, there was some consistency between the priorities identified in the country
strategy and private sector transactions. However, two projects with potentially high
developmental impacts were cancelled (i.e., Viet Nam Leasing Company and Lyonnaise Viet
Nam Water Company). Of the remaining five projects, three were ranked excellent for private
sector development impacts and two satisfactory. In volume terms, two power projects and a
cement factory dominated the Viet Nam portfolio. The two power plants are performing an
important role servicing the growing electricity demand in Viet Nam and have had strong
demonstration impacts. Nghi Son Cement Company has been a pioneer satisfying the demand
for cement. RMIT International University of Viet Nam is performing well. There has been a
42

good effort in Viet Nam catalyzing additional funding from third party commercial sources using
the complimentary financing scheme and partial risk guarantee instruments.

2. Business Success and Economic Sustainability

103. Business success and economic sustainability are specific to investee companies and
are concerned with sustainability. The rating for both criteria was satisfactory. The quality of
the portfolio from a risk rating perspective indicates the financial performance of the underlying
projects has improved, following problems that arose in the aftermath of the Asian financial
crisis.

104. OED’s Evaluation of the Energy Sector Policy (2007) found that ADB-supported private
sector projects in this sector were generally profitable and performing well. In a number of
countries there had been problems with tariff adjustments, but ADB participation had played an
important role resolving these types of issues. There are relatively few examples of PSOD
projects in the road sector, although the Manila North Tollway is performing well. In the water
sector, ADB financed the Chengdu Generale Des Eaux-Marubeni Waterworks Company, which
was the first water concession awarded under competitive bidding in the PRC, and it is
operating satisfactorily.

105. In the project evaluation reports, the financial internal rates of return ranged from 6.1%
to 39.5%, and the economic internal rates of return ranged from 12.1% to 38.8%, with no
obvious trends across countries or sectors. While these are satisfactory business and economic
outcomes, the performance indicators can only be regarded as indicative due to the small
number of projects that have been evaluated. In project reviews in the country case studies the
focus of analysis was primarily on project profitability, with a qualitative assessment of whether
there were market distortions or externalities that might impact on economic returns. In the
Philippines financial and economic performance was mainly satisfactory, with only one
investment in an industrial enterprise experiencing financial difficulties. This result was due to
the nature of the sector, coupled with the negative effects of the Asian financial crisis. In India,
portfolio quality moved from 77% of projects being rated satisfactory or better in 1995, to 45% in
2000, to 75% in March 2006 indicating financial performance was now satisfactory. In the
limited number of infrastructure projects, the results were positive and exceeded financial
returns. There was only one project in the banking sector that experienced serious financial
difficulties, although ADB was able to play a major role in restructuring the enterprise and
achieving a profitable exit. In Viet Nam the financial and economic returns over the period of
analysis were excellent or satisfactory.

3. Contribution to Living Standards and Environmental Performance

106. Living standards and environmental performance refers to project externalities and the
level of compliance with the social and environmental safeguard policies of ADB and
governments. The rating for both these criteria was satisfactory. Because of the limited
information on the social and environmental impacts of PSOD transactions, the evaluation relied
heavily on the country case studies.

107. Employment and tax data are not typically collated and published by PSOD, and
formal reports on social and environmental impacts are typically limited to compliance with
agreed resettlement programs. Project evaluation reports only consider these issues for
infrastructure projects, and then primarily in terms of compliance. Social and environmental
impacts of sub-investee companies of financial intermediaries are difficult to identify. PSOD was
 43

only assigned a safeguard specialist in late 2006. While progress is being made, safeguard
reporting arrangements are not yet well developed. This lack of information on social and
environmental impacts represents a gap in PSOD’s management reporting system. In the
limited number of projects where detailed social and environmental data has been collected,
there has typically been a positive social outcome. However, project evaluation reports indicated
there may be some issues arising in regard to resettlement.

108. In the Philippine case study, there was only one infrastructure project closed, and the
overall impact was highly favourable. The Manila North Tollway carried increased volumes of
traffic and reduced traveling times, leading to a reduction in vehicle operating costs and
emissions per kilometer over that stretch of road. The non performing loan and credit rating
agency transactions should help contribute to better social living standards by improving SME
access to finance, which will help create employment and improve profitability.

109. In India, the Petronet LNG project plays an important role servicing India’s large and
growing demand for clean energy and supplies 20% of the LNG gas that is used to fuel taxis
and buses in major urban centers in India and to industrial commercial users (Box 5). The use
of gas rather than oil by vehicles has caused a dramatic reduction in the level of pollution in
major cities in India. Petronet LNG contributed to positive social impacts by investing in local
road, water, and power infrastructure. During the 3 years of construction, an average of 700
new jobs was created, and when operations commenced 390 jobs were created. The Tala-Delhi
transmission project transports clean hydro generated power to Delhi, removing the need to
construct more polluting forms of thermal power. ADB’s support for housing finance in India has
had important positive social benefits.

Box 5: Equity Investment in Petronet LNG Limited

In December 2003, the Asian Development Bank (ADB) approved (i) an equity investment in Petronet LNG Limited
(PLL); and (ii) a partial credit guarantee, without government guarantee. The funds would be used to construct and
operate a liquefied natural gas (LNG) import and re-gasification terminal with a capacity of 5 million metric tons per
year at Dahej, Gujarat. The project would serve gas users along the 2,500-kilometer Hazira-Bijaypur-Jadgishpur
pipeline covering Gujarat, Western Madhya Pradesh, Rajasthan, Delhi, Haryana, Western Uttar Pradesh, and
Maharashtra. ADB had provided technical assistance in 1996 and 1997 to prepare a plan to develop LNG facilities in
India using public-private partnership. Subsequently, four state companies formed PLL to develop the LNG facilities at
Dahej, Gujarat and Kochi, Kerala. In 2002, the sponsors approached ADB seeking financial assistance to implement
the project in Dahej. The project was to be the first ADB private sector transaction to utilize a long-term partial credit
guarantee that would support local currency debt.

The project has realized significant positive development impacts and generated substantial environmental benefits by
substituting cleaner LNG for polluting coal. Demand for energy in India continues to grow rapidly, and the increased
availability of energy at internationally competitive prices is vital for the development of the country. The project
created a facility that provided 20% of the country’s LNG needs and 1% of total energy consumption. The project
demonstrated that importing LNG at competitive prices is possible, thereby supporting the liberalization of the gas
sector and enhancing the level of private sector participation in the energy sector. PLL demonstrated the high
standards of performance that a modern, well-run, private company can achieve. The project is being replicated at
several other facilities across India. Financial performance has been strong due to lower-than-expected operating
expenses and interest costs. ADB’s investment returns have been excellent.

Source: Operations Evaluation Department staff compilation.

44

110. An OED evaluation of a cement plant in Viet Nam constructed in a remote and relatively
poor area found that it was having important positive social impacts. The plant had helped
attract other private investment to the region and is becoming a nucleus of an export processing
zone. Road, rail, port, power, water and industrial infrastructure was being created. The
company was the largest tax payer in the province and it had made substantial contributions to
the state education system. During construction the project employed 3,500 people, and when
operations commenced there were 1,300 jobs. In terms of the environment, the company was
rated as being one of the best firms in the country at implementing its environmental plan. ADB
had financed two private gas fired power plants in Viet Nam that provide access to clean
energy. ADB was active in a series of pilot social projects in the education and health sectors in
Viet Nam. Both projects were able to attract international specialists to Viet Nam and the quality
of services provided by these operations appears to be excellent.

C. ADB’s Investment Profitability

111. This criterion is concerned with investment outcome and sustainability and the
evaluation was premised on financial data. The rating for this criterion was satisfactory, based
on portfolio profitability indicators. The Controllers Department prepares a standalone set of
financial statements for PSOD on a quarterly basis. These accounts are indicative in the sense
results are derived by attributing notional interest and overhead costs to PSOD. There is no cost
of capital deducted for guarantee operations. Loan loss provisions are indicative and are
currently being reviewed by the Risk Management Unit.61 PSOD’s balance sheet does not have
a notional structure of equity and liabilities, making it impossible to calculate a return on equity.
The financial statements indicate that on a consolidated basis PSOD is profitable. Margins on
debt and rates of return on equity are positive, although equity is not generating commercial
rates of return (i.e. it is lower than its cost of capital), and it is not possible to determine if ADB
profitability is commensurate with project risks.

112. While the portfolio is profitable, there is need to ensure that quality is protected over the
medium term. These results need to be placed in context, as the Asia Pacific Region has been
enjoying an extended period of growth of almost 10 years. In 2000, following the Asian financial
crisis, 37% of the PSOD portfolio was rated as marginal or worse, indicating that circumstances
can change rapidly for reasons beyond the control of either ADB or the client. The OED
evaluation of investment funds in 2002 found only two out of seven exited funds achieved a
satisfactory or excellent result. Project evaluation reports repeatedly cite issues such as
unenforceable minority shareholder rights, difficulties exiting from projects, and problems with
adverse exchange rate movements undermining returns on equity. Offsetting these issues,
historical results are distorted by the Asian financial crisis. It is understood performance has
improved significantly for funds established post 1997. PSOD has substantial unrealized capital
gains from a recent financial sector transaction, although it is a statistical outlier and is not
representative of the portfolio as a whole.

113. While the current level of portfolio profitability is satisfactory, there are some issues
associated with the risks embodied in the PSOD portfolio. Risk Management Unit prepared its
first nonsovereign guaranteed portfolio assessment for the year ended 2006, and it prepared a
new set of credit exposure limits for nonsovereign operations that was approved in April 2007.
Under these new arrangements, project limits will be based on proportions of a notional portfolio
of $5 billion, which has been taken as the operational portfolio target for non sovereign
operations for the next three years. This target equates with annual approvals for loans and

61
ADB. 2007. Review of Prudential Exposure Limits for Non-sovereign Operations. Manila.
 45

guarantees of $1.1 billion in 2007 and $1.2 billion in 2008 and 2009 respectively. The country
exposure limit will remain at 25% of the portfolio and single industry exposure limit was
increased from 15% to 30% of committed exposure. A single obligor will be subject to the
following limits: (i) guarantees will be capped at $400 million (8% of capital) or 40% of project
cost, whichever is lower; (ii) debt single exposure limit will be raised from $75 million to $250
million (5% of capital) or 25% of project cost, whichever is lower; and (iii) equity would remain at
$75 million (1.5% of capital), or 25% of aggregate issued share capital, whichever is lower.

114. Table 11 provides an analysis of the risk exposure of PSOD’s outstanding portfolio62
against several criteria that reflect varying degrees of risk. This analysis is based on country,
sector, client and financial instrument classification system maintained by PSOD. The sector
classification methodology used by PSOD is slightly different to the one used by Risk
Management Unit, which disaggregates figures down to the sub sector level. While the PSOD
classification system is slightly dated, it is sufficiently detailed to provide an analysis of the
portfolio. A review of this data indicates there are a number of features that may potentially be of
concern.

Table 11: Portfolio Risk Exposure, 31 December 2006

Risk Category Exposure

Non Financial Sector

Financial Sector

Obligor/Project
Country

Financial Instrument

Underwriting
Guarantees
Equity
Loans

and
Largest Single
350.0a 350.0a 75.0 350.0a 185.6a 75.0b 185.6a
Exposure
($ million)
Percentage of 13.5 13.5 2.9 13.5 7.1 2.9 7.1
Portfolio (%)
c
Portfolio/Sector 21.3 41.0d 27.3e 5.8 49.12 35.4 15.5
Exposure (%)
a = Tangguh LNG project in Indonesia; b = Bank of China; c = People’s Republic of China; d = power sector;
e = financial sector.
Source: Asian Development Bank Operations Evaluation Mission.

115. A single country exposure of 21% is reaching the upper limits of the credit portfolio
restriction of 25%. The country limit of 25% appears to be high as it reduces opportunities to
lower portfolio risks through geographic diversification. An exposure to the power sector of more
than 40% of the portfolio appears disproportionate, and exceeds ADB’s 30% sector portfolio
limits. Disaggregating this exposure into energy and power sectors does not reduce this risk
materially as returns from these sub-sectors will be correlated. While the total portfolio consists
of exposures to 122 companies, a single obligor in a single project represents 13.5% of the total
portfolio which is high. A portfolio with 35.4% equity at the end of 2006 is an aggressive
structure for a bank that may involve risks. While PSOD has informally applied a ceiling of 30%
of the portfolio for equity in 2007, consideration should be given to determining whether explicit

62
Disbursed and outstanding on ADB’s own account
46

exposure limits should be adopted for types of funding modalities such as equity that are based
on formal risk management principles.

116. The current credit limits do not recognise problems of borrowing fixed interest rate funds
to finance equity investments with highly variable cash flows. Neither do the new credit limits
discuss the portfolio structure and limits on the amount of equity as a proportion of total non
sovereign guaranteed transactions. This issue is important as it potentially has implications for
ADB’s “AAA” credit rating and cost of borrowing funds. Apart from setting a limit of $5.0 billion
the Board has not yet considered the issue of the scale of non sovereign risk. The Risk
Management Unit has been requested by the Board to prepare a strategic paper analysing this
issue. Given the current small size of non sovereign operations, and ADB’s high capital ratio,
there is a reasonably high degree of flexibility structuring the portfolio. However, this flexibility
will diminish as the size of the portfolio increases.

D. ADB’s Effectiveness

117. ADB’s effectiveness is concerned with ADB’s (i) project screening, appraising, and
structuring; (ii) monitoring and supervising capacity; and (iii) role and contribution. While there
have been exceptions, especially more recently, the rating for the entire evaluation period is
partly satisfactory.

1. Screening, Appraising and Structuring Projects

118. The rating for these criteria was partly satisfactory. Screening is concerned with the
way in which projects are prioritized at a strategic level within a country strategy framework. The
results of the evaluation indicate the private sector investments could have been targeted more
precisely to fit within more clearly defined sector reform programs. As discussed in the Task
Force’s review in 2006 of the Private Sector Development Strategy, there have been problems
with the interface between the public and private sector departments in ADB. This was
confirmed by this evaluation, both in the analysis of country strategies in general and in the
three country studies. This lack of coordination constrains the quality and level of growth of
private sector transactions. This result arose due to weaknesses in the planning process led by
the regional departments (see Chapter III). There was a lack of PSOD involvement in the
formulation of country strategies. There are also issues related to the quality of the private
sector related aspects of country strategies and the availability and use of private sector
assessments.

119. There was no formal requirement to include private sector development road maps or
provide measurable and monitorable performance indicators.63 While the Private Sector
Assessments that were produced appeared to be of a reasonable standard, they were not used
in the preparation of country strategies and programs. As a result, country strategies were not
effective instruments for ADB to help create a sound enabling environment for private sector
development to occur in a structured systematic fashion. In infrastructure sectors, there were
few examples of regional departments creating enabling conditions such as public private
partnership procurement agencies, sector roadmaps identifying project needs, concession
designs, or mechanisms such as funds to help resolve consumer income, and supplier risks.
The lack of PSOD engagement in the country strategy process meant that public sector led
reviews of sectors were often not subject to any significant internal pressure to consider

63
This issue was applicable to both private and public sector operations. ADB did not make results based country
strategies mandatory until 2006.
 47

alternative private sector modalities when appraising projects. No steps were taken within ADB
to introduce techniques to assess value for money arising from public versus private sector
provision using project appraisal techniques to explicitly address issues of maximizing
productive efficiency.64

120. In addition to problems with planning prioritization, there were also issues that arose due
to the characteristics of private sector projects that meant they were often not included in
country strategies. Two factors contributed to these circumstances: (i) commercial confidentiality
concerns for private sector projects under consideration; and (ii) the nature of business as it
responds to requests for financing from private sector clients. Public sector lending is
programmed two to three years in advance, and ADB typically finances some of the project
preparatory work. Private sector sponsors are expected to finance their own feasibility studies to
demonstrate their proposed transactions are bankable. When the sponsors approach ADB for
financing the transaction has reached a mature stage and they are seeking financing within a
year. Private sector clients do not approach ADB for financing in, say, three years before it is
needed.

121. Given these factors, it is understandable why country strategies did not include a forward
list of private sector projects. What is not understandable is the lack of a private sector strategy
within the country strategies that: (i) identifies specific priorities in terms of sectors and types of
interventions where PSOD would pro-actively seek to provide assistance; (ii) helps to position
ADB’s private sector operations; (iii) provides a framework to build synergies between the public
and private sides of ADB; and (iv) identifies clear public sector interventions, both for loans and
TA, that help to improve the business environment in areas where private sector transactions
are anticipated. ADB appears to have recognized the need to strengthen the private sector
aspects of country strategies and issued new guidelines governing the preparation of country
partnership strategies in 2007 which mandate greater PSOD participation in their formulation. It
remains to be seen if these new guidelines will be effective in solving this problem.

122. A Private Sector Development Committee was established in 2000 to help coordinate
ADB’s private sector development efforts. The committee did not have any representatives from
Management, and primarily acted as a network focal point. Various ADB-wide presentations
were organized and several studies were produced analyzing issues such as the preparation of
development indicators and implementation of private sector reform strategies. Five Private
Sector Development Specialists were employed in the regional departments to help prepare
Private Sector Assessments and implement enabling environment projects and TAs that would
provide a platform for private sector transactions. The independent review of the 2002 ADB
reorganization noted that the presence of the specialists did “not seem to have much impact on
the private sector development activities. The subject area for the specialists is vast. It is
doubtful that even three or four specialists in each regional department could cover the
expertise needed for ADB to plan and promote private sector development in individual
DMCs.”65 Subsequent analysis by OED indicates that while a lack of breadth of expertise may
have been an issue, it was not the critical constraint. There were not enough specialists, and
even when present, it appears they were often co-opted to work on other priorities of the
regional department.

64
An example of this methodology is presented in Minister of Public Works and Government Services Canada. 2003.
The Public Sector Comparator, A Canadian Best Practices Guide. Industry Canada. Ottawa, Canada: Canadian
Government Publishing.
65
ADB. 2004. Independent Assessment of the Effectiveness of the Reorganization of the Asian Development Bank
Diagnostic Report. Manila.
48

123. Appraisal quality is concerned with due diligence procedures and compliance with
social safeguard requirements. The high level (24%) of cancellations in the PSOD portfolio from
1996 to 2000 suggests there have been weaknesses in ADB’s due diligence procedures in a
number of cases. Cancellations at this level undermine the effectiveness and efficiency of
PSOD operations. Interviews with project managers in the three country studies indicated that
cancellations were primarily due to problems with economic instability arising from the Asian
financial crisis, lack of political stability in some DMCs, regulatory issues, and lack of demand
due to the high cost of ADB funds compared to other sources of financing in the market. The
country case studies indicated that in some cases more effective due diligence procedures
might have avoided this outcome. In the power sector OED found that standards of due
diligence had improved over time.66 Overall, the level of due diligence appears adequate as
PSOD’s procedures do not appear to be resulting in projects with a high level of credit risks.

124. A review of PSOD project completion reports indicates the processing time for ADB’s
financing from due diligence to documentation and signing tends to be lengthy when viewed
from a private sector client’s perspective. While such delays are frequently due to reasons other
than inefficiency, they raise concerns. Some sponsors interviewed by OED voiced concerns
about the lengthy turn around time ADB needed to complete all required internal procedures,
document transactions, and reach financial close and disbursement. These problems reflect, in
part, the nature of ADB’s business processes that are derived with a public sector mentality and
a lack of harmonization with other international financial institutions in areas such as safeguard
policies.

125. Structuring is concerned with influencing the characteristics of the assets being
financed and the financial structure itself, including type of funding instruments, currency, pricing
and tenor. For much of the evaluation period, PSOD relied heavily on conventional debt and
equity (Figure 11).

Figure 11: Private Sector Operations Approvals (2000–2006)

1600
1400
1200
1000 Equity
$ Million

Loan
800
Guarantee
600 CFS
400
200
0
2000 2001 2002 2003 2004 2005 2006

CFS = complementary finance scheme.

Source: Asian Development Bank records.

66
ADB. 2007. Evaluation of ADB Energy Policy 2000 Review. Manila.
 49

126. During the evaluation period, more use could have been made of hybrid forms of finance
such as subordinated debt. These instruments would help address the risk capital needs of
clients without compromising exit options and ADB’s need to earn an acceptable return in
foreign currency terms. Greater use could have been made of credit enhancement instruments
such as complementary finance scheme and guarantees which provide an efficient means of
using ADB’s capital relative to debt and equity. At the end of 2006, complimentary financing
schemes and guarantees accounted for 31% of the portfolio (19% complimentary financing
schemes and 11% guarantees67). The complementary financing scheme instrument was only
used three times from 2000-2005. This result was mainly due to negative market perceptions
about the value of the instrument following problems that primarily occurred with IFC’s similar
instrument in South America. In 2006 demand for complementary financing schemes increased
due to improvements in the regional political environment. Four facilities were approved with a
total value of $455 million. It remains to be seen whether the increased use of complementary
financing scheme instruments will continue.

127. Guarantees are more complex and expensive than complementary financing scheme
instruments and have not been used extensively. The demand for Political Risk Guarantees for
infrastructure projects has been declining with the improving economic environment in the Asian
region. This instrument was used in five countries (i.e., Afghanistan, Bangladesh, Lao PDR, Sri
Lanka, and Viet Nam) over 2000–2006. With more innovation and effort, it might have been
possible to make greater use of the instrument in countries such as India, the PRC and the
Philippines. Partial Credit Guarantees were mainly used to support SME credit lines, and their
use was sporadic. After a hiatus of two years, two Partial Credit Guarantees were used in 2006
in capital market securitization transactions in Indonesia and Kazakhstan to support commercial
cofinancing facilities, although the Indonesian transaction only had a value of $10 million.
Partial Credit Guarantees are more difficult to design than Political Risk Guarantees due to
problems of moral hazard, and adverse selection. Despite these factors, there should have
been opportunities for ADB to use these instruments to help support local capital raisings.

128. There is potential for making greater use of blends of financing and credit enhancement
instruments such as by providing finance for construction followed by a partial credit guarantee
to support a sponsor bond issue. The range of risks covered by ADB could be extended to
include economic, financial, social and environmental risks. Lack of demand for credit
enhancement instruments appears to stem from problems with product characteristics of the
credit enhancement instruments and institutional problems within ADB. The product
amendments presented in the Credit Enhancement Policy Paper (2006)68 should help stimulate
demand for credit enhancement products, although there are concerns about lack of incentives
for PSOD to use cofinancing scheme and guarantee instruments.

129. The Credit Enhancement Operations Policy Paper reviewed options for facilitating the
use of guarantees and syndications through mechanisms such as lender of record, reinsurance
and sell down mechanisms. Reforms were proposed to help increase flexibility in the use of
Credit Enhancement Operations instruments through measures such as eliminating lender of
record provisions, and allowing ADB to provide standalone guarantee products. Provisions were
introduced making the risks covered by complementary financing scheme instrument facilities
more transparent. While all of these measures were important, it is not clear these issues will
be resolved without more fundamental changes to the organization structure and staff incentives
67
This figure cannot be benchmarked against IFC as it does not directly provide political risk guarantees. This is done
by Multilateral Investment Guarantee Agency within the World Bank Group. In regard to CFS, syndications (which
encompass CFS type instruments) accounted for 32% of IFC’s global portfolio at 30 June 2005.
68
ADB. 2006. Review of ADB’s Credit Enhancement Operations. Policy Paper, August 2006.
50

to utilize economic capital more efficiently through greater use of guarantee instruments. The
limited use of guarantee instruments reflects a combination of organizational factors including a
lack of: (i) skills and incentives for operational staff to process these types of transactions; and
(ii) lack administrative procedures and performance measures that could prioritize the use of
these types of instruments in a way that makes better use of ADB capital relative to total
investment catalysed by transactions. There are institutional barriers as PSOD and Office of
Cofinancing Operations (OCO) report to separate Vice Presidents.

130. ADB has good progress in identifying ways of using local currency finance. ADB has
been actively engaged in finding ways of mobilizing local currency since 2004, initially for private
sector. This initiative should help to mitigate or avoid some of the risks associated with currency
mismatches that arose in the past. However, there are issues related to pricing and tenors of
loan instruments. At present PSOD is subject to pricing procedures where financial instruments
are priced exclusively by reference to the market. It is difficult to derive efficient funding
structures using this approach due to yield curve effects that make tradeoffs between the cost of
funds and the tenor of the grace and repayment periods difficult to determine due to a lack of
market comparators. There is also a lack of detail on the reasonableness of the size of the risk
premium and whether it is commensurate with the probability of loss. ADB’s administration costs
are allocated to PSOD projects on the basis of headcount rather than actual usage of
resources. Without detailed cost information, PSOD will be at risk of either being too expensive
and non competitive, subsidizing operations, crowding out the private sector, and not covering
the costs of its operations. Pricing needs to: (i) cover ADB’s actual costs of operations, cost of
funds, and risk return margin adjusted for probability of loss; and (ii) be set at a rate that is
competitive in the market.

131. A review of the terms of loan facilities indicates there is a lack of innovation in the area of
using performance payments, and limited use of structures such as corporate finance for the
construction period, coupled with bond finance for the operations period. The term of grace
periods and tenors of loans is invariably determined on a whole of project basis, rather than
partitioning risks and finance modalities by stage of project development. Similar to loans, there
are concerns about how equity investments and guarantees are priced as there is a lack of
formal procedures to determine a reasonable return on investment relative to ADB’s cost of
capital.

2. Monitoring and Supervisory Capacity

132. The rating for these criteria was partly satisfactory. Many PSOD staff combine project
origination and administration responsibilities. While PSOD staff numbers have increased from
29 in 1995 to 36 in 2000 to 67 in 2006, the increases have not kept pace with changes in
transaction volumes or reflected rising demand from clients. An OED benchmarking study
presented in its Annual Report on Loan and TA Portfolio Performance69 indicated that PSOD
had substantially fewer staff resources than peer international finance institutions after
normalizing for transaction volumes (see Table 12). In some cases borrower firms were not
visited annually to ensure problems were not arising. PSOD would benefit from additional staff
with skills in areas needed to define and monitor developmental and socioeconomic impacts of
transactions, portfolio management, and management reporting capacity.

69
ADB. Annual Report and Loan and Technical Assistance Portfolio Performance for the Year Ending 31 December
2005. 2006. Manila. Pages 100–111.
 51

Table 12: Comparison of Volume and Number of Portfolio Transactions Relative to Staff
Outstanding Portfolio 2005 EBRD IFC PSOD
(net of cofinancing)
Investments per staff ($ million) 6.4 7.1 17.3
Number of portfolio transactions per staff 0.6 0.9 1.2
EBRD = European Bank for Reconstruction and Development; IFC = International Finance Corporation;
PSOD = Private Sector Operations Department.
Source: ADB. 2006. Annual Report on Loan and Technical Assistance Portfolio Performance for the Year
Ending 31 December 2005. Manila (p. 105).

133. Experience from the public sector side indicates that project supervision and monitoring
improves if staff in resident missions is involved. Several sponsors were critical of PSOD’s lack
of presence in the market relative to institutions such as IFC. Currently, PSOD staff is stationed
in only three out of the nineteen resident missions (India, the PRC and Thailand). In most cases
these staff report to the Director General of PSOD, and operate independently from other ADB
staff at the resident missions. PSOD representation in so few DMCs is inadequate to achieve
the objectives identified in ADB’s Private Sector Development Strategy. This lack of market
presence undermines PSOD’s ability to pursue business development initiatives and manage
the existing portfolio, leading to a competitive disadvantage relative to commercial banks and
IFC. In a recent annual review, IFC noted it has almost doubled staff numbers in the field from
669 staff (35% of total staff) in 2000 to 1,249 staff (46% of total staff) in 200570. Going forward
IFC intends to accelerate the presence of core operations staff in the field and decentralize
management decision making authority for the first time to the East and South Asian region.
This vastly greater presence in the field provides IFC with a more credible in-country presence
than ADB.

134. It is difficult to monitor and supervise the quality of investee companies of venture capital
funds in which ADB has invested, creating a potential reputation risk for ADB. Similarly, there
are potential concerns about co-investors in some equity funds. Equity investment implies a
high level of endorsement by ADB of sponsors and co-investors. This type of relationship entails
risks as ADB becomes more engaged with local firms in the Asia Pacific Region where it can be
difficult to obtain reliable information on the integrity of some parties.

135. Reporting systems do not provide a clear indication of development and financial
performance or critical risks. Project objectives and report formats lack clarity, and Concept
Clearance Papers, Reports and Recommendations of the President, and OED and PSOD
evaluation reports, have different performance criteria and stated objectives. In the past there
have been few clearly defined performance targets in funding proposals presented to the Board.
A Development Impact Framework has recently been introduced as an Appendix in Reports and
Recommendations of the President. However, there are no details on the expected level of
performance targets, which are not always related to objectives specified in the main text.
PSOD is working with the Central Operations Service Office to develop a training module in
2007 to strengthen staff skills in the preparation of design and monitoring frameworks.

136. There are gaps in the data collected for monitoring project development impacts, credit
risks, social and environmental effects, and reputation risks. Even assuming data was collected
on the proposed development measures, there is no document prepared by PSOD which
reports on whether targets are achieved over the life of the project, and reasons for variations.
The only time achievement of performance targets occurs is the OED and PSOD evaluation
70
IFC. 2006. Strategic Directions Paper. Washington.
52

documents which are only prepared once in the life of a project at the point when they reach
“early operating maturity”. In the absence of specific quantitative and qualitative development
targets, planned resource utilization patterns, and reports against targets, it is not possible to
determine if the private sector development and operational objectives are being achieved. A
PSOD annual report for monitoring projects was introduced in 2005 but reports are incomplete
due to factors such as difficulties measuring project risks and allocating indirect administration
costs. Contrary to the recommendation in the Private Sector Development Strategy, no
balanced scorecard has been produced to help guide private sector development reforms.
These problems are compounded by the fact that information systems are incomplete. In many
cases the information systems are manual, based on distributed systems, and are not secure,
creating risks of errors and omissions.

3. Role and Contribution

137. Role and contribution was satisfactory. Evidence indicates PSOD played a positive role
in transactions. In some cases, when projects encountered difficulties related to government
actions, sponsors particularly appreciated ADB’s ability to access senior decision makers, in the
role of an honest broker, to help resolve the problem. During the country studies PSOD was
complimented by sponsors on a number of occasions on its efforts to establish standards of
high corporate governance in both infrastructure and financial sector projects. Various sponsors
valued the endorsement of project quality in the area of safeguards that rose through ADB
participation.

138. ADB’s safeguard policies are typically valued by clients, and project evaluation reports
indicate that implementation has been of an acceptable standard in most cases. However, there
are issues with ADB’s safeguard policies and standards that need to be addressed related to
IFC’s recently announced intention to apply equator principles to its projects when considering
environmental impacts. There is a need to harmonize the ADB and IFC approach to safeguards,
particularly when they are both cofinancing a project. The situation is further complicated by
local governments that have different standards to ADB and the World Bank in areas such as
resettlement and compensation, raising an issue of which standards should apply.

E. ADB’s Additionality

139. Additionality is concerned with answering the question: “Is ADB adding value?”
Additionality was evaluated along two dimensions: (i) ADB’s contribution to improving design
and functioning of the private sector projects; and (ii) the extent ADB helped support the
realization of the projects and mobilized private finance, either directly or indirectly. Additionality
appears to have been present to a material degree in the majority of the private sector
transactions that were reviewed. Although the PSOD portfolio has been growing rapidly in
recent years, the lack of involvement in project design and small scale and narrowness of
investments by country and sector has meant a rating of satisfactory rather than excellent has
been assigned to this criterion.

140. Feedback from most sponsors about the positive benefits of their involvement with ADB
was encouraging. Some sponsors considered that ADB’s involvement was critical as a means
of enhancing creditworthiness and catalyzing commercial funding. In infrastructure projects,
ADB participation provided an important means of ameliorating political risk, especially for tariffs
and adherence to contracts in the power and energy sectors. While there have been exceptions
(e.g., Manila water sector; the Manila North Tollway), ADB has not been able to play a
significant role in strengthening design of concession agreements in sectors such as roads and
 53

water. Following the Asian financial crisis it became apparent that infrastructure concession
agreements did not properly allocate risks in areas such as tariff, traffic and currency
movements. ADB could potentially add value to transactions by introducing concession designs
such as annuities for roads and affermage agreements for water. Improving the structure of
concession agreements would, however, require ADB to be involved very early in the project
cycle.

141. In the financial sector, ADB has played an important role enhancing credibility of
financial institutions by providing a quality seal on sponsors, improving governance systems,
and, in some cases, taking positions on the boards of directors to oversee operations. Offsetting
these positive factors, financial sector projects lacked focus in some cases and did not clearly
target development solutions to alleviate constraints on financial mobilization. It is difficult to
measure performance of private equity funds. Funding is often provided in the form of equity or
credit lines without clearly demonstrating whether property and financial rights are capable of
being enforced.

142. These design problems have arisen in part, because PSOD is dependent upon regional
departments and third parties to strengthen the enabling environment and develop its project
pipeline. The regional departments have lacked incentives to pursue private sector enabling
reforms. PSOD’s lack of a mandate and resources mean it operates in a reactive rather than
proactive fashion and had limited involvement in undertaking advisory work to create entry
points in areas such as privatization, and design of public private partnerships. PSOD’s lack of
market presence and inability to access significant TA resources to initiate enabling
environment reforms on its own account has exacerbated these weaknesses.

143. PSOD has made progress in helping to mobilise funds for private sector projects. ADB
funding represents on average 15% of total project costs, or a leverage ratio of 6.7. Under risk
management procedures, ADB is not permitted to finance more than 25% of project costs (or
50% of guarantee projects). ADB’s public sector has traditionally been able to finance up to
40%, 60% or 80% of project costs, depending upon the country classification, and now under
the Innovation and Efficiency Initiative it can finance up to 100%.71 As a result of these rules, the
potential leverage in terms of the amount of dollars invested by third parties for every dollar
invested or loaned by ADB in regard to private sector funds mobilization is substantial and far
exceeds that of typical public sector operations. PSOD has made greater use of ADB’s capital
in recent years, as demonstrated by the level of direct funding as a percentage of total ADB
lending. Trends in both of these sources of leverage are illustrated in Figure 12. The results
indicate the level of investment mobilized by PSOD (as defined by project costs) exceeded
public sector lending in 2005 by 67% and in 2006 by 26%.

71
ADB. 2006. Innovation and Efficiency Initiative, Cost Sharing and Eligibility of Expenditures for Asian Development
Bank Financing: A New Approach.
54

Figure 12: Annual Approvals for Public and Private Sector Operations Compared to
Private Sector Funds Mobilized

10,000 20%
9,000 18%
8,000 16%
7,000 14% Public
6,000 12%
$ Million

Private
5,000 10%
Private Funds Mobilised
4,000 8%
3,000 6% Private (% ADB Total)
2,000 4%
1,000 2%
- 0%
19961997 19981999 2000 20012002 20032004 20052006

ADB = Asian Development Bank.

Source: ADB Lotus Notes database on Loan, TA, Grant, and Equity Approval.

V. ISSUES AND RECOMMENDATIONS

A. Overview

144. The purpose of this section is to identify the implications of the evaluation findings and
consider possible options for leveraging strengths and addressing weaknesses in the future.
The market context for both public sector products and private sector operations in which ADB
is operating is changing, particularly in middle income countries. There is a growing demand for
ADB to finance more non-sovereign transactions, and despite strong growth in the size of the
PSOD portfolio, many DMCs are complaining that ADB is not responding adequately to this
demand. In most countries in the Asia Pacific Region, the private sector is playing a much
greater role in financing, managing and delivering services than was the case 40 years ago
when ADB was founded. This is particularly the case in sectors such as energy, transport, and
water utilities. The financial sectors in many DMCs, particularly in middle income countries have
deepened. Governments are shifting their operational focus to policy and regulatory functions
(see Figure 13). These trends require changes in the nature and scope of both public and
private sector operations and demand greater synergy between ADB’s departments.
 55

Figure 13: Asian Development Bank’s Current and Forecast Client Mix

Concept To Scale

Today 2012

Sovereign/Private Sovereign/Private

Sovereign/ Sovereign
Public /Private Sovereign/Public
Sovereign/Public

Nonsovereign Nonsovereign
/Public /Private Non-sovereign/Public

Non-sovereign/private Non-sovereign/private

Source: ADB. 2006. Asian Development Bank’s Role in Private Sector Development, Task Force Discussion Paper.
Manila.

145. As discussed in the Second Medium Term Strategy72 and the presentation of the Private
Sector Development Task Force to the Board in 2006, the role of private sector operations
within the context of ADB’s operations is expected to grow substantially over the next five years.
To achieve this adjustment in customer mix and scale of operations, there will need to be
changes to the roles, products, responsibilities and organization structures of ADB in general
and PSOD in particular. These changes will involve the level and type of resources, and
PSOD’s reporting arrangements to Management. An operational review of PSOD was
conducted as part of the evaluation (see Appendix 7) and the findings have helped inform the
discussion in this section on areas where potential reforms could be introduced to increase the
effectiveness and efficiency of ADB’s private sector development activities. These types of
reforms are complex, and require changes in the organization culture and the way in which
things are done. It will take time, strong leadership and changes in incentives and possibly
organization structure to achieve these reforms. Nevertheless, the potential benefits are likely to
be very large and the challenges are not unique to ADB. To varying degrees these issues are
being tackled by all of the large international financial institutions.

B. Issues

1. Organization Structure

a. Overview

146. Over the years, ADB has struggled to find the best organization structure for PSOD. The
vision given in Figure 13 that nonsovereign lending will grow significantly faster than sovereign
lending will create tensions within ADB’s organization structure. Future changes in ADB’s
organization structure may be required to achieve this vision. It is beyond the scope of this
evaluation to make specific organization recommendations. However, some observations can
be offered that may be useful for future deliberation when this issue is considered.

72
ADB. 2006. Medium-Term Strategy II, 2006–2008. Manila.
56

147. ADB’s organization model has failed to achieve the Private Sector Development
Strategy (2000) objective of realizing synergies through cooperation of public and private sector
operations. This has constrained ADB’s ability to increase the scale of its private sector
transactions. To ensure that ADB is well positioned to respond to the changing demands of its
major clients, an organizational review could be undertaken to determine the most suitable
structure to provide private sector development and operations in these evolving market
conditions. Currently, tension is evident between geographic, sector, and thematic objectives,
which is undermining the strategic performance of ADB. Other international finance institutions
have addressed conflicting requirements by developing an organization structure that places
sector orientation and country and regional orientation in a matrix. This framework requires a
movement away from binary concepts of public and private sector towards a continuum
between sovereign and nonsovereign guaranteed operations.

b. Role of Management

148. The Vice-President (Operations 1) is responsible for PSOD and all public sector
operations in Central and West Asia and South Asia. The Vice-President (Operations 2) is
responsible for East Asia, South East Asia, the Pacific, and Central Operations Services Office.
The Vice-President (Knowledge Management and Sustainable Development) is responsible for
the Office of Cofinancing Operations, Regional Sustainable Development Department, and
Economics and Research Department. Risk Management Unit reports, through the Managing
Director General, to the President. This organization structure is inconsistent with PSOD’s
mandate to process and administer private sector investments in all DMCs. Further, it makes it
difficult for Management to provide strong leadership to drive an integrated delivery of services.
With rising demand for private sector transactions, ADB should consider whether it would be
desirable to review this structure.

149. There are a number of possible options that could be considered including: creating a
fifth Vice President to provide strategic leadership for all of ADB’s private sector business;
separating sovereign and non-sovereign responsibilities between two Vice Presidents; having
PSOD report to the Managing Director General; or having PSOD report directly to the President.
Decisions related to revising the reporting structure for PSOD are complex and involve factors
that extend far beyond matters that are covered in this report. However, if the ADB’s private
sector operations grow at the rate that was expected in the 2006 private sector review, ADB will
need to consider at some point whether the current allocation of responsibilities among Vice-
Presidents is optimal for ADB’s changing business mix. This issue could be considered in the
context of the midterm review of the Long-Term Strategic Framework currently being
undertaken by the Strategy and Policy Department (SPD) and OED.

c. Role of Resident Missions

150. In line with the vision in the resident mission policy, more resident missions need to have
PSOD staff with private sector skills and capabilities. The resident missions must take on
greater responsibility, accountability, and leadership to promote this type of business. The
current situation, where PSOD cannot make full use of resident missions in countries with
significant private sector operations potential, is unsatisfactory. It calls for a review of the roles
and responsibilities of resident missions, their staffing and skills mix, and overall business
orientation. This issue extends beyond the scope of this evaluation as it involves fundamental
questions related to ADB’s role of resident missions, the balance of staff in ADB’s headquarters
and resident missions, and ADB’s business processes. These broader issues are being
addressed in an ongoing evaluation of resident mission effectiveness. The results of that
 57

evaluation will feed into the work that is being undertaken by SPD, and the Budget, Personnel
and Management Systems Department (BPMSD) to review the effectiveness of the resident
mission policy and to propose changes. Following the example of IFC and EBRD, consideration
could be given to placing PSOD staff in major commercial centers, and focusing initially on
resident missions located in countries where the development of the private sector is a major
element of ADB’s country strategy.

d. Organization Structure of PSOD and OCO

151. There are some conflicts of interest inherent in the current organization structure of
PSOD, where project origination and administration are combined to an unusually high degree.
These activities should be in separate divisions within PSOD. There is a need to strengthen
guarantee origination capacity within PSOD. The Credit Enhancement Operations Policy
Paper73 clarified responsibilities of PSOD, Regional Departments and the Office of Cofinancing
Operations in the guarantee syndication process. The paper noted that operating departments
would be responsible for the design and due diligence of financial structures (including both
direct and indirect financial instruments) and the Office of Cofinancing Operations would act in
an advisory capacity and have responsibility for arranging and financing all reinsurance and
syndications. Various other reforms were proposed to simplify use of Credit Enhancement
Products.

152. While the structure and actions in the guarantee policy paper are important, other issues
associated with lack of staff incentives and institutional barriers limiting the potential application
of credit enhancement products are still outstanding. To help resolve these concerns, ADB can
consider transferring staff with guarantee expertise to PSOD, and setting up an independent
syndication and reinsurance function. Office of Cofinancing Operations would be responsible for
syndication of existing and new loans such as complimentary financing scheme, reinsurance of
guarantees, possibly the divestment of PSOD’s equity shareholdings, and the PSOD workout
function. The establishment of this type of structure might warrant a review of where Office of
Cofinancing Operations should be located in ADB. Because PSOD is the main user of
guarantee products, a case could be made for Office of Cofinancing Operations to report to the
same Vice-President as PSOD.

e. Risk Management

153. An independent review of ADB’s risk management procedures found many material
weaknesses relative to other international finance institutions74. ADB does not have a senior
management credit committee that discusses credit issues on a non-transaction basis from an
overall risk management perspective. Risk Management Unit did not start preparing
consolidated quarterly reports for the Board and Senior Management until December 2006.
Reporting lines to Board and the Audit Committee through the President need to be
strengthened. It was found there was a lack of understanding in ADB about the role of Risk
Management Unit and this issue should be addressed through a bank wide communications
program. Risk Management Unit staff do not always have sufficient seniority at meetings,
undermining their ability to balance risk management and business objectives and provide for
independent monitoring.

73
2006. Review of ADB’s Credit Enhancement Operations. Policy Paper, August 2006.
74
Ernst and Young, 2006. Development of an Enterprize-wide Risk Management Capability, Manila.
58

154. ADB’s credit strategy and policies need to be documented, including details on approved
authorities, scope of work, committee terms of reference, relations between business units and
Risk Management Unit, a standardized due diligence process, and guidance on transaction
structures. Risk Management Unit resources with appropriate skills needed to be increased as a
matter of priority to allow for appropriate risk assessments and portfolio monitoring. Risk
Management Unit should have sufficient staff to maintain involvement in transactions post credit
committee approval. A management committee should be established to review credit risks on
an ongoing basis. The risk ratings methodology needs to be revised and standardized across
the whole PSOD portfolio, with regular reports prepared throughout the life of projects. A
framework needed to be developed to manage operational risks in areas such as reputation
risk. It was recommended that information systems in areas such as credit data management be
upgraded to support these reforms.

f. Responsibility and Accountability for Private Sector Development

155. Private Sector Development Specialists were recruited and assigned to the regional
departments to ensure that private sector development activities were embedded firmly in
country strategies. Productive links were meant to be created between PSOD and the public
sector side of ADB. This approach has not worked as envisaged. By assigning full accountability
for private sector development objectives to regional departments, PSOD was effectively
disengaged from initiatives defined in the Private Sector Assessments and country strategies.
PSOD was not involved in essential enabling environment reforms that would provide the basis
for generating future business. To help avoid this fragmentation of PSOD’s business processes,
ADB needs to reconsider its strategy on how to develop synergies to promote private sector
development. One option would be to assign PSOD the responsibility and accountability for all
private sector development activities, along with the associated private sector specialist staff
positions. Alternatively, regional departments could continue to address private sector
development issues, but PSOD could be given the capacity to pursue initiatives in this area
where they provide critical entry points to support private sector transactions.

156. The Private Sector Development Specialists could be placed in a new division within
PSOD. Transferring these staff to PSOD would strengthen its staff skill mix in the areas needed
to define, monitor, and assess the development and socioeconomic impacts of transactions.
This structure would (i) provide capacity within PSOD to improve its strategic planning, (ii)
ensure private sector transactions had stronger development features, and (iii) allow PSOD to
be more directly involved in formulating country strategies and preparing country business plans
to private sector operations and departmental management reports. These staff could provide
inputs to help prepare and implement the public sector program, as well as policy-based lending
and non-lending activities that have positive impacts on the enabling environment for the private
sector. PSOD’s role could be broadened and deepened to encompass the development of entry
points within a country, such as public-private partnerships procurement units, property rights
systems, and e-government.

2. Policy, Strategy and Project Selection

157. More effective PSOD participation in the country strategy process would help to ensure
that niches are identified for ADB involvement in supporting private sector development. ADB
needs to be better positioned to provide the expected support by ensuring the resources
required for delivery are consistent with PSOD’s staffing and the country strategies do not raise
unrealistic expectations. The sector roads maps that will be included in country strategies will
 59

help address this issue, and PSOD can use them as a basis for preparing more focused country
business plans. Projects can be formulated following project appraisal methods that assess
value for money (estimated by comparing the unit cost of private versus public sector provision),
using a range of financial instruments encompassing guarantees, equity, and debt. While public
financing would be appropriate for many projects, the Private Sector Development Strategy75
indicates that it should not be considered the automatic default option. There is little evaluative
evidence to suggest that ADB has seriously considered private sector as an alternative to public
sector financing, once a project enters the country programs. Indeed the informal incentives that
govern behavior of ADB staff probably work against this approach as loan approvals is an
indicator of staff performance on both the public and private sector sides of ADB. The use of
value for money appraisal techniques would help counter this bias.

3. Scope of Investments

158. The Middle-Income Country Initiative and the Second Medium Term Strategy76 program
call for a concerted effort toward more private sector operations. There are many opportunities
for PSOD to diversify its markets. Opportunities include: (i) middle-income countries such as
Thailand and Malaysia; and (ii) non-traditional sectors such as ports, airports, roads, and water;
and (iii) engaging in areas such as recapitalization and financial restructuring of state owned
enterprises to strengthen operational competitiveness; (iv) privatization to help governments
move forward with their stated policies by providing technical advice and investment funds to
support restructuring efforts; (v) securitization of assets as a means of mobilizing resources, and
(vi) trade facilitation to expand regional cooperation; (vii) adopting more innovative concession
designs such as annuities and affermage contracts to make private investments in non-
traditional sectors, such as roads and water, more attractive; (viii) mergers and acquisitions; (ix)
acting as a “matchmaker” for joint ventures; and (x) serving as a “project developer” by creating
the basic components of a project in a market where the private sector finds it difficult, if not
impossible, to develop the facility, and then invite private firms to bid and take over the
operations.

159. In line with these opportunities, the broadening of PSOD’s range of business activities is
something the middle income countries have been demanding and ADB has committed to
achieve in recent strategy documents. However, PSOD should not pursue all opportunities in all
countries. Selectivity is required. The strategic choices should be made in the context of country
partnership strategies. For example, where the public sector is active developing road and rail
transport corridors and ADB participation in private airports and seaports that act as gateways
to these facilities would seem to offer substantial potential for synergies. Similarly, if ADB’s
public sector operations decided to scale up public sector administrative reform projects based
on e-government initiatives, then telecommunications support through PSOD would potentially
form a central platform for realizing the full benefits of this type of assistance. In other cases
there may not necessarily be a direct linkage between public and private sector operations.
Nonsovereign funding in a country might or might not be supported by policy work undertaken
by the public sector side of ADB. The demonstration of development impacts that create
additionality should be a major criteria used for selecting those areas where PSOD will operate
in a particular country.

160. The Private Sector Development Strategy advocated the creation of strategic alliances
with other institutions. These alliances should not be limited to partners such as IFC and EBRD.

75
ADB. 2000. Private Sector Development Strategy, Manila.
76
ADB. 2006. Medium-Term Strategy II, 2006–2008. Manila.
60

Strategic alliances could be formed with local institutions by making investments with a dual
purpose. ADB could collaborate with local banks and provide foreign currency debt, which the
borrower can swap into local currency finance. ADB can increase efforts to provide equity to
funds operating in frontier countries. Further, it can provide funding coupled with an agreement
requiring the entity receiving the investment to help support PSOD in those markets. These
forms of strategic investments would provide a form of local presence that would be helpful for
business promotion, market intelligence, and project monitoring, especially in countries without
resident missions, or at the state or provincial levels of large countries such as India and the
PRC.

4. Financial Instruments and their Application

161. ADB has relied upon a narrow set of financial instruments. PSOD can rebalance its
financial products to manage portfolio risks better, improve flexibility, and respond to different
market conditions. PSOD should carefully manage the use of equity due to conflicts of interest,
substantial resource requirements, inadequate systems, lack of incentives to divest ownership
interests once development objectives are achieved, and high levels of reputation and financial
risks in some cases. PSOD could increase the use of quasi-equity instruments that carry some
of the characteristics of straight equity, but carry lower risk. These instruments can be employed
as means of strengthening the capital base of projects without needing to resort to equity. The
use of these mezzanine instruments provides flexibility and room to maneuver when designing
the financial structure and ADB’s role in projects. It also allows for an exit strategy and a more
certain pricing structure that is commensurate with the project risk and return profile.

162. More sophistication and flexibility can be introduced in deal pricing and structuring by
using mechanisms such as progress- and performance-linked fee structures and interest
margins that act as performance incentives. More flexible amortization schedules can be linked
with cash flows, and might include features such as cash consolidation and cash repayment
mechanisms. Instruments such as B loans and guarantees could be used more often. The use
of guarantees with local banks can serve multiple developmental purposes by (i) improving
project sponsors’ access to local currency funding at more affordable terms, (ii) exposing local
banks to project financing techniques, (iii) facilitating capacity building of local financial
institutions, and (iv) helping develop financial markets by creating a benchmark curve in the
bond and swap markets. The use of these guarantee instruments can increase the development
impact of ADB by leveraging the use of its capital base.77 The scope of guarantees could be
broadened to cover social and environmental risks, as well as traditional political and credit
risks. Guarantees can be used to support output-based aid payment mechanisms for public
sector procurement funds, as well as secure funding risks for project sponsors.78

5. Operational Safeguards and Quality Controls

163. Two important issues that emerged from the country case studies were the potential
risks that ADB’s safeguard processes create for PSOD projects and the high level of project
cancellations that occurred after Board approval. Both factors can undermine development
impacts, reduce effective demand for private sector services, and increase ADB’s transaction
costs.
77
See the World Economic Forum. 2006. Building on the Monterrey Consensus: The Untapped Potential of
Development Finance Institutions to Catalyze Private Investment. New York. This report argues for multilateral
development banks to make better use of guarantee and risk mitigation instruments and capabilities to increase
commercial investment in development projects.
78
von Klaudy, S. and U Goswami. 2005. Credit Enhancing Output Based Aid. Washington, DC: World Bank.
 61

a. Safeguard Policies and Standards

164. As a matter of prudence, consistency, and operational strategy, international financial

institutions promulgate policies for various aspects of corporate activities, including lending and
investment operations. Some of these activities need to be documented in legal agreements. In
general, safeguards for social and environmental policies tend to be reasonably well
harmonized among international financial institutions. However, differences exist that tend to
complicate matters for clients and international financial institutions alike, when cofinancing is
involved. This may be the case for large infrastructure projects. This issue has become more
pronounced since IFC began to apply the Equator Principles to evaluate environmental impacts.
ADB is preparing a safeguards policy update. For PSOD to remain competitive ADB’s safeguard
policies and standards should be harmonized with those of IFC to the greatest extent possible.

b. Integrity Risks

165. Increasingly, PSOD is forming partnerships with local sponsors. While this strategy has
the potential to strengthen development impacts, it also creates counterparty risks. Procedures
need to be codified to ensure PSOD staff processing transactions comply with integrity due
diligence guidelines that form part of ADB’s Anticorruption Policy Framework. This framework
should encompass various aspects of corruption, including fraud, money laundering, and
terrorist finance. Mechanisms need to be put in place to address critical areas of risk, such as
public sector procurement and corruption. Provisions can be adopted to facilitate detection and
allow for investigations and audits, if required. In the first instance, operational staff should be
required to provide their judgment and decide whether a specific due diligence report is
necessary. Risk Management Unit or the private sector credit committee should also have the
ability to request integrity due diligence investigation if reasonable grounds for concern are
found. Similarly, a mechanism needs to be established, such as a signed due diligence
checklist, where PSOD can confirm that adequate procedures are in place. This will allow
PSOD to monitor project implementation, and ensure that procurement procedures meet ADB’s
Corruption Policy standards.

c. Credit Committee Structure and Operations

166. The Vice-President (Operations 1) chairs the Private Sector Credit Committee, which
reviews nonsovereign guaranteed proposals to assess development, financial, social, and
environmental impacts. The effectiveness of this committee is compromised, as it cannot make
decisions on the value of development returns relative to financial risks, because pricing is the
responsibility of the Credit Enhancement Committee led by the Managing Director General.
Merging these two subcommittees would allow Management to make decisions based on risk-
reward tradeoffs.

167. The Credit Committee only meets to review specific transactions. In line with other
international financial institutions, it could be established as a permanent body that meets
regularly, independent of transaction volumes. While the chair of the Credit Committee should
be a representative of Senior Management, its members need not all be line managers. It is
more important to ensure the members include professionals with strong hands-on private
sector investment experience. Membership of the Credit Committee should include
representatives from Controllers, Office of the General Counsel (OGC), Office of Cofinancing
Operations, PSOD, Regional Sustainable Development Department (RSDD) for social and
environmental compliance, Risk Management Unit, and Treasury Department. Representative
62

members of relevant regional department should attend to discuss development impacts and
relationships with public sector operations.

168. Current internal credit review procedures tend to rely on written comments solicited from
concerned departments independently, creating concerns about the effectiveness of procedures
for exchanging information. Another problem is that PSOD is required to consult, rather than
demonstrate that comments have been considered and issues addressed. This type of
procedure sometimes can result in superfluous reviews and comments for the sake of
procedural compliance, rather than emphasizing substance through open, frank discussion.
PSOD is responsible for recording the minutes of credit committee discussions. This
arrangement has the potential for conflicts of interest. The Credit Committee could have an
independent secretariat to record discussions and follow up on actions.

169. The scope of the credit reviews should be extended to encompass Concept Clearance
Papers, and Reports and Recommendations of the President. This would help ensure that
development impacts, including social, environment, and credit concerns are embodied
explicitly in project designs. Formal procedures and guidelines need to be established to
determine pricing based on market benchmarks and a clear understanding of ADB’s own cost of
capital. An additional stage is needed in the credit approval process to allow the review of
projects after Board approval, following the completion of negotiations with the sponsor, and
before disbursement of ADB funds. The purpose of this review would be to confirm that the
underlying terms of the transaction have not changed materially since ADB approval.

6. Plans and Resources

170. PSOD should develop a strategic plan for its private sector development and operational
activities and likely volume of transactions over five years that has clear objectives and
benchmarks against which to assess performance, and if necessary make mid term corrections.
This plan should be supported by indicative forecasts of activity by country and sector, a revised
organization structure and functions in headquarters and resident missions, and estimated staff
and TA resources to meet forecast needs. Subsequently, the planning process can be
institutionalized by consolidating country business plans to prepare rolling 3–5 year PSOD
country and department plans. These plans can be used to forecast staff and other resources,
including TA, based on staff drivers, such as volume of transactions. PSOD needs to be given
sufficient resources to meet demand forecasts and perform functions in a way that reflects best
practices in peer comparator international financial institutions. The staff skills mix might need to
be modified to include staff with transaction experience in roads and water, and guarantees.
Supporting functions, such as Risk Management Unit and Office of Cofinancing Operations,
need to be strengthened in areas such as risk management and syndications to allow resource
levels to keep pace with the growth in transaction and portfolio volumes.

171. PSOD needs the capacity to support privatization and provide public-private partnership
units with advice and assistance in the design of concessions, as well as transparent and
competitive procurement procedures, as they create the necessary entry points for PSOD
transactions. PSOD’s links with the public side of ADB need to be strengthened to develop
regulatory agencies for infrastructure and finance. Capacity needs to be created to establish
registries for property and financial rights (creditor and shareholder); and to support bank
corporatization, privatization, and financial sector liberalization programs. Improving property
rights requires a range of skills interpreting local customs and differentiating between formal and
informal rights, understanding and modifying legal systems, and developing title-based
registries. These registries could be created in the context of e-government projects that
 63

address issues such as compliance with taxes and regulations. These are only some examples
of issues that need to be considered when assessing ADB’s staff skills mix to provide the level
and types of services that ADB’s clients are requesting.

172. Given the limitations on the future growth of ADB staffing numbers, decisions on the
desirable skills mix should be made after strategic decisions are made related to focus and
selectivity. Vacant staff positions could potentially be reallocated from elsewhere in ADB to
PSOD-related functions. There may be a need to introduce more flexibility into the number and
location of staff positions, job descriptions and recruitment practices to support this process.
Similar types of resource issues will need to be considered concerning the allocation of TA to
support private sector development activities, and upgrading of ADB’s management information
systems. Financial incentives can be introduced to help reward staff responsible for project
origination and processing. These incentives could be based on the effective use of economic
capital relative to the level of project funding that is mobilized, using similar concepts to
measure capital as the Risk Management Unit when it performs risk assessments.

7. Reports and Information Systems

173. ADB should develop a more systematic framework for assessing the development
impacts of PSO based on a clear and focused set of indicators that link impacts, outcomes,
outputs, activities and resources. Report structures used by PSOD are not based on a common
framework, which weakens the process for evaluating project impacts in a standardized
manner. The Evaluation Cooperation Group’s Good Practice Standards for Evaluation of Private
Sector Operations79 and OED’s Guidelines for Preparing Project Performance Evaluation
Reports for Nonsovereign Operations80 could be used in the design and monitoring frameworks
in Board documents to define objectives and provide a reference for project approval and post-
evaluation. Similar to IFC and EBRD, ADB could develop reports based on balanced scorecard
principles that present indicators on: (i) development impact; (ii) operational performance; (iii)
financial performance; (iv) organizational performance; and (v) resource needs in terms of staff
and expenditure. The scorecard could be used as a framework for setting objectives at both the
country and departmental levels and monitoring performance.

174. Like other international finance institutions, ADB can develop a management and
reporting system that is based on a central portfolio management concept and individual project
risk reviews. The frequency of such reviews (annual, biannual, quarterly, or more frequently for
watch list or problem loans) will depend on risk ratings assigned by an independent and
adequately resourced Risk Management Unit. The results of these individual project reviews
can be incorporated in quarterly and annual reports. These reports would compare forecasts
from country and departmental business plans to actual development and financial outcomes,
provide details on major risks, and identify any likely corrective actions that might be required.
To support this type of system ADB’s management information systems would need to be
strengthened to provide a single comprehensive online application that ensures data
consistency, and provides financial data at the individual transaction level. The review of
information technology needs should be supported by a clear specification of report
requirements.

79
Evaluation Cooperation Group, 2006. Good Practice Standards for Evaluation of Private Sector Operations.
Washington.
80
ADB. 2007. Guidelines for Preparing Project Performance Evaluation Reports for Nonsovereign Operations.
Manila.
64

C. Recommendations

175. The following recommendations are directional and are designed to help address the
main issues outlined in this report.

Table 14: Recommendations to Strengthen Private Sector Development and Operations

Recommendation Responsibility Timing

1. Corporate Level:

(i) Assess the need for changes in organizational structure BPMSD with SPD, 2009/10
supporting Private Sector Operations and Private Sector RDs, OCO, and
Development activities such that the potential synergies of PSOD after
the public and private sectors working together are more completion of the
effectively captured. LTSF review

(ii) Establish a permanent unified credit committee that is

supported by a permanent independent secretariat. Revise VPs and Managing 2008
credit committee operations so that it considers risks and Director General
returns of transactions. Encourage a more direct and frank
exchange of information by meeting on a regular basis, and
review projects from concept clearance stage.

(iii) Strengthen the Risk Management Unit in anticipation of a VPs and Managing 2008 and onwards
significant increase in non-sovereign lending. Director General

(iv) Develop a corporate management plan covering a five

year period that aligns resources with aspirations to expand PSOD, RDs, SPD,
private sector operations, including details on necessary and BPMSD 2009
administrative budget, technical assistance resources, staff
skill mix, and strengthening supporting functions of risk
management and commercial co-financing. Introduce
balanced scorecard framework for assessing achievements in
private sector operations, drawing on the experience of other
similar multilateral development agencies.

2. Department Level:

(i) Prepare country business plans for delivering private PSOD and RDs Beginning in 2008
sector operations and private sector development related
outputs in the country partnership strategy framework.

(ii) Develop and implement a medium term strategic plan, PSOD and BPMSD 2008
including new products for supporting private sector and non-
sovereign clients, monitorable results indicators, and
resource requirements.

(iii) Prepare and implement integrity due diligence guidelines

for private sector operations that form part of ADB’s PSOD and OAGI 2008
anticorruption policy framework encompassing various
aspects of corruption, including fraud, money laundering, and
financing for terrorism.

ADB = Asian Development Bank; BPMSD = Budget, Personnel and Management Systems Department; LTSF =
Long-Term Strategic Framework; OCO = Office of Cofinancing Operations; OAGI = Office of the Integrity Division;
RD = Regional Department; RMU = Risk Management Unit; SPD = Strategy Policy Department; VP = Vice President.
Source: Operations Evaluation Department Staff Evaluation.
 Appendix 1 65

LITERATURE REVIEW

A. Private Sector Participation1

1. Increasing private sector participation has been a key objective of economic reform in
developed and developing economies for the past 15 years. A large amount of research has
been undertaken to identify ways of reducing constraints in the enabling environment for
competitive private investment.2 It has become increasingly apparent the development of
market-based instruments that can be used by the private sector entails a transformation of
governments and markets.3 International financial institutions have been seeking to broaden the
relevance and performance of their services; and providing public goods, such as policies, laws,
regulations, and institutions, through policy adjustment modalities.4 Table A1.1 illustrates some
of the many different forms of private sector participation.

Table A1.1: Source of Resources and Allocation of Risks under Various Private Sector
Participation Options
Output Risk
(Quality, Investment
Minimum Unit Risk
Capital Private Costs, and (Competitive
Investment/ Contract Secure Return on
Option Labor Financing Duration Availability) Capital)
Government Public Private – Public Public
ownership and
private finance
Service Private Public 1–2 years Public Public
contract
Management Private Public 3–5 years Public Public
contract
Operating Private Public 8–15 years Public Public
lease to private
sector
Concession Private Private 8–15 years Public or Public and
private private
Divestiture and Private Private Indefinite Private Private
green field (might be
investments limited by
license, or
alternatively
free entry)
— = not applicable.
Source: Operations Evaluation Department compilation.

1
This section draws upon material presented in Nellis. J. 2006. Center for Global Development. Privatization in
Developing Countries: A Summary Assessment. Washington DC.
2
World Economic Forum. 2006. Building on the Monterrey Consensus: The Untapped Potential of Development
Finance Institutions to Catalyze Private Investment. New York.
3
Sachs, J., C. Zinnes, Y. Eilat. 2000. Patterns and Determinants of Economic Reform in Transition Economies:
1990–1998. Consulting Assistance on Economic Reform II Discussion Paper 61 Cambridge, MA: Harvard: Institute
for International Development.
4
World Bank. 2005. A Better Investment Climate for Everyone. World Development Report. Washington, DC.
66 Appendix 1

2. These private sector participation techniques have been used to different extents in most
countries in the world. The structure that is adopted, which varies by case, is determined by the
risks, returns, and overall value for money (VFM) associated with each transaction. This might
include lower costs, improved access and availability, and better quality outputs through
innovation and improved risk allocation.

B. Private Sector Development Strategies

1. Overview

3. A reasonably high degree of consensus has emerged on the primary constraints

impeding Private Sector Development (PSD) in developed and developing countries. These
include (i) macroeconomic instability, (ii) widespread informality to avoid excessive taxes and
regulations, (iii) absence of the rule of law, (iv) lack of competitive pressure for large companies,
(v) limited availability of physical and social infrastructure, and (vi) an inability of small and
medium-sized enterprises (SME) to access finance. The magnitude of these constraints has
been documented extensively through initiatives such as Asian Development Bank Institute
reviews5, Asian Development Bank’s (ADB) private sector assessments (PSA), World Bank’s
Doing Business database and investment climate studies, and the European Bank for
Reconstruction and Development’s (EBRD) transition reports.

Box A1: Privatization

Privatization has been one of the most widespread techniques used to support private
sector development. The rate of privatization in the new millennium has been lower than
the rates achieved through the 1990s, even though the “vast majority of studies report
post-privatization increases in profitability, efficiency and returns to shareholders.”a While
privatization has been successful in most cases, it was less likely to succeed in low-income
countries or in places lacking institutional capacity, as was the case in some post-
communist countries. Privatization is less likely to be successful in natural monopoly
segments of infrastructure sectors, and banks and insurance services where regulations
are required to protect consumers and depositors. Typical problems that arose included (i)
false records on tariffs, value of assets, and liabilities; (ii) difficulties adjusting regulated
tariffs; (iii) enforcement of contracts and property rights through the courts, particularly for
minority shareholders; and (iv) difficulty enforcing private sector obligations. These
problems are primarily a function of the quality of the institutions, especially the executive
and judiciary, and their ability or willingness to enforce regulations, property rights, and
contracts. In the early 1990s, reform programs initially assumed the creation of a system of
property rights through privatization would generate demand for institutions that would
allow the market to work. However, in low-income and some post-communist countries, it
was often more rational for investors to use private “mafia”-based solutions to enforce
ownership rights, rather than rely upon the state.
a
Nellis, J. 2006. Privatization in Developing Economies: A Summary Assessment. Washington DC: Center for
Global Development.
Source: Operations Evaluation Department staff compilation.

5
Quibria. M. 2002. Growth and Poverty: Lessons from the East Asian Miracle Revisited. Tokyo: Asian Development
Bank Institute.
 Appendix 1 67

4. These analyses have led to international financial institution (IFI) programs that are
focused on addressing enabling environment issues such as (i) fiscal and monetary reform; (ii)
strengthening the rule of law by institutional reforms to eliminate conflicts of interest and
increase transparency; (iii) enforcing property rights by strengthening the judiciary, preparing
accurate land cadastres, and property and creditor registries; (iv) reforming taxes and
regulations to reduce compliance costs and encourage entry to the formal sector; and (v)
developing skills, knowledge, and institutional capacity in areas such as foreign languages,
information technology, regulation, and public private partnerships (PPPs).6

5. While the types of PSD constraints are widely recognized, it is apparent there is no
unique combination of policies and institutions that can be used to achieve development
objectives. The former Soviet Union (FSU) and Eastern Europe adopted capitalist systems, and
rebuilt their economies by rapidly creating markets and privatizing firms. In comparison, India
and the People’s Republic of China (PRC), which together account for about 40% of the
developing world’s population, adopted incremental reform programs, slow market liberalization,
and limited privatization. The transition process in the FSU proved to be more difficult than
anticipated, and only recently have economies such as the Czech Republic started to recover.
In comparison, growth in India and PRC has been rapid, although often occurring in
geographically restricted areas with an emphasis on new investment rather than restructuring
existing businesses.7

6. These trends have broadened the recognition of the diverse range of options for creating
policies and institutions that support PSD and economic growth. Country-specific diagnostic
studies are needed that identify interventions that focus on binding constraints, rather than
applying uniform policy prescriptions across countries. While the diversity in potential
adjustment programs that can be applied by different developing member countries (DMCs) is
considerable, some common themes that have emerged from reforms in the 1990s: (i)
macroeconomic stability is critical; (ii) trade openness and competition are key elements of
reform; (iii) privatization programs need to reflect institutional strengths and weaknesses in a
country; (iv) level of success of financial liberalization will depend upon quality of institutions,
property rights, and macroeconomic stability; (v) public sector governance reform should be
incremental and pragmatic; and (vi) effective political checks and balances are needed.8

2. Private Infrastructure

7. Through the 1990s, many governments sought to include the private sector in the
provision and financing of infrastructure by a combination of divestment and—more importantly
in volume terms—greenfield investment supported by concessions. Because of privatization, the
proportion of assets in private ownership in emerging economies is estimated to be: power,
45%; telecommunications, 42%; water, 40%; and transport, 30%.9 The decline in privatization
and relatively low level of private sector participation in infrastructure ownership reflects a
number of factors, including problems that arose, especially concerning macroeconomic
instability in the late 1990s, and political constraints on regulated tariff adjustments. Some high-
profile renegotiations of projects occurred, particularly after changes in government or major
currency devaluations, and some contracts were canceled or renationalized. This reduced the

6
United Nations Development Programme. 2000. Unleashing Entrepreneurship, Commission on the Private Sector
and Development. New York.
7
ADB. 2004. Private Sector Development in the People’s Republic of China. Manila. A discussion on reform in PRC
can be found in T. Kanamori and Z. Zhijun.
8
World Bank. 2006. Economic Growth in the 1990s. Washington, DC.
9
Kikeri, S. 2006. IFC Presentation: Privatization Trends. Washington DC.
68 Appendix 1

appetite of many traditional foreign investors and financiers for such projects, and many are no
longer pursuing projects in developing economies. Some public discontent related to private
sector infrastructure provision also has been evident, especially in the electricity and water
sectors. Notwithstanding these developments, local governments are facing significant funding
constraints and huge demand to maintain and upgrade infrastructure. Consequently, private
sector participation continues to be recognized as an important source of financing, operational
expertise, and technological innovation in most DMCs. Emerging market sponsors are
becoming increasingly important in telecommunications, power, transport, and water sectors.10
Many IFI reforms are targeting strengthening local capital markets to support private
infrastructure development.

Figure A1.1: Investment in Infrastructure Projects with Private

Participation in Developing Countries by Purpose, 1990-2005

$ billion
120

100

80

60

40

20

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Investment in Sector Expansion Investment in Aquiring Govt Assets

Source: The World Bank and Asian Development Bank Public Private Infrastructure Facility (PPIAF), PPIAF project
database.

8. These largely foreign-financed investment flows peaked in 1997, and then subsequently
dropped by more than half by 2004, before starting to recover. Most private investment in
infrastructure in developing countries during 1990–2003 occurred in telecommunications (50%),
power (36%), transport (8%), and water (3%).11 The greatest efficiency gains from private sector
participation in infrastructure have been achieved in sectors such as telecommunications and
power, and are concentrated in urban areas. The main problems limiting privately financed
infrastructure are a lack of fundamental reform of policies and institutions in areas such as
procurement, tariffs, regulations, and contracting arrangements. In some cases, optimism about
the ability of governments to implement reform, particularly in a short time frame, has been

10
Izaguirre, A. 2005. Private Infrastructure, Emerging Market Sponsors Dominate Private Flows, Public Policy for the
Private Sector. Washington, DC: World Bank.
11
Kikeri, S., and A. Kolo. 2005. Privatization: Trends and Recent Developments. Washington, DC: World Bank.
 Appendix 1 69

excessive. In other cases, demand has been overestimated. Establishing competent and
legitimate regulators also has been difficult. In the power sector, many Asian countries have
preferred to use concessions to purchase power from greenfield projects on a take-or-pay basis,
rather than introduce competition by unbundling the sector infrastructure and buying power on a
competitive basis. Procurement agencies often have lacked experience, and some transactions
have been opaque, with sole source negotiated agreements, rather than concessions, being
awarded based on transparent competitive bidding. Public sector decentralization and
increasing urbanization have further complicated the development of road and water
infrastructure. Local government agencies responsible for administering infrastructure often
have lacked the experience and necessary credit profile to access capital markets. Weak
domestic capital markets in many cases have led to large currency mismatches in projects with
revenues denominated in local currency and debt service obligations in international currencies.
As the Asian financial crisis demonstrated, such are projects vulnerable to currency
devaluations.

Figure A1.2: Investment in Infrastructure Projects with Private

Participation in Developing Countries by Sector, 1990–2005

$ billion
120

100

80

60

40

20

0
1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Water Telecom Energy and Transport Total

Source: The World Bank and Asian Development Bank Public Private Infrastructure Facility (PPIAF), PPIAF
project database.

9. There is now a much better awareness of critical risks and public-private partnership
schemes are an increasingly important mechanism for facilitating private investment in
infrastructure. In addition to providing a means of accessing long-term finance, concessions
have the potential for generating large cost savings for governments through competition,
innovation, and risk transfers to the private sector.12 The United Kingdom has been a leader in

12
An overview of the Private Finance Initiative can be found in: Dixon, T., et al. 2005. Lessons From the Private
Finance Initiative, Benefits, Problems and Critical Success Factors. Journal of Property Investment and Finance.
23(5):412–423.
70 Appendix 1

this area through its Private Finance Initiative. As of April 2003, it had contracted $104 billion
worth of infrastructure using this modality. This initiative increasingly has come to be seen as a
way of achieving better value for money (cost savings through procurement from the private
sector rather than in-house provision by the public sector) compared to government provision.
Public sector construction and infrastructure projects have a reputation for being poorly
managed, leading to cost and time overruns and long-term technical problems.

10. The central tenet of the Private Finance Initiative is the transfer of risk from the public
to the private sector in a competitive environment. By achieving the correct allocation of risk, the
government is able to treat public sector expenditure on projects as off-balance sheet. This
provides fiscal space for governments to pursue spending in other areas, such as health and
education. While the results are less apparent in more complex facilities such as schools and
hospitals, the potential gains appear to be substantial. A study13 estimated that project cost
savings had been on the order of 17%, and the National Audit Office confirmed that costs
savings can be significant.14 This success has generated interest among other governments. In
India, such modalities are now an important component of its transport development program.
Recent research by ADB in the Indian road sector indicates the cost and time savings of
privately financed and managed projects are substantial. Traditional public sector construction
contracts have incurred costs exceeding the awarded contract price by an estimated 20%, with
delays on average of 16 months. Private annuity projects achieved costs 3% in excess of
awarded contract price and had average delays of 3.3 months. Build Operate Transfer (BOT)
projects achieved costs savings of 44% relative to contract award, and projects were completed
1.1 months ahead of schedule. In addition to being cheaper and available earlier, the average
size of projects was $24 million for public sector construction contracts versus $71 million for
Build Operate Transfer projects.15

3. Financial Markets

11. PSD initiatives have focused on domestic capital formation and the need for efficient
financial markets and institutions. Assistance is often split between targeting SMEs, and more
generally strengthening banks and creating capital markets that can be used to mobilize savings
and allocate funds efficiently. Subsequently instruments such as insurance and derivatives can
be developed to hedge risks such as price volatility.

12. The most effective way of providing assistance to SMEs has been the subject of an
ongoing discussion. Most government assistance to SMEs is provided in the form of subsidized
finance. Research indicates that, while access to finance is a major constraint, this tends to
reflect problems with the enabling environment, particularly in areas such as the quality of the
legal framework for property rights and availability of accurate financial information (footnote
21). Evidence16 indicates that providing credit lines for SMEs is not sufficient. These firms have
difficulties accessing finance because they represent a material credit risk, not due to a lack of
finance or resources available to these firms. Some skeptics17 have questioned whether SMEs
should be singled out for assistance, or whether reforms should be targeted at all firms that form
part of private sector value chains.

13
Arthur Andersen/Enterprise LSE. 2000. Value for Money Drivers in the Private Finance Initiative London.
14
National Audit Office. 2003. PFI: construction performance. The Stationery Office, London, Report No. HC 371.
15
Tsukada, S. Mainstreaming the PPP for Infrastructure Development in India–Emerging Modalities in the Transport
Sector. ADB presentation, April 2007, ADB Manila.
16
ADB. 2006. Best Practice Notes on Small and Medium-Sized Enterprise Support. Manila.
17
World Bank. 2007. SMEs, Growth and Poverty, Do Pro-SME Policies Work?. Washington, DC.
 Appendix 1 71

13. The quality of property rights and the effectiveness of the legal system18 are key
determinants of the level of investment and effectiveness of the financial system. An important
study of investment behavior in the Central Europe19 found that entrepreneurs with weak
property rights reinvested almost 40% less of their profits than individuals with secure property
rights. The analysis found no evidence that access to bank credit stimulates more investment
for these firms. Firms with weak property rights did not wish to borrow, even when they had
assets that could be used as collateral. These results suggest that, irrespective of the quality of
the banking regulatory framework and bank corporate governance systems, internal investment
and bank development will not occur without effective property rights. Once property rights are
defined, the key issues that need to be addressed are the identification of ways to reduce the
transaction costs and risks associated with providing various forms of debt and equity finance,
and insurance to third parties. Evidence suggests the effectiveness of the secured transaction
laws and the availability of registered collateral are probably the most important determinants of
the level of external finance that can be accessed by the private sector. A debtor that can
provide secure collateral can anticipate receiving six to eight times more credit, take two to ten
times longer for repayment, and pay interest rates 30–50% lower than borrowers without secure
collateral.20 Once frameworks have been developed for relatively low risk mortgage and lease
finance modalities reforms can progress to more complex types of finance such as venture
capital and bonds. Figure A1.4 illustrates the indicative risk-return profiles of the various
financial instruments available to the private sector that need to be developed.

Figure A1.3: Indicative Risk Return Profiles

for Various Financial Instruments

D e r iv a tiv e s
R e tu r n /R is k s
S h a re s

B onds

V e n tu re c a p ita l

M ic r o fin a n c e

E - c o m m e rc e

C re d it c a r d s

T r a d e fin a n c e

P le d g e o n m o v e a b le a s s e ts
F in a n c ia l le a s e s
P aw nshops
Rf M o rtg a g e s o n im m o v a b le A s s e ts

F a m ily & fr ie n d s

C o m p le x ity

Rf = Risk Free.
Source: Operations Evaluation Department Staff compilation.

18
La Porta, R., F. Lopez-de-Silanes, A. Shleiffer, R. Vishney. 1998. Law and Finance. Journal of Political Economy.
volume number 106: 1113-55 .
19
Johnson, S. J. McMillan, C. Woodruff. 2002. Property Rights and Finance. Nashville,TN: American Economic
Association. Massachusetts Institute of Technology, Stanford University and the University of California, San
Diego.
20
ADB. 2000. Law and Policy Reform at the Asian Development Bank. Volume II.
72 Appendix 1

4. Future Directions

14. Privatization continues to be a primary mechanism for many governments to support

private sector development. Apart from 1997, transaction volumes in 2005 were the highest
since the World Bank started collecting data in 1990.21 The scope for strengthening the
definition and transferability of property rights in agricultural and urban properties and financial
assets (e.g., shares) is substantial. Property rights for nontraditional assets, such as forests,
fisheries, water, and carbon credits, can be developed.22 The vast amounts of assets in DMCs23
ensure that programs to facilitate financial intermediation will continue to play a central role in
development efforts. A key mismatch exists between the poor, who typically have movable
assets, and the banks, which prefer immovable assets as collateral. The European Bank for
Reconstruction and Development (EBRD) has used special purpose legal teams and technical
specialists to develop legislation and registries for recording pledges on moveable assets such
as floating charges over stock or accounts receivable. The International Finance Corporation
(IFC) has specialist legal departments independent of transaction teams to develop leasing
legislation that can be used by SMEs to finance items such as equipment. Venture capital is an
important tool to help develop SMEs, especially in frontier economies. A wide range of
development finance institutions invest in SMEs using these types of financial instruments.

15. The successful implementation of public-private partnership schemes requires

significant institution building within government. Legislation and institutional capacity need to
be strengthened to (i) simplify procurement procedures at country and sub-sovereign levels, (ii)
increase transparency, and (iii) reduce costs and the risk of corruption.24 Sector reform
programs need to be complemented with regulators that are well-staffed and genuinely
independent, with powers to establish contractually defined cost-based tariffs, subject to
adequate measures of accountability. Clear processes for dispute resolution, the ability to
enforce contracts, and effective lender remedies under bankruptcy and insolvency laws are
needed to support the enabling environment for the private sector. Concession structures need
to be designed to enable donors and governments to help mitigate risks that the private sector
cannot afford to assume due to a lack of control. Opportunities exist to (i) introduce innovative
concession designs, such as leases and affermage25 contracts; (ii) develop more user-friendly
risk mitigation products in the areas of regulatory and contractual risk; (iii) enhance the
development of local capital markets; and (iv) increase the use of credit-enhancement products,
such as political risk guarantees. Private investments potentially can be coordinated through
regional development programs for geographically defined special economic zones or along
transport corridors.

16. Creative project designs can be developed that meet the twin goals of addressing the
needs of a broader cross section of people, while pursuing commercial returns. The private
sector potentially could provide services in sectors that traditionally are serviced by the public
sector, such as water, without compromising social objectives. Projects such as the privately
financed Manila Water Concession, which was developed with ADB assistance, required
bidders to provide services to poorer areas using mechanisms such as public standpipes or low

21
World Bank. 2007. Privatization Trends. Public Policy for the Private Sector, Note Number 314. Washington, DC.
22
Tietenberg, T. 2002. The Tradable Permits Approach to Protecting the Commons: What Have We Learned?
Department Economics, Colby College, Maine.
23
World Bank. 2006. Unlocking Dead Capital, How Reforming Collateral Laws Improve Access to Finance, Public
Policy for the Private Sector. Note Number 307. Washington, DC.
24
Harris, C. 2003. Private Participation in Infrastructure in Developing Countries: Trends, Impacts and Policy
Lessons. Washington, DC: World Bank.
25
These types of contracts are similar to leases and are commonly used in the French water utility sector.
 Appendix 1 73

lifeline tariffs for water supply, with the Government bearing the associated financial impact in
the form of lower concession revenues. There have been experiments with the establishment of
state and municipal funds to subsidize consumers or compensate private providers of
noncommercial services in sectors such as roads, where charging tariffs using output-based aid
concepts is difficult. Using these types of arrangements, the introduction of mechanisms such
as voucher schemes and the provision of connection or consumption subsidies are possible. On
the supply side, payment to private sector suppliers can be linked to service delivery using
direct consumer charges or shadow tolls, or based on availability of facilities. Governments
have opportunities to facilitate private sector infrastructure financing through the development of
national and municipal procurement funds that pool risks and potentially can issue financial
instruments in the local bond markets. These state funds can be given access to tax revenues,
as well as the use of credit ratings and guarantee instruments to reduce credit risks and interest
costs, and to extend the tenors of debt instruments. ADB can provide assistance managing the
funds at the portfolio26 and project level through provision of finance to address timing issues
and guarantees to mitigate credit and political risks.27

17. In some DMCs, domestic bonds and cross-currency swaps are becoming feasible
sources of local currency finance for IFIs. Like IFC, ADB has issued local currency bonds in
countries such as India, Philippines, and the PRC to help develop capital markets and provide
access to local currency finance. Following the introduction of the Innovation and Efficiency
Initiative (IEI) in 2005, ADB can provide commercial multitranche financing through its public
and private sector windows to sovereign and nonsovereign entities. Funds can be provided on a
limited or non-recourse basis, in foreign or local currency, and can be used for greenfield
developments, or to refinance existing facilities. The efforts of ADB’s Office of Regional
Economic Integration to strengthen capital markets in Asia are supporting this capacity.28 The
Financing Partnership Strategy29 and the Credit Enhancement Operations Policy Paper,30
prepared by the Office of Cofinancing Operations in 2006, have introduced the additional
flexibility offered by credit enhancement instruments such as guarantees and syndications. ADB
has provided support in DMCs to securitize collaterized debt assets in bond markets and
encourage cross border flows.

18. International financial institutions have been extending the range of services offered to
frontier countries and regions, and developing policies and procedures to help mitigate social
and environmental risks associated with private sector provision. Best practice in dealing with
social and environment risks and meeting global standards is not only ethically desirable, but
also a sign of commercial and forward-looking management. Environmental, involuntary
resettlement, and other social policy standards supported by ADB have provided a useful
benchmark that levels the playing field for all market participants, particularly in infrastructure.
26
Boyle, G. et al. 2005. Techniques for Estimating the Fiscal Costs and Risks of Long-term Output-based Payments.
Washington, DC: Global Partnership on Output Based Aid.
27
Von Klaudy, S. et al. 2005. Credit Enhancing Output Based Aid Washington, DC: Global Partnership on Output
Based Aid.
28
Capital market reforms in Asia have tended to be more successful in equity rather than bond markets. ADB
provides TA to support regional integration in areas such as transport, communications, and financial flows. ADB
helps strengthen capital markets and regulatory frameworks, and conducts research on issues such as the types of
capital controls required at various stages of development.
29
ADB. 2006. ADB’s Financing Partnership Strategy. Manila.
30
ADB. 2006. Review of ADB’s Credit Enhancement Operations. Policy Paper, August 2006. This paper defines
credit enhancement products as (i) guarantees, which could be in the form of partial credit guarantees or political
risk guarantees issued by ADB; and (ii) syndications through “reinsurance” and non-funded risk participations or
other means that allow ADB to transfer risk associated with loans and guarantees made by ADB, or through the
use of a “B loan” (formally known as complementary financing scheme) or “guarantor of record” program under
which ADB shares risk (and salvage) with co-financiers, while taking no counter party risks.
74 Appendix 1

ADB is currently undertaking a review of its safeguard policies and expects to issue an updated
policy framework in 2008 that will help address issues in areas such as private financial services
and the need to harmonize standards with other international financial Institutions and local
governments’ regulations.31 ADB has been pursuing strategies to reduce the potential for
corruption and fraud in its private (and public) operations through the application of its Anti-
Corruption Policy and investigations undertaken by the Integrity Division within ADB’s Office of
the Auditor General.

31
ADB. 2005. Safeguard Policy Update, A Discussion Note.
 Appendix 2 75

PROJECT EVALUTION REPORTS

Table A2.1: Project Performance Evaluation Reports (1992–2006)

Name Country Year Result

Petronet LNG India 2006 Satisfactory

Nghi Son Cement Viet Nam 2006 Satisfactory

Fujian Pacific Electric PRC 2006 Successful

SBI DFHI India 2005 Satisfactory

CESC Limited India 2002 Successful

Investment Fund Operations Regional 2002 Generally Satisfactory

Batangas Power Philippines 1999 Partly successful

Fauji Fertilizer Pakistan 1998 Generally successful

National Devt. Leasing Pakistan 1997 Generally successful

Philippine Long Distance Telephone Philippines 1996 Successful

BBL Dharmala Finance (Lease) Indonesia 1994 Generally successful

Planters Development Bank Philippines 1993 Generally successful

PT Gunung Garuda (steel mill) Indonesia 1993 Generally successful

Padma Textiles Bangladesh 1992 Generally successful

LNG = liquefied natural gas, PRC = the People’s Republic of China.

Source: Operations Evaluation Department staff compilation.
76 Appendix 2

Table A2.2: Project Completion Reports (1995–2006)

Name Country Year Result

Grameen Telecommunications Bangladesh 2005 Satisfactory

Colombo Port Sri Lanka 2005 Excellent

NDB Housing Sri Lanka 2005 Satisfactory

Bhutan National Bank Bhutan 2004 Successful

AIG Sectoral Equity Fund India 2004 Satisfactory

Nghi Son Cement Viet Nam 2003 Successful

Asia Pacific Ventures Regional 2002 Partly successful

Fauji Kabirwala Power Pakistan 2002 Successful

Walden AB Ayala Ventures Philippines 2002 Partly successful

Himal Power Nepal 2002 Partly successful

Mutual Fund Company of Philippines Philippines 2001 Not formally rated, but
unsatisfactory financial
performance

Global Trust Bank India 2001 Not formally rated, but

appears satisfactory

SBI Gilts India 2001 Not formally rated, but

appears partly satisfactory

China Asset Holdings PRC 2001 Not formally rated, but

unsatisfactory financial
performance

Centurion Bank India 2001 Not formally rated, but

appears partly satisfactory

IL&FS Venture Capital India 2001 Not formally rated, but

appears partly satisfactory

H&Q Philippine Ventures Philippines 2000 Not formally rated, but

appears partly satisfactory

Asian Convertibles and Income Fund Regional 2000 Not formally rated, but
unsatisfactory financial
performance
 Appendix 2 77

Name Country Year Result

Union Assurance Sri Lanka 2000 Not formally rated, but
appears partly satisfactory

Merchant Bank of Sri Lanka Sri Lanka 2000 Partly satisfactory

CESC (Power) India 1999 Not formally rated, but

unsatisfactory financial
performance

IL&FS and Kotak Mahindra Finance India 1999 Not formally rated, but
appears satisfactory

Korea Technology Finance Republic of Korea 1999 Not formally rated, but
unsatisfactory financial
performance

Xiamen International Bank PRC 1999 Not formally rated, but

appears partly satisfactory

Pacven Investments Regional 1999 Not formally rated, but

appears satisfactory

Hopewell Power Philippines 1997 Not formally rated, but

appears satisfactory

Jyoti Spinning Mills Nepal 1996 Not formally rated, but

unsatisfactory financial
performance

Batangas Power Philippines 1996 Generally successful

United Leasing Bangladesh 1995 Not formally rated, but

appears satisfactory

Pakistan Synthetics Pakistan 1995 Not formally rated, but

appears satisfactory

Guangzhou Pearl River Power PRC 1995 Not formally rated, but
appears satisfactory

PRC = the People’s Republic of China.

Source: Compiled by ADB Operations Evaluation Department staff compilation.
78 Appendix 3

COUNTRY CASE STUDIES: COMPARISON OF INVESTMENT CLIMATES

1. Figure A3.1 shows the global competitiveness index ranking of India, Philippines, and
Viet Nam compared against three other regional countries, Indonesia, Malaysia, and Thailand.

Figure A3.1: Comparative Global Competitiveness Index Ranking of Target Countries

120
110
100
90
80
70
Rank

60
50
40
30
20
10
0
India Philippines Viet Nam Indonesia Malaysia Thailand

Growth Competitiveness Technology Public Institutions

Macroeconomy Business Competitiveness

Source: World Economic Forum 2005.

2. Over the past 10 years, the Heritage Foundation and Wall Street Journal jointly have
produced an index on economic freedom that is updated annually. The economic freedom index
reflects various features of the enabling environment, and provides time series data on areas
that are constraining economic growth. The Index of Economic Freedom for 2006 was
measured for 161 countries against a list of 50 independent variables divided into 10 broader
categories of economic freedom. The results for 2006 are in Table A3.1.
 Table A3.1: Business Environment Characteristics

Countries Philippines India Viet Nam

Categories
Overall Rank 98 – Mostly Unfree 121 – Mostly Unfree 142 – Mostly Unfree
(Among 161 Countries Included)
1. Trade Policy Moderate level of protectionism. Very high level of protectionism. Very high level of protectionism.
Weighted average tariff 2.6% (2003). Weighted average tariff 28% (2004). But weighted average tariff down
Widespread corruption and Extensive nontariff barriers, e.g., from 17.4% (2001) to 13.7% (2003).
irregularities in customs. confusing bureaucracy. Nontariff barriers also falling.
2. Fiscal Burden Moderate income tax (top 32%) Moderate income tax (top 33%). High income tax (top 40%)
High corporate tax (35%) High corporate tax (33%). High corporate tax (28%)
Government expensive at 19.2% High cost of Government at 29% High cost of Government at 29%
(2003) of GDP. (2003) of GDP. (2003) of GDP.
3. Government Intervention Low level. Moderate level. High level.
in the Economy Public sector consumption 11.4% of Public sector consumption 12.8% of 5,000 state-owned enterprises
GDP (2003) GDP (2003). generate 41% of industrial output.
4. Monetary Policy Low inflation. Weighted average Low inflation. Weighted average Low inflation. Weighted average
inflation (1995–2004) 5.15%. inflation (1995–2004) 3.85%. inflation (1995–2003) 5.98%.
5. Capital Flows and FDI High barriers. Negative sector lists Moderate barriers. Limits on equity High barriers. Time-consuming
restrict FDI, e.g., engineering, and voting rights, mandatory licensing, ownership restrictions,
medicine, accounting, law, retail, Government approvals and capital allocation of investment rights,
media, security, marine resources. controls. domestic protectionism, etc.
6. Banking and Finance Moderate level of restrictions. High level of restrictions. High level of restrictions. Five state
NPLs down from 17.3% (2001) to Increasing tolerance toward foreign banks hold 75% of sector assets.
11.3% (2003). State banks hold banks. State banks have 70% of Since 2004, 100% foreign-owned
11.1% of market. market. banks permitted.
7. Wages and Prices Moderate level of intervention. Moderate level of intervention. Moderate level of intervention.
Minimum wage maintained. Most Price controls on “essential” Minimum wage maintained. Price
prices market-driven. Controls in commodities, e.g., electricity, controls on electricity, water, petrol,
electricity, water, and public transport. petroleum products. telecommunications, and public
transport.
8. Property Rights Low level of protection. Slow Moderate level of protection. Very low level of protection.

Appendix 3
judicial system, insufficient skilled Applied unevenly across India. Large Complicated legal system,
judges, corruption, etc. International backlog creates long delays. interferences, and corruption.
arbitration preferred by foreigners. International arbitration preferred by
foreigners.
9. Regulation High level. Burdensome and lack of High level. At federal and state level. Very high level. Lack of
transparency and haphazard transparency, uniformity, and
enforcement, etc. consistency, etc.

79
10. Informal Market High level of activity. High level of activity. High level of activity.

FDI = foreign direct investment; GDP = gross domestic product; NPL = nonperforming loan.
Source: Based on the Heritage Foundation’s and Wall Street Journal’s Index of Economic Freedom, 2006.
80 Appendix 3

3. Despite the difficulties in defining precisely the constraints on private sector development
(PSD), all three case study countries clearly are making important progress in this area. The
spider charts presented in Figures A3.2 (Philippines), A3.3 (India), and A3.4 (Viet Nam) provide
a means of evaluating PSD progress in broad terms by assessing the changing patterns in
economic structure and the increasing levels of participation by the private sector in the
economy. The spider charts show the change in PSD against each of the following eight criteria
that have been given a score on a scale of 0 to 10:

(i) The proportion of private sector contribution to gross domestic product (GDP);
(ii) The proportion of private sector investment in fixed capital;
(iii) Progress in privatization in terms of proportion of existing state-owned assets
having been privatized;
(iv) Private sector participation in infrastructure by relating private sector investment
with public sector investment, and the prevalence and progress of public-private
partnerships (PPP) and independent power producers (IPP);
(v) The proportion of foreign direct investment (FDI) of GDP;
(vi) The expansion and contribution to value added by the small and medium-sized
enterprise (SME) sector;
(vii) Progress made in registration, organization, and arrangement of financing for
microfinance and the proportion of the sector’s contribution to GDP; and
(viii) The share of private sector participation in finance and banking, based on assets
and loan portfolios.

4. Because of limited statistical data on some of the criteria, the scores contain a degree of
subjectivity. However, the purpose of the spider charts is to show PSD progress in the three
target countries on a comparative basis and not in absolute terms. The case study countries
have made some progress on PSD. In the Philippines, the private sector was substantially in
place over the review period, although weak institutions have undermined its effectiveness. In
India, after many years of incremental liberalization, private sector growth is emerging.
However, limited progress has been made on privatization, use of PPPs in infrastructure, and
access to FDI. In Viet Nam, while the level of private sector participation is still quite low, limited
privatization and development of PPP facilities have occurred. Access to FDI has helped fuel
strong growth in special economic zone (SEZ) enclaves on the coast. All three countries have
high levels of nonperforming loans (NPL), one of the factors that restrict SME access to finance.
In India, NPLs have been reduced significantly, although some existing NPLs may have been
warehoused rather than worked out, and problems with the underlying flow of bad debts
continue.
 Appendix 3 81

Figure A3.2: Private Sector Participation Progress in the Philippines

GDP
GDP 10
10 Finance and Banking Fixed Capital
Finance and Banking Fixed Capital 5
5

Micro - Inform al Sector 0 Privatization

Micro - Inform al Sector 0 Privatization

SMEs Infrastructure SMEs Infrastructure

FDI FDI

Philippines 1995 Philippines 2000

GDP
10
Finance and Banking Fixed Capital
5

Micro - Inform al Sector 0 Privatization

SMEs Infrastructure

FDI

Philippines 2005
FDI = Foreign Direct Investment; GDP = Gross Domestic Product; SMEs = small and medium enterprise.
Source: Operations Evaluation Department staff compilation.

1. Philippines

5. Private sector participation plays a dominant role in the Philippines, with the private
sector contributing 95% of GDP. In 1995, privatization was progressing and FDI accounted for
about 2% of GDP, although private sector participation in infrastructure was modest. The private
sector accounted for about 75% of total banking assets. By 2000, all criteria showed positive
movement except FDI, which had fallen to only 0.5% of GDP due to the Asian financial crisis,
concerns about political stability, and a deteriorating business climate. Privatization progressed
and private sector participation in infrastructure and finance increased. By 2005, a further
expansion of the octagon can be observed with increased private sector participation against
most criteria except FDI, which has only marginally recovered. Slight improvements are
noticeable for private sector participation in fixed capital formation at 70%. Private sector
participation in infrastructure has increased, with private IPPs’ share of power generation
exceeding the output of the public sector. Similarly, the micro and SME sectors had grown,
accounting for 32% of value added. Private sector participation in finance and banking made
substantial progress, with private banking assets (including foreign) representing 88% of total
assets in 2005.
 82 Appendix 3

Figure A3.3: Private Sector Participation Progress in India

GDP
GDP 10
10 8
8
Finance and Banking Fixed Capital
Finance and Banking Fixed Capital 6
6 4
4 2
2 Micro - Inform al Sector 0 Privatization
Micro - Inform al Sector 0 Privatization

SMEs Infrastructure
SMEs Infrastructure
FDI
FDI

India 1995 India 2000

GDP
10
8
Finance and Banking Fixed Capital
6
4
2
Micro - Inform al Sector 0 Privatization

SMEs Infrastructure

FDI

India 2005

FDI = Foreign Direct Investment; GDP = Gross Domestic Product; SMEs = small and medium enterprise.
Source: Operations Evaluation Department staff compilation.

2. India

6. In 1995, India showed modest progress in private sector participation for all criteria,
especially privatization, infrastructure, and finance. The area within the 1995 octagon is small.
The private sector accounted for about 70% of GDP and 62% of fixed capital formation. FDI, at
around $3 billion in absolute terms, was well below 1% of GDP. By 2000, private sector had
improved. Its contribution to fixed capital formation had risen, privatization grew, and private
sector participation in infrastructure had increased. The largest improvement involved SMEs,
where the number of firms is growing rapidly and their importance in the economy is increasing.
Private sector investment and FDI, as proportions of GDP, had not changed between 1995 and
2000, and private sector participation in finance and banking did not increase. By 2005, the
impact of the economic liberalization was clear, as illustrated by an expansion of the octagon.
While private sector participation as a proportion of GDP (74% in 2005) had remained fairly
constant from 1995 through to 2005, the proportion of fixed capital formation owned by the
private sector increased from 62% in 1995 to 71% in 2005. Following a Government policy
review, progress on privatization was put on hold, and private sector participation in
infrastructure increased only slightly. As a proportion of GDP, FDI grew marginally to 0.8% by
2005, but increased substantially in absolute terms. The number of registered SMEs increased
to 15 million in 2005, and SMEs were receiving increasing attention and financial support from
 Appendix 3 83

Government. Private sector involvement in banking and infrastructure made further progress,
although the private sector share of banking assets is still only 25%.

Figure A3.4: Private Sector Participation Progress in Viet Nam

GDP
10
GDP
10
Finance and Banking Fixed Capital
5
Finance and Banking Fixed Capital
5
Micro - Inform al Sector 0 Privatization
Micro- Inform al Sector 0 Privatization

SMEs Infrastructure SMEs Infrastructure

FDI
FDI

Viet Nam 1995 Viet Nam 2000

GDP
10
8
Finance and Banking Fixed Capital
6
4
2
Micro - Inform al Sector 0 Privatization

SMEs Infrastructure

FDI

Viet Nam 2005

FDI = Foreign Direct Investment; GDP = Gross Domestic Product; SMEs = small and medium enterprise.
Source: Operations Evaluation Department staff compilation.

3. Viet Nam

7. Given its stage of transition from a centrally planned to a market economy, Viet Nam’s
very limited private sector involvement in 1995 was not surprising. The private sector accounted
for 20 to 30% of GDP and 10% of fixed capital formation. Infrastructure and banking had
virtually no private sector. Although the SME sector had begun to make progress, it was
relatively small in 1995, and the micro-enterprise sector was disorganized and lacked attention.
Most points shown in the 1995 octagon in Figure A3.4 cluster around the center. The notable
exception relates to FDI, which accounted for 4% of GDP. By 2000, clear progress had been
made on private sector participation in Viet Nam. Private sector accounted for 40% of GDP, and
the private sector share of fixed capital formation had increased to 23%. However, privatization
(equitization) had made little progress, although IPPs had entered into power generation.
Because of the Asian financial crisis, FDI dropped to 2% of GDP in 2000, about half of the 1995
level. The number of registered private SMEs increased from a few thousand to 44,000, and the
private sector was present in the banking sector. The rapid progress in private sector
84 Appendix 3

development continued. By 2005, private sector participation exceeded 50% of GDP, and the
share of private investment in fixed capital had increased to 31%. Although privatization
remained the exception, the private sector accounted for 21% of power generation. FDI had
recovered to 4% of GDP by 2005, and the number of private SMEs had increased to more than
200,000. In addition, about 2.7 million micro-enterprises were registered at the district level, and
their access to microfinance was improving. The share of banking assets owned by the private
sector is increasing, reaching 30% in 2005. While private sector participation in Viet Nam is still
comparatively modest, the progress during the past 10 years has been remarkable.
 Appendix 4 85

COUNTRY CASE STUDY: PHILIPPINES

A. Investment Climate

1. Background

1. In the Philippines, the private sector has always played an important role in the
economy. The country has been progressive in East Asia in terms of liberalizing the economy,
privatizing state-owned firms, and procuring privately financed and operated infrastructure by
using public private partnership (PPP) arrangements. While these programs initially made
substantial gains in the early 1990s, the openness of the economy and weakness of institutions
created significant problems following the Asian financial crisis. After almost a decade of relative
stagnation, private sector-led growth is starting to become apparent again.

2. Macroeconomic Stability

2. Following the Asian financial crisis and political instability in 2001, the exchange rate fell
by almost 50%. The economy still has not recovered fully from the instability, and significant
structural weaknesses persist. An important macroeconomic policy requirement has been the
need to address the fiscal imbalance by raising budget revenues on a sustainable basis. As tax
revenue in recent years has persistently remained at 15% of gross domestic product (GDP),
and interest costs on public sector debt denominated in foreign currency have risen, the
Government has had difficulty investing in adequate levels of physical and social infrastructure.
The Government is addressing these concerns through continued restructuring and
liberalization of the economy, with an increasing emphasis on improving the enabling
environment for the private sector.

3. Competition and Trade

3. The legacy of “crony capitalism” under President Ferdinand Marcos, and the impact of
past policies based on import substitution and price controls, led to high levels of industry
concentration in many sectors. The resulting vested interests of dominant family business
groups, which often are interlinked with banks, have limited the level of competition and
discouraged private investment. Despite these constraints, trade policy liberalization and
deregulation has been quite successful in the Philippines. Nominal average tariffs fell from 28%
in 1985 to 7.2% in 2004, and nontariff barriers have been reduced. The Philippines accession to
the World Trade Organization (WTO) in 1994 and participation in Association of South East
Asian Nations (ASEAN) Free Trade Area (AFTA) have helped to improve the trade regime.
Under AFTA, the intention is to create a free trade area that includes Japan and the People’s
Republic of China (PRC) by 2010. The Philippines has numerous bilateral trade and investment
agreements.

4. Domestic liberalization has been occurring in many sectors. Telecommunications,

shipping, air transport, and retail trade have been opened to greater competition since 1987.
Despite these reforms, competition laws are not effective at addressing problems of oligopoly.
Some parties have expressed concerns about labor productivity, which is seen to be low relative
to other countries in the region due to high minimum wage rates and moderately restrictive
employment laws. While a consumer protection law is in place, a comprehensive antitrust law
does not exist, and unfair trade practices are addressed through ad hoc legislation. Essential
items, such as rice, have price ceilings in case of national emergency. Specific regulators
86 Appendix 4

handle electricity, water, telecommunications, public transport, ports, and road tolls. These
regulators are not independent, and they do not have the ability to set tariffs based on cost
recovery principles.

4. Privatization

5. Privatization of Government agencies started in 1986. Significant progress was made—

about 450 of the 562 Government-owned and -controlled corporations (GOCC) had been
privatized by the end of the 1990s. Privatization has slowed since 2001, as most of the
remaining assets constitute the more difficult cases. The Government continues to own
substantial interests in companies such as Philippine National Oil, Light Rail Transit Authority,
Philippine National Railways, National Power Corporation, five banks, and a state pension
system. The private sector plays a leading role in delivering some infrastructure services, such
as telecommunications, bus and trucking services, and power distribution in Manila. However,
the public sector is also a major provider of infrastructure services. Most GOCCs have posted
sustained deficits, constraining their ability to provide services. The sale of the shares in the
Philippine National Bank in September 2005, the biggest privatization since 1995, demonstrated
the Government’s continuing commitment to reform in this area. Progress in privatizing the
infrastructure services include (i) unbundling the power sector to allow independent power
producers (IPP) to generate electricity, (ii) privatizing the water supply in Manila, and (iii)
privatizing the Manila International Container Terminal in the 1980s.

5. Public Private Partnerships

6. Public sector procurement through PPPs has been an important component of the
Government’s infrastructure programs. Build-operate-transfer (BOT) laws were enacted in 1990
and 1994 to allow private sector participation (PSP) in the development and operation of
infrastructure, especially in the power sector. By 2003, the Philippines had commitments for $25
billion in private finance using concessions.1 This program has been substantial, encompassing
45 power-related projects with a total value of $10 billion, 20 transport projects with an
aggregate value of $6 billion, 17 environment-related projects valued at $8 billion, and 49 other
projects in areas such as property development and information technology procurement.

7. While the scale and scope of PPP projects in the Philippines is impressive, some
problems have arisen. Ambiguities in the implementing regulations of the BOT laws have led to
challenges. The law permits a “Swiss challenge”, which allows a challenger to make a counter
bid to an unsolicited proposal. This creates the potential for inefficient litigation. Loopholes in the
rules for reviewing projects after award, which can extend beyond technical and contractual
considerations, create the potential for expropriation of assets. The Supreme Court has ruled on
several PPP contracts, sometimes to the detriment of private firms. While the Government has
not unilaterally revised any contracts, it has renegotiated 18 of 35 IPP contracts in the power
sector that were signed in the early 1990s. Most of these contracts were negotiated contracts
and were not awarded based on transparent competitive bidding, creating concerns among the
public about crony capitalism. In 2002, the Government introduced the Government
Procurement Act, which was designed to promote competitive bidding, transparency, and
accountability. Despite these reforms, the recovery of the PPP program has been slow.

1
N. Kintanar et al. 2003. Locking Private Sector Participation into Infrastructure Development in the Philippines.
Transport and Communications Bulletin for Asia Pacific. No 72, 2003.
 Appendix 4 87

6. Foreign Direct Investment

8. Foreign Direct Investment (FDI) was liberalized in 1991 to allow 100% foreign ownership
of Philippine assets, apart from those on two negative lists that included restricted foreign
ownership of items such as land. In 1993, legislation was enacted that allowed foreigners to
lease land for 50 years, renewable for an additional 25 years. Profits and capital can be
repatriated fully, and private firms face relatively few restrictions in borrowing offshore. These
reforms led to a significant increase in investment by multinational corporations in
manufacturing facilities in the early to mid-1990s. The Philippines established several export
processing zones to attract FDI, and made a available a complex system of incentives. Despite
these arrangements, the level of FDI in recent years has been about 0.5–0.7% of GDP, which
compares unfavorably with other countries in the region.

7. Infrastructure

9. Due to the Philippine’s weak infrastructure, coupled with persistent public sector funding
constraints, the Government has sought private sector investment since 1994 when it enacted
the BOT Law. Initially, this legislation was successful, stimulating (mainly foreign) investment of
more than $25 billion to increase capacity in the power and road sectors. This form of
investment has largely dried up, partly because of concerns about corruption and political
instability. In addition, contractual and regulatory disputes between the public and private
sectors in the power, water, and airport sectors have eroded private investment. To stimulate
private investment, coherent sector plans need to be developed, supported by capable public
sector agencies that include independent regulators, unbundled competitive operations, and
clear rules on procurement using PPP instruments, tariffs, and dispute resolution. While sector
regulators have been established, Congress typically is responsible for setting tariffs.
Politicization of the tariff process has led to tariffs in the power and water sectors being set at
levels below cost in some cases, without any compensation provided for private sponsors.

10. Private investment has been most successful in communication infrastructure due to the
nature of the technology and ability to rely on greenfield investment in mobile rather than
regulation of existing fixed lines to generate competition. The Government deregulated the
telecommunications sector in 1993, removing the monopoly of the privately owned Philippine
Long Distance Telephone Company and allowing the development of competitive service
providers, particularly in the mobile phone and Internet markets. In the power sector, domestic
energy capacity increased substantially following large state investments in geothermal and
hydropower generating capacity and private IPPs in the 1990s. The rate of electrification in the
Philippines is relatively high by East Asian standards. However, this is offset by the many
interruptions, and transmission and distribution system losses of about 14% of capacity.
Electricity charges are the highest in the region. As noted in the Philippine Power Sector
Assistance Program Evaluation (SAPE), and similar to other countries, the restructuring and
unbundling of the power sector has been a difficult and time-consuming task in the Philippines.2

11. The transport sector was liberalized in the 1990s, although institutional complexity has
hindered progress on reforms to support increased private sector participation. Sixteen
agencies are involved in the operations and management of the transport network, which makes
coordination and inter-modal planning difficult. Cost-based tariffs administered by independent
regulators are needed, but these types of institutions are not yet in place in the transport sector.

2
ADB. 2005. Sector Assistance Program Evaluation of ADB Assistance to Philippines Power Sector. Manila (paras.
30–31).
88 Appendix 4

The Government remains the predominant owner of the physical assets in roads, rail, air, and
seaports. A notable exception to Government infrastructure ownership was the successful
Manila North Luzon Expressway BOT project, which was financed by Asian Development
Bank’s (ADB) private sector operations (PSO), and the Manila International Container Terminal.
In contrast, the Philippine International Air Terminal Company (PIATCO) airport project is
embroiled in legal disputes between the Government and its sponsors.

12. The Government has pursued reforms to increase the level of private sector
engagement in the water sector with mixed results. Private sector participation has consisted of
two concessions in Manila, a concession in Subic, and many small-scale independent providers
that serve about 15% of the urban population and 10% of the rural population using technology
ranging from pushcarts to small piped water systems. Problems coordinating the wide range of
public sector agencies involved in water provision have constrained planning of water projects.
The Metropolitan Water Systems Services (MWSS) regulates two private concessions in
Manila, and it continues to have operational responsibilities that create a conflict of interest. The
tariff adjustment mechanisms, which became a major issue for one of the Manila concessions
(Maynilad), have faced problems. Due to currency mismatches associated with the large
amount of MWSS foreign-denominated debt assigned to Maynilad, the concession experienced
financial difficulties following the substantial depreciation of the peso and disputes over the
timing of tariff adjustment. Because of these problems, the concession was canceled. In
contrast, the Manila Water concession has been successful, and provides an excellent example
that water infrastructure can be financed privately.3 Apart from the Manila concessions, private
sector participation in the water sector has been limited. Local Government units have been
unable to sign any contracts with private operators, despite attempts to do so, due to concerns
about quality of the system and regulatory framework.

8. Small and Medium-Sized Enterprises

13. Micro-enterprises and small and medium-sized enterprises (SME) account for 99% of
business establishments, 32% of value added, and 68% of employment. SMEs traditionally
have been a high priority sector for the Government. In 1991, the SME Magna Carta was
enacted, which highlights the importance of lowering the costs of doing business, raising
productivity, and improving access to technology and finance. The legislation (i) created an
SME Development Council that is responsible for coordinating development of SMEs; (ii)
specified mandatory bank credit allocations to SMEs; and (iii) created the state-owned Small
Business Guarantee and Finance Corporation, which is part of Department of Trade and
Industry. In 1999, the Government required the guarantee agency and the state-owned
Philippine Export Import Credit Agency to start direct lending to SMEs. In 2004, President Gloria
Arroyo announced a 10-point reform agenda that included provisions to triple available credit for
SMEs.

9. Financial and Capital Markets

14. About half of Philippine companies use bank financing for working capital, while the
remaining 50% of funding is sourced primarily from retained earnings. Banks dominate the
Philippine finance sector, accounting for 64% of financial assets in 2004, followed by the
Philippine Stock Exchange with 22% and nonbank financial institutions (NBFI) with14%. The

3
IFC, 2006, Making a Difference, how private enterprise is creating opportunities and improving lives in developing
economies, Washington DC, IFC. This report provides an interesting case study on Manila Water Company
Limited:
 Appendix 4 89

Government is still an important participant in the finance sector, partly owning one universal
bank (Philippine National Bank) and three specialized banks: Development Bank of the
Philippines, Land Bank of the Philippines, and a small special purpose Islamic bank. The
remaining banks are privately owned, typically by a larger conglomerate that uses the banks as
a means of accessing finance. Of the 21 foreign financial institutions, four are large commercial
banks.

15. Loan portfolios grew rapidly before the Asian financial crisis, but subsequently slowed as
economic growth rates fell and credit constraints increased due to the deteriorating quality of
loan portfolios. Loan security is weak due to problems related to foreclosing on collateral. At the
end of 2003, nonperforming loan (NPL) ratios were estimated to be 15% of bank loans,
representing 53% of bank capital. The central bank has initiated reforms to clean up NPLs. This
program is making progress, and by 2005 NPLs for commercial banks had declined to 7.5%.

16. The stock exchange is small relative to others in South East Asia, with only 237 listed
companies and an average of about four initial public offerings per year. The corporate bond
market is virtually nonexistent, and large Philippine companies prefer to list offshore to take
advantage of better liquidity and pricing. Weaknesses in minority shareholder rights, restrictions
on foreign ownership, and high transaction costs constrain growth in demand for equities. To
help resolve these issues, the Securities Exchange Commission, in association with the Capital
Markets Development Council, recently prepared a blueprint to strengthen the capital markets
on a wide range of fronts.

B. ADB’s Country Strategy and Development Program

1. Overview

17. ADB started operations in the Philippines in 1969. Traditionally, ADB has focused on a
mixture of public sector-financed infrastructure projects designed to support growth and other
operations to meet rural development, and social and environmental objectives. As illustrated in
Figure A4.1, public and private sector financing levels have been volatile and trending
downwards.

Figure A4.1: Public and Private Sector: Annual Approvals in Philippines

($ million)

900
800
700
600
500 Public
400 Private
300
200
100
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: Asian Development Bank records.

90 Appendix 4

18. Annual public sector lending, which peaked at $851 million in 1998, has averaged $170
million per year since then. From 2003 through 2005, public sector lending ranged between
$175 and $213 million. Volatility has been associated with the Asian financial crisis in 1997,
political instability in 2001 and 2002, and the Government’s fiscal situation that made debt
service increasingly difficult. During 1995–2005, lending has come almost exclusively from non-
concessional ordinary capital resources (OCR), with a shift from project to program lending.

19. PSO, which ADB began in 1986, have been much more limited than public sector
operations. ADB has approved 29 PSO projects for $579.8 million on ADB’s own account,
yielding an average project size of $20 million. In addition, loans totaling $233.6 million were
approved under the complementary financing scheme (CFS) for two projects in transport, one in
water distribution, one in energy, one in manufacturing, and two in the petrochemical industry.
Like public sector lending, PSO has been volatile. In the 11 years since PSO began, ADB made
private sector loans in 5 of the years. ADB did not have any PSO in the Philippines in the
balance of the period. The early investments in the Philippines related to manufacturing. ADB
then moved into telecommunications and power. A significant expansion in PSO took place
during the early 1990s when ADB played an important role in the Government’s “fast track”
approach to solve the acute power shortages.4 ADB invested in three of the 10 IPP projects that
were put in place. At the end of 2005, Private Sector Operations Department’s (PSOD) country
exposure totaled $112 million, which represented 6.6% of the PSO portfolio. These PSO
investments were made almost exclusively to financial institutions.

2. Country Strategies

20. In the early 1990s, slow economic growth was the primary concern of the Philippines.
Reflecting the Government’s priorities, the ADB’s 1993 country strategy focused mainly on
infrastructure development, supported by social and environmental initiatives, such as
employment generation and environmental protection. The Asian financial crisis slowed
economic growth and precipitated a substantial depreciation of the peso. The exchange rate
adjustment created pressure on inflation and the financial performance of projects that
generated local currency receipts but were financed in foreign currency.

21. The 1998 country strategy program5 (CSP) concluded that ADB’s strategy in the
Philippines should focus on five areas: (i) upgrading the country’s infrastructure by improving
efficiency in public provision and laying the groundwork for private provision through policy and
institutional reform, particularly by (a) enhancing BOT bidding procedures and creating a project
pipeline, (b) strengthening PPP capacity at local Government level, and (c) developing capital
markets; (ii) rural development through microfinance; (iii) human resource development in areas
such as basic education and primary health for the poor; (iv) more balanced regional
development, with a special focus on Mindanao; and (v) environmental management.
Infrastructure continued to be a priority as investment during the 1980s had lagged other parts
of South East Asia, and electricity shortages were widespread in the 1980s and early 1990s.

22. In 2001, the country strategy was revised. It noted that PSD assistance would focus on (i)
SME support; (ii) increased private sector participation in rural infrastructure, railroads, tollways,
telecommunications in rural areas, power and renewable energy, water supply, and waste
management; (iii) restructuring of Philippine National Railways; and (iv) privatization of National
Power Corporation. In 2005, ADB published a private sector assessment (PSA) that identified

4
ADB. 2005. Sector Assistance Program Evaluation of ADB Assistance to Philippines Power Sector. Manila.
5
ADB. 1998, Philippines: Country Operational Strategy: Manila.
 Appendix 4 91

specific measures to implement the PSD strategy in Philippines. Following early findings of the
PSA, resolving NPLs, enhancing local government access to finance, and increasing PPP in
areas such as housing were emphasized. Judicial reform was identified as an important
enabling environment objective. PSOD focused on supporting privatization, especially in power
infrastructure, and developing the finance sector in areas such as NPL resolution. More
recently, PSOD has been looking for ways to mobilize local currency finance, particularly
through the use of swaps. In October 2005, ADB issued a local currency bond in the Philippines
of P2.5 billion.

3. ADB Assistance Program

23. Table A4.1 provides a breakdown of public sector lending in the Philippines that is
relevant to PSO. Infrastructure appears to have gradually declined in importance relative to
finance sector assistance.

Table A4.1: Sector Allocation of Public Sector Loans

($ million)

Water and
Public Power and Urban
Year Administration Energy Transport Development Finance Total
1995 30 244 150 424
1996 5 167 50 20 242
1997 191 93 284
1998 300 320 620
1999 3 3
2000 175 175
2001 30 75 105
2002 40 40
2003 34 150 184
2004 0
2005 175 175

Total 30 781 260 609 573 2,253

Source: Asian Development Bank records.

24. Apart from two large public sector loans for urban redevelopment projects in Manila, the
major volume of lending during 2000–2005 was directed to capital markets, SMEs and
microfinance. The public side of ADB was not involved in the telecommunications sector, and it
has gradually disengaged from the transport and water sectors. ADB provided extensive
assistance to MWSS, which resulted in one highly successful water concession. The other
water facility that ADB intended to finance through PSO was canceled. Public sector lending in
the power sector shifted from project to program lending to support ongoing efforts to
restructure the industry. Key issues addressed included unbundling the sector, improving the
legal framework, developing an independent regulator, promoting privatization, and addressing
tariff issues. Restructuring the power sector, which should create more business opportunities
for PSO, has been a long and difficult process.

25. PSOD has followed a broadly similar strategy to the public sector, with several large
water- and transport-related infrastructure PPP projects being the main priorities in the late
1990s—all of which were negatively impacted by the depreciation of the peso and political
uncertainty. PSOD was not active in the Philippines from 2000 through to 2004. In 2005, PSOD
 92 Appendix 4

initiated a series of NPL transactions and obtained approval to invest in a credit bureau,
although these transactions were small.

4. PSO Transactions in the Philippines

26. Table A4.2 presents a summary of ADB’s PSO investment approvals for the Philippines
from 1995 through 2005. During this period, 11 projects were approved for a total of
$613.1million, including CFS loans for $193.58 million and a partial guarantee for $18.4 million.
Investments approved for the finance and capital market sector dominate the country portfolio.

Table A4.2: PSO Investment Approvals in the Philippines (1995–2005)

ADB Financing ($ million) Year Status

Name Sector Loan CFS Equity PCG Total Approved
Management Finance – – 0.05 – 0.05 1995
Companya
Mutual Fund Company Finance – – 3.85 3.85 1996
Oleochemicalsa Industry 19.42 8.58 5.84 - 33.84 1998 Investment
liquidated
Water Services Water 45.00 120.00 – – 165.00 1999 Canceled
Air Terminals Transport 40.00 40.00 – – 80.00 1999 Canceled
Tollways Corporation Transport 45.00 25.00 – – 70.00 2000
Peso Swap and Finance 200.00 – – – 200.00 2004 Canceled
Financing Project
Guarantee Corporation Finance – – 2.00 – 2.00 2004
Disposal of NPLs Finance 33.00 1.00 – 34.00 2004
Housing Finance Finance 29.24 – – – 29.24 2004
Bank Disposal of NPLs Finance 5.00 – – – 5.00 2005
Facility and Credit Finance – 1.00 18.40 19.40 2005
Information
– = not applicable, ADB = Asian Development Bank, CFS = complementary financing scheme, NPL= nonperforming
loan, PCG = partial risk guarantee, PSO = private sector operations.
a
Includes initial investment.
Source: Operations Evaluation Department staff compilation.

27. Several large projects that were canceled after approval distort these figures. The
Maynilad Water Services project did not reach financial close due to the financial difficulties
experienced by the company. The investment in PIATCO air terminal was canceled as
implementation and operational disputes emerged between the sponsors and the Government
before the commissioning of the completed terminal. The Government canceled the peso swap
facility. While the justification for this move is not clear, it was probably because the
Government believed it could access sufficient foreign currency on a more flexible basis through
the local foreign exchange market. These cancellations totaled $445 million, or 73% of gross
approvals. ADB did not approve any investments in 2000–2003, and 50% of the transactions by
number have occurred since 2004.

28. Following the cancellations, the remaining portfolio is $168.1 million, consisting of
$102.5 million in loans on ADB’s own account, $33.6 million under CFS, and $18.4 million under
partial risk guarantee. ADB’s equity exposure is $13.7 million, or a reasonable 8% of the country
portfolio. Of the projects that were not canceled, one infrastructure and one industrial project
account for $103.4 million, or 61% of the gross total; the remaining eight ($60.9 million) were
financial and capital market transactions.
 Appendix 4 93

29. The Philippines has benefited from some of PSOD’s regional funds. Over more than 10
years, 48 SMEs in a wide variety of sectors have received equity investments from these funds
totaling $16.64 million. The average size of the investment has been about $350,000, with the
smallest being $20,000 and the largest $3.56 million. This source of SME funding, especially for
the smaller segment of new ventures, has been highly useful.

30. An OED evaluation of the PSO projects in the Philippines, based on a mixture of desk-
based reviews and company visits, derived the indicative project performance results shown in
Table A4.3.

Table A4.3: Summary of Evaluated Project Performance in the Philippines (1995–2005)

Project PSD Investment Comments/Issue
Performance
Management Company Satisfactory Marginal –
Mutual Fund Company Unsatisfactory Unsatisfactory –
a
Oleochemicals Unsatisfactory Unsatisfactory Investment liquidated
Water Services Canceled – Project canceled
Air Terminals Canceled – Project canceled
Tollways Corporation Excellent Excellent –
Peso Swap and Financing Project Canceled – Canceled by client
Guarantee Corporation Satisfactory Satisfactory –
Disposal of NPLs Excellent Satisfactory –
Bank Disposal NPLs Excellent Satisfactory –
Facility and Credit Information Satisfactory Satisfactory Project not yet
operational
– = not applicable, NPL = non performing loan, PSD = Private Sector Development.
a
Including initial investment in 1993.
b
Source: Operations Evaluation Department staff compilation.

C. PSD Issues in the Philippines

31. The Philippine’s is a country that has high potential for PSO as it is strategically located
in East Asia, has a large relatively well-educated population that speaks English, and has an
open economy and a political and legal system based on American standards. The private
sector accounts for about 95% of GDP and 70% of fixed capital formation. Despite these
advantages, growth has been volatile and low by regional standards; and investment, especially
from FDI, has fallen dramatically.

32. Because of the Asian financial crisis and the derived fiscal problems, ADB’s public
sector lending has been limited since 2002, and PSO has been marginal throughout the period
of review. Power sector reform and urban development projects have been the dominant areas
of public sector lending. In the country strategy documents, PSD has been a high priority, with
infrastructure being the focus in the 1998 CSP. In subsequent updates of the CSP, the focus
started to shift to SMEs and NPL resolution, coupled with a continued focus on power sector
reform. The Country Assistance Program Evaluation prepared in 2003 concluded that only 29%
of public sector projects had been successful during 1986–2001, and some private
infrastructure projects had run into serious difficulties. The PSA published in 2005 set out a
clear strategic framework for facilitating private investment, focusing on strengthening
competition, pursuing corruption eradication efforts, strengthening the judiciary and the legal
framework, establishing independent regulators, and strengthening capacity to procure privately
financed infrastructure. While the CSPs (and updates) have a strong PSD orientation, the level
of cooperation between the public and private sector sides appeared to be poor. PSOD staff
had limited involvement in the preparation of the last CSP.
94 Appendix 4

33. Despite a strong private sector orientation in the CSP, and calls for increased levels of
cooperation between public and private sector departments, the results on the ground were
disappointing. Public sector lending has been declining, and PSO has not taken off. In public
administration reform, the public sector provided advice to the LGU Guarantee Corporation in
1996, which might have helped pave the way for a PSOD investment of $2.0 million in 2004.
The public sector has been heavily engaged in the power sector, and it appears to be putting in
place the policy and institutional framework that will support increased levels of private sector
participation in the sector. ADB’s public sector operations were heavily involved in the MWSS
privatization program, which was followed by a PSOD loan approval. Conversely, in the
transport and urban development sectors, the regional department appears to have provided
little advice or technical capacity building to support greater PSOD involvement. ADB’s public
and private sector operations have been heavily involved in the finance sector. However, the
public sector appears to have focused primarily on NBFIs and capital markets, while PSOD has
concentrated on NPLs.

34. The size of the PSO portfolio in the Philippines is small at $111.9 million, or 6.6% of the
ADB’s PSO portfolio as of 31 December 2005. The quality of the portfolio appears to be
deteriorating, mainly due to legacy funding facilities provided in high-risk manufacturing sectors,
such as agricultural process, that was discontinued in the early 1990s. The Asian financial crisis
and subsequent macroeconomic instability also have undermined the quality of investments,
and the ability to close transactions. Infrastructure investment has almost ceased following
problems with Maynilad, PIATCO, Manila Electric Company, and Manila North Tollway. PSO
has sought to turn these difficult circumstances to its advantage by putting in place a series of
innovative NPL transactions that acts as an important constraint on SME’s ability to access
funds.
 Appendix 5 95

COUNTRY CASE STUDY: INDIA

A. Investment Climate

1. Background

1. India’s economic liberalization reform process started approximately 15 years ago. At

the time, because of a socialist philosophy, Government regulation and administrative
processes at the national, state, and local levels were extensive. Public sector investment
dominated the economy. The economy was inward oriented, based predominantly on
agriculture with a large public sector and an import substitution policy. High tariffs protected
domestic industry. Following a balance of payments crisis in the early 1990s, the Government
decided to review the import substitution policy and began to introduce a program of market
liberalization. This program has been largely successful, and has laid the foundation for India’s
impressive economic performance over the past decade.

2. Macroeconomic Stability

2. India avoided the worst effects of the Asian financial crisis due to the rigid foreign
exchange controls that were in place. Similar to the Philippines, the fiscal deficit is the primary
risk to macroeconomic instability, and political constraints have made it difficult to implement
reforms that are needed in taxation, public expenditure reduction, and privatization of
commercial state enterprises. Nevertheless, the Government has started to make progress on
fiscal reforms, although monetary policy continues to be subject to high levels of political
influence.

3. Competition and Trade

3. The Government has started to liberalize the economy under its obligations to the World
Trade Organization (WTO), which India joined in 1995. Despite these measures, increased
agricultural tariffs and the imposition of anti-dumping duties have offset reductions in the overall
rates. The Government also has moved to modernize domestic competition, and introduced the
new Competition Act (2002). The Government has removed bureaucratic restrictions on
business licensing. Nevertheless, the regulatory environment is still very constrained compared
to other countries in the region, and price controls and state monopolies continue to be
prevalent. Obsolete labor laws further constrain the development of a competitive manufacturing
sector in India.

4. Privatization

4. Privatization has not been a feature of private sector development (PSD) programs in
India. A Cabinet Committee on Disinvestment, headed by the Prime Minister, was set up in
2000 to supervise a divestment program. The policy was unsuccessful. By 2005, the
Government had divested its controlling shares in only 17 industrial companies and 19 hotels.
The Government continued to own 222 public sector units, of which 130 were incurring losses.
With the change of Government in 2004, the divestment policy was put on hold.
96 Appendix 5

5. Public Private Partnerships

5. Public-private partnerships (PPP) have played a limited role in India, and almost 50% of
the PPP investment has occurred in Gujarat. Given the fiscal constraints, PPPs are being given
a larger role to play in financing infrastructure. The Government has established a PPP
Appraisal Committee at the national level that will evaluate central Government projects. This
committee will help address a key constraint on PPPs, as traditionally no single agency has
been responsible for public sector infrastructure procurement. Line agencies at the central and
state levels have been responsible for their own projects, creating problems with project
formulation and implementation.

6. In 2005, the Government initiated a new framework designed to strengthen the legal and
regulatory environment. The Government intends to provide “viability gap” funding in the form of
grants to private sponsors to cover up to 40% of project costs. The Government also
established the India Infrastructure Finance Company Limited, which has authority to provide
loans covering up to 20% of project cost and refinance loans on a tenor of at least 5 years. The
Government’s $40 billion road development program is the main area envisaged for PPPs,
although it is also inviting private investors and contractors to build airports and ports, water
systems, and electricity distribution networks.

6. Foreign Direct Investment

7. The Government has sought to encourage foreign direct investment (FDI) and foreign
portfolio investment in non-strategic sectors, including parts of the manufacturing sector,
telecommunications, finance, and insurance. Portfolio investment has risen dramatically,
attracted by high growth rates coupled with the liberalization of foreign ownership laws and the
opening of Indian stock exchanges to foreign capital. FDI has been rising, although the amount
represented less than 1% of gross domestic product (GDP) in 2005. To help streamline FDI
approval processes, the Government formed the Foreign Investment Implementation Authority
in 1999. An export-import policy was introduced in 2000 that launched a series of special
economic zones (SEZ) based on the Chinese model, consisting of geographic duty free
enclaves. Most FDI has been directed towards information communication technology (ICT) and
outsourcing. FDI could play a critical role in financing India’s infrastructure deficit, although
reforms in this area have been only moderately successful to date. India’s largest FDI project
was a power plant at Dahbol, where the funding facility was withdrawn due to problems with the
tariff, leading to a withdrawal of most foreign companies from power generation projects
sponsored by the Government.

7. Infrastructure

8. The quality of infrastructure in India is considered particularly poor, and it is one of the
main constraints on growth. The Committee on Infrastructure has estimated the investment
needed for ports, national highways, and airports are equivalent to 8% of GDP per year over the
next 5–7 years. Traditionally, the Government has financed about 80% of infrastructure,
although it is seeking to increase the level of private sector participation through PPPs.

9. Telecommunications. Although the industry continues to lag other countries, such as

the People’s Republic of China (PRC), telecommunications infrastructure has seen the most
progress on reform and development. While some disputes over issues such as interconnection
 Appendix 5 97

and availability of spectrum rights have arisen, the overall regulatory framework in the
communications sector appears to be working reasonably well and the sector is expanding
rapidly.

10. Power Generation. This is the most resource-intensive infrastructure sector, and private
sector participation has been very limited to date. Problems with supply include (i) inefficient
production, (ii) theft and technical losses of about 25%, (iii) tariffs set at levels substantially
below cost, (iv) cross-subsidization policies that distort demand, (v) substantial
underinvestment, and (vi) failure to enforce billing. While central and state governments are
involved in the power sector, the 21 state electricity boards and 14 electricity departments
traditionally have had monopoly rights for generation, transmission, and distribution. In 2003,
the Government enacted the Electricity Act, which led to 13 states initiating reform programs by
the end of 2005 to unbundle vertically integrated state boards and establish independent
regulators to initiate tariff reforms. The Government is seeking additional capacity of 100,000
megawatts (MW) over the next 10 years, and much of this capacity will need to be financed by
the private sector.

11. Transport. The Government still dominates almost all aspects of infrastructure provision
in this sector, although PPP schemes are being pursued, especially at the national level. The
National Highways Authority of India is responsible for developing the national road network.
The National Highways Development Project seeks to expand the 14,000-kilometer (km)
network by 10,000 km under private sector concession, and increase the width to between four
and six lanes. The private sector is financing many of these roads under PPP arrangements,
using a combination of toll revenue-based concessions and annuities financed by the
Government from the Central Road Fund. The Government recently announced a PPP program
in the road sector with a total value of $40 billion, which is probably the largest such program in
the world. The Government has decided to liberalize airlines and move forward on privately
financing airports in major centers, such as Mumbai, and more that 30 non-metropolitan airports
across the country. The development of seaports has progressed in states such as Gujarat. The
Government continues to own and operate the rail system, although it recently permitted private
sector participation in non-core functions such as container services.

12. Water. In this sector, private sector participation is constrained by the absence of a
national water regulatory body and cost-based tariff system administered by independent
regulators. Private sector participation in the water, sewerage, and sanitation systems is almost
nonexistent, as tariffs in most cities are set at levels substantially below cost, and revisions are
politically difficult. Overstaffing and poor revenue collection practices accentuate problems with
low levels of cost recovery. Unaccounted for technical water losses generally range from 40% to
50%. In the past, the predominant sources of finance were state and central government loans
and grants, although they have been declining in importance due to fiscal constraints.
Governments in states such as Tamil Nadu are experimenting with commercial sources of
water.

8. Small and Medium-Sized Enterprises

13. The main means of supporting small and medium-sized enterprises (SME) has been
directed credit through the Small Industries Development Bank of India (SIDBI). SIDBI uses the
concept of industry clusters and small enterprise financial centers to service SMEs, often in
conjunction with commercial banks. In 2005, the Government announced a comprehensive
policy package requiring public sector banks to double the amount of funding directed to SMEs.
98 Appendix 5

The Government also reserves some labor-intensive industries, such as textile manufacturing,
for small enterprises. These provisions are enforced through the licensing system.

9. Financial and Capital Markets

14. The Government owns 27 of the 96 commercial banks, and they hold about 75% of all
bank assets. These state-owned banks typically were established as development finance
institutions (DFI), which gradually have been commercialized. Despite these changes, all state-
owned banks must lend 40% of advances to sectors such as agriculture and small businesses,
and an additional 12% to exporting firms. The Government recently allowed private competition
to emerge by issuing a limited number of licenses to new private banks, while starting to relax
restrictions on foreign banks. As a result, deposits and bank credit have been growing over the
past decade at more than 15% per year. However, the benefits of improved access to finance
have been offset by an associated rapid increase in nonperforming loans (NPL), leading to
undercapitalization of banks. NPLs, which peaked in 1994 at 25% of bank assets, have been
declining slowly, reaching about 13% in 2001 and 5% in 2005. Bankruptcy procedures are
ineffective, and the state banks have been recapitalizing and issuing shares through initial
public offers to access additional equity.

15. The Government has extensive ownership interests in nonbank financial institutions
(NBFI) operating in areas such as housing development and microfinance. Municipal and state
governments are experimenting with local infrastructure funds that pool finance from different
sources and issue rated bonds. The Government is a major shareholder in venture capital funds
(VCF) through its ownership of banks. VCFs focused on the ICT have expanded rapidly,
especially in the past 6 years. The state is a dominant owner in financial institutions, such as
Life Insurance Corporation, General Insurance Corporation, and Unit Trust of India. These are
an important source of long-term investment funding. Similar to banking, foreign ownership
restrictions in the insurance sector have been relaxed in recent years.

16. Capital markets are going through a rapid transformation. A group of large institutional
investors established the National Stock Exchange in 1994 using a corporate ownership
structure. This operation is based on an electronic trading platform that was used successfully
to break the oligopoly of the 22 state stock exchanges operating across the country. Apart from
the Bombay Stock Exchange, the state stock exchanges are now defunct, although they
continue to exist on paper. The size of the Indian stock market has increased significantly in
recent years, fueled in part by foreign portfolio investors, and corporate bonds have become an
increasingly important source of funding.

B. ADB’s Country Strategy and Development Program

1. Overview

17. India began to borrow from Asian Development Bank (ADB) in 1986. In India, ADB has
traditionally funded public sector infrastructure projects (power, gas, and roads) and finance
reforms (NBFIs and capital markets) identified in country strategies. Public and private sector
financing levels have been volatile (Figure A5.1).
 Appendix 5 99

Figure A5.1: Asian Development Bank Financing, Annual Approvals in India

($ million)

1,600
1,400
1,200
1,000
Public
800
Private
600
400
200
0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: Asian Development Bank records.

18. Public sector lending fell because of the nuclear testing sanctions in 1998. Demand for
public sector funds to finance national road projects was high during 2000–2004. In 2005, no
lending occurred outside the natural resource sector. Private sector operations (PSO) have
been minor relative to public sector lending, although it has become more significant since
2002. During the period reviewed, only one project involved a complementary finance scheme
(CFS) for $5 million.1

2. Country Strategies

19. From the mid-1990s through early 2000, ADB changed its strategy in India. It began
decentralizing some assistance from the national to the state level, targeting Gujarat, Kerala,
and Madhya Pradesh. PSD was major theme of the country strategy and program (CSP), which
identified the following possibilities: (i) providing credit enhancements to mobilize private
resources using ADB’s guarantee operations, (ii) providing Government-guaranteed public
sector loans to support private investments in infrastructure, and (iii) pooling ADB funds with
private investors in funds or credit facilities to finance infrastructure. These instruments were to
be used to help pursue sector strategies. In the power sector, the focus was on creating new
generation and transmission capacity, and privatizing existing power stations. The CSP also
envisioned establishing telecommunications facilities, and developing highways and ports, in
part by mobilizing the private sector.

20. As envisaged, ADB would support industrial liberalization programs that increased
competition and corporate restructuring programs, and establish financial facilities to support
SMEs in agro-based industries. ADB also would help identify ways of developing the long-term

1
While this study only examines PSO during 1995–2005, six additional PSO projects in India, with a total value of
$347.6 million, were approved in 2006, bringing the cumulative total approvals to $975.6 million by September
2006. These recent approvals include three projects in energy and power, two in financial institutions focusing on
infrastructure financing, and one in a capital markets institution. In addition to these direct ADB facilities, PSOD
mobilized two loans from third party commercial banks with a total value of $225 million under CFS.
100 Appendix 5

debt markets. Financial markets would be strengthened by supporting interest rate liberalization,
developing new private sector banks, restructuring state banks, and strengthening the
regulatory framework. In the capital markets, the focus would be on developing an integrated
national market; developing depositories; reforming stock exchanges; facilitating FDI in financial
institutions; freeing up long-term sources of capital from insurance companies and pension
funds; developing credit enhancement and loan securitization instruments; and strengthening
capital market regulation.

21. In 2001–2002, ADB prepared a new CSP for 2003–2006 to reflect the new overarching
goal of poverty reduction, and presented a program that was consistent with the Government’s
Tenth Five Year Plan (2002–2007). The primary focus of the revised ADB strategy was on
growth, supported by social development and environmental protection programs. The main
sector and thematic priorities of the CSP included fiscal consolidation, infrastructure
development, PSD, agriculture and rural development, state-level operations, regional
cooperation, social development, environmental protection, and good governance. In 2003,
ADB commissioned a Private Sector Assessment2 to help sharpen the PSD emphasis in its
economic sector work, as well as in the overall CSP process. This document did not form part of
the CSP process, and was used primarily as a discussion document. In 2004, ADB issued a
local currency bond that raised Rs5 billion (equivalent at the time to $110 million) to help
alleviate problems with local currency risks for large infrastructure projects. IFIs, such as ADB,
increasingly have sought local currency since the Asian financial crisis, when many foreign
sponsors ran into difficulties servicing financial structures denominated in foreign currency while
project receipts were denominated in local currency. With dramatic depreciations in currency,
project sponsors needed to increase project output prices to maintain their return on investment.

3. ADB Assistance

22. As illustrated by the breakdown in public sector lending relevant to PSO in Table A5.1,
infrastructure, especially in transport and power sectors, has been the primary focus of the
regional departments.

Table A5.1: Sector Allocation of Public Sector Lending (1995-2005)

($ million)

Public Power and Urban

Year Administration Energy Transport Development Finance Total
1995 275 105 250 630
1996 250 100 250 600
1997 150 113 300 563
1998 250 250
1999 250 375 625
2000 600 180 120 900
2001 350 450 500 200 1,500
2002 200 150 814 1,164
2003 250 980 200 1,430
2004 150 400 650 1,200
2005 0
Total 850 2,275 3,187 1,430 1,120 8,862
Source: Asian Development Bank records.

2
Prepared by CRISIL.
 Appendix 5 101

23. ADB has pursued institutional reforms to strengthen PPP procurement capacity in the
infrastructure by providing technical assistance (TA) to help create PPP units at the state level,
as well as in National Highway Authority of India (NHAI). Contrary to proposals in some of the
earlier country strategies and the PSA, ADB exited the telecommunications and ports sectors in
the mid-1990s, and has focused on power, roads, water, and urban infrastructure since then.
The public sector side of ADB has been engaged consistently in the power sector. Successful
ADB-supported reforms are starting to create conditions for private sector investment, and
possible increased Private Sector Operations Department (PSOD) deals in the power sector.
Public sector operations in the gas sector contributed to strengthening the framework for the
private sector to enter the industry. Assistance from the public sector side of ADB in the
transport sector has been oriented mostly to roads and, to lesser extent, railways. Some TA was
provided in 2000 and 2001 to support private sector participation for road maintenance. After
pursuing a substantial public sector lending program up to 2004, PSO-related lending ceased in
2005. PSO has not been involved in the transport sector, even in ports3 where it would seem
feasible to support private projects.

24. The finance sector has been the other strategic focus with a PSO orientation. ADB
assistance has been designed to help channel funds to infrastructure in sectors such as power,
roads, and urban facilities. TA in the finance sector was unrelated to the lending program and
appeared to lack focus. TA was targeted at the stock exchange, dispute resolution, housing
finance, pension and insurance reform, and use of mortgage-backed securities in the capital
markets. The public sector loans provided to the Government were essentially infrastructure and
housing credit lines. Two large sovereign guaranteed private sector infrastructure facility (PSIF)
loans ran into difficulties due to the high cost of funds and denomination in foreign currency,
which reduced demand, and there were problems finding attractive projects.

25. ADB approved its first PSO investments in India in 1987. Initial PSO investments in the
1980s were targeted at the manufacturing industries. Throughout the 1990s, the finance sector
was emphasized with many relatively small capital market equity investments. After the
approval of the Private Sector Development Strategy (PSDS) in 2000, the emphasis on
infrastructure increased, particularly in energy and power, with one power plant approved in
2003. By the end of 2005, 394 projects had been approved for $478 million, making India the
largest recipient of ADB’s PSO. The average investment size was $13.7 million. During the
period of analysis, only one CFS facility was issued for $5 million. At the end of 2005,
outstanding PSO commitments were $289.3 million, with most of these funding facilities directed
to the finance sector.5

26. Finance sector interventions have been the main source of assistance provided by
PSOD, initially by taking equity interests in banks, then moving to equity funds and providing
banks with Tier 2 capital funds (secondary bank capital such as subordinated dent). In recent
years, PSOD has had difficulty obtaining central bank approval for bank-related transactions
due to concerns about ADB crowding out commercial operations because of its potential to
provide funds at below-market rates. Central bank concerns about ADB’s involvement in the
Indian finance sector also have affected infrastructure operations. PSOD has experienced
problems obtaining access to competitively priced local currency through mechanisms such as
the swap market due to perceived risks that ADB’s involvement might distort that market.

3
While the Petronet LNG facility had a port that formed part of the overall plant, it could be used only for conveying
LNG to the shore. As such, it falls under the classification of an energy rather than transport facility.
4
Including one line of equity of $5 million, from which 15 small equity sub-investments were made by 1994.
5
While the study covers 1995–2005, six more projects with a total value of $347.6 million were approved 2006,
bringing cumulative approvals to $975.6 million by September 2006.
 102 Appendix 5

4. PSO Transactions in India

27. During 1995–2005, 22 PSO transactions were approved for India, totaling $459.85
million (Table A5.2). The dominant focus was on finance sector and capital market projects.
Possibly due to inadequate due diligence or premature processing, ten of the 21 approved
projects subsequently were canceled for reasons such as regulatory restrictions, lack of
demand, or uncompetitive pricing. Taking into account these cancellations, the portfolio shrinks
by $353.2 million, or 58%, to $258.4 million. The resulting portfolio has a disproportionately
large amount of equity, totaling $126.4 million (49%), compared to $132.0 (51%) in senior debt.
This is a high-risk portfolio structure. Dividing the non-canceled approvals according to sectors,
$136.9 million (53%) was invested in financial and capital markets interventions, $71.5 million
(8%) in two infrastructure projects, and $50 million (19%) indirectly target infrastructure through
local financial institutions.

Table A5.2: PSO Investment Approvals in India (1995–2006)

ADB Financing ($ million)
Name Sector Loan CFS Equity PCG Total Date Status
Equity Management Finance – – 0.1 – 0.1 1995 –
Sectoral Equity Fund Finance – – 15.0 – 15.0 1995 –
Securities Finance – – 4.3 – 4.3 1995 Canceled
Capital Markets Finance – – 21.2 – 21.2 1995 –
Finance Company Finance – – 4.5 – 4.5 1995 –
Power Company Power 25.0 100.0 15.0 – 140.0 1996 Canceled
Infrastructure Finance Finance – – 15.5 – 15.5 1997 –
Mortgage Guarantee Finance – – 10.0 – 10.0 2002 Canceled
Healthcare Institute Services 20 – – – 20.0 2002 Canceled
Infrastructure Fund Finance – – 15.0 – 15.0 2002 –
Transmission Power 62.3 – – – 62.3 2003 –
Bank (supplementary) Finance – – 0.7 – 0.7 2003 Exited
Housing Finance Finance 20.0 – – – 20.0 2003 –
Home Finance Finance 20.0 – – – 20.0 2003 Canceled
LNG Energy – 65.3 – – 65.3 2004 Canceled
Power Generation Power 54.4 – 20.6 – 75.0 2004 Canceled
Private Equity Finance – – 20.0 – 20.0 2004 –
Asset Reconstruction Finance – – 5.6 – 5.6 2005 Canceled
Infrastructure Finance Finance 50.0 – – – 50.0 2005 Canceled
Bank Finance 23.0 – – – 23.0 2005 Canceled
Private Equity Finance – – 15.0 – 15.0 2005 –
– = not applicable, ADB = Asian Development Bank, CFS = complementary financing scheme, PCG = partial risk
guarantee, PSO = private sector operations.
Source: Operations Evaluation Department staff compilation.

28. An OED evaluation of the PSO projects in India, based on a mixture of desk-based
reviews and company visits, derived the indicative project performance results shown in Table
A5.3.
 Appendix 5 103

Table A5.3: Summary of Evaluated Project Performance in India (1995–2005)

Investment
Project PSD Performance Comments/Issues
Equity Management Satisfactory Satisfactory –
Sectoral Equity Fund Excellent Satisfactory –
Securities Canceled – Lack of demand
Capital Markets Satisfactory Satisfactory –
Finance Company Satisfactory Satisfactory –
Power Company Canceled – –
Infrastructure Finance Excellent Excellent –
Mortgage Guarantee Satisfactory Satisfactory Regulatory issue
Bank(supplementary) Unsatisfactory Unsatisfactory Almost bankrupt
Healthcare Institute Canceled – –
Infrastructure Fund Satisfactory Satisfactory –
Transmission Limited Satisfactory Satisfactory –
Housing Finance Satisfactory Satisfactory –
Home Finance Canceled – Price not competitive
LNG Satisfactory Excellent
LNG Canceled – Price not competitive
Power Generation Canceled – Price not competitive
Private Equity Satisfactory Satisfactory –
Asset Reconstruction Canceled – Regulatory issue
Infrastructure Finance Canceled – Price not competitive
Bank Canceled – Regulatory issue
Private Equity Excellent Satisfactory –
– = not applicable, LNG = liquefied natural gas, PSD = Private Sector Development.
Source: Operations Evaluation Department staff compilation.

C. PSD Issues in India

29. India has grown more than 8% per year over the past 3 years, primarily due to three
factors: (i) a robust global economy, (ii) the delayed impact of liberalization measures initiated in
response to economic crisis in 1991, and (iii) a substantial boom in consumer lending. While
interest rates are starting to rise, growth appears to be sustainable in sectors such as
manufacturing, where macroeconomic stability coupled with increasing competition is improving
quality and cost-effectiveness. Nevertheless, overall progress and balanced growth will depend
upon reforms to modernize infrastructure for power, ports, and roads. The benefits of reforms in
the infrastructure are starting to become apparent only now, and most private sector
participation continues to be limited to PPPs in the road sector and some captive ports and
power generation projects. While the finance sector is liquid and consumer credit growth is
booming, long-term corporate debt and access to foreign credit and FDI continues to be limited.

30. Traditionally, India has not had a policy of pursuing PSD. It has been focused on
developing its industrial sector through regulatory protection and directed lending programs. The
economy for the most part has been closed, which helped insulate it from the effects of the
Asian financial crisis. Recently, the Government has started to liberalize the economy, and is
pursuing investment in infrastructure, particularly in the power and transport sectors. The
Government continues to maintain a highly centralized approach to economic reform, especially
in the infrastructure and finance sector development where development programs are
articulated in five-year plans. Liberalization is modest, with high trade barriers and regulatory
constraints by international standards, though much improved relative to historical conditions. In
critical infrastructure sectors, such as power and water, tariffs continue to be set at levels
substantially below cost. The Government’s lack of control over state governments in the power
sector has meant reform has been extremely slow, although moving in the right direction. While
104 Appendix 5

progress is more apparent in the road and ports sectors, funding needs are substantial.
Infrastructure still needs to be developed to improve access to water and support more inclusive
growth in semi-urban manufacturing and service initiatives. A key constraint has been the lack
of access to long-term finance. The Government appears to have made good progress in this
area, although credit availability at affordable rates continues to be quite low despite high levels
of savings.

31. The Prime Minister recently estimated that $155 billion6 is required over the next 5 years
to support infrastructure development, and this figure could rise as high as $250 billion if
infrastructure investment reaches 9–10% of GDP. Assuming the public sector provides about
80% of this funding, the private sector would have to provide up to $50 billion over the next 5
years. In practice, the total financing figure seems optimistic, and only a fraction of this amount
is likely to be raised without substantive reforms. In the power and water sectors, cost-based
tariffs administered by independent regulators are the key issue. For roads and infrastructure,
acquisition of land is the primary constraint. The substantial gap between demand for resources
and the low levels of FDI and modest growth in local sources of corporate finance indicates the
Government also needs to pursue reforms in the finance sectors to help mobilize the necessary
funding. Critical areas of reforms involve strengthening the municipal and corporate bond
markets, removing investment restrictions on local savings vehicles, and freeing up of the
capital account to improve access to long-term foreign sources of finance.

32. ADB’s CSP issued in 1996 signaled a shift in focus from the national to state level.
Private sector development was a core priority of the country strategy, and ADB intended to
focus on power infrastructure, and government guaranteed private infrastructure credit lines. In
2003, the CSP shifted emphasis toward poverty reduction and social and agriculture projects. A
draft PSA was issued in 2003 that highlighted the importance of issues such as privatization and
resolving NPL problems, although it did not form part of the country strategy. In line with ADB’s
country strategic programs, public sector support for power sector reforms has been reasonably
constant throughout the period of analysis, occurring initially in Gujarat, followed by Madhya
Pradesh, and then Assam. In 1998, PSO-related public sector lending almost stopped due to
India’s nuclear testing, and then grew rapidly to peak in 2001 due to substantial incremental
demand to help finance national road projects. Lending for urban development has been
reasonably constant over the review period, with emphasis on housing and urban water.
Financial assistance has occurred primarily in the form of four private sector infrastructure
facilities (PSIF) and seven housing loans.

33. Despite being the single largest country exposure in PSOD’s portfolio, India’s level of
PSO over the period of analysis has been surprisingly limited given the size of the country. The
size of the PSO portfolio at $289.3 million, or 17% of the portfolio as of 31 December 2005, is
small given the number of transactions and effort expended over a 10-year period. The PSDS
approved in March 2000 does not seem to have had a material impact on the scale and focus of
PSOD’s operational activities. While the public sector provided assistance to help strengthen
the enabling environment in selected states in power infrastructure, reforms have been slow to
materialize. As such, the Board has approved only three significant transactions. This lack of
progress reflected in part the serious constraints present in the energy sector in the form of
insolvent state electricity boards and noncommercial tariffs. PSOD also has made surprisingly
little progress is the transport sector, especially in subsectors such as ports that can finance
operations without having to hedge currency risks. ADB’s public sector operations provided
assistance to the NHAI as early as 2000 to help facilitate PPPs in the road sector. However, it

6
18 August 2006. Editorial. Financial Times.
 Appendix 5 105

was directed mainly at maintenance contracts, and only a few privately financed concessions
have been put in place successfully.

34. The weak enabling environment has been reflected in the poor performance of the
Government-guaranteed PSIF provided by ADB’s public sector operations. The PSIF loans
were not particularly successful as suitable projects were hard to find. The Government, which
appears to accept the need for fundamental reform to support private investment, has indicated
that it does not consider the PSIF consistent with its policy on PPP. The Government’s shift
toward viability gap funding, and general progress on unbundling the power sectors and putting
in place independent regulators, suggests that circumstances are starting to improve for PSO in
India. This change has been reflected in the scale of PSOD’s operations, as approvals have
started to accelerate since 2003. Four approvals were recorded in 2005, followed by five
approvals midway through 2006. These transactions are occurring increasingly frequently in the
infrastructure sector in line with the PSDS priorities.

35. Despite these encouraging trends, obtaining central bank approval to access local
currency finance in the swap market continues to be a serious problem. Thus, ADB is likely to
experience increasing difficulty providing financial assistance to banks in India. In most cases,
sponsors and borrowers praised ADB’s commercial processing procedures. However, several
complaints were heard about unnecessarily complex legal documentation requirements that
were slow to process compared to those of competing IFIs, such as International Finance
Corporation. Social safeguard project processing requirements might be another issue,
especially in the road sector, although this is difficult to confirm given the lack of PSOD
involvement in this sector. The National Highway Authority has been negotiating with ADB’s
public sector operations over whether squatters should receive compensation, and whether this
should be paid at market rates. The Government has expressed concerns about PSOD’s low
level of engagement in infrastructure reforms. The resident mission in Delhi has only one PSOD
staff member who does not have any support staff. This scale of operation appears seriously
inadequate given the scale of opportunities within the country, the complexity of the
environment, and the need to be on the ground establishing relationships with the Government
and the private sector.
106 Appendix 6

COUNTRY CASE STUDY: VIET NAM

A. Investment Climate

1. Background

1. Following decades of war, Viet Nam adopted a socialist political system at the time of
unification in 1976. In 1986, the Government launched the Doi Moi (economic renovation) policy
that permitted a role for the private sector. Initially progress was slow, but the Government
launched dramatic reform measures following a famine in the northern provinces of Viet Nam in
1988. These measures included (i) abolition of the commune system in agriculture, (ii) removal
of subsidies from state-owned enterprises (SOE), (iii) reduction of price controls, (iv)
liberalization of external trade, (v) establishment of a central bank, and (vi) devaluation of the
Vietnamese dong. Most importantly, the economic strategy relied heavily on private sector
growth and foreign direct investment (FDI), and the basic foundations for a market economy
were in place by 1992. As a result, Viet Nam has achieved economic growth of more than 7%
per year over the past 10 years. While the share of private sector participation (PSP) has more
than doubled during this time, it remains low by international standards at 50–60%.

2. Over the past decade, Viet Nam has pursued a policy of accommodating, rather than
encouraging, private sector development (PSD). The Government has maintained a policy of
heavy regulation, and ownership and management of more than 4,000 SOEs that account for
29% of gross domestic product (GDP). The Government has pursued a highly centralized
approach to economic reform, especially in infrastructure development, that is articulated in
long-term plans of 10–20 years duration. Similar to other socialist economies, such as India, the
ultimate objective of the Government’s development program has been industrialization.
Recently, the Government has pursued opportunities to encourage public-private partnerships
(PPP) in power generation.

2. Macroeconomic Stability

3. At 1.9% of GDP in 2005, the fiscal deficit is low by international standards, and it is
supported by a low level of external public sector debt. Tax reforms have been successful. Tax
revenue as a proportion of GDP in 2005 was 21.8%, which is reasonably high relative to other
developing member countries (DMC). The central bank has had limited success in maintaining
economic stability through monetary policy. Following a period of low inflation through the
1990s, inflation started to accelerate as the central bank accommodated the Government’s
growth objectives and permitted an expansion in credit. The dong is not a freely convertible
currency, and the exchange rate is managed. The high level of control over the currency helped
insulate Viet Nam from the worst effects of the Asian financial crisis.

3. Competition and Trade

4. While Viet Nam’s economy is reasonably open to trade by international standards,

further reform is required to increase competitiveness. Quotas and tariffs are highly variable
and provide significant protection to selected sectors, such as car assembly, sugar, steel, and
cement. Viet Nam is implementing tariff reductions under its Association of Southeast Asian
Nations (ASEAN) Free Trade Agreement (AFTA) obligations, and it is in the final stages of
joining the World Trade Organization (WTO). The Government is liberalizing the domestic
economy—it has a policy of cutting administrative interference in business and nominally does
not discriminate between socialist and non-socialist enterprises. In practice, SOEs continue to
gain access to subsidized inputs, and the Government still administers prices of strategic items
 Appendix 6 107

such as cement. The State Pricing Committee sets prices for utility services such as water.
Nevertheless, reforms are continuing. In 2005, the Government introduced the Competition
Law, a new Unified Enterprise Law, and the Common Investment Law. The Unified Enterprise
Law is meant to level competitive conditions between SOEs and private firms. The Common
Investment Law harmonizes requirements for foreign and domestic investments.1

4. Privatization

5. The Government has a program to restructure and divest SOEs, although very little
progress has been made on privatization in Viet Nam. Privatization does not receive much
support from management and staff due to the preferential access rights held by SOEs to state
contracts, licenses, land, and finance. Viet Nam does not have a system of private property,
and the Government issues land use rights that cannot be purchased, sold, inherited, and
mortgaged. The scarcity of land and legal complexities associated with its use has been viewed
as probably the most significant constraint to PSD in Viet Nam. The development of supporting
infrastructure, such as property registries, is needed urgently. (footnote 1)

5. Public Private Partnerships

6. A build-operate-transfer (BOT) law is in place, which has been revised on several

occasions. Despite these reforms, very little private sector participation has been seen in
publicly financed infrastructure projects, and no limited recourse projects without the support of
international financial institutions (IFI) such as the Asian Development Bank (ADB). During
1990–2003, $3.2 billion, or 15% of infrastructure investment, was sourced through PPP
facilities. Of this amount, 81% is associated with two Phu My power projects. Project finance
has not taken off in Viet Nam due to factors such as (i) foreign exchange controls; (ii) absence
of guarantees on minimum returns; (iii) inadequate loan security (no mortgaging of land use
rights, lack of step-in rights, and underdeveloped dispute resolution procedures); (iv) corruption;
and (v) lack of common procedures and standardized contracts. Due to the absence of long-
term commercial funding denominated in dong, all project finance is denominated in hard
currency, mostly United States dollars. A further constraint has been Decree 155, which was
introduced in 2004 and precludes private ownership of infrastructure in sectors such as ports,
roads, and water.

6. Foreign Direct Investment

7. The Government’s FDI program has been very successful. Between 1988 through to
September 2006, Viet Nam attracted $56 billion in commitments, with half of this amount
disbursed. FDI peaked in 1996–1999 at more than 4% of GDP, subsequently declining to 2% of
GDP in the early 2000s in the aftermath of the Asian financial crisis. Following a slow recovery,
FDI has accelerated since 2003 and again reached 4% of GDP in 2006.

7. Infrastructure

8. The Government has invested heavily in infrastructure at an average annual rate of

almost 10% of GDP during 1997–2003. Despite this high investment rate, private sector firms
still consider the quality of transport and, to a lesser extent, electricity infrastructure some of the
most important constraints on growth in Viet Nam.

1
ADB. 2005. Private Sector Assessment. Manila.
108 Appendix 6

9. The telecommunications sector has been growing rapidly. While the Vietnam Post and
Telecommunication Corporation has lost its monopoly and is facing increasing competition,
especially in the mobile market, most participants are SOEs. Although private sector
participation currently is limited, Viet Nam’s accession to WTO will help increase competition
from private operators.

10. Electricity of Viet Nam (EVN), which operates a vertically integrated power system,
dominates the power sector. Rapid urbanization and industrialization has been increasing the
pressure on the power sector, resulting in a series of peak period outages in 2004 and 2005.
Independent Power Producers (IPP) account for about 21% of Viet Nam’s generating capacity.
This capacity is derived from the ADB-supported Phu My 2.2 and 3.0 gas plants, which were
the first projects constructed under Viet Nam’s BOT Laws. The Electricity Law, which was
passed in 2005, calls for unbundling the sector and creating a competitive supply market,
initially with EVN as a single buyer. Eventually a spot market will be set up, and an electricity
regulator that reviews tariffs and reports to the Ministry of Industry will be established. Delays in
preparing and issuing supporting regulations have hindered the implementation of this
legislation.

11. The Government continues to control the transport sector, dominating the provision of
services and infrastructure. The Government owns the airports and the national airline, and
competition is limited. Apart from three minor seaports that have been developed under BOTs,
the Government owns all of the major seaports. The Government also owns all of the roads,
although SOEs administer several roads and charge tolls to use them. The development of the
inner city metros for Ho Chi Minh City, Hanoi, and Da Nang have become a high priority and the
Government is considering private sector participation for these facilities.

12. Water services are sourced primarily from municipalities. The State Price Committee
sets maximum tariffs for water, which typically cover only direct operating costs. Tariffs set at
levels below full costs of production effectively have precluded private sector participation,
except in areas such as small-scale retailing of water and some wastewater removal
businesses. In some cases, private sponsors have sought to provide bulk water supply under a
BOT, but an agreement could not be reached on the tariff. In 2000, the Government issued a
decree prohibiting BOT water projects that involved foreign investors. A second decree was
issued in 2004 confirming it would retain more than 50% ownership of large urban water
companies (footnote 1).

8. Small and Medium-Sized Enterprises

13. In November 2001, the Government officially recognized small and medium-sized
enterprises (SME) by issuing Decree 90, which provides a framework for public sector support
and development. The decree covers the establishment of (i) an SME promotion council with
cross-ministry membership that acts as an advisory body to the Prime Minister; and (ii) an
agency for SME development that coordinates SME-related activities. The Government has
created the Viet Nam Chamber of Commerce and Industry and the Viet Nam Cooperative
Alliance to interface with commercial operations. Hundreds of other business-related
representative bodies exist at the national and provincial level.

9. Financial and Capital Markets

14. Four state-owned commercial banks that hold about 75% of outstanding bank credit
dominate the banking sector. These banks extend approximately 45% of their loans to SOEs at
subsidized rates (footnote 1). The central bank has proposed that the state banks be partly
 Appendix 6 109

privatized starting with Vietcombank, possibly in 2007. The private sector is involved through 34
private joint stock banks and 26 foreign bank branches, which together supply 17% of
commercial credit. In 2005, two foreign banks, ANZ Bank and Standard Chartered, purchased
minority shareholdings in the two largest commercial banks in Viet Nam.

15. As a result of years of directed lending, nonperforming loans (NPL) held by state banks
were equivalent to approximately 50–70% of their loan portfolios in 2003. The Government has
had limited success restructuring insolvent SOEs, as the legal framework remains inadequate.
The Government has been taking steps to facilitate the use of collateral, and it has established
a Secured Transactions Registry and revised the Bankruptcy Law. However, without an
effective foreclosure regulatory framework, the results have been limited.

16. The Government has established special purpose nonbank financial institutions (NBFI),
such as the Development Assistance Fund, to help overcome limits on credit availability. This
fund, one of the largest financial institutions in the country, does not act as a commercial bank,
allowing it to provide loans to SOEs on concessional terms. The Government also created a
Central Credit Fund and approximately 60 microfinance banks. Viet Nam’s capital market is
small and underdeveloped.

B. ADB’s Country Strategy and Development Program

1. Overview

17. ADB’s operations in Viet Nam, which resumed in 1993, have focused on (i) public
administration reform; (ii) rehabilitation of physical infrastructure in the agricultural, energy, and
transport sectors; (iii) finance sector reform, with a focus on the nonbank sector; and (iv)
preventative health care and secondary education. The public side of ADB has undertaken the
following activities to support PSD: (i) public administration reforms to improve transparency in
the interface with the private sector; (ii) SOE Reform and Corporate Governance Program; (iii)
formulation of the Electricity Sector Development Plan; and (iv) SME Development Plan. ADB
public sector lending has been relatively stable, apart from in 2005 when a large loan was
provided to help develop the power system (Figure A6.1).

Figure A6.1: Asian Development Bank Financing, Annual Approvals in Viet Nam
($ million)

700

600

500

400 Public
300 Private

200

100

0
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

Source: Asian Development Bank records.

110 Appendix 6

18. Viet Nam is a comparatively new entrant into the realm of ADB private sector operations
(PSO). The first investments in a leasing company and a cement factory were approved in
1996. Since then, five additional investments were approved in the water, education, health,
and power sectors. PSO approvals in Viet Nam totalled $168.5 million, and they were bolstered
by a $26.5 million complementary financing scheme (CFS) and a $60 million partial risk
guarantee (PRG). The Private Sector Operations Department’s (PSOD) exposure at the end of
2005 was $136.7 million, of which about two thirds involved the two Phu My power projects
approved in 2002. PSO activities in Viet Nam have been sporadic, with approvals in only 4 of
the 11 years under examination. ADB has not approved any PSO investments in Viet Nam
since 2002, although a follow-up investment in the power sector was approved in late 2006.

2. Country Strategies

19. The 1995 country strategy program (CSP) equivalent provided a framework that built on
the liberalization reforms embodied in Doi Moi. The strategy included geographic links between
three growth zones of northern, central, and southern Viet Nam, as well as links with other
countries in the Greater Mekong subregion. ADB was to focus its operations on transportation
corridors and related development zones to support economic growth. This strategy had the
potential for increasing links between public and private sectors, and facilitating private sector
participation in infrastructure. ADB was to strengthen the legal and regulatory framework for the
private sector, finance sector reform, and support progress on equitization and privatization of
SOEs. Proposed strategic initiatives included: (i) policy and institutional development, with a
particular emphasis on strengthening the banking sector under a finance sector program loan
that was being prepared at that time and strengthening the public sector; (ii) infrastructure
development, especially transport, followed by power and other facilities; (iii) rural development,
targeting rural credit and irrigation facilities; (iv) human development in health and education;
and (v) natural resource and environmental management.

20. The 2001 CSP2 for the period 2002–2004 sought to strengthen ADB’s focus by targeting
(i) sustainable growth through rural and private development (improving the business
environment, catalyzing private sector participation in infrastructure, strengthening the finance
sector); (ii) inclusive social development; (iii) good governance in areas such as public
administration reform, decentralization, and legal reforms to the extent these factors affect PSD;
and (iv) geographic focus on the Central Region that is relatively more impoverished than other
regions. Aid agency activities would be coordinated through the Comprehensive Poverty
Reduction and Growth Strategy agreed with other development partners. PSD was a major
theme of the CSP and it was envisaged the business environment would be strengthened by
addressing policy constraints at the national level in areas such as taxation, regulation, and
licensing using a sector development loan. At the local level, ADB sought to alleviate land and
credit constraints. Private sector participation in infrastructure would be supported by
unbundling the power sector, creating an independent regulator, and supporting transactions
with a significant demonstration role. Policy dialogue would be held with the Government to
help address regulatory constraints on the use of BOT instruments. In the finance sector, the
focus was on (i) restructuring state banks; (ii) providing housing finance; (iii) strengthening
SMEs; and (iv) developing NBFIs, such as leasing and insurance entities and capital markets
over the medium term.

21. ADB published a private sector assessment (PSA) of Viet Nam in 2005. Like most other
PSAs, the review and recommendations were comprehensive. The recommendations in the

2
ADB. 2001. Viet Nam: Country Strategy Program (2202-2004). Manila.
 Appendix 6 111

PSA addressed all three thrusts of the PSDS. To improve the enabling environment, it
suggested that ADB provide support for improving financial intermediation, specifically through
insurance and pension products. SME development assistance also could be expanded. ADB
could help develop the policy, legal, and planning framework needed for private sector
participation, particularly in the power sector, where a new electricity law had been passed and
private investment was needed to increase generating capacity. In the transport sector, support
was needed to define future sector structures and development programs, including private
sector investment for ports, airports, and roads. To generate business opportunities, the PSA
proposed that project development facilities be created and private sector access to public
procurement contracts improved through better dissemination of information on opportunities
and revision of tendering procedures. The PSA called for PSO investments with demonstration
impacts in infrastructure, and supported the creation of investment funds and other financial
instruments that improved domestic firms’ access to long-term funding.

3. ADB Assistance

22. Table A6.1 shows the breakdown in public sector lending relevant to PSO (about 70% of
total public sector lending).

Table A6.1: Sector Allocation, Public Sector Lending

($ million)
Water and
Public Power and Urban
Year Administration Energy Transport Development Finance Total
1995 80 30 66 176
1996 120 140 260
1997 100 72 172
1998 130 130
1999 100 100
2000 80 80
2001 70 60 130
2002 80 80
2003 45 134 179
2004 120 95 215
2005 360 101 74 535
Total 145 660 451 406 395 2,056
Source: Asian Development Bank records.

23. ADB’s public sector operations have focused on strengthening core public sector
functions. However, ADB has not been engaged in activities such as privatization or creation of
public-private partnership (PPP) units. The regional department was active in the power and
energy sectors. The sector restructuring programs supported by ADB provide a basis for private
sector participation, including two 2002 PSO transactions in power generating facilities. In the
transport sector, the focus has been directed almost exclusively to roads. Apart from a public
sector loan to the Port of Saigon in 1995, ADB has not been involved in rail, airports, or
seaports. Almost all of the transport-related technical and financial assistance has been project-
specific. No work was done to establish a road fund, a regulator, or a PPP unit to procure and
manage private roads or ports. In the water sector, assistance was provided to help develop a
water resource management system. ADB did not assist with corporatization, PPP
procurement, or the creation of an independent regulator.

24. Despite the weak enabling environment, PSOD did participate in a successful
negotiation of a private water concession. Unfortunately, the sponsor abandoned this project
112 Appendix 6

before implementation due to difficulties reaching an agreement on the tariff. The public sector
side of ADB has been active in the finance sector, with a diverse, seemingly unfocused,
technical assistance (TA) program. While ADB provided assistance to help put in place a
secured transaction framework in 1997, it has not followed through and the framework is not yet
effective. ADB did not do any work in areas such as creating asset management companies or
generally putting in place mechanisms to resolve the NPL problem, or to strengthen banks in
anticipation of market liberalization. Apart from a lease project approved in 1996, and
subsequently canceled in 1999 due to sponsor concerns following the Asian financial crisis, the
finance sector has not had any PSO operations.

4. PSO Transactions in Viet Nam

25. Viet Nam had seven PSO transactions during 1995–2005 (Table A6.2). The total value
of the PSO portfolio is $257.0 million, including $170.5 million on ADB’s own account, $26.5
million under CFS, and $60 million as PRGs. The approvals are distributed across the finance,
cement, water, education, health, and power sectors.

Table A6.2: PSO Investment Approvals in Viet Nam

ADB Financing ($ million)

Name Sector Date
Approved Status
Loan CFS Equity PRG Total
Leasing Finance 2.00 – – – 2.00 1996 Canceled
Cement Cement 30.00 26.50 – – 56.50 1996 –
Water Water 31.00 – – – 31.00 2000 Canceled
University Education 7.50 – – – 7.50 2001 –
Medical Health 10.00 – – – 10.00 2001 –
Energy Power 50.00 – – 25.00 75.00 2002 –
Power Power 40.00 – – 35.00 75.00 2002 –
– = not applicable, ADB = Asian Development Bank, CFS = complementary financing scheme, PRG = partial risk
guarantee, PSO = private sector operations; Univ = University.
Source: Operations Evaluation Department staff compilation.

26. While ADB did not approve any direct equity investments for Viet Nam, it has made two
PSO investments in regional funds that primarily target Viet Nam. ADB invested $4 million and
$9 million, respectively, in the Mekong Enterprise Funds I and II. The PSO performance in Viet
Nam suffered from the cancellation of the investment approvals for Viet Nam Leasing and
Lyonnaise Viet Nam Water Ltd. These cancellations occurred primarily because of the Asian
financial crisis, which negatively affected Viet Nam’s FDI performance, and the Argentinean
financial crisis that affected the sponsor. Given Viet Nam’s strong economic performance and
pace of liberalization since 2001, the absence of new PSO investment approvals since 2002 is
surprising.3

27. An Operations Evaluation Department (OED) evaluation of the PSO projects in Viet
Nam, based on a mixture of desk-based reviews and company visits, derived the indicative
project performance results in Table A6.3.

3
A follow-up investment in the power sector is in the pipeline.
 Appendix 6 113

Table A6.3: Summary of Evaluated Project Performance in Viet Nam (1995–2005)

Investment
Project PSD Performance Comments/Issues
Leasing Canceled – Canceled by client
Cement Satisfactory Satisfactory –
Water Canceled – Canceled by client
University Excellent Satisfactory –
Medical Satisfactory Unsatisfactory –
Energy Excellent Satisfactory –
Power Excellent Satisfactory –
– = not applicable, PSD = Private Sector Development.
Source: Operations Evaluation Department staff evaluation.

C. PSD Issues in Viet Nam

28. Viet Nam, strategically located next to the People’s Republic of China, is following a
similar program of economic reform that is producing dramatic results. Due to the closed nature
of the economy in the 1990s, Viet Nam avoided the worst effects of the Asian financial crisis,
and the economy has been growing more than 7% per year over the past 10 years. Despite this
impressive performance, and important reforms to the policy, legal, and regulatory framework,
private sector participation still represents only 50% of GDP—very low by international
standards. Over the past decade, Viet Nam has followed a policy of accommodating, rather
than actively supporting PSD. The Government has maintained a policy of heavy regulation,
and retained ownership and management of more than 4,000 SOEs that account for 29% of
GDP. The Government continues to pursue a highly centralized approach to economic reform,
especially in infrastructure development, which is articulated in long-term plans of 10–20 years
duration.

29. ADB’s level of public sector lending has been relatively low over the review period,
averaging about $200 million per year from 1998 through 2003, before starting to rise rapidly in
2004 and 2005 due to a series of large power sector projects. Apart from the two power
projects in 2002, PSO in Viet Nam has been limited. Although PSD was a stated CSP priority,
the country plans over the review period did not present any details on forecast PSO, indicating
a lack of focus and awareness of private investment opportunities within the country. Public
sector operations provided assistance in the late 1990s to corporatize SOEs. The power sector
has seen a substantial amount of activity, and public sector operations have been involved
heavily in the developing a reform program for power and energy. The Government is taking
steps to unbundle the sector. EVN is still the single buyer of power, while the Ministry of
Industry is responsible for tariffs, providing some independence in tariff administration.

30. PSOD has not been involved in the transport sector, which continues to be dominated
by SOEs. However, the planned metro lines in Hanoi and Ho Chi Minh City are expected to
have private sector participation. Despite efforts on the part of PSO to put in place a water
concession in Ho Chi Minh City, financial difficulties experienced by the sponsors following the
financial crisis in Argentina undermined the successful implementation of the project. ADB’s
public sector operations have been active in the finance sector, providing assistance to help
develop a secured transaction framework. However, this framework is not yet effective due to
problems enforcing collateral. The level of NPLs in the sector is high, and foreign participation is
limited due to legal restrictions, although these are being relaxed gradually and some of the
large international banks are taking minority shareholdings. Given the developments in the
banking sector, and the high level of interest from international investors, the lack PSOD
investment in the sector since a leasing company transaction was approved in 1996 is
surprising.
114 Appendix 7

PSOD OPERATIONAL REVIEW

A. Business Development

1. The Private Sector Operations Department (PSOD) business development function

needs to be strengthened. Business development draws direction from prevailing institutional
policies and strategies, the availability of resources, and a distinct and continuous business
function. This capacity should build on experience and be fully up to date with market
developments. PSOD needs to maintain regular personal contacts with potential investors,
business associations, financial institutions, authorities, and other stakeholders. In terms of
direction and priorities, prudent business development needs to guide the evolution of the
portfolio exposure in terms of country, sector, type of client and instrument, and the resulting
risk profile.

2. Apart from improving productivity by allowing transaction-oriented officers to focus on

deal processing, the adoption of this type of function by PSOD would help to set the operational
priorities in accordance with the strategic objectives in the country strategic plans (CSP). This
approach would reflect the business procedures of other private sector operations (PSO)-
oriented institutions, such as International Finance Corporation (IFC), which have assigned the
main responsibility for business development to the local IFC offices. The European Bank for
Reconstruction and Development (EBRD) has gone even farther, with a substantial proportion
of the staff being located in local offices, where they perform the mainstream private sector
operations (PSO) business activities.

3. The Asian Development Bank (ADB) has 19 resident missions. The Resident Mission
1
Policy , approved in 2000, states that resident missions will provide the primary operational
interface between ADB and the host developing member countries (DMC). Further, the resident
missions are to strive to maximize the efficiency, effectiveness, and impact of ADB operations in
the DMC. In handling relationships with stakeholders and players in the development process,
the resident missions were meant to take the lead. In practice, however, PSOD staff from
headquarters almost exclusively handles private sector operations. PSOD staff have been
placed in only three resident missions—India, People’s Republic of China, and Thailand. The
PSOD staff is classified as being “independent” of public sector staff. As a result, they are
isolated from the mainstream operation of the resident mission and left to deal independently
with relationship management and business development. This arrangement is not effective and
leads to the dilution of the already limited and overextended PSOD staff at headquarters.
Resident missions need to be staffed with professionals who possess appropriate backgrounds
and PSO skills. To optimize PSO opportunities, appropriately staffed resident missions should
take the lead in private sector operations business development and the preparation of country
strategies.

4. Another important means of enhancing business development is the creation of productive

strategic alliances. While some projects involve cofinancing with other PSO-oriented
international financial institutions (IFI), which might be considered a form of strategic
partnership, this approach can be expanded to include other local and international
organizations that are involved in business and investment in DMCs. These organizations might
include financial institutions or businesses that specialize in certain types of operations. For
example, in the emerging area of sub-sovereign municipal financing, some companies and

1
ADB. 2000. Resident Mission Policy, Manila.
 Appendix 7 115

project developers specialize in certain types of projects and services, and can repeat similar
investments in different countries. PSOD could develop strategic alliances, possibly initially by
investing directly in suitable project developers, holding companies, or special purpose vehicles.
PSOD then could participate in subsequent repeat investments alongside the developer(s),
which would result in a cost-efficient and productive business development process, even if the
individual projects are relatively small.

5. Strategic investments can be considered that have a dual purpose, such as providing
financial support to an investment recipient who is then required by an agreement to perform a
certain role on behalf of ADB. For example, in countries without resident missions, strategic
investments in local banks could serve as a form of local presence. The resulting proximity to
the market, as well as the improved access to business intelligence, would be useful for future
ADB PSO in that market.

B. ADB’s Strategic Planning Processes

6. The difficulties defining coherent programs of reform and identifying bankable projects
suggests the strategy program and project feasibility procedures require a substantial overhaul.
ADB needs to consider developing a systematic framework for assessing the impact of its
activities on PSD. EBRD and IFC have formulated development effectiveness methodologies
that ADB could use as models. ADB needs to focus more clearly on ways to measure and
monitor development impact in the design and monitoring frameworks. For example, when ADB
makes privatization investments, its impact can be measured as a proportion of total
privatizations made in the DMC. The same philosophy could be applied for public-private
partnership (PPP) projects. When ADB supports the project of a foreign sponsor in a DMC,
ADB’s role can be evaluated in the context of overall foreign direct investment (FDI). These
aspects are sufficiently complex to justify a study in its own right. ADB needs to put in place
systems and procedures that create incentives to reward staff for project outcomes rather that
project approvals.

7. Productive collaboration between the private and public sector windows of ADB was an
explicit objective in the 2000 Private Sector Development Strategy2 (PSDS). Essentially, the
market drives private sector operations. PSOD needs to support ADB’s strategy planning
process and position itself strategically vis-à-vis the market. The derived programs need to be
reflected in country business plans (CBP) for PSOD. The CBP would help business
development and resource allocation, as well as provide a basis for ex post performance
appraisal. While an overall PSDS is needed to lay out the basic parameters and establish the
rules for ADB’s internal handling and division of accountability for various tasks, the country
partnership strategic plans (CPSs) business planning process and the CBPs should determine
the PSO strategy in a given DMC. A key lesson from country assistance program evaluations
(CAPE) is that sector focus, engagement for a decade or more, and appropriately qualified staff
in ADB are important requirements in achieving development results. These general
observations apply to PSD and private sector operations. Within clearly defined risk
management parameters, a reasonable amount of flexibility is required in terms of how PSOD
operates.

8. ADB recruited private sector specialists and assigned them to regional departments to
help implement PSD and provide a productive link with PSOD. This approach did not work, as
the assignment of full accountability for PSD to regional departments meant PSOD was

2
ADB. 2000. Private Sector Development Strategy.
116 Appendix 7

detached from this objective. Further, the regional departments diverted the private sector
specialists to serve broader public sector objectives. The preparation of sector road maps was
not required in CSPs based on PSD objectives. Given this outcome, the reassignment of the
responsibility and accountability for PSD to PSOD, along with the private sector specialists who
were recruited, should be considered. The specialists could be placed in a new PSD department
within PSOD with the responsibility to focus exclusively on developing PSD within a strategic
context. This structure would create an incentive for ADB to orient strategic planning toward
private sector operations, and encourage PSOD to make better use of the CPS process, which
is the established mechanism for high-level policy dialogue with DMCs. This division could be
made responsible for processing and administering technical assistance (TA) within the PSD
priorities established in the CPSs.

C. The Credit Process

1. Overview

9. The credit process refers to the flow of measures and steps involved in bringing a project
from initial screening, through investment documentation and signing, to ADB’s full exit by
divestment and/or loan repayment. It involves many activities with responsibilities across
several departments, and with reviews and decision points at various levels in the organization.
The objective of a well-structured credit process is a logical sequence of events, documents,
and meetings that provide for reviews and assessments, leading to corrective measures on a
timely basis. A well-designed credit process will ensure that appropriate corporate governance
procedures are adopted, and a reliable and accurate audit trail of all key documents and
decisions is created. Typically, the credit process is divided into four functions:

(i) Credit approval. The steps and measures from project identification through its
analysis, evaluation, and Board approval, including documentation and signing
with the objective of facilitating credit decisions based on solid, reliable, and well-
researched information.
(ii) Credit management. Systematic credit monitoring of projects being
implemented, board representations, periodic reviews and reassignment of credit
ratings, provisioning for potential losses, and overall portfolio monitoring for credit
worthiness and risks until exit.
(iii) Credit workouts and recovery. Reappraisal and restructuring of projects in
distress with the objective of improving their credit ratings and prospects for
recovery, including foreclosure and liquidation.
(iv) Credit information systems. A complete database on all projects in the project
cycle, from identification, through project completion, and final exit. Typically,
these types of databases are full online applications that provide for
decentralized inputs into a secure centralized database, and facilitate
instantaneous production of reports. This function also includes the maintenance
of a comprehensive centralized credit file containing all key documents of the
credit process, and provides an accurate audit trail.

2. Credit Approval

10. The current PSO credit approval process contains some features that might not result in
an acceptable level of rigor, and creates unnecessarily time-consuming report writing
requirements instead of constructive and prompt face-to-face discussions. The project appraisal
 Appendix 7 117

procedures could be strengthened to capture more effectively the value for money (VFM) for
client DMCs, derived from ADB’s various types of assistance.3 Agencies, such as the Treasury
of the United Kingdom, have developed a comprehensive three-stage evaluation processes that
encompasses program-, project-, and procurement-level assessments. These assessments are
used to determine where private sector participation adds value to a project by improving long-
term efficiency and or effectiveness, relative to a public sector comparator.

11. When considering a project that might be financed by ADB, the first question that should
be asked is the whether ADB could finance the project with nonsovereign instruments. In most
cases, this would be a more efficient solution for the population within a country than sovereign
guaranteed projects due to benefits from competition, innovation, and risk transfers. If the
answer is no, the next question should be whether the project could be broken in parts to allow
some of the components to be financed with nonsovereign instruments. If the answer is still no,
then a sovereign product will be the most appropriate instrument. These tradeoffs can be
explicitly captured in VFM procedures that contrast public sector provision with private sector
provision under various risk-sharing arrangements. ADB’s internal staff incentives, which focus
on project approvals, mean that the public sector side of ADB does not systematically look for
opportunities to turn public sector loans into PSO. Strong leadership from the Vice-Presidents
would be needed to change ADB’s culture in this area.

12. ADB’s PSO occasionally has experienced difficulties competing on price, which is
surprising given ADB’s financial strength. This suggests PSO pricing procedures should be
reviewed. Among other things, procedures need to be systematized and should distinguish
between country risk bands. A close working relationship between PSOD, RMU and the
Treasury Department is necessary to ensure an appropriate cost of funding is taken into
consideration when performing due diligence. This requirement is particularly important when
local currency needs to be raised for back-to-back financing. In many cases, guarantees might
be a more efficient instrument than providing direct finance. Procedures and incentives need to
be put in place to ensure effective dialogue between PSOD and the Office of Cofinancing
Operations (OCO). Ideally, both operations should report to the same Vice President.

13. More sophistication and flexibility could be introduced in deal pricing and structuring,
such as the use of progress- and performance-linked fee structures and interest margins that
act as performance incentives. ADB also could provide more flexibility by introducing
mechanisms, such as amortization schedules, that are linked to cash flows. These could include
features such as cash sweeps and claw backs that allow for accelerated loan recovery. When
designing these project structures, effective input is required from the Office of General Counsel
(OGC) and some departments, such as Regional and Sustainable Development Department
(RSDD), which is responsible for environmental and social safeguards. Safeguards,
documentation requirements, and costs must be within commercially acceptable limits and
consistent with ADB policies. For the application of safeguards, ADB should harmonize its
standards and documents with IFC. The potential to develop standardized documents,
guidelines, and procedures, as well as training programs that can be used to streamline the use
of PSO instruments is substantial. The recent addition of a safeguard specialist to PSOD’s staff
should facilitate this work.

14. PSOD project approval procedures could be streamlined. For example, the project
concept approval is obtained by circulating a Concept Clearance Paper for written comments,
which are sought from various departments. Because this type of procedure solicits comments,

3
HM Treasury. 2006. Value for money (VfM) Assessment Guidance. London: HM Treasury.
118 Appendix 7

it does not create any direct “ownership.” Further, it tends to result in superfluous reviews and
provision of comments for the sake of procedural compliance, rather than to improve the
substance. Such a procedure causes delays. More importantly, however, it precludes the
benefit of simultaneous awareness of views expressed by other interested parties that would be
facilitated by open frank discussion in a Private Sector Credit Committee (PSCC) meeting.

15. Once a concept clearance paper has been approved and due diligence has been
performed, the project under consideration is discussed for the first and only time at the PSCC
as a draft Report and Recommendation of the President (RRP). At this stage, all major
decisions have been made, and the sponsor and concerned ADB staff already have agreed
upon the transaction. This procedure precludes a critical review and discussion of issues, such
as the deal structure, use of alternative instruments, and other problems that might have
emerged during due diligence. Presenting a project at concept clearance paper stage to the
PSCC has the additional benefit of providing project stakeholders with prior awareness of
potential issues that need to be addressed during the due diligence process. Other ADB
departments should provide their input further upstream in the project processing cycle. This
would help to improve project quality and avoid surprising sponsors with new requirements late
in the process.

16. For a PSCC-based procedure to work in a smooth, productive, and professional manner,
a number of requirements must be met. An effective credit committee is a working group of
professionals that have been empowered by senior Management to make certain decisions in
accordance with its terms of reference on credit issues in projects brought to its attention. While
the chair of the committee should be a representative of senior Management independent of
PSOD, its members need not all be line managers. The committee should include members
who are professionals with strong hands-on private sector investment experience. The
committee should meet regularly (at least every two weeks) to discuss openly ongoing private
sector operations issues. Regularity of meetings helps create continuity, an essential feature for
a productive and effective credit committee. The committee needs a strong professional
secretariat with the skill to synthesize and consolidate the key points and decisions made, and
disseminate this material to concerned parties.

17. An important milestone in the credit approval process is the formal commitment of ADB
to a financing agreement by signing the legal documents. Based on a review of PSOD project
completion reports (PCR), the processing time for ADB’s financing from due diligence to
documentation and signing tends to be lengthy. In exceptional cases, it has taken years. While
such delays are frequently due to reasons other than inefficiency, they raise another concern.
During such long periods, certain changes are likely to have occurred in project scope and
design; perhaps the financing plan; and, most importantly, market circumstances. It would be
inappropriate for ADB to sign and commit to a project without ensuring that nothing of substance
has happened since project appraisal that would jeopardize successful implementation.
Therefore, a formal procedure might be considered where the responsible officer issues a
closing certificate that is approved by the director general of PSOD. This certificate would be
issued immediately before signing, stating the project parameters are still substantially in
accordance with the estimates and findings presented for Board approval, and no material
adverse events have taken place in the enabling environment that would raise concern for
successful implementation.
 Appendix 7 119

3. Credit Management

18. PSOD traditionally has handled credit management, a system that has created some
conflicts of interest. The Risk Management Unit (RMU), which is independent from PSOD, was
created in 2005 to resolve this issue. While the location of RMU outside PSOD is appropriate
and in line with normal practice in financial institutions, the RMU’s precise terms of reference
are still being discussed and its business systems and working procedures developed. Specific
concerns that arise concerning the credit management function include the procedure for
carrying out periodic project credit reviews, credit rating, project provisioning, portfolio
monitoring, workouts, and recoveries. While the input for these assessments will emanate from
PSOD’s periodic project review missions, monitoring consultants’ reports, and client’s progress
reports, the findings and feedback must be presented at an appropriate forum for consistent
attention and follow-up. The RMU should be the only department empowered to assign a risk
rating for proposed and existing projects, and it will require adequate resources to perform this
function.

19. A dedicated and appropriately skilled risk management team needs to be created to
oversee the PSOD portfolio risk profile. Best practices for handling these matters and
developing reporting systems can be developed based on models used by other similar
institutions. For example, EBRD applies central portfolio management concepts and individual
risk reviews with a frequency (annual, biannual, quarterly, or more frequently for watch list or
problem loans) that depends on risk ratings assigned by an independent RMU. Project reviews
within EBRD are then prepared, led, and minuted by the RMU.

20. In addition to addressing organization issues, there is need to revise the portfolio
management reporting systems. An important intermediate milestone in the credit management
process is physical project completion. Typically, physical completion is defined in the legal
documentation, and for example it could trigger an event such as a reduction of the interest
margin. As such, a system is needed to formally record when a project is physical completed.
ADB needs to record how the project arrived at physical completion, starting from appraisal,
through Board approval and signing, and physical project implementation. Brief notes should be
available that identify any issues such as delays, cost overruns, and contractors’ performance.

21. These types of matters should be reported in PCRs. To date, only a few PCRs have
been prepared for PSOD projects, typically a few years after start of commercial operation. This
self-evaluation has covered only 35 of 119 PSOD projects. In addition, Operations Evaluation
Department (OED) has prepared only 13 project performance evaluation reports (PPERs) for
PSOD projects, together with one special evaluation study (SES) on funds. This level of self-
evaluation and independent evaluation is insufficient to meet the information needs of ADB’s
Board and Management. However, clearing the backlog by preparing PCRs in their current
format for all PSOD projects is not feasible, given PSOD’s staff complement and consulting
budget. The use of a project completion certificate can be considered to help address the
backlog. Such reports would briefly and concisely describe the events in project implementation
until physical completion, and state whether it was successful. The certificate then would form
part of the quarterly, biannual, and annual reporting systems used to help administer loans and
monitor portfolio performance.

22. PSOD prepares a range of quarterly and annual reports. The structure and content of
the documents need to be reviewed. These documents do not provide a clear view of
consolidated performance, and focus primarily on new approvals rather than disbursements.
120 Appendix 7

The link between development impacts and financial performance relative to country, sector,
and project targets is missing. Ideally, the structure of the project reports should be harmonized
in accordance with an agreed set of performance indicators, such as those used in the OED
guidelines for private sector operations. In this way, a common reporting framework can be
established for concept clearance papers, RRPs, PCRs, and PPERs. Under such a framework,
a common set of performance standards would be used for the entire project cycle. The
additional work requirements for each report in the cycle can be standardized in a format that is
known and uses indicators that are easily accessible.

4. Credit Workouts and Recovery

23. The workout function is performed by staff in the division of PSOD that is responsible for
finance sector-related PSO. This could lead to conflicts of interest. Following the practices of
IFC and EBRD, this function should be established in a special purpose unit or attached to the
Office of Cofinancing (OCO). Projects that have been assigned to this unit require reporting
systems that monitor progress continuously. This is an area where staff in the resident missions
could be integrated more tightly into the credit management process than they are currently.

5. Credit Information Systems

24. PSOD uses a number of data and information dissemination systems and procedures.
These systems have evolved from manual systems with gradual modifications, expansions, and
the development of parallel systems for specific purposes. The credit information systems
include:

(i) Private sector investment management (PSIM). This system produces a

report that is based on a manually prepared compilation of all projects under
administration. PSIM identifies project performance, credit rating, and operational
issues, as well as pertinent data on the structure of the portfolio. PSIM is
circulated quarterly to the Board for information.
(ii) Comprehensive loan administration servicing system (CLASS). This
computerized system records all board approvals, signed commitments,
disbursements, loan repayments, and divestments. It is maintained for the use of
the Controllers Department and PSOD. This system provides information for
PSIM. A CLASS report is compiled annually for internal use.
(iii) Private investment securities management system. This computerized
system records all ADB investments in funds, and the subinvestments made by
the various funds. The system is used for internal purposes by PSOD.
(iv) Private sector project processing report. This manual compilation of all
projects in the pipeline serves the purpose of reviewing project progress in a
monthly internal PSOD meeting.
(v) Private sector portfolio assessment report. This is a manual compilation of all
projects under administration with a risk rating of RR4 (marginal) or worse. It is
discussed quarterly in conjunction with PSIM in a meeting chaired by PSOD with
RMU, OCO, OGC, Treasury Department, and Central Operations Services Office
in attendance.
(vi) Project processing information system. This is an ADB-wide system of all
pipeline projects. Once a project is approved, its data is transferred into CLASS.
 Appendix 7 121

25. These information systems are typically manual. They have limited means of controlling
access, are slow in providing information, are prone to errors, and are not secure. The credit
information system needs to provide participants in the credit process with timely access to
accurate information on projects at various stages in the project cycle—exploration, Board
approval, signature, disbursement, completion, and closure. The information systems need to
be consolidated under one comprehensive online application. This facility should enable the
instantaneous and secure generation of various reports structured to reflect the specific decision
making needs of eligible recipients, such as the Board, Management, and staff.
 MANAGEMENT RESPONSE TO THE SPECIAL EVALUATION STUDY
ON PRIVATE SECTOR DEVELOPMENT AND OPERATIONS:
HARNESSING SYNERGIES WITH THE PUBLIC SECTOR

On 22 June 2007, the Director General, Operations Evaluation Department, received the
following response from the Managing Director General on behalf of Management:

I. General Comments

1. We welcome OED’s Special Evaluation Study (SES) on Private Sector

Development and Operations. The private sector indeed plays a vital role in
development as the engine of growth and poverty reduction, and the study
provides a solid analysis of the role of private sector in ADB’s operations.

2. We note the SES findings that ADB’s private sector development and
operations have been satisfactory overall. Having private and public sector
operations under one roof is a unique strength of ADB and this provides an
excellent basis for collaboration between private and public sector operations
with the aim to increase development effectiveness of ADB’s operations. We
agree with the suggestion that synergy between public and private sector
operations is the key to ADB’s success in promoting the private sector. We have
been taking several initiatives to foster synergies between various operations in
ADB such as the adoption of the new Country Partnership Strategy (CPS)
processes.

II. Comments on Specific Recommendations

3. Assessment of the Need for Changes in Organizational Structure.

We note the recommendations for changes of the organizational structure and
operational arrangements, including further strengthening of the Risk
Management Unit. As a matter of fact, some of them are under discussion, but
any further view on them will be taken up in the context of the ongoing review of
the Long-term Strategic Framework including the resource implications of these
changes.

4. Corporate Management Plan. We believe that an additional medium-

term corporate management plan will add little value since there is already a
well-established system for planning and budgeting in place. The long-term and
medium-term strategies set strategic and operational priorities. These strategies
are implemented with a country focus through CPS, operationalized and
resourced through the annual work program and budget framework. Private
sector operations are fully integrated in this planning process.

5. Country Business Plan. We agree with the suggestion that the CPS
and the Country Operations Business Plan should be the common business
basis for both the public and private sector operations at ADB. We note that the
new CPS processes were adopted in August 2006 to ensure smooth
coordination between the Private Sector Operations Department (PSOD) and
regional departments.

6. Medium-term Strategic Plan. We agree with the SES suggestion that a

medium-term strategic plan for private sector development and operational
activities needs to be developed. However, we note that such a strategic plan
has ADB-wide implications and therefore, should be jointly prepared through an
ADB-wide initiative rather than by PSOD alone. A separate strategic plan for
PSOD would not foster the envisaged synergies but rather emphasize a silo
structure within ADB.

7. Due Diligence Guidelines. We agree with the suggestion that

procedures need to be codified to ensure that private sector transactions comply
with integrity due diligence guidelines that form part of ADB’s Anticorruption
Policy Framework. Work is already ongoing on revising the Operations Manual
section on private sector operations, expanding its coverage to the processing of
non-sovereign operations.
 DEVELOPMENT EFFECTIVENESS COMMITTEE

Chair’s Summary of the Committee’s Discussion on 27 June 2007

Special Evaluation Study (SES) on Private Sector Development and Operations:

Harnessing Synergies with the Public Sector

1. The SES is the first of four related studies which provide a comprehensive assessment
of ADB’s private sector operations and its efforts to improve the business climate in DMCs.

2. The SES shows that PSOD’s portfolio is profitable and its quality is satisfactory. The
92% project success rate for PSOD projects substantially exceeds the 64% success rate for
public sector projects and the 80% standard that ADB uses as a benchmark defining
satisfactory performance. Overall, ADB’s Private Sector Development and Operations were
rated “satisfactory”. The rating was mainly due to a lack of synergy between the public and
private sector areas.

3. ADB is uniquely placed to provide the required combination of services because its
public and private sector operations are both under one roof, but the evaluation found that ADB
had not yet fully developed the synergies between the public and private sector parts of ADB,
which were not always working together as a team.

4. Despite strong growth in the size of PSOD’s portfolio, many DMCs complain that ADB is
not responding adequately to this demand. Responding to this demand however, requires
changes in (i) ADB’s organizational structure; (ii) the level and type of resources; and (iii) roles,
products and responsibilities. This type of change will not be easy, since ADB has struggled to
find ways of merging public and private sector operations for some time. It is a challenge to
introduce a private sector culture into an organization like ADB that is dominated by a public
sector culture.

5. In OED’s view, some organizational changes are needed to fully exploit the
public/private synergies. The SES only highlights this fact rather than providing any concrete
solutions at this stage. OED agrees with the Management’s response that organizational
changes need to be taken up in the context of the review of the Long Term Strategic Framework
(LTSF).

6. In sum, the two main findings of the report could be summarized as (i) the need for
closer and more structured public-private synergies and (ii) the need to include close
collaboration between public and private sectors in the CSP.

7. Director General, PSOD and Director, SPMS presented the Management’s Response
which agreed with the general findings and recommendations of the SES and raised a few
concerns on the specific recommendations.

8. DG, PSOD noted that the dramatic shift in the Asia Pacific region over the last four
decades, where it has changed from a capital deficient to a capital abundant region. In addition,
societies have realized that the private sector is more apt at providing goods and services and
that economic development needs to include private sector development. Thus private sector
assistance is becoming an increasingly important role of ADB and all the MDBs. The increasing
demand for private sector work from ADB’s DMCs requires an internal paradigm shift towards
private sector. However, current resource limitations constrain PSOD’s capability to deliver in
the face of an increasing portfolio. Director General, PSOD considered that a 92% success rate
is a very good result given PSOD’s constraints. While the PSOD is supportive of the report and
its overall thrust, the classification of the Department as “satisfactory” with a 92% rating was the
subject of intense discussion with OED. The explanation provided by OED that this was as a
result of circumstances outside of the PSOD’s control was not considered a satisfactory
explanation by PSOD.

9. While ADB’s competitive advantage is to have both public and private sector areas
under one roof, this was also a challenge, since many of ADB’s procedures are based around
public sector work. In comparing with other private sector focused organizations, it was noted
that, for example, IFC has broken away from the public sector area of the World Bank, and in
EBRD, the private sector prevails over any public sector interventions. Thus, in choosing a
strategy which includes Public-Private Partnerships (PPP) as ADB’s core product, PSOD has
adopted a more difficult but also more comprehensive strategy.

10. There is currently no reward structure in place to stimulate public sector cooperation with
the private sector area of ADB, since incentives are still focused on lending volume. While there
are successful examples of close collaboration between PSOD and Regional Departments,
such as in energy related projects, these occur thanks to positive working relationships between
staff rather than as a result of any existing structure promoting cooperation. PSOD strongly
advocated a reward structure that would facilitate closer cooperation.

11. DEC commented on the following key points, to which OED and the Management
responded.

12. Private Sector Development. DEC agreed that indigenous private sector development
(PSD) is essential, and the focus of private sector operations (PSO) should not be limited to
encouraging foreign direct investment (FDI). PSOD agreed with this perspective, while at the
same time noted that ADB should continue to be involved in promoting FDI in DMCs, as it can
provide a catalyst for investment.

13. Similarly, ADB should not only focus on privatization but should also support governance
issues in the corporitization process of state-owned enterprises (SOE). PSOD fully agrees
adding that the ADB can play an invaluable role in such privatizations by leveraging off the risk
management theme that underscored all PSOD operations. With respect to both SOEs and
private sector companies, PSOD reminded DEC that it only works with sound companies in
order to avoid undue financial risks.

14. DEC indicated that since the majority of DMCs agree with the importance of PSD, CPS
and CAPEs should devote a section to PSD, providing a framework for the public and private
sectors to work together effectively. Staff agreed to include PSD and PPPs in future reports.

15. A DEC member raised the issue of monitoring income generation resulting from PSOD
activities. PSOD noted that results of PSOD operations must be profitable in order to attract
others into transactions.

16. Resource Issues. DEC agreed that PSOD is both under-resourced and over-stretched.
To support PSOD’s requests for additional resources, it would be useful to illustrate the large
volume of project requests. For example, it would be useful for DEC to see figures on PSOD’s
activities broken down by country and by sector, and to know which projects are rejected and
why. PSOD agreed to provide the figures upon DEC’s request. PSOD clarified that only one in
every eight transactions is selected by PSOD, and that projects are rejected for reasons such as
the project is not financially viable, it has limited development impact, or it is in a sector that
PSOD has chosen not to work in. While not disagreeing, DG PSOD stated that he hesitated to

2
create more internal reports (unless so requested), favoring instead the evidence provided by
the very rapid growth of private sector operations.

17. Overall Institutional Framework. DEC agreed that any changes regarding private
sector operations should be addressed during the review of the LTSF. However, one DEC
member expressed disappointment that Management would like to consider any organizational
changes during the LTSF review. Director, SPPI reiterated that the LTSF was the appropriate
framework to consider the organizational issues raised in OED’s report.

18. A DEC member expressed concern over the satisfactory rating, and considered that
improvements were required, particularly with regard to development impact of PSOD’s
interventions and PPP interventions. He agreed with the need for a culture change within ADB
at the institutional and operational levels, but this change needs to be driven by Management.
He recommended that Management responds to the DEC on this issue.

19. A DEC member noted that, while this SES is the first of four reports and its conclusions
may only be preliminary, he would have like to read about how other organizations are doing
private sector work, what models are used by others, and if others were achieving better
outcomes, and if so, why. He agreed with the proposal for structural changes and revised
operational plans, but indicated that these were not enough, and changes in culture, incentives
and managing for results with maximum impact were required. He noted that resources and
accountabilities need to be addressed first in order to deliver on development outcomes. He
emphasized that Management could have been more proactive in its response to the report by
providing some indication of a future direction or vision.

20. PSOD indicated that ADB has a model that works well, and other organizations such as
AfDB and IADB would like to adopt the same model. As opposed to IFC and EBRD, ADB works
with financial institutions on the ground, which helps keep costs under control and at the same
time contributes to developing the financial sector in the country of intervention. DG PSOD
considered the strategy adopted by the other MDBs less effective. Evidence to support this
included the success enjoyed by PSOD, the low level of underperforming assets and the
benchmark studies of both OED and CTL showing PSOD far ahead of the other private sector
arms of other IFIs.

21. OED explained to DEC how IFC and IADB are set up in terms of public and private
sector departments: IFC is based on a commercial bank model using a scorecard tool and with
50% of its staff in the field, and IADB is based on a development bank model but with a newly
revised organizational structure.

22. A DEC member noted that other organizations such as IFC have large and well
resourced offices in client countries such as PRC and India, while ADB has only one staff in
each Resident Mission (RM). He noted that clients will not wait for ADB and will approach other
institutions which can meet their demand. If ADB agrees that it wants to service the demand for
private sector interventions, then resources need to be allocated to the RMs. The member also
noted that PSOD is not a member of the steering committee on the review of the LTSF and
found this inadequate if the synergy between public and private sector areas of ADB is to be
improved.

23. PSOD Portfolio. A DEC member indicated that given the demand for private sector
work, the one roof model ought to be attractive, and noted that the current PSOD portfolio
showed innovative elements with some good results. In his view, ADB is more successful in
delivering and completing projects than in terms of development impact.

3
24. Another DEC member raised the issue of the relationship between PSOD and the Office
of Cofinancing Operations (OCO). DG, PSOD indicated that given their current structures, OCO
was better positioned to focus on public sector work and PSOD should use its own syndicating
capabilities.

25. The issues on the acceptable level of risk with regard to the non-sovereign portion of
PSOD’s portfolio, the harmonization of safeguards with IFC, and counterpart risks and conflicts
of interest were also raised. A DEC member suggested that a balance scorecard for PSOD
could be a useful tool for measuring achievements in the future.

26. Another DEC member indicated that the limitations with regard to risk may need to be
reviewed to allow PSOD to enter into more projects. He also suggested that PSOD diversify into
other areas such as SMEs, agriculture and clean energy, and that PSOD consider regional
cooperation projects in future. DG, PSOD indicated that PSOD is already indirectly active in
these areas through its funds activities and is considering some of these other areas.

27. Finally, DEC Chair indicated that DEC generally endorsed the key findings and
recommendations of the SES. DEC would look forward to the completion of the other three
related evaluations by OED, in order for DEC to have a comprehensive assessment of ADB’s
private sector operations.