Performance Evaluation Report

Operations Evaluation Department

Project Number: 30375 Loan Number: 1504-UZB December 2006

Uzbekistan: Rural Enterprise Development Project

CURRENCY EQUIVALENTS Currency Unit – sum (SUM)

At Appraisal At Project Completion At Operations Evaluation (Sep 1996) (Feb 2003) (Jul 2006) SUM1.00 = $0.0250 $0.0010 $0.0008 $1.00 = SUM40 SUM963 SUM1,226

ABBREVIATIONS

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

Key Words uzbekistan, rural development, small medium-sized enterprises, agroprocessing, evaluation, central asian, credit lines, transition economies

Director General : B. Murray, Operations Evaluation Department (OED) Director : R. B. Adhikari, Operations Evaluation Division 2, OED Team Leader : T. Ito, Evaluation Specialist, Operations Evaluation Division 2, OED Team Members : V. Ramos, Evaluation Officer, Operations Evaluation Division 2, OED R. Perez, Senior Operations Evaluation Assistant, Operations Evaluation Division 2, OED

Operations Evaluation Department, PE-694

ADB – Asian Development Bank BCBS – Basel Committee of Banking Supervision BME – benefit monitoring and evaluation

DSCR – debt service coverage ratio EBRD – European Bank for Reconstruction and Development EIRR – economic internal rate of return

EPAS – Entermod project appraisal system

FIL – financial intermediation loan

FIRR – financial internal rate of return FX – foreign exchange GDP – gross domestic product HQ – headquarters IMF – International Monetary Fund J/V – joint venture LIBOR – London interbank offered rate MOF – Ministry of Finance NBU – National Bank for Foreign Economic Activity of the Republic of Uzbekistan OECD – Organisation for Economic Co-operation and Development OED – Operations Evaluation Department OEM – Operations Evaluation Mission PCR – project completion review PIU – project implementation unit PPER – project performance evaluation report REDP – Rural Enterprise Development Project

ROE – return on equity RRP – report and recommendation of the President SMEs – small and medium-sized enterprises SMEDP – SME Development Project TA – technical assistance TCR – technical assistance completion report

CONTENTS

Page

BASIC DATA iii EXECUTIVE SUMMARY iv MAP vii I. INTRODUCTION 1

A. Evaluation Purpose and Process 1 B. Expected Results of the Project 2 C. Evaluation Methodology and Limitation 2

II. DESIGN AND IMPLEMENTATION 4

A. Formulation 4 B. Rationale 5 C. Cost, Financing, and Executing Arrangement 6 D. Procurement and Scheduling 7 E. Design Change 7 F. Outputs 8 G. Loan Covenants 12

III. PERFORMANCE ASSESSMENT 13

A. Overall Assessment 13 B. Relevance 14 C. Effectiveness 14 D. Efficiency 15 E. Sustainability 16

IV. OTHER ASSESSMENT 18

A. Impact 18 B. Asian Development Bank Performance 19 C. Executing Agency Performance 20 D. Technical Assistance 20

V. ISSUES, LESSON, AND FOLLOW-UP ACTIONS 21

A. Issues 21 B. Lessons 23

C. Follow-Up Actions 25

ii APPENDIXES 1. Project Framework 262. Subloan Characteristics 273. Overview of Subloans 284. Subproject Profiles 305. Assessment of the National Bank for Foreign Economic Activity of the Republic of Uzbekistan

43

6. Evaluation of TA 2714-UZB: Institutional Strengthening of the National Bank of Uzbekistan

53

Attachment: Management Response

The guidelines formally adopted by the Operations Evaluation Department on avoiding conflict of interest in its independent evaluations were observed in the preparation of this report. The fieldwork was undertaken by Debra Boyer (banking expert/international consultant); Mirzaulugbek Anvarov (SME credit specialist/domestic consultant); Maruf Olimov (research assistant); and Rustam Abdurakhmanov (research assistant/translator) under the guidance of the mission leader. To the knowledge of the management of the Operations Evaluation Department, there were no conflicts of interest of the persons preparing, reviewing, or approving this report.

BASIC DATA

Loan 1504-UZB: Rural Enterprise Development Project Project Preparation/Institution Building TA No.

TA Project Name Type Person- Months

Amount1 ($)

Approval Date

2624 Rural Enterprise Development PPTA — 100,000 2 Aug 1996 2714 Institutional Strengthening of National

Bank of Uzbekistan ADTA 25 830,000 17 Dec 1996

As per ADB Key Project Data ($ million): Loan Documents Actual Total Project Cost 87.0 — Foreign Currency Cost 57.0 — Bank Loan Amount/Utilization 50.0 45.6 Bank Loan Amount/Cancellation 4.4 Key Dates: Expected Actual Fact-Finding

Jun/Jul 1996

Appraisal 10-30 Sep 1996 Loan Negotiations 18-20 Nov 1996 Board Approval 17 Dec 1996 Loan Agreement 7 May 1997 Loan Effectiveness 13 Jun 1997 13 Jun 1997 First Disbursement 2 Apr 1998 Loan Closing 13 Jun 2002 13 Jun 2002 Months (effectiveness to loan closing) 60 60 Borrower: Republic of Uzbekistan Executing Agency: National Bank for Foreign Economic Activity of the Republic of

Uzbekistan Mission Data: Type of Mission No. of Missions Person-Days

Fact-Finding 1 85 Appraisal 1 136 Project Administration - Inception 1 4 - Review 5 61 - Project Completion 1 24 - Operations Evaluation 1 73

— = not available, ADB = Asian Development Bank, ADTA = advisory technical assistance, PPTA = project preparatory technical assistance, TA = technical assistance. 1 Represents approved amount of technical assistance.

EXECUTIVE SUMMARY

On 17 December 1996, the Asian Development Bank (ADB) approved the Rural Enterprise Development Project (REDP) to Uzbekistan, for $50 million, from its ordinary capital resources, with the National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) as the Executing Agency. This was the first loan from ADB to Uzbekistan, which joined ADB in 1995. The purposes of the REDP were to (i) rehabilitate and modernize small and medium-sized enterprises (SMEs) in agroprocessing to increase exports, and (ii) provide collectives and family farms with new micro-processing facilities to increase rural income. In conjunction with the REDP, ADB approved an advisory technical assistance (TA) grant for the Institutional Strengthening of NBU for $830,000.

Of the committed $50.0 million, ADB disbursed $45.6 million to finance 28 subloans by the loan closing date of 13 June 2002; 6, totaling $23.7 million, were above the free limit of $3.0 million. Six subloans, amounting to $16.6 million, supported subprojects for production of tomato puree, and fruit juice and concentrate. Two beer production units accounted for $8.3 million in subloans. Another $6 million for seven subloans supported production of biscuits, waffles, and pasta. Other subloans financed dairy production, wool processing, meat processing, vegetable and fruit freezing, and production of mineral water and edible oil. Eighteen subloans, amounting to $31.3 million, financed startup companies, and the rest financed modernization of existing undertakings. Twenty subloans for $24.2 million supported wholly Uzbek-owned SMEs. The remaining subloans supported joint-venture SMEs. Seven subloans ($21.1 million) supported export-oriented projects, and the remaining subloans supported import substitution projects. Of the total 28 subloans, 13 for $10.1 million were fully repaid; 6 subloans for $20.7 million were rescheduled and are being repaid, with outstanding balance of $9.7 million (including arrears of $0.26 million for 3 subloans); and the remaining 9 subloans for $14.8 million are currently frozen, with the outstanding balance of $11.2 million in arrears for its full amount. In total, $11.5 million (25.2% of the total disbursements) are in arrears. Of the nine frozen subloans, four amounting to $6.6 million have been sold (or are being sold) to new investors. NBU is trying to identify investors to take over the remaining five subprojects. The three key factors for the underperforming subprojects were (i) disputes between Uzbek and foreign sponsors of joint ventures, (ii) unstable and inadequate supply of raw materials, and (iii) inadequate working capital. The devaluation of the sum from 1998 to 2003 adversely affected the 21 import substitution subprojects in different degrees. The REDP is rated irrelevant, because of (i) inadequate at-entry assessments of the financial sector, and NBU’s performance and capacity; (ii) the inappropriate choice of investment modality although options available were limited at appraisal to fulfill the project purpose; (iii) inadequate financial covenants and the scope of the associated TA; (iv) inadequate foreign exchange risk analysis and risk-mitigating measures; and (v) ADB’s inadequate policy dialogue with the Government on financial sector reforms. Given the difficulties associated with operating in the financial sector in a transition economy, there was a high degree of risk associated with such loans. ADB failed to adequately recognize and mitigate these risks. This loan was a poor choice for ADB’s first loan to Uzbekistan despite it being clearly identified as a Government priority. The REDP is rated less effective based on the underperformance of 12 out of 28 subprojects, 25.2% of the loan, led to less-than-expected outcomes. A subproject success rate of 57% is disappointing. The Operations Evaluation Mission (OEM) findings can be summarized as follows: (i) NBU stopped using the benefit monitoring and evaluation (BME) system created

v

under TA 2714-UZB at project completion, limiting the evaluation of the REDP’s overall contributions; (ii) of the eight operational subprojects that the OEM visited, three are export-oriented, and their total export revenues in 2005 amounted to $9.3 million; (iii) the eight operational subprojects helped create over 440 full-time and 150 part-time jobs; (iv) SME loans approved by NBU constantly increased, from SUM49.6 billion in 2001 to SUM105.8 billion in 2004; and (v) NBU has strengthened its credit policies and procedures under TA 2714-UZB, but weaknesses remain in portfolio management and a management information system. The REDP is rated less efficient because of its (i) less-than-satisfactory subloan repayment performance, with arrears amounting to $11.5 million, 25.2% of the loan; (ii) discernible contributions to improvement of NBU’s SME credit allocation but marginal improvement of the overall operational efficiency; and (iii) limited subproject contributions to productivity gains and organizational innovations. The OEM also noted that NBU’s SME portfolio improved during the REDP. This achievement attributed, in part, to the NBU’s improved SME credit policies pursued in conjunction with REDP implementation complemented by TA 2714-UZB. If there had been no evidence of improvement, the OEM would have rated the REDP inefficient. The REDP is rated less likely to be sustainable. The relevant OEM findings can be summarized as follows: (i) of the eight operational subprojects that the OEM visited, five used 90% of their production capacity or more, and the rest 40–60%; (ii) NBU provided updated financial information on seven performing subprojects, of which five achieved return on equity of at least 15% and a financial internal rate of return of at least 20%; (iii) a possible change in preferential treatment given to SMEs and joint ventures is a risk for all the operational subprojects; (iv) NBU classified nearly 60% of its loan portfolio as substandard, doubtful, or loss as at end 2004, and its loan-loss provisioning may not be adequate; and (v) NBU relied on credit lines from foreign sources to finance SME loans, while its deposit mobilization remained weak. The REDP’s impact was not evident in building domestic capacity to promote term financing. TA 2714-UZB is rated partly relevant considering its (i) weak at-entry assessment, (ii) inappropriate purpose setting, and (iii) inadequate scope and duration. The TA is rated less effective despite the largely satisfactory implementation of the consultants’ recommendations on credit policy because of (i) the limited use of the project appraisal and the BME systems, and (ii) the subsequent resignation of all project implementation unit staff and most training seminars participants. The TA is rated less efficient considering that (i) NBU did not fully capitalize on its benefits, and (ii) NBU no longer uses the BME system developed under the TA. The TA is rated less likely sustainable as current levels of problem loans and domestic resource mobilization question the viability of NBU’s operations. On the basis of the above, the overall rating of the REDP is partly successful bordering on unsuccessful, and as is that of TA 2714-UZB. The report identified the following key lessons:

(i) It is important to fully understand the country and sector context and the capabilities of government officials for project decision making and implementation at the time of project processing and approval. There were issues such as (a) difficulty in accessing information for project processing, (b) slower-than-expected decision making by the Government, and (c) a less-than-desired level of donor feedback. ADB did not consider these issues sufficiently.

vi

The risks associated with the REDP were high as it was ADB’s first project in the country. ADB ignored them and fast-tracked the loan processing.

(ii) A detailed institutional analysis of financial intermediary and effective policy dialogue with the Government are essential in designing financial intermediation loans (FILs) in transitional economies. During appraisal, ADB should have assessed more vigorously the magnitude of NBU’s nonbanking activities and the Government’s influence over NBU’s credit allocation and their implications for portfolio performance. Such assessment should be requisite to ADB’s FILs to a financial intermediary controlled by governments, especially in transitional economies. Policy dialogue should be maintained throughout project implementation since OEM believes that weaknesses in the financial sector policy are significant risk factors in transition economies.

(iii) It is useful to include risk management in loan covenants for FILs. ADB should identify financial covenants that complement the intermediary’s credit and risk management and the country’s prudential guidelines. ADB should have included a financial covenant that could address and complement NBU’s inadequate loan-loss provisioning for state-guaranteed loans.

(iv) ADB should have been more aware of the general weakness in SME corporate and financial sector governance as well as the significant overvaluation of the currency at the time of project entry. These issues were typically found in countries during the early stages of transition from a centrally planned to a market economy. These significant risks should have raised serious questions about proceeding with the project.

(v) The project experience underscores the need for ADB to consider an alternative approach in creating a functional monitoring framework for FILs that balances increased administrative costs with the need for, and use of, the data collected. In the case of the REDP, the project agreement stipulated that “NBU shall assist ADB to monitor and evaluate the long-term benefits of a random sample of five qualified projects.” However, ADB did not select such sample subprojects during implementation. ADB should have dealt more vigorously with the BME loan covenant.

No specific follow-up actions were identified for the Borrower and for ADB. Bruce Murray Director General Operations Evaluation Department

Aral Sea

Am

udarya R.

Syrdarya R.

Gazli

Muynak

NukusKhodzheyli

Urgench Turtkul

SukhJordan

TASHKENTChirchik

Gulistan

Djizzak

Samarkand

Navoi

Bukhara

OklyaKarshi

Denau

Termez

Uchkuduk

Zarafshan

Namangan

Kokand

Andijan

Fergana

Kungrad

Angren

Vozrozdeniya Island

NAVOI

SAMARKAND

DJIZZAK

KARAKALPAKSTAN

NAMANGAN

ANDIJAN

FERGANA

TASHKENT

SYRDARYA

SURKHANDARYA

KASHKADARYA

BUKHARA

KHOREZM

T U R K M E N I S T A N

AFGHANISTAN

TAJIKISTAN

KYRGYZREPUBLIC

KAZAKHSTAN

KAZAKHSTAN

Project Area

National Capital

Provincial Capital

City/Town

Main Road

Railway

River

Provincial Boundary

International Boundary

Boundaries are not necessarily authoritative.

UZBEKISTAN

RURAL ENTERPRISE DEVELOPMENT PROJECT(as implemented)

0 50 100 150

Kilometers

N

06

-41

90

HR

69 00'Eo

69 00'Eo60 00'Eo

60 00'Eo

39 00'No 39 00'No

45 00'No45 00'No

I. INTRODUCTION

A. Evaluation Purpose and Process

1. On 17 December 1996, the Asian Development Bank (ADB) approved the Rural Enterprise Development Project (REDP),1 for $50 million, from its ordinary capital resources, with the National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) as the Executing Agency. This was the first loan to Uzbekistan, which joined ADB in 1995, and its processing was fast tracked within ADB. In conjunction with the REDP, ADB approved an advisory technical assistance (TA) grant2 for the Institutional Strengthening of NBU for $830,000. ADB's Operations Evaluation Department (OED) selected the REDP as part of the annual sample of completed projects for performance evaluation because of concerns about its rating in the project completion report (PCR)3. This project performance evaluation report (PPER) was prepared by the Operations Evaluation Mission (OEM) that visited Uzbekistan on 2 to 18 July 2006. 4 The evaluation draws upon a review of REDP documents and other studies, and discussions between OEM members and representatives of NBU, selected subborrowers, the Ministry of Finance, development partners, and other stakeholders. It also incorporates the results of the OEM’s field inspections of selected subprojects. The draft PPER was shared with NBU and ADB’s concerned departments and offices, and their views have been incorporated where appropriate. 2. The PCR rated the REDP as successful. The PCR rated the REDP relevant since its objectives were consistent with ADB’s interim country strategy and Uzbekistan’s development priorities. The PCR rated the REDP efficacious because (i) more than 90% of the loan was used for 28 subprojects, most of them financially viable; (ii) it created 847 jobs (38% of them for women) directly and 7,167 jobs indirectly; and (iii) it generated exports of $1.6 million in the first 3 years of operations. The PCR rated the REDP efficient as (i) 23 of the 28 subprojects had financial internal rates of return (FIRR) that compared favorably with their weighted average cost of capital, and (ii) 78% of the subloan amount due for collection was being serviced on schedule. The PCR rated it sustainable considering the (i) continued demand for credit from agroprocessing industries; (ii) satisfactory recovery of subloans, enabling NBU to recycle funds for new ventures; (iii) upgraded NBU’s capacity in project financing; and (iv) satisfactory financial conditions of NBU in terms of solvency and liquidity. The PCR recommended that OED evaluate the REDP’s performance in 2005. 3. The PCR was subjected to in-depth review by OED.5 Despite the several rounds of discussions and revisions made to the draft PCR, OED was not able to validate the overall rating of the PCR, pointing to its inadequate information and analysis. The key issues highlighted in OED’s final comments included (i) 13 of 28 subborrowers (46%) were in arrears despite liberal grace periods;6 and (ii) there was little discussion on project processing, and no

1 ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and

Technical Assistance to the Republic of Uzbekistan for the Rural Enterprise Development Project. Manila (Loan 1504-UZB, for $50 million, approved on 17 December).

2 ADB. 1996. Technical Assistance to the Republic of Uzbekistan for Institutional Strengthening of National Bank of Uzbekistan. Manila (TA 2714-UZB, for $830,000, approved on 17 December).

3 ADB. 2003. Project Completion Report on Rural Enterprise Development Project in Uzbekistan. Manila; ADB. 2003. Country Assistance Program Evaluation for Uzbekistan. Manila (OED, para. 84, footnote, 53).

4 The OEM also visited the European Bank for Reconstruction and Development (EBRD) in London on 29 and 30 June 2006 to discuss EBRD’s evaluation findings on its Small and Medium Enterprises (SME) Credit Line I and II in Uzbekistan (para. 16). EBRD fully cooperated with the OEM.

5 OED did not review the terms of reference for the PCR mission. 6 REDP arrears were 21.8% of the amount due and 11.6% of the total disbursement at the time of PCR.

2

reference to the project preparatory TA in the PCR. The OEM aimed to fill gaps in the PCR’s assessment of the subprojects’ success/failure. 4. The TA completion report (TCR) rated TA 2714-UZB successful based on the following. First, the TA was relevant in view of NBU’s limited experience in the (i) appraisal of agroprocessing small and medium-sized enterprises (SMEs), and (ii) benefit monitoring and evaluation (BME) of such projects. Second, the TA was implemented effectively and efficiently, and resulted in (i) the creation within NBU of a competent core of officers to rigorously and efficiently evaluate investment projects under donor credit lines, (ii) the expeditious use of funds under the REDP, and (iii) the satisfactory performance of most subprojects under the REDP. Third, this TA outcome was likely to be sustained. The TCR succinctly assessed the TA outputs and consultants’ service delivery. However, the OEM sought to fill gaps in the TCR’s assessment of the TA outcome and sustainability. B. Expected Results of the Project

5. The REDP’s sector goal was to support agroprocessing development, including access to new export markets and mitigation of rural unemployment. The REDP’s purposes were to (i) rehabilitate and modernize agroprocessing SMEs to increase exports, and (ii) provide collectives and family farms with new micro-processing facilities to increase rural income. Subborrowers were prioritized as follows: (i) export-oriented medium-scale enterprises focusing on rehabilitating and modernizing processing and packaging, and (ii) small-scale import substitution projects. 6. The purposes of TA 2714-UZB were to (i) strengthen the capacity of branch offices to screen credit proposals from clients and to help clients improve subproject design and formulate business plans that match sound criteria, including requirements for equity and collateral; (ii) strengthen credit-processing procedures between branches and headquarters to reduce delays and dropout rates; and (iii) implement systems for subproject BME.7 C. Evaluation Methodology and Limitation

7. The OEM assessed the REDP based on (i) NBU’s answers to the questionnaire; (ii) interviews with NBU management and operational staff at headquarters and four branches (in Djizzak, Samarkand, Navoi, and Bukhara); (iii) site visits (with interviews) to 12 subprojects8 (5 in Tashkent, 1 in Djizzak, 3 in Samarkand, 1 in Navoi, and 1 in Bukhara (see Map, page vii) and

7 The project agreement stipulated that “NBU shall monitor the financial and economic performance, and

socioeconomic and environmental benefits of Qualified Projects. NBU shall assist ADB to monitor and evaluate the long-term benefits of a random sample of five Qualified Projects.”

8 The OEM initially requested NBU to arrange OEM visits to all 10 subprojects in Djizzak, Samarkand, Navoi, and Bukhara. However, NBU could not arrange visits to three subprojects (one each in Djiakh, Samarkand, and Bukhara). These three subborrowers fully repaid on schedule and had no loan outstanding with NBU. The OEM requested NBU to arrange OEM visits to seven subprojects in Tashkent. Of the seven subborrowers, five were interviewed by the OEM. The remaining two subborrowers fully repaid on schedule, and had no loan outstanding with NBU.

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a site visit (without interview) to 1 subproject 9 in Samarkand; 10 (iv) interviews with representatives of several other institutions; and (v) publicly available information. 8. Following the Guidelines for Preparation of PPERs of Public Sector Operations,11 this report evaluates the REDP based on the following criteria and subcriteria. (i) Relevance

(a) Adequacy of the assessment of issues and opportunities at the time of project approval

(b) Consistency of the targeted impact, outcome, and outputs of the REDP with the Government’s development strategy, ADB’s strategy and program for the country, and ADB’s strategic objectives

(c) Appropriateness of modality of ADB’s assistance, project design and scope, and implementation arrangement

(d) Appropriateness of selection of NBU as Executing Agency, and the financial covenants

(ii) Effectiveness

(a) The REDP’s contributions to the increase in production and revenue of SMEs, collectives, and family farms

(b) Subprojects’ contributions to promotion of exports and import substitution (c) Subprojects’ contributions to job creation in rural areas (d) The REDP’s contributions to the development of NBU’s SME lending

operations

(iii) Efficiency (a) Subloans’ repayment performance (b) The REDP’s contributions to the improvement in credit allocation and

operational efficiency of NBU (c) Subprojects’ contributions to productivity gains and innovations,

measured by the degree of protection in the domestic market, export performance, product differentiation, and other relevant data

(iv) Sustainability

(a) Conditions and use ratio of facilities funded under the REDP (b) Financial viability of subborrowers in view of profitability, liquidity, and

availability of funding for proper operation and maintenance (c) Appropriateness of policy and regulatory environment for subborrowers to

maintain proper operations (d) Environmental, social, technological, and natural resource risks of

subprojects (e) Financial viability of NBU and its SME lending

9 This subproject has suspended its operations because of the dispute between the Uzbek and foreign sponsors; the

subloan has been frozen, with arrears of $1.7 million (against the subloan amount of $2.5 million). The OEM prepared this subproject’s profile based on the information from NBU.

10 The 12 subprojects that the OEM visited represented 68.3% of the total disbursement under the REDP. Of the 12 subloans, 2 were repaid on time, 1 was rescheduled and repaid, 5 were rescheduled and are being repaid, and the remaining 4 are frozen. The total arrears of the 4 frozen subloans and 2 other subloans (that were rescheduled and being repaid) amounted to $5.0 million and $0.2 million (para. 29).

11 ADB 2006. Guidelines for Preparation of PPERs of Public Sector Operations. Manila.

4

9. The targets indicated in the REDP’s project framework (Appendix 1) were not specific,12 and the framework provided no relevant baseline data and thus was not fully useful for monitoring and evaluation. NBU created a BME system supported under TA 2714-UZB. Specific areas to be monitored under this system included (i) financial and operational performance of subprojects; (ii) direct job creation and impact on the poor, women, and other vulnerable groups; and (iii) indirect job creation. ADB was to use the BME system to monitor and evaluate the long-term benefits of a random sample of five subprojects (footnote 7). However, ADB did not select a sample of subprojects, and NBU stopped using this system at REDP completion. This prevented the OEM from updating the operational performance and development impacts of many subprojects and constrained evaluation. 10. To facilitate REDP implementation, NBU set up a project implementation unit (PIU) in its SME Unit under the Credit Department. However, all the PIU staff and most of the participants of the training seminars held under TA 2714-UZB have resigned. In addition to NBU loosing the benefit of this training, the fact that the trainees could not be contacted constrained the evaluation of the TA.

II. DESIGN AND IMPLEMENTATION

A. Formulation

11. During his visit to Manila in March 1996, the deputy prime minister proposed that ADB consider a line of credit to NBU to support agro-industry.13 The Government followed up this proposal with the head of concerned Programs Department during the annual meeting of the European Bank for Reconstruction and Development (EBRD) in April 1996 and in a letter dated 2 May 2006. In response, ADB fielded a reconnaissance mission in June–July 1996. ADB approved the project preparatory TA14 grant to (i) identify the demand for the proposed loan; and (ii) assess the institutional capacity, lending policies, and management practices of NBU. ADB fielded an appraisal mission in September 1996 and completed the loan negotiation in November 1996. On 17 December 1996, ADB approved the REDP and TA 2714-UZB. The REDP became effective on 13 June 1997 and the TA consultants were fielded on July 1997, as per the original plan. 12. In response to the Government’s request, ADB fast-tracked the REDP processing (6 months after the reconnaissance mission) with only two processing missions. Justification of this fast-track treatment is questionable given that the REDP was ADB’s first loan to Uzbekistan and the challenges faced in financial sectors of other transition countries at the early stage of the market reform process. The OEM could not fully assess the adequacy of ADB’s at-entry assessment as the consultant report of the project preparatory TA is not in the ADB’s records section. However, it is noted that the back-to-office report of the appraisal mission indicated three important matters: (i) difficulty in accessing information needed to process a project (i.e., financial and corporate sector data, and macroeconomic indicators); (ii) slower-than-expected

12 The targets (corresponding to the project purposes) in the project framework were to (i) arrest further deterioration

of production facilities, (ii) sustain demand for agriculture outputs and jobs, (iii) improve efficiency (by 25%) and product standards in medium-scale enterprises with export potential, (iv) modernize small enterprises to provide better products for the local market, and (v) increase the share of exports paid for in hard currency.

13 During the preparation of the Uzbekistan Country Assistance Program Evaluation, the Government confirmed that this line of credit was the Government’s top priority.

14 ADB. 1996. Technical Assistance to the Republic of Uzbekistan for the Rural Enterprise Development. Manila (TA 2624-UZB, for $100,000, approved on 2 August).

5

decision-making by the Government; and (iii) a less-than-desired level of feedback from EBRD on the progress of its first credit line.15 13. The OEM believed ADB Management had not considered seriously these matters and the potential risks associated with a line of credit during the early stage of ADB’s operations in transition economies. By the mid-1990s, it became clear that financial operations in such countries involved significant risks. 16 Under the centrally planned system, credit was not allocated based on market signals, interest rates were not market based, the legal and regulatory systems provided limited protection for financial institutions, and credit risk management procedures were underdeveloped. The foreign exchange (FX) risks associated with the significant devaluation of all the new currencies introduced following the breakup of the former Soviet Union and the possibilities of very high inflation also became evident.17 ADB should have been more sensitive to the risks related to this type of operation. Given these risks, a line of credit was a poor choice to fast-track as ADB’s first loan to Uzbekistan. B. Rationale

14. In conjunction with the introduction of the sum in July 1994, the Government introduced a comprehensive stabilization and economic reform program.18 The key development goals set under the 1996 economic program 19 were to consolidate the gains made in economic stabilization, lay the foundation for economic recovery, and improve living standards by accelerating market-oriented economic reforms. As part of the program, the Government targeted export diversification and job creation in rural areas. To attain these targets, the Government aimed to reactivate agroprocessing by increasing the flow of credit to rural enterprises, which faced severe financial constraints. 15. In October 1996, ADB formulated an interim operational strategy designed to assist the Government in its transition to a market economy by (i) supporting policy reforms, capacity building, and institutional strengthening; and (ii) financing sector investments that would support growth, improve efficiency, and rehabilitate deteriorating infrastructure. In the interim strategy, ADB identified agriculture (including financial support for rural SMEs) as one of three priority sectors.20 15 The first two issues were highlighted in the note to file attached to the back-to-office report dated 9 October, and

the third issue in the main text of the report. 16 For instance, the PCR on the Financial Sector Program to the Lao People’s Democratic Republic (issued in

December 1994) noted “the introduction of market-based reforms in the transitional economies should recognize that the effects of new measures such as allocation of resources by prices are subject to high risks and uncertainties because of the lack of experience.” The RRP on the Financial Sector Program to Mongolia (approved in November 1996) noted that “like other centrally planned economies, Mongolia inherited a Soviet-style monobanking system in which all banking business was conducted by the State Bank of Mongolia. The monobank acted as a cashier to the Government and allocated financial resources to (inefficient) industries according to Government directions within the framework of a credit plan… The financial system was not designed to respond to price signals and interest rates were administered.”

17 The RRP on the Special Assistance Projects to Kazakhstan and the Kyrgyz Republic, both approved in November 1994, as the first ADB projects in those countries, illustrated the macroeconomic instability faced by these countries at the time of appraisal.

18 This program was supported by the first drawing under the International Monetary Fund’s (IMF) Systemic Transformation Facility (STF) and a rehabilitation loan from the Word Bank. As a result, inflation, as measured by the 12-month change in consumer price index, was sharply reduced from 1,281% in 1994 to 117% in 1995.

19 The program was supported by a second drawing under the STF and by a standby arrangement of the IMF. During late 1995 and early 1996, the Government (i) reduced the number of export commodities subject to bans and taxes, (ii) lowered the maximum and average import tariffs, and (iii) increased access to foreign exchange.

20 The other two sectors included (i) infrastructure rehabilitation, especially railways and roads; and (ii) education.

6

16. EBRD approved SME Credit Line I to NBU, for $60 million, in October 1993 for onlending to SMEs. In November 1996, EBRD expanded this credit line, as Credit Line II, to provide term loans to NBU ($60 million), Asaka Bank ($30 million), and other eligible participating banks ($30 million). The World Bank approved the Rural Enterprise Support Project in December 2001.21 17. The report and recommendation of the President (RRP) stated: “With EBRD assistance, NBU headquarters (HQ) has established satisfactory subproject appraisal and credit approval procedures. This assistance is expected to be completed by the end of 1996. At present, however, NBU’s loan portfolio to the non-State sector is very young, and its branch offices lack experience and skills in dealing with loan applications with non-State subborrowers.” This experience with EBRD provided the rationale for the REDP and justified the design of TA 2714-UZB, which targeted NBU branch operations. However, NBU headquarters’ capacity to appraise projects at the time of REDP approval proved to be weak, partly because lending procedures under the EBRD’s first credit line were confined to assigned credit staff and not integrated into overall credit operations. C. Cost, Financing, and Executing Arrangement

18. ADB entered into a loan agreement with the Ministry of Finance and a project agreement with NBU.22 The borrower re-lent the ADB loan to NBU under a subsidiary loan agreement.23 NBU onlent to eligible subborrowers under subloan agreements. 24 Under the REDP, NBU financed up to 100% of the direct and indirect FX costs of subprojects. The amount of each subloan was not to exceed $5 million.25 The loan agreement did not specify a currency for subloans, while it stipulated that “the FX risk in respect of subloans shall be borne by the qualified enterprises.” Because the currency devalued from SUM40 to $1 in September 1996 to around SUM1,200 in July 2006, this turned out to be a very significant risk. Given the early stage of Uzbekistan’s transition to a market economy and the legacy of central planning, it was not reasonable to expect the subborrowers and perhaps even NBU to fully appreciate this risk. ADB should have done a better job explaining this risk, based on its experience in Mongolia and the Central Asian republics. 19. The REDP subborrowers were to be non-state SMEs. The loan agreement stipulated that non-state enterprises would include private enterprises, collective enterprises, joint ventures (J/Vs) with foreign partners, and joint-stock companies with the state shareholding

21 The project’s original closing date was 31 July 2006. The World Bank said that implementation of this project has

been significantly delayed by slow progress in envisaged reforms to eliminate state control over cotton production and distribution.

22 The terms of the ADB loan included the interest rate set in accordance with the pool-based variable lending rate for dollar loans, the commitment charge of 0.75% per annum, and a repayment period of 15 years, including a grace period of 3 years. The relending terms for NBU were identical to those of ADB loan to the borrower.

23 Under the REDP, the financial requirements for NBU included (i) a debt–equity ratio of a maximum of 12:1; (ii) a ratio of equity to risk adjusted assets of at least 8%; (iii) provisions for loan losses and write-off for bad debts in accordance with international standards; (iv) a minimum debt service coverage ratio of not less than 1.25; (v) maximum exposure to a single borrower, or to a group of related borrowers, of not exceeding 15% of its capital and reserves; and (iv) adoption of international accounting standards.

24 The onlending interest rates charged by NBU were to be based on market rates in Uzbekistan. Subloans were to be repayable up to 8 years, including a grace period not exceeding 3 years. Each subloan was to be secured by collateral valued at a minimum of 120% of the subloan amount.

25 Except for the first four subloans, there would be a free limit of $2 million. The first four subloans, irrespective of their amount as well as all subsequent subloans greater than $2 million, would be subject to prior approval by ADB. Subloans for subprojects that would not generate FX earnings would also be subject to prior approval of ADB even if their amount was below $2 million. Overall, the REDP was to finance 25–50 subprojects.

7

being less than 50%. Neither the RRP nor the loan/project agreement defined the SMEs. The selection criteria for qualified enterprises and subprojects included the following: (i) subborrower’s capacity to contribute a minimum 25% of subproject cost in equity; (ii) a projected economic internal rate of return (EIRR) of at least 12% (later, replaced by return on equity of at least 12%); (iii) a projected FIRR in excess of the subproject’s weighted average cost of capital; (iv) a projected debt service coverage ratio (DSCR) of at least 1.5 times at the time the subproject attained normal production capacity; and (v) compliance with the requirements of all applicable environmental laws and regulations in force in Uzbekistan. The project agreement also stipulated that priority was to be given to projects that would generate FX earnings. However, the project agreement did not define export-promotion projects (vis-à-vis import substitution projects) in terms of proportion of the export earnings. The RRP estimated the total cost of REDP subprojects at under $87 million, of which $57 million was the FX cost. Apart from this estimate, the RRP indicated 108 potential subprojects estimated to cost a total of $270 million. 20. The key financial requirements for NBU stipulated in the project agreement included (i) a debt–equity ratio at maximum 12:1; (ii) a risk-weighted capital adequacy ratio of at least 8%; (iii) adequate loan-loss provisioning and write-offs for bad debts in accordance with international standards; (iv) a DSCR of not less than 1.25 after tax; (v) loans to a single borrower, or to a group of related borrowers, not exceeding 15% of NBU’s capital and reserves; (vi) not more than 20% of NBU’s total portfolio being accounted for by any one sector; and (vii) full application of international accounting standards. D. Procurement and Scheduling

21. ADB’s Procurement Guidelines (2006) applicable to loans to development finance institutions were to be followed, which required subborrowers to (i) demonstrate that their procurement procedures were appropriate; (ii) ensure that the goods and services to be financed by subloans were purchased at a reasonable price, while accounting for other factors such as time of delivery, efficiency, and reliability and suitability of the goods, the availability of maintenance facilities and spare parts, and, in the case of services, the quality and the competence of the parties rendering them; and (iii) ensure that all goods and services financed under the loan were procured from ADB member countries. The OEM did not discern any major deviations in procurement under the REDP from the Procurement Guidelines. 22. The ADB loan for the REDP had a commitment period of 3 years and disbursement period of 5 years. The closing date for submission of subloan applications for approval and authorization for withdrawal was 3 years after the date of loan effectiveness. The project implementation unit oversaw the preparation and appraisal of all subloans and monitored subsequent implementation and supervision. NBU had almost fully committed to the total loan amount corresponding to 33 subloans by the termination date of subloan applications on 13 June 2000. E. Design Change

23. There were no major changes in the project design other than some relaxation of the loan covenants to expedite the loan disbursement as discussed in para. 24.

8

F. Outputs

1. Use of the Loan

24. Slower-than-expected loan commitments and disbursements were the main issues during the initial phase of implementation. For example, several fruit-processing subprojects in the pipeline identified during processing of the REDP were not eligible because the subborrowers lacked the minimum equity contribution. Pipeline projects for bottling mineral water were dropped as NBU believed that such activities were extractive (similar to mining and did not involve agroprocessing). To expedite project implementation, NBU requested the October 1998 ADB Review Mission to relax three covenants: (i) subborrowers’ equity contributions to be at least 25% of the total project cost, (ii) the EIRR to be at least 12%, and (iii) raise the free limit set at $2 million. In response, ADB agreed to (i) raise the free limit to $3 million, and (ii) relax the minimum EIRR requirement of 12% and replace it with an expected return on asset of 12%. However, ADB did not agree to relax the debt–equity ratio requirement. Subsequently, loan commitments were expedited but the pace of disbursement remained slower than expected until later in implementation. ADB tried to expedite the loan disbursement in 2000 to justify the SME Development Project (SMEDP), the follow-on credit line to Uzbekistan.26 25. Of the committed $50.0 million, ADB had disbursed $45.6 million to finance 28 subloans by the loan closing date of 13 June 2002, and the remaining balance of $4.4 million was cancelled on the same day. As of the OEM, 13 subloans had been fully repaid. NBU’s receivable for the remaining 15 subloans is around $21.0 million while its payable to ADB27 is $26.8 million. The balance of these amounts, $5.8 million, is considered the revolving fund.

2. Characteristics and Performance of Subloans

26. Approved subloans were widely distributed by loan size, region, and industry (Table 1; see Appendix 2 for details). Of the 28 subloans, 6, totaling $23.7 million, were above the free limit of $3 million.28 Twelve subloans, accounting for $23.8 million, were directed to subborrowers from the Tashkent and Samarkand regions. All 12 projects visited by the OEM were either in or near cities. The other 17 projects are also in or near cities, although it is not clearly indicated in the project documents. Of the 28 subloans, 6 amounting to $16.6 million (36% of the total disbursements) supported subprojects for the production of tomato puree, and fruit juice and concentrate. Two beer production units accounted for $8.3 million in subloans, and another $6.0 million for seven subloans supported the production of biscuits, waffles, and pasta.

26 ADB. 2000. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the

Republic of Uzbekistan for the SME Development Project. Manila (Loan 1799-UZB, for $50 million, approved on 11 December, of which $20 million was to be allocated to NBU).

27 To be precise, this amount should be payable to the Government. However, NBU actually repays the loan directly to ADB.

28 Another four subloans, totaling $10.3 million and representing 23% of the total amount and 14% of total number, were from $2 million to $3 million. All subloans were approved after the free limit was raised from $2 million to $3 million in November 1998. The remaining 18 subloans were below $2 million.

9

Table 1: Summary of Subloan Characteristics Item Number % Amount ($) % A. Size 1. Below $2 million 18 64.3 11,611,515 25.5 2. Between $2 million to $3 million 4 14.3 10,290,903 22.5 3. Above 3 million 6 21.4 23,727,092 52.0 Total 28 100.0 45,629,510 100.0B. Region 1. Tashkent 7 25.0 15,886,078 34.8 2. Samarkand 5 17.9 7,875,383 17.3 3. Others 16 57.1 21,868,049 47.9 Total 28 100.0 45,629,510 100.0C. Subsector 1. Tomato paste and concentrated fruit juices 6 21.4 16,566,699 36.3 2. Beer 2 7.1 8,324,014 18.2 3. Biscuits, waffles, and pasta 7 25.0 5,976,006 13.1 4. Others 13 46.5 14,762,791 32.4 Total 28 100.0 45,629,510 100.0Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

27. Nine subloans amounting to $22.9 million supported J/V with foreign investors,29 and the remaining subloans supported wholly Uzbek-owned SMEs. Seven subloans amounting to $21.1 million supported export-oriented projects, 30 and the remaining subloans supported import substitution projects. Of the seven export-oriented subborrowers, five produce tomato puree, and fruit juice and concentrate; one produces frozen fruit and vegetables; and one produces fleece (Appendix 3). 28. The interest rates for subloans were based on the ADB loan’s interest rate with spreads 2.0%–3.0% with grace periods ranging from 6 to 20 months. Eighteen subloans had maturities of more than 4 years. 29. Of the total 28 subloans, 13 for $10.1 million were fully repaid; 6 subloans for $20.7 million were rescheduled and are being repaid, with outstanding balance of $9.7 million (including arrears of $0.26 million for 3 subloans31); and the remaining 9 subloans for $14.8 million are currently frozen,32 with the outstanding balance of $11.2 million in arrears for its full amount (Table 2). In total, $11.5 million (25.2% of the total disbursements) are in arrears. Of the nine frozen subloans, four amounting to $6.6 million have been sold (or are being sold) to new investors.33 NBU is trying to identify investors to take over the remaining five subprojects.

29 At the time of subloan approval, 21 subborrowers were wholly Uzbek-owned SMEs. Subsequently, two of them

were partly taken over by foreign investors. 30 The OEM considered that export revenues are accounted for more than 25% of companies’ total sales if they are

export-oriented (para. 19). 31 NBU expected that arrears in conjunction with these three subloans would be settled soon. The OEM

independently verified the financial viability of one subproject through the field interview. However, the financial viability of another subproject that the OEM visited remained uncertain. The OEM did not visit the other subproject.

32 Of the nine frozen subloans, six were rescheduled. 33 The OEM visited two (SP19 and SP20) of the four frozen subprojects under this category. These two subborrowers

were invested by the same foreign investor and subsequently merged. NBU expects that the merged company will soon become profitable and fully repay the subloans. The OEM verified this through the field inspections.

10

Table 2: Repayment Status of Subloans at the Operations Evaluation

Item Number% of Total

Loan Amount ($ million)

% of Total

Loan Amount

($ million) Arrears

($ million) 1. Fully Repaid without Rescheduling 12 42.9 6.8

14.9 6.8 0

2. Fully Repaid with Rescheduling 1 3.6 3.3 7.2 3.3 0 3. Being Repaid with Rescheduling (with no arrears) 3 10.7 13.4

29.4 13.4 0

4. Being Repaid with Rescheduling (with arrears) 3 10.7 7.3

16.0 7.3 0.3

5. Frozen 9 32.1 14.8 32.5 14.8 11.2 Total 28 100.0 45.6 100.0 45.6 11.5

Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

3. Analysis on Subprojects

30. Appendix 4 presents the profiles of 12 subprojects that the OEM visited (footnote 10). Based on the profiles and the supplementary information provided by NBU, the OEM identified the following key success factors: (i) professional management; (ii) vertical integration and coordination with farms, offering constant and sufficient supply of raw materials; and (iii) financial strength of sponsors. The three major factors, however, were associated with failed subprojects: (i) disputes between Uzbek and foreign sponsors of J/Vs, (ii) unstable and inadequate supply of raw materials, and (iii) inadequate working capital because of devaluation of the sum and/or expansion of the sponsors’ other businesses. 31. Several OEM interviewees pointed out that some joint-venture foreign partners are offshore investment vehicles sponsored by domestic investors to take advantage of tax benefits given to J/V projects. The OEM could not fully verify if any of successful J/V subprojects under the REDP fall into this category. In cases of genuine J/Vs that involve direct participation of foreign partners in the management of companies, disputes between the Uzbek and foreign partners often arose especially when initial operations were successful, leading to suspension of the companies’ operations. This is illustrated by three underperforming J/V subprojects, two of which produced tomato puree and fruit juice (SP1 and SP734) and one produced biscuits (SP19). 32. The subproject data suggest that the country has a comparative advantage in fruit and vegetable products (tomato puree; fruit juice and concentrate; jam; and frozen fruits and vegetables). Of the 28 REDP subprojects, 8 engage (or were engaged) in such production. Of these 8, 4 were operational35 but 4 suspended their operations because of (i) disputes between Uzbek and foreign sponsors (SP1 and SP7), and (ii) insufficient and unstable supply of raw materials (SP1, SP9, and SP26). This finding suggests that export orientation of subprojects was not a guarantee for success. Nevertheless, SP27 demonstrates that export-oriented companies processing fruits and vegetables can be profitable if (i) professional management is in place, and (ii) the supply of raw materials is sufficient and constant through vertical integration. 33. SP3 (edible oil manufacturer) also demonstrates the sufficiency and constant supply of raw materials through vertical integration (with the sunflower farm) is a key success factor.

34 Some of the subborrowers were reluctant to share information with the OEM unless they were given assurance that

the final report would not indicate their names. Accordingly, this report uses code names for all the subborrowers. 35 One of the four operational subborrowers has trouble repaying its loan because of expansion of the sponsor’s other

business.

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34. From 1998 to 2003 the sum devalued from Sum80 to $1 to Sum976 to $1 (Figure 1).36 Significant devaluations also occurred in other Central Asian countries. Large currency movements made imports costlier to domestic consumers and exports cheaper to foreign consumers, adversely affecting the 21 import substitution subprojects in different degrees. Of these 21 subloans, 11 were fully repaid on time, 1 was rescheduled and fully repaid, 1 was rescheduled and is being repaid (with no arrears), 3 were rescheduled and are being repaid (with arrears), 3 were rescheduled and are frozen, and the remaining 2 are also frozen (without rescheduling). The 11 subprojects that were fully repaid on time could, to some extent, pass on the increased cost of operations because of the devaluation in the price of products. These subborrowers were not exposed to competition against foreign producers, while domestic competition was relatively low. These successful import-substitution subprojects maintained profit margins owing to protection given them. The OEM also noted that the devaluation was not among the primary reasons for the failure of the five subprojects that are currently not operational: Other reasons included: (i) disputes among sponsors/management (SP19 and SP20 [waffle manufacturers], and SP14 [bottled mineral water manufacturer]); (ii) inadequate supply of raw materials (SP26 [tomato puree and fruit juice manufacturer]); (iii) technical problems of procured production facility (SP28 [cookie manufacturer]); and (iv) imprisonment of an initial sponsor for drug trafficking (SP5 [ice cream manufacturer]). 35. In 2005, a Kazakh investor purchased 100% of the shares of SP19 and SP20, merged the two companies, and found a local partner to manage the merged company in a J/V format. The company is benefiting from economies of scale resulting from the merger as well as the vertical integration with the Kazakh sponsor’s flour mills offering constant and sufficient supply of raw materials. NBU expects these two subprojects to turn around with the new sponsor. 36. Out of six subprojects with subloan amounts above the free limit ($3 million), one was rescheduled and fully repaid, three were rescheduled and are being repaid (with no arrears), and two were rescheduled and being repaid (with arrears amounting to $0.05 million and $0.2 million). Of the nine frozen subloans, five were between $1 million and $2 million, three were

36 The formal FX rates were SUM80.4 to $1 on 6 January 1998, SUM140.5 on 4 January 2000, SUM975.5 on 28

October 2003, and SUM1,225.5 on 11 July 2006. Curb market rates were recorded at SUM290–335 on 12 January 1998, SUM770–790 on 3 January 2000, SUM980–985 on 31 October 2003, and SUM1,215–1,228 on 13 July 2006.

Figure 1: Formal Exchange Rate of the SUM (June 1998-June 2006)

0200400600800

1,0001,2001,400

J-19

98

D-1

998

J-19

99

D-1

999

J-20

00

D-2

000

J-20

01

D-2

001

J-20

02

D-2

002

J-20

03

D-2

003

J-20

04

D-2

004

J-20

05

D-2

005

J-20

06

Date

Sum

/$

D = end of December, J = end of June. Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

12

from $2 million to $3 million, and the remaining one was below $1 million. None of the subloans above the free limit is frozen. The OEM did not find particular correlation between the size of subprojects and the failure rate. G. Loan Covenants

37. Apart from the standard loan covenants, the project agreement for the REDP stipulated the eligibility criteria for subprojects (para. 19) and the financial requirements for NBU (para. 20). 38. The subloan application documents indicate that all of the subprojects met the eligibility criteria at approval. However, several OEM interviewees noted that SMEs tend to casually prepare business plans, in some cases merely for a loan application. Such business plans are not under public scrutiny as SMEs are not listed on the stock exchange. Moreover, the OEM assesses that NBU’s capacity in project appraisal can be further strengthened by upgrading the project appraisal software (Appendix 5, para. 12). Subproject information provided in subloan applications, therefore, is not fully reliable, and so the at-entry eligibility clearance of subprojects needed to be complemented by off-site monitoring and on-site examination during implementation. Considering the difficult business environment as well as the magnitude of currency devaluation, ADB should have given extra attention and resources to on-site inspection of subprojects.37 39. On paper, NBU’s loan portfolio classification system is largely consistent with international standards (Box, Appendix 5). NBU’s portfolio performance submitted to the PCR mission indicated that the total categories—four doubtful and five loss loans—were consistently less than 1% of the total portfolio during 1996–2001. Since 2002, a more realistic proportion of loans has moved into these categories. As of the end of 2004, the most recent information the OEM could obtain, 41% of the loan portfolio was classified as good and satisfactory, 39% category 3 (substandard), 13% doubtful, and 7% loss. The OEM could not fully verify if the repayment performance and the classification of subloans under the REDP represent NBU’s overall portfolio performance and classification. If they do, the observation of the REDP subloans suggests the possible under-classification of the entire loan portfolio and resulting inadequate loan-loss provisioning.38 40. Loan-loss provisioning percentages set in NBU’s policies are appropriate for each classification,39 with the exception of state guaranteed loans.40 NBU did not make provisions for state-guaranteed loans until 2002, requiring only a general provision of 1% on this portion of the portfolio irrespective of repayment status. This was in accordance with the Central Bank of Uzbekistan’s norms, but not fully in accordance with the Guidelines from the Basel Committee

37 The ex-ADB Uzbekistan Resident Mission staff member responsible for the later stage of REDP implementation

supported this view. 38 For instance, five frozen subloans with arrears for 30 months or over are classified as satisfactory or substandard,

and one frozen subloan with arrears for 47 months is classified as doubtful. The OEM considered that it would be more appropriate to classify the former as doubtful or loss and the latter as loss.

39 This includes a general provision of 1% of the good credit, 5–10% for satisfactory credits, 25% for substandard credits, 50% for doubtful credits, and 100% for bad credits.

40 According to NBU, nearly 80% of its portfolio is state-guaranteed loans. To be precise, repayments of subloans under the credit lines from multilateral and bilateral development banks are typically not guaranteed by the Government. However, NBU’s liabilities corresponding to these credit lines are either payable to the Government or to development banks with state guarantees. It appears that NBU treats subloans under these credit lines as state-guaranteed loans. The OEM could not fully verify this finding because of inconsistent feedback from interviewees in NBU and the Ministry of Finance.

13

of Banking Supervision (BCBS).41 On the recommendation of external auditors in 2002, NBU introduced a policy of provisioning 25% of each asset classification category for state-guaranteed loans except for loans classified as a loss, which are provisioned fully at 100%. 41. NBU did not fully meet the REDP covenants requiring (i) adequate loss provisioning and write-offs for bad debts in accordance with international standards, and (ii) full application of international accounting standards (paras. 39–40). The OEM confirmed NBU’s compliance with the covenant on its capital adequacy ratio. However, the OEM could not fully verify the implications of possible underestimation of risks in state-guaranteed loans and the lower-than-desired level of provisioning to this ratio. 42. The DSCR progressively declined from 5.6 in 1997 to 1.3 at the end of 2005, but was still above the ADB requirement of 1.25. Several OEM interviewees noted that commercial banks did not commonly use a DSCR as their performance indicator. Presumably for this reason, the ADB’s ongoing third credit line42 to Uzbekistan does not include the DSCR as a financial requirement but instead sets a maximum loan-deposit ratio. The OEM considers this to be more appropriate. The OEM could not obtain the information necessary to verify compliance with the following: (i) no loan to a single borrower, or to a group of related borrowers, exceeding 15% of its capital and reserves; and (ii) not more than 20% of its total portfolio being accounted for by any one sector.

III. PERFORMANCE ASSESSMENT

A. Overall Assessment

43. Overall, the REDP is rated partly successful, bordering on unsuccessful (Table 3),43 reflecting weighted averages of the individual ratings for four criteria: relevance (20%), effectiveness (30%), efficiency (30%), and sustainability (20%). Individual criterion ratings are in whole numbers from 0 to 3, in increasing order of project performance.44 As discussed in the following sections, the REDP is assessed as irrelevant, less effective, less efficient, and less likely sustainability.

41 Guidelines from BCBS exempt banks that make loans against sovereign guarantees from Organization of

Economic Cooperation and Development (OECD) governments from having to make loan-loss provisions. BCBS does not allow this exemption to non-OECD government-guaranteed loans.

42 ADB. 2002. Report and Recommendation of the President to the Board of Directors on a Proposed Loan to the Republic of Uzbekistan for the Small and Microfinance Development Project. Manila (Loan 1963-UZB, for $20 million, approved on 9 December).

43 At the time of the PCR, NBU classified over 94% of its loan portfolio as good or satisfactory. However, at the time of the OEM, NBU classified only around 40% of the loans in these categories because of tightening of its classifications. REDP arrears were 11.6% of total disbursement at the PCR, as compared with 25.2% at the time of the OEM (because of the increase in amounts due). These more recent findings contributed to the downgrading of the overall rating reported in the PCR.

44 For example, irrelevant = 0, partly relevant = 1, relevant = 2, and highly relevant = 3.

14

Table 3: Overall Performance Assessment of REDP

Criteria Assessments 1. Relevance 0 2. Effectiveness 1 3. Efficiency 1 4. Sustainability 1

Total Ratinga 0.8 a Highly successful > 2.7; successful 2.7 ≥ S ≥ 1.6; partly successful 1.6 >

PS ≥ 0.8; unsuccessful < 0.8. Source: Operations Evaluation Mission.

B. Relevance

44. The REDP was ADB’s first project in the country. The appraisal mission reported difficulty in obtaining information to process a project, and a less-than-desired level of donor feedback. Nevertheless, the ADB Management endorsed fast-track loan processing and approval in response to the Government’s strong request. ADB’s at-entry analysis or understanding of country context, sector issues, and NBU’s institutional capacity was weak. ADB, however, was in a position to know the depth of the challenges in the banking sector and exchange rate in risks in transitional economies and the difficulty of their transformation, especially in other Commonwealth of Independent States countries. Had ADB been prudent, a credit line to a state-owned bank that dominates the banking system, such as NBU, would have not been its first project in a country like Uzbekistan. A credit line should follow only after a thorough financial sector assessment and possible policy support and capacity building. For this reason, the OEM considered the modality of the REDP and its approval timing inappropriate. As the OEM felt these were important issues and that ADB should have recognized the corresponding risks related to the project, the REDP is rated irrelevant despite it being clearly identified as a Government priority. 45. The OEM’s assessment of relevance can be summarized as follows: (i) at-entry assessments of the financial sector and NBU were inadequate, (ii) at-entry assessments of the potential of the agroprocessing industry were appropriate, (iii) the targeted result of the project was consistent with Government development priorities and ADB’s country operational strategy at the time of loan approval, (iv) choice of investment modality was inappropriate although at the time of appraisal options to fulfill the project purpose were limited, (v) financial covenants and the scope of the associated TA were inadequate, (vi) FX risk analysis and risk-mitigating measures were inadequate, and (vii) ADB’s policy dialogue with the Government on financial sector reforms was inadequate. OED’s overall assessment is that ADB should not have selected this project to fast-track as ADB’s first loan to Uzbekistan. C. Effectiveness

46. The REDP is rated less effective based on the underperformance of 12 out of 28 subprojects at the time of the OEM, leading to less-than-expected outcomes as described below. The three key factors for the underperforming subprojects were (i) disputes between Uzbek and foreign sponsors of J/Vs, (ii) unstable and inadequate supply of raw materials, and (iii) inadequate working capital caused by devaluation of the sum and/or expansion of sponsors’ other businesses.

15

47. Of the 12 subprojects that the OEM visited, 8 are operational. In 2005, the 8 projects produced (i) 1,000 tons/year of fruit concentrate and 12,000 tons/per year of tomato paste (100% capacity use) with an annual turnover of SUM2.0 billion; (ii) 1.5 tons/day of chicken sausages (100%), SUM300 million; (iii) 1,400 tons/year of vegetable and cotton oil (100%), SUM1.2 billion; (iv) 3 million liters/year of beer (100%), $2.75 million; (v) 480 tons/year of fruit jam (40%), SUM1.5 billion; (vi) 1,200 tons/year of fruit puree and concentrate (90%), SUM6.0 billion; (vii) 6 million liters/year of beer (60%), $3.50 million; (viii) 840 bottles (1.5 liters each) per hour of mineral water (20%), $1.00 million. 48. The “rural population” was not defined either in the RRP or the loan and project agreements although one of the REDP purposes was to increase rural income. All 28 subprojects are located within or near cities although the raw material for agroprocessing was generally produced in rural areas. Thus the project had an indirect positive impact in rural areas by creating a demand for agriculture produce. However, this positive impact was mostly related to the 16 subprojects (57% of all subprojects) that are fully operational. 49. The OEM could not obtain adequate information to estimate the REDP’s overall contributions to export promotion. Of the eight operational subprojects that the OEM visited, three are export-oriented. Their total export revenues in 2005 amounted to $9.3 million. 50. Data submitted by NBU show that 28 subprojects under the REDP helped create 847 jobs directly and 7,167 jobs indirectly.45 The 8 operational subprojects that the OEM visited helped directly create over 440 full-time jobs (105 for women) and 150 part-time jobs (75 for women). 51. SME loans approved by NBU steadily increased from SUM49.6 million in 2001 to SUM105.8 million in 2004. NBU’s credit policies and procedures, including those for SME loans, are now closer to good banking practices, at least on paper, after NBU adopted the consultant recommendations under TA 2714-UZB. However, weaknesses remain in NBU’s operations, especially in portfolio management, commercial risk assessment, and management information systems. Improvements in these areas are required to further promote NBU’s SME lending operations. D. Efficiency

52. The REDP is rated less efficient bordering on inefficient because of its (i) less-than-satisfactory subloan repayment performance, (ii) discernible contributions to improvement of NBU’s SME credit allocation but marginal improvement of the overall operational efficiency, and (iii) limited subproject contributions to productivity gains and organizational innovations.46 53. NBU showed some evidence of the improved management and performance of its SME portfolio over the years, as compared with the performance of the other donor’s credit line implemented before the REDP. This achievement attributed, in part, to the NBU’s improved

45 NBU derived these figures based on the data collected by the (i) PCR mission as to 15 subprojects, and (ii) NBU as

to the remaining 13 subprojects. The OEM could not verify the method of calculating the REDP’s indirect contribution to job creation.

46 This efficiency rating reflects weighted averages of the individual ratings for three subcriteria: (i) subloan repayment performance (33.3%), (ii) project contributions to improvement of credit allocation and operational efficiency of the financial intermediary (33.3%), and (iii) subproject contributions to productivity gains and innovations of the economy (33.3%). The scores for the subcriteria that are the basis of the efficiency rating in Table 3 are 0.75, 1.35, and 1.05.

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SME credit policies pursued in conjunction with REDP implementation complemented by TA 2714-UZB. Interviews with the NBU management and the relevant donor supported this view. Nevertheless, 9 of the 28 subloans for $14.8 million were frozen, and the outstanding balance of $11.5 million (25.2% of the total loan disbursements) was in arrears at the time of the OEM.47 This less-than-satisfactory repayment performance of subloans and the continuing Government’s direct and indirect influence over NBU’s credit decisions suggest the REDP’s marginal contribution to improving NBU’s credit allocation. NBU’s non-interest expense to operating income ratio increased from 6 to 21% during 1996–2000 to 13 to 39% during 2001–2005 (Appendix 5, Table A5.2). This suggests little improvement in NBU’s operational efficiency over the years. Clearly, the REDP’s contribution to improving NBU’s credit allocation and operational efficiency was far less than expected. 54. The OEM could not obtain adequate information to estimate the subprojects’ overall contribution to improving economic efficiency. The external trade data and the import-related tax rates suggest that among the subborrowers’ products the country has a comparative advantage in production of tomato paste, fruit puree, fruit juice, and frozen fruits and vegetables. Of the 28 REDP subprojects, 7 were to engage in such production, and of these, 3 have been successful but 4 have suspended their operations because of (i) disputes between Uzbek and foreign sponsors, or/and (ii) problems in supply of raw materials. Several other subborrowers’ products are protected by import tariffs and discriminatory rates of other relevant taxes, suggesting their lack of competitiveness. 55. Of the eight operational subborrowers that the OEM met, five are vertically integrated: (i) tomato farm and tomato puree producers (SP27), (ii) chicken farm and sausage producer (SP23), (iii) sunflower farm and sunflower oil producer (SP3), and (iv) flour mills and confectionary producers (SP19 and SP 20). Two of these subborrowers also rely on contract farming to secure a constant supply of raw materials. Such vertical integration and coordination reduce the transaction costs associated with uncertainty in the supply of raw materials, thus improving economic efficiency. The merger of SP19 and SP20 may lead to efficiency gains through sharing of management resources and marketing channels. 56. NBU has been trying to find new investors to take over and restructure underperforming subprojects under the REDP. For some cases such as SP19 and SP20, these efforts resulted in resumption or improvement of subprojects’ operations. In this way, NBU is improving economic efficiency. E. Sustainability

57. The REDP is rated less likely sustainable. 58. Of the total 28 subloans, 13 were fully repaid and 3 were rescheduled and are being repaid with no arrears. NBU provided updated return on equity and FIRR for only 7 of these 16 performing subprojects.48 All but two subborrowers achieved return on equity of at least 15%,49

47 ADB’s Evaluation Guidelines do not refer to any threshold arrears ratio (of subloans) as a benchmark for efficiency

rating of financial intermediation loans. However, the OEM considers the arrears ratio of over 20% unacceptably high.

48 The OEM could not independently verify the calculation of these ratios but confirmed their profitability through field interviews.

49 The return on equity of the remaining one was 13.5% in 2005.

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and all but the same two subborrowers achieved an FIRR of at least 20%.50 The latter five subborrowers are considered financially viable given their large profit margins. 59. The condition of the facilities funded under the eight operational subprojects that OEM visited were satisfactory. Of these, five maintained capacity use of 90% or over, and three currently use 40–60% of their production capacity. Of the latter three, two are identical to those with relatively low FIRR and return on equity. 60. Environmental, social, technological, and natural resource risks of the eight operational subprojects that the OEM visited appear to be low. 61. All the 28 subprojects benefited from various forms of preferential treatment for SMEs, and most of the performing subborrowers have retained such benefits. Nine subborrowers also benefit from various forms of preferential treatment for J/Vs. The OEM believes that a possible change in the preferential treatment given SMEs and joint ventures J/Vs is a potential risk for all these subprojects. 62. As at end 2004, nearly 60% of NBU’s loan portfolio is classified as substandard, doubtful, or loss. Underperforming loans could have been underestimated, resulting in inadequate loan-loss provisioning (paras. 39–40). Under the new management put in place in 2004, NBU’s handling of underperforming loans has become more prudent: it has more quickly downgraded underperforming loans, discontinued further lending to seriously past-due borrowers, and has been trying to expedite the liquidation of failed projects.51 However, NBU needs to intensify the operational and financial restructuring of underperforming loans to restore its financial viability. Restoring NBU’s financial performance is a major challenge. Early detection and response to problem loans and more realistic and prudent loan loss provisioning are important steps in this direction. 63. NBU relied on credit lines from multilateral development institutions, including the REDP revolving fund of $5.8 million (para. 25), and bilateral export credit agencies for financing SME loans.52 NBU’s deposit mobilization remained relatively small.53 Given this liability structure, reduced intermediation of foreign loans as witnessed in 2005 may translate into contraction of its SME lending.54 Further strengthening of deposit taking is requisite to sustain the growth of NBU’s SME lending.

50 The FIRR of the remaining two as of the end of 2005 were calculated at 4% and 9.2%. 51 The proposed legal reform to expedite the liquidation of failed projects was recently rejected in the Parliament. 52 Such institutions include ADB, EBRD, IFC, Kreditanschdalt fur Widerafbau (KfW), the OPEC Fund, the Islamic

Development Bank, and the Chinese Development Bank. The outstanding amounts of credit lines from these institutions ranged from $1.4 billion to $1.6 billion during 2000–2004. NBU currently avails credit lines from the Islamic Development Bank ($15 million) and the Chinese Development Bank ($20 million). NBU claims that its ratio of foreign currency loans to local currency loans dropped from 57.6% as of August 2006 to 30.2% as of 1 January 2007.

53 NBU’s deposits started to gradually increase from $349 million at end 2002 to $542 million at end 2005. NBU’s deposits (in dollar terms) were in a down-trend during 1999–2002 because of devaluation of the sum.

54 The outstanding amount of credit lines from foreign sources dropped to $1.1 billion at end 2005 (para. 71).

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IV. OTHER ASSESSMENTS

A. Impact

64. In 2005, the Government set the ambitious goal of raising SMEs’ share of GDP to 45% by 2007. However, the International Finance Corporation (IFC) survey55 of recent economic trends shows that the current rate of SME development does not point to achieving that objective.56 65. Following the SME lending promoted by NBU over the last decade, some other banks also started SME lending. However, NBU continues to dominate the credit market, including SME lending, despite its weak portfolio performance partly because most other banks are constrained by lack of long-term funds. As a result, Uzbekistan’s financial depth as measured by M2/GDP remained less than 15%, which is low in international and regional comparison.57 Not only the financial data but also the OEM’s field survey suggested that limited access to finance remains a key constraint on the SME development. The REDP was not effective in building indigenous capacity to promote term financing for SMEs.

1. Socioeconomic Impact

66. NBU reported that 28 subprojects under the REDP helped create 847 jobs (325 for women) directly and 7,167 jobs indirectly. The OEM did not detect significant backward links of subprojects and the associated impact on farmers. However, given the remaining inefficiency in the agricultural distribution systems, farmers that are vertically integrated with subborrowers may be benefiting from subprojects through lower marketing costs.

2. Environmental Impact

67. The OEM did not discern any adverse environmental impact of the subprojects from information provided by NBU and subborrowers that were visited. All the subborrowers that the OEM visited confirmed that they had submitted all the relevant environment-related information to the NBU as required during project appraisal.

3. Institutional and Policy Impact

68. NBU considers the REDP (and the follow-on SMEDP [footnote 26]), complemented by TA 2714-UZB (Appendix 6), as having contributed to the quantitative and qualitative development of NBU’s SME credit activities. The development of SME lending was one of NBU’s key achievements over the last decade. However, the OEM considers that NBU’s lending operations, especially in commercial risk assessment, portfolio management, and management information systems, remain weak. The fundamental issues continue in NBU’s operations related to its remaining nonbanking activities as a government agent as well as its noncommercial lending activities. The OEM believes that these multiple tasks imposed on NBU hinder its operational efficiency, loan portfolio performance, and deposit mobilization.

55 IFC. 2004. Business Environment in Uzbekistan as Seen by Small and Medium Enterprises: Survey Results Based

on 2004. Washington, DC. 56 The IFC study showed that the SME share as a percentage of GDP increased marginally from 33.6% in 2001 to

35.6% in 2004. 57 Reference to the handouts at the World Bank’s Presentation for a Roundtable for Financial Sector Reform on 15

June 2006 in Tashkent.

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69. NBU’s nonbanking activities include (i) controlling cash supply and liquidity, (ii) monitoring financial transactions of corporate depositors, and (iii) automatically deducting outstanding taxes from depositors on behalf of tax authorities.58 The noncommercial lending activities are represented by state-guaranteed loans (to development-oriented, strategically important projects) and loans made at a subsidized interest rate (to the wheat and cotton industry and social sector projects). The state-guaranteed loans still represent about 80% of NBU’s total loan portfolio. The OEM concluded that the lack of clear delineation between these activities and commercial lending undermined NBU’s commercial orientation, resulting in less-than-satisfactory portfolio performance. Government support is needed to rationalize/detach these activities from the NBU’s operations. 59 ADB should have had more vigorous policy dialogue with the Government, which might have complemented the REDP and SMEDP. 70. Since 2002, NBU has tightened its loan classifications. This is an important, positive development. However, as a result, the proportion of the loans classified as good or satisfactory went down to around 40% at the end of 2004 as compared with over 90% at the end of 2001. As the application standard of the rule changed over the period, it is difficult to accurately measure the change in quality of NBU’s portfolio. However, the current level of problem loans questions the sustainability of NBU’s operations. The REDP failed to address this critical issue. 71. As at end 2005, funding for NBU’s operations was sourced from interstate credits—international governments and development banks (52%),60 the Government (19%), customer accounts (26%), and other liabilities (3%). The portion of interstate credits of total liabilities grew from 27% at end 1997 to 63% at their peak at the end of 2003 before declining to 43% at the end of 2005. Customer deposits declined from 23% of liabilities in 1997 to 12% in 2001 despite the expansion of the branch network, but have grown back now to 26%, reflecting reduced intermediation of foreign loans since 2005. The capacity of NBU as a commercial bank to mobilize deposits remains weak, and the REDP (together with other interstate credits) failed to strengthen it. B. Asian Development Bank Performance

72. The OEM assesses the performance of ADB as less than satisfactory. 73. In response to the Government’s request, ADB fast-tracked project processing (in less than 6 months) with only two processing missions. This fast-track processing was not appropriate given the fact that the REDP was ADB’s first loan to Uzbekistan and given the challenges faced by the financial sector in transition economies. ADB’s project supervision was generally adequate, including ADB staff continuity and frequency of review missions, except for the monitoring of (i) subproject performance; and (ii) NBU’s handling of nonperforming loans. ADB should have examined more vigorously these aspects, especially during the appraisal of the SMEDP (footnote 26). ADB should have also addressed the issues in the suspension of the BME system developed under TA 2714-UZB in conjunction with the SMEDP implementation.

58 Reference to ADB. 2006. Country Strategy and Program (2006–2010): Uzbekistan. Manila (Appendix 3, para. 68). 59 NBU projected that its nonbanking activities were being wiped out of its operations. However, it did not indicate

when it would be completely wiped out. 60 NBU’s 2003 and 2004 annual reports reported these to be ADB, EBRD, International Development Bank, IFC, KfW,

Islamic Development Bank, Eximbank of China for the People’s Republic of China, and OPEC. The interstate credits also include the Government’s cofinancing portion of the projects funded by these international financial institutions. The OEM could not verify the proportion.

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74. The PCR assessment of the NBU’s financial statements was solid. However, considering the country context and institutional constraints remaining in the banking and SME sectors, the PCR should have more in-depth analysis on the (i) regulatory environment and investment climate,61 and (ii) NBU’s noncommercial lending (sovereign guaranteed loans and subsidized loans) and remaining nonbanking activities.62 The PCR mission and/or project review missions should have selected sample subprojects for measuring the long-term benefits (job creation and income generation) as stipulated in the project agreement. C. Executing Agency Performance

75. NBU’s performance is rated less than satisfactory in view of (i) its limited capacity to identify, appraise, and monitor SME projects; (ii) its less-than-satisfactory recovery of subloans; (iii) its suspension of the BME system developed under TA 2714-UZB;63 and (iv) the governance issues of the previous management that surfaced in 2004 (based on media articles [Appendix 5, para. 8]). It is, however, noted that several OEM interviewees in the financial industry outside of NBU acknowledged that NBU has a pool of quality bankers. NBU was also one of the few financial institutions offering SME credit at the time of the REDP appraisal. D. Technical Assistance

76. TA 2714-UZB is rated partly relevant, despite its evident complementarity to the REDP, mainly because of (i) weak institutional assessment and inadequate discussions between NBU and ADB on the TA’s expected results at entry,64 and (ii) inappropriate purpose setting 65 and inadequate scope and duration. NBU functions as both a development and a commercial bank. As the Government’s agent, NBU also engages in nonbanking activities. At entry, ADB should have assessed carefully the justification for and the feasibility of NBU’s multiple agendas.66 The outcome of such assessment might have led to broader scope and duration of this TA. The TA is rated less effective despite the largely satisfactory implementation of the consultants’ recommendations on credit policy, because of (i) limited use of the TA outputs such as the Entermod project appraisal system and the BME systems, and the (ii) subsequent resignation of all project implementation unit staff and most training seminar participants. The TA is rated less efficient considering that (i) NBU did not fully capitalize on the TA’s benefits, as a large portion of NBU’s loan portfolio remains to be guaranteed by the Government, and it continues its nonlending activities; (ii) the repayment performance of subloans under the REDP was less than satisfactory; and (iii) NBU no longer uses the BME system developed under the TA. Over the last years, NBU management has continued to implement more prudent practices to classify, 61 The OEM considers the PCR as not having adequately assessed the excessive external trade and FX regulations,

except the mandatory surrender of FX revenues imposed on exporters, which hindered SME development. 62 The OEM considers these aspects relevant in assessing the viability of NBU’s operations and, hence, the

sustainability of the REDP outcome. 63 The project agreement stipulated that “NBU shall monitor the financial and economic performance, and

socioeconomic and environmental benefits of Qualified Projects. NBU shall assist ADB to monitor and evaluate the long-term benefits of a random sample of five Qualified Projects.” NBU did not comply with these requirements at the time of the OEM.

64 For instance, the project files suggest that there was little discussion on what type of projects (apart from subloans under the REDP) NBU would subject to the use of the envisaged BME system.

65 The initial emphasis of this TA was the capacity building of the NBU branches based on the assumption that NBU headquarters had established satisfactory subproject appraisal and credit approval procedures assisted by EBRD. However, this assumption proved to be incorrect, and the consultants actually spent much time with headquarter staff.

66 During contract negotiations with the consultant, the terms of reference were changed to remove the review of all nonbanking activities from the envisaged diagnostic review of NBU’s strategic plan as requested by NBU. The OEM believes this change was inappropriate.

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provision, and recover problem loans. Nevertheless, the OEM considers NBU’s operational efficiency, loan portfolio performance, and deposit mobilization less than satisfactory. In particular, the current level of problem loans calls into question the viability of NBU’s operations. On this basis, the TA is rated less likely sustainable. Overall, this TA is rated partly successful.

V. ISSUES, LESSONS, AND FOLLOW-UP ACTIONS

A. Issues

1. Financial Deepening

77. The gross domestic product (GDP) grew by 7.7% in 2004 and 7.0% in 200567 because of strong growth of mining, agriculture, and light industry. With the increase of exports by 11.5%, the country recorded the largest trade account surplus of above $1.3 billion in 2005 since its independence in 1991. As a result, foreign reserves were estimated to be around 10.4% of GDP at the end of 2005.68 Despite this noteworthy performance of the real and external sectors, the financial sector remained weak: (i) bank assets as a share of GDP decreased from over 60% in 2001 to less than 40% in 2005, mainly because of reduced intermediation of foreign loans; (ii) financial depth as measured by M2/GDP remained less than 15%; and (iii) excessive concentration in the largest five banks (Appendix 5, para. 2), including NBU and Asaka Bank, and their low profitability.69 The financial sector currently plays a role far below its potential. Rationalizing NBU would have significant implications for achieving such potential. ADB’s ongoing TA for Financial Sector Infrastructure Development70 is designed to comprehensively address constraints on the banking sector and nonbank financial institutions. However, this is a challenging task that will require consistent engagement over many years. It remains to be seen if ADB’s efforts will be successful. 2. Restructuring of NBU 78. To accomplish the Government’s plan of privatizing NBU by 2009, significant operational and financial restructuring is required. Preparing a road map with monitorable, verifiable indicators should be a key initial step. Strong Government support will be essential for NBU to succeed in this endeavor. Among the many challenges that need to be addressed in the road map, the OEM puts particular emphasis on (i) transferring nonbanking activities; (ii) clearly delineating commercial banking and other lending operations; (iii) further improving project appraisal and monitoring; (iv) early detection and response to problem loans, possibly by establishing an independent loan recovery vehicle; and (v) more realistic and prudent loan-loss provisioning.

67 Reference to the announcement on key economic indicators in 2005 at the Cabinet meeting on 10 February 2006. 68 Reference to the joint announcement of the Government and the IMF in December 2005. Some of the OEM

interviewees assessed this positive economic performance as possibly partly representing the transfer of resources from the informal to the formal sector as a result of tightening of the Government regulations against shuttle traders and other informal sector activities in recent years.

69 According to the World Bank, the average return on equity of state-owned banks was 2.0% in 2005 compared with private banks’ 16.1%, foreign banks’ 5.9%, and mixed ownership of 10.7%.

70 ADB. 2005. Technical Assistance to the Republic of Uzbekistan for Financial Sector Infrastructure Development. Manila (TA 4564-UZB, for $400,000, approved on 10 February).

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3. External Trade Barriers 79. In conjunction with the adoption of the import-substitution strategy in 1997, the Government introduced a series of external trade restrictions.71 The introduction of current account convertibility in October 2003 resulted in an increase in import duties and other relevant taxes for imported goods. Most subborrowers that the OEM met noted that their improved access to FX, in conjunction with the introduction of current account convertibility in October 2003, has been conducive to their business. However, other OEM interviewees pointed out that FX conversion has been occasionally delayed and, in some cases, importing of particular goods was explicitly or implicitly discouraged. The 2004 IFC survey (footnote 54) supported this observation. It was found that 78% (66% in the 2003 survey) of sample SMEs felt importing was “problematic” or “very problematic” despite the introduction of current account convertibility. Likewise, 63% (66% in the 2003 survey) felt that exporting was “problematic” or “very problematic” because of a variety of administrative barriers. 4. Corporate Governance 80. One of the two key factors for the failure of subprojects was disputes between local and foreign J/V partners. Some of these episodes revealed weaknesses in subborrowers’ corporate governance and management capacity, aggravated by inadequate corporate legal structures and lack of compliance with legal norms. Some OEM interviewees pointed out that, in some cases, a foreign partner is actually an investment vehicle established by domestic sponsors merely to obtain the preferential treatment for J/Vs. Other OEM interviewees pointed out that foreign J/V partners typically arrange to supply equipment, in some cases causing conflicts of interests and abuses through over-invoicing for imported goods as the source of the J/V partner’s equity contribution to the subproject. These observations suggest the general weakness in SME corporate governance. The TA for Enterprise Restructuring and Corporate Governance72 addressed some of these issues but did not result in a policy-based loan as initially envisaged. Many issues related to corporate governance remain. 5. Supply of Raw Materials for Agroprocessing 81. The OEM field assessment highlighted vertical integration and coordination as a key factor for successful agroprocessing projects. This suggests that vertical integration is one way to strengthen the infrastructure for distributing agricultural products and to ease the consequent difficulty and high transaction costs of securing a constant and sufficient supply of raw materials. The outputs of the ongoing TA for Preparing the Development of Market Infrastructure for Private Farms and Agribusiness Projects73 are expected to analyze this issue and provide practical recommendations. Consistent follow-up will be required to translate these outputs into Government specific decisions that are sufficient to significantly improve the agribusiness environment.

71 The Government (i) increased trade tariffs in November 1997, (ii) required mandatory surrender of export revenues

set at 50% in January 1999, (iii) introduced barriers to trade with Kazakhstan and the Kyrgyz Republic in February 1999, (iv) further restricted access to hard currency in June 2000, and (v) started regulating shuttle traders from August 2002.

72 ADB. 2002. Technical Assistance to the Republic of Uzbekistan for Enterprise Restructuring and Corporate Governance. Manila (TA 4062-UZB, for $1 million, approved on 19 December).

73 ADB. 2004. Technical Assistance to the Republic of Uzbekistan for Preparing the Development of Market Infrastructure for Private Farms and Agribusiness Project. Manila (TA 4328-UZB for $330,000, approved on 13 April).

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6. Business Environment for SMEs 82. Over the years, the Government has introduced several SME promotion measures, including preferential tax treatments and the exemption of mandatory surrender of export earnings. The Government passed a package of legal and regulatory measures74 in 2005, which outlined a 2-year action program to improve the business environment. Implementation of this program involves deregulation and simplification measures that would offer less opportunity for arbitrary application of rules by authorities as well as rent-seeking in business circles. In this way, this initiative is expected to help improve the investment climate. B. Lessons

1. Fast-Track Loan Processing 83. The REDP was processed in a short period. ADB Management endorsed this fast-track approach because “with EBRD assistance, NBU HQ has established satisfactory subproject appraisal and credit approval procedures.” However, the ADB appraisal mission did not fully verify this observation. The appraisal mission’s back-to-office report noted (i) difficulty in accessing information necessary to process a project, (ii) slower-than-expected decision making by the Government, and (iii) a less-than-desired level of feedback from EBRD on the progress of its first credit line. Evidently, ADB Management did not sufficiently consider these critical matters despite the REDP being the country’s first ADB project. Endorsement of fast-track loan processing was not appropriate. 2. Assessment of Financial Sector and Intermediary, and Policy Dialogue 84. The RRP assessed the potential of the agroprocessing industry, but its assessment of NBU and the financial sector was weak. The RRP should have assessed the magnitude of NBU’s nonbanking activities and the Government’s influence over NBU’s credit allocation decisions, the structure, regulation and governance in the financial sector, and the implications for NBU’s commercial orientation and portfolio performance. Such an assessment should have preceded ADB’s financing credit lines to state-controlled financial intermediaries, especially in a transition economy. Active policy dialogue should be maintained throughout project implementation given the weaknesses in the financial sector and in all aspects of the policy, legal and regulatory framework and corporate governance, and the consequent risks for the targeted financial intermediary’s operations. Considering the scope and depth of these issues, a line of credit was not appropriate as a first intervention in a country that was just beginning its transition to a market economy.75

74 These included (i) a decision to draft a new tax code, (ii) further reform and liberalization of the banking system, (iii)

improvement of legal protection for businesses, (iv) introduction of a unified tax payment for SMEs, (v) guarantees of unimpeded access to cash held in bank settlement accounts, and (vi) further reduction of the number of inspections.

75 The OEM findings included the following: (i) ADB started its first assistance to Central Asian countries with the Special Assistance Projects to Kazakhstan and the Kyrgyz Republic (footnote 17) that supported macroeconomic stabilization and structural adjustment programs led by the IMF and the World Bank; (ii) Uzbekistan had no comprehensive economic reform program in place (supported by the IMF and the World Bank) at the time of the REDP appraisal; (iii) the Special Assistance Project to the Kyrgyz Republic was rated generally successful by the PCR circulated in September 1997; (iv) the Special Assistance Project to Kazakhstan was rated successful by the project performance audit report circulated in January 2002; and (v) the Rural Finance Institutions Project in Kyrgyz Republic (Loan 1529-KGZ), approved on 2 August 1997, resulted in sanctions against fraudulent activities of 21 credit unions and 4 individuals.

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85. The Operations Manual (OM) at the time of REDP approval (section 82, issued on 22 February 1988, on Development Finance Institutions [DFI]) noted “government policies and economic environment should be congenial to the satisfactory operations of a DFI.” While this guideline lacked specificity, the OEM questions the REDP’s compliance with this requirement. The current OM (section D6/BP, issued on 15 December 2003, on Financial Intermediation Loans [FIL]) included “autonomy in lending and price decisions” as a condition for financial intermediaries that onlend funds under FILs. The current OM also notes that “financial intermediaries should have or built up capacity for mobilizing domestic resources.” Had these guidelines been in place, the REDP could not have probably become a standard credit line. The REDP underscores the need for diligent application of these guidelines. 86. The OEM considers the slow progress in NBU’s restructuring to be a hindrance to banking sector development. Several other commercial banks have emerged over the decade and some are reported to be profitable. However, the OEM’s tentative assessment suggests that their lending activities and domestic resource mobilization have been limited, rather focusing on other niche areas that are not directly competing against NBU. Under this market structure and environment, development impacts of FILs on the emerging banks remain uncertain. Besides, ADB’s medium-term strategy II 76 classifies DFIs under group III. The strategy proposes that operations in the group’s subsectors be gradually wound up except under some special circumstances. ADB should prudently take all these aspects into account in considering future FIL operations in Uzbekistan. 3. Financial Covenants of Financial Intermediation Loans 87. In considering financial covenants for an intermediary of ADB FILs, prudential guidelines in the country, their enforcement status, and the intermediary’s capacity to manage risk should be thoroughly reviewed during appraisal. Based on such review, ADB should identify financial covenants that complement the intermediary’s risk management systems and the country’s prudential guidelines. From this perspective, ADB should have included a financial covenant that addressed NBU’s inadequate loan-loss provisioning for state-guaranteed loans. 4. On-Site Inspection during Project Implementation 88. The SMEs prepared only pro-forma business plans, in some cases merely for a loan application. Such business plans are not under public scrutiny as SMEs are typically not listed on the stock exchange. Therefore, loan application documents are often not fully reliable. Hence, the at-entry eligibility clearance of subprojects needed to be complemented by frequent on-site inspections by NBU and ADB. A general weakness in SMEs’ corporate governance as well as the significant overvaluation of the national currency at project entry were clear indications that portfolio problems could be anticipated and that ADB should have allocated extra resources to monitoring subprojects. 5. Benefit Monitoring and Evaluation 89. NBU has little information on the subprojects’ operational performance and development impacts. Weak BME has been common among ADB’s FIL operations. 77 Experience 76 ADB. 2006. Medium-Term Strategy II 2006-2008. Manila. 77 The three recent evaluation reports (ADB. 2004. Project Performance Audit Report on the Second Development

Finance Project in Indonesia. Manila; ADB. 2005. Project Performance Audit Report on the Financial Second Intermediation Loan in Pakistan. Manila; and ADB. 2006. Project Performance Evaluation Report on the Private Sector Infrastructure Facility in India. Manila) highlighted this issue.

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underscores the need for ADB to consider an alternative approach to creating a functional monitoring framework that balances increased administrative costs with the need for, and use of, the data collected. One possibility is to specify the required data and timing of data collection in a loan/project agreement.78 Another option is to select sample subprojects in case their number is large. The REDP’s project agreement stipulated that “NBU shall assist ADB to monitor and evaluate the long-term benefits of a random sample of five qualified projects.” However, ADB did not select such a sample and should have dealt more vigorously with the BME clause during project implementation. C. Follow-Up Actions

90. No specific follow-up actions were identified for the Borrower and for ADB.

78 The RRP specified the key indicators to be monitored under the BME system, but the loan and project agreements

did not specify the indicators.

26 Appendix 1

PROJECT FRAMEWORK

Design Summary Targets Project Monitoring

Mechanism Risks 1. Sector Goals Support the development of agroprocessing SMEs by promoting access to new export markets, and mitigating rural unemployment

• Improve economic efficiency and product quality

• Diversify export markets

• Government statistics

• Project progress reports

• Review missions

• Slowdown in transition to a market economy

• Macroeconomic instability

2. Objectives Proposed Rehabilitate and modernize agroprocessing SMEs and provide collective and family farms with new dairy micro-processing facilities to increase value added and rural income • First priority – export-oriented

medium-scale enterprises • Second priority – small-scale

import substitution projects • Investments will modernize

outmoded facilities, particularly processing and packaging lines

• Arrest further deterioration of production facilities

• Sustain demand for agricultural outputs and employment

• Improve efficiency (by about 25%) and product standards in medium-scale enterprises with export potential

• Modernize small enterprises to provide better products for the local market

• Increase share of exports paid for in hard currency

• Project progress reports and review missions

• Annual reports from enterprises to ascertain level of gains in efficiency (gross margin), product standards, value-added, exports, and job preservation

• Lack of management and marketing skills

• Failure to capture new export markets due to insufficient improvements in product standards

• Access to foreign exchange

• Inadequate price incentives for input producers

3. Project Outputs 3.1 Economically and financially viable agroprocessing projects

• The financing of 25 to 50 projects consistent with the objectives and priorities

• The first four projects will be subject to ADB approval

• Projects above the free limit will be subject to ADB approval

• Inability of credit applicants to meet lending criteria

• Lack of experience with ADB procedures

3.2 Enhanced underlying value and marketability of enterprise shares through increased returns and stronger balance sheets

• Insufficient funds for investment and inadequate capital market development

3.3 Project management and institutional development • Sound project design and

business plans, including technical, marketing, and financial aspects

• Sound risk analysis and credit approval procedures

• Achieved EIRR for each project of at least 12%

• Achieved FIRR for each project above the cost of capital

• Enhanced systems for risk analysis and credit approval procedures

• Guidelines for addressing debt recovery/delinquency

• Models for sponsors of business plan preparation

• Establishment of a competent PIU

• Annual financial statements and other data from the project enterprises

• Review missions • Project progress

reports and review missions

• Absorptive capacity of counterpart staff

• Inability to retain competent staff

4. Activities Inputs Project Monitoring

Mechanism Risks 4.1 Project finance • $50 million • Project progress

reports and review missions

• Slowdown in transition to a market economy

4.2 TA for capacity building of NBU and project sponsors

• Advisory TA $830,000 • 25 person-months of consulting

services

• PCR/PPER • Macroeconomic instability

ADB = Asian Development Bank, EIRR = economic internal rate of return, FIRR = financial internal rate of return, PCR = project completion report, PIU = project implementing unit, PPER = project performance evaluation report, SMEs = small and medium enterprises, TA = technical assistance. Source: ADB. 1996. Report and Recommendation of the President to the Board of Directors on a Proposed Loan and Technical Assistance to the Republic of Uzbekistan for the Rural Enterprise Development Project. Manila (Loan 1504-UZB, for $50 million, approved on 17 December).

Appendix 2 27

AmountItem Number % ($) %

A. Purpose New project 18 64.3 31,303,654 71.3 Modernization 6 21.4 5,182,776 14.7 Expansion 4 14.3 9,143,080 14.0 Total 28 100.0 45,629,510 100.0 B. Size $100,000–$500,000 10 35.7 3,037,930 6.7 $500,000–$1 million 3 10.7 2,068,314 4.5 $1 million–$2 million 5 17.9 6,505,271 14.3 $2 million–$3 million 4 14.3 10,290,903 22.5 $3 million–$4 million 3 10.7 9,737,094 21.3 $4 million–$5 million 3 10.7 13,989,998 30.7 Total 28 100.0 45,629,510 100.0 C. Maturity 2.1-4 years 10 35.7 3,505,350 7.7 4.1–6 years 16 57.2 33,124,162 72.6 6.1–7 years 2 7.1 8,999,998 19.7 Total 28 100.0 45,629,510 100.0 D. Region Namangan 1 3.6 1,182,000 2.6 Samarkand 5 17.9 7,875,383 17.3 Djizzak 2 7.1 638,910 1.4 Khorezm 2 7.1 2,935,000 6.4 Navoi 2 7.1 5,640,218 12.4 Tashkent 7 25.0 15,886,078 34.8 Bukhara 1 3.6 4,990,000 10.9 Karakalpakstan 2 7.1 3,084,250 6.8 Andijan 1 3.6 1,212,689 2.6 Ferghana 1 3.6 292,700 0.6 Kashkadarya 2 7.1 1,129,451 2.5 Surkhandarya 2 7.2 762,831 1.7 Total 28 100.0 45,629,510 100.0 E. Subsector

Ice cream 4 14.3 2,050,496 4.5Tomato paste and concentrated fruit juices 6 21.4 16,566,699 36.3Sunflower oil 1 3.6 524,680 1.1Biscuits, waffles, and pasta 7 25.0 5,976,006 13.1PET bottles and bottling of mineral water 2 7.1 3,301,351 7.2Wool processing 1 3.6 2,306,204 5.1Beer 2 7.1 8,324,014 18.2Dairy products and fruit jams 3 10.7 1,278,517 2.8Frozen fruits and vegetables 1 3.6 4,999,998 11.0Sausages 1 3.6 301,545 0.7 Total 28 100.0 45,629,510 100.0

F. Ownership Wholly Uzbek 19 67.9 22,701,703 49.8Joint venture 9 32.1 22,927,807 50.2 Total 28 100.0 45,629,510 100.0

PET = polyethylene telephthalate.Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

SUBLOAN CHARACTERISTICS

28 Appendix 3

No. Description of ProjectLocation (Region) Ownership

Initial Purpose of the Project

Subloan Approved Date by

ADB

Subloan Amount

Approved ($)

Subloan Amount

Disbursed ($)

Initial Maturity Interest Rate (%)

SP1 Production of tomato paste and fruit puree

Namangan JSC Modernization 03/12/1997 1,182,000 1,182,000 10/01/2004 10.70 (ADB rate + 4.00)

SP2 Production of ice cream Samarkand JV Start-up 12/09/1997 288,557 288,557 10/07/2006 9.70 (LIBOR + 5.00)

SP3 Production of sunflower and safflower vegetable oil and cotton oil

Djizakh Private company

Start-up 10/06/1998 524,680 524,680 - 9.66 (ADB rate + 2.96)

SP4 Manufacturing of short-cut macaroni

Djizakh Private company

Start-up 14/09/1998 114,230 114,230 - 9.66 (ADB rate + 2.96)

SP5 Production of ice cream Andijan Private company

Start-up 14/09/1998 1,212,689 1,212,689 10/01/2005 9.32 (ADB rate + 3.00)

SP6 Production of biscuits and macaroni

Kashkadarya Private company

Modernization 07/12/1998 843,634 843,634 10/07/2003 9.09 (ADB rate + 2.39)

SP7 Production of tomato paste and fruit puree

Samarkand JV Modernization 20/01/1999 2,514,699 2,514,699 10/01/2003 9.66 (ADB rate + 3.00)

SP8 Production of waffles with chocolate icing

Tashkent Private company

Modernization 28/01/1999 443,000 443,000 10/07/2003 9.04 (ADB rate + 2.34)

SP9 Production of tomato paste and fruit puree, juices and ketchup

Khorezm JV Start-up 11/02/1999 2,720,000 2,720,000 10/07/2004 9.61 (ADB rate + 2.91)

SP10 Production of ice cream Karakalpakstan JV Start-up 14/04/1999 334,250 334,250 10/07/2003 9.66 (ADB rate + 2.96)

SP11 Production of bread Surkhandarya JSC Modernization 22/06/1999 464,560 464,560 10/07/2004 9.61 (ADB rate + 2.91)

SP12 Production of mineral water in Tashkent Private company

Expansion 23/08/1999 3,003,080 3,003,080 10/07/2005 9.66 (ADB rate + 2.96)

SP13 PET - bottles Navoi JSC Start-up 17/09/1999 2,306,204 2,306,204 10/01/2005 9.61 (ADB rate + 2.91)

SP14 Production of fleece Surkhandarya Private company

Start-up 17/09/1999 298,271 298,271 10/07/2002 9.61 (ADB rate + 2.91)

SP15 Production of mineral water in Navoi JSC Start-up 11/10/1999 3,334,014 3,334,014 10/01/2006 9.78 (ADB rate + 3.00)

SP16 PET - bottles Fergana Private company

Modernization 04/11/1999 292,700 292,700 10/07/2005 9.49 (ADB rate + 2.79)

SP17 Production of beer Tashkent JV Start-up 19/11/1999 700,000 700,000 10/07/2004 9.61 (ADB rate + 2.91)

SP18 Production of milk, yogurt and cheese

Tashkent JSC Start-up 10/12/1999 5,000,000 4,999,998 10/07/2007 9.61 (ADB rate + 2.91)

SP19 Production of plum, Tashkent JV Expansion 10/12/1999 1,245,000 1,245,000 10/07/2005 9.61 (ADB rate + 2.91)

SP20 Apple and pear jams, and condensed milk

Tashkent JV Expansion 10/12/1999 1,495,000 1,495,000 10/07/2005 9.61 (ADB rate + 3.00)

SP21 Shock freezing for fruits and vegetables

Bukhara JV Start-up 14/12/1999 4,990,000 4,990,000 10/01/2005 9.61 (ADB rate + 2.78)

SP22 Production of confectionary (biscuits)

Khorezm Private company

Start-up 17/12/1999 215,000 215,000 10/01/2004 9.66 (ADB rate + 2.96)

SP23 Production of waffles Samarkand JSC Start-up 13/01/2000 301,545 301,545 10/07/2004 9.66 (ADB rate + 2.96)

SP24 Production of beer Tashkent JV Start-up 13/01/2000 4,000,000 4,000,000 10/01/2007 9.66 (ADB rate + 3.00)

SP25 Production of ice cream Kashkadarya JSC Modernization 13/01/2000 285,817 285,817 10/07/2004 9.66 (ADB rate + 2.79)

SP26 Production of chicken sausages Karakalpakstan JSC Start-up 27/04/2000 2,750,000 2,750,000 10/01/2005 9.61 (ADB rate + 2.91)

SP27 Production of juices, fruit concentrates

Samarkand JSC Expansion 27/06/2000 3,400,000 3,400,000 10/07/2006 9.66 (ADB rate + 3.00)

SP28 Production of dairy products Samarkand JSC Start-up 27/06/2000 1,370,582 1,370,582 10/07/2006 9.70 (ADB rate + 2.68)

OVERVIEW OF SUBLOANS

Appendix 3 29

No.Grace Period

Subloan Amount

Repaid ($)

Subloan Amount

Outstanding ($)

Amount in Arrears ($)

Age of Arrears

in Months

Current Status of Subloan

Export Min. 25%

Rescheduled (Y/N)

Number of Employee

Current Class of

Creditworth-iness

Assigned by NBU % USD

SP1 1 year 779,725 402,275 402,275 37 Frozen Yes No 13 2 10% 40,200

SP2 9 months 288,557 0 0 0 Repaid No No 21 - - -

SP3 1 year 524,680 0 0 0 Repaid No No 12 - - -

SP4 6 months 114,230 0 0 0 Repaid No No 10 - - -

SP5 1 year 121,268 1,091,421 1,091,421 47 Frozen No No 20 4 50% 545,700

SP6 20 months 843,634 0 0 0 Repaid No No 22 - - -

SP7 1 year 838,233 1,676,466 1,676,466 41 Frozen Yes Yes 20 3 25% 419,100

SP8 1 year 443,000 0 0 0 Repaid No No 16 - - -

SP9 1 year 348,458 2,371,542 2,371,542 32 Frozen Yes Yes 55 4 50% 1,185,800

SP10 1 year 318,940 15,310 15,310 30 Repaying No Yes 42 4 50% 7,200

SP11 1 year 464,560 0 0 0 Repaid No No 11 - - -

SP12 1,5 year 2,251,538 751,542 196,292 6 Repaying No Yes 40 1 0% 0

SP13 1 year 2,306,204 0 0 0 Repaid Yes No 22 - - -

SP14 9 months 119,743 178,528 178,528 30 Frozen No Yes 11 3 25% 44,600

SP15 1 year 3,334,014 0 0 0 Repaid No Yes 42 - - -

SP16 14 months 292,700 0 0 0 Repaid No No 12 - - -

SP17 15 months 700,000 0 0 0 Repaid No No 14 - - -

SP18 2 year 2,557,109 2,442,889 0 0 Repaying Yes Yes 154 1 0% 0

SP19 1 year 340,476 904,524 904,524 29 Frozen No Yes 27 3 25% 226,100

SP20 1 year 488,522 1,006,478 1,006,478 48 Frozen No Yes 27 3 25% 251,600

SP21 10 months 1,574,001 3,415,999 0 0 Repaying No Yes 48 3 25% 854,000

SP22 1 year 215,000 0 0 0 Repaid No No 10 - - -

SP23 1 year 301,545 0 0 0 Repaid No No 20 - - -

SP24 18 months 1,547,636 2,452,364 52,364 3 Repaying Yes Yes 50 2 10% 245,200

SP25 1 year 285,817 0 0 0 Repaid No No 12 - - -

SP26 2 year 515,249 2,234,751 2,234,751 21 Frozen No Yes 49 4 50% 1,117,400

SP27 18 months 2,722,897 677,103 0 0 Repaying Yes Yes 97 1 0% 0

SP28 1 year 0 1,370,582 1,370,582 49 Frozen No No 23 3 25% 341,600

Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan and subborrowers.

NBU Provision

- = not available, ADB = Asian Development Bank, JSC = joint stock company, JV = joint venture, LIBOR = London interbank offered rate, NBU =National Bank for Foreign Economic Activity of the Republic of Uzbekistan.

30 Appendix 4

SUBPROJECT PROFILES

A. SP3

Company Format: Private1 Subloan Amount: $524,680 Location: Djizakh City Industry: Vegetable and cotton oil production

1. Overview 1. Located in the Djizakh region (about 250 km from Tashkent), SP3 was founded in 1998 to produce sunflower, safflower, and cotton oil. Before the company started, the sponsor ran a bakery with a $50,000 yearly turnover in the same location. The conversion of facilities from a bakery to an extraction plant resulted in an annual turnover of $1 million and $25,000 annual net profit starting from 2000. 2. The purpose of the subloan was to purchase from a French supplier new oil extrusion equipment capable of producing 10,000 tons of raw material annually, processing it with a 14% yield, making about 1,400 tons of oil available for sale (with a selling price of $0.65 per kg for sunflower and safflower oil and $0.70 for cotton oil sold in bulk). The funded production facility was successfully installed, with no cost overruns and delays.

2. Subloan 3. The loan was approved on 15 August 1998 for $524,680 with a London interbank offered rate (LIBOR)-based floating interest rate initially at 9.5% and a 1-year grace period. The maturity of the subloan was 4 years and the subloan was fully repaid in 2003 as per the original repayment schedule.

3. Outcome 4. The subproject currently works at full capacity producing safflower oil (2 months a year), sunflower oil (1 month) and cotton oil (9 months). The cotton seeds for production are purchased from private farms, while sunflower and safflower seeds are harvested by the subborrower itself from the 1,000 ha it rents. The company produces 1,400 tons of vegetable (sunflower and safflower oil) and cotton oil every year.

5. Much of the oil produced is cotton oil, which has almost no export potential because there is no international demand for it. However, there is local demand because cotton oil is traditionally used for cooking. Currently, 100% of the company’s products are sold locally but management plans to export safflower oil (up to 360 tons per year) to Russia and Kazakhstan.

1 A private company is defined as a company owned by one individual.

Appendix 4 31

For this reason, the company used its own resources to purchase equipment to improve the quality of oil produced. 6. The company created 12 jobs (for 9 men and 3 women) equivalent to 50% growth in the number of employees. Edible oils are protected by import duties (10% import duty + 50% excise tax + 20% value-added tax). The impact of devaluation was negative as to be expected for an import-substitution company. However, the profit margin was good for the reasonably low loan amount.

4. Sustainability 7. The funded facilities are in good condition and well maintained and serviced, aided by the fact that their key spare parts are domestically produced. NBU computed the subproject’s financial internal rate of return (FIRR) at 20% and return on equity (ROE) at 35%. The company has adequate liquidity for operation and maintenance. A key success factor is the constant and sufficient supply of sunflower and safflower seeds from the 1,000 ha of rented land. The company also secures a constant and sufficient supply of cotton seeds through direct purchase from private farms.

B. SP7

Company Format: Joint Venture Subloan Amount: $2,514,699 Location: Samarkand City Industry: Production of tomato paste and fruit purees

1. Overview

8. The company was established in 1998 near Samarkand as a J/V between Uzbek (15%) and Bulgarian businessmen (85%). The purpose of the subloan was to purchase Italian equipment to produce tomato paste and fruit concentrates and purees, with a daily processing capacity of 150 tons per day. The subproject’s operations have been suspended since 2003 because of disputes between the Uzbek and Bulgarian sponsors despite the first 2 years’ success. According to NBU, the Uzbek sponsor started a litigation case against the Bulgarian sponsors in an attempt to take over the company. NBU is looking for prospective investors to buy out the company and take charge of it.

2. Subloan

9. The subloan was approved on 20 December 1998 for $2.5 million with a LIBOR-based floating interest rate plus an NBU fixed margin initially at 9.66% and a 1-year grace period. The maturity of the subloan was 5 years. The outstanding balance of the subloan was $1.7 million, and the entire amount was in arrears as of July 2006. Because SP7 has recorded arrears for 41

32 Appendix 4

months, NBU classifies this subloan as substandard. The OEM questioned the appropriateness of this classification.

3. Outcome 10. The company initially employed 20 people (15 men and 5 women) but all were laid off.

C. SP12

Company Format: Private Subloan Amount: $3,363,300 Location: Tashkent City Industry: Bottling of mineral water and beverages

1. Overview

11. SP12 was established in 1991 in Tashkent to produce and sell glass vases. In 1999, NBU approved a subloan to the company to purchase German equipment for bottling mineral water and beverages in 1.5 liter-PET bottles. The company worked at 100% of capacity until 2003. Because of foreign exchange (FX) losses, however, the company applied for rescheduling of repayment by 2 years, and NBU approved it in 2004. In 2005, SP12 suspended its operations for 3 months because of litigation with the tax authorities.2 Despite winning, however, the company had lost so much in sales that the subborrower found it difficult to comply with the amended repayment schedule. Management indicated its plans to apply to NBU for a second restructuring of the subloan. 12. The purpose of the subloan was to purchase German equipment to bottle mineral water (gas and still), with a capacity of 4,200 bottles per hour. The facility was installed as per the original plan, with no cost overruns and delays.

2. Subloan 13. The subloan was approved on 21 May 1999 for $3.5 million, with a LIBOR-based floating interest rate, plus fixed spread, initially at 9.66% and a 1.5-year grace period. The maturity of subloan was 6 years. The outstanding balance of the subloan was $0.8 million, with arrears of $0.2 million as of July 2006. Although SP13 has recorded arrears for 6 months, NBU classifies this subloan as good. The OEM questioned the appropriateness of this classification. 2 In November 2002, Resolution 390 of the Cabinet of Ministers provided tax exemption until 2007 to companies that

had increased production (exempting only the amount of growth), as well as reduced the tax rate by 25% on the remaining base volume of production. In March 2003, however, Resolution 164 was issued, listing the companies entitled to tax privileges described in Resolution 390. SP12 was not on the list. However, the company invoked its right to continue the tax exemption privileges within 2 years after the abolition of such privileges in accordance with the law protecting the rights of entrepreneurs. Tax authorities defended this in the court, stating that the company enjoyed these tax exemptions illegally.

Appendix 4 33

3. Outcome 14. The subproject currently works at 60% of capacity. The subproject proved to be marginally successful under professional management. The subborrower indicated that 100% of the produced mineral water and carbonated beverages have been sold domestically. Last year the company sold mineral water and beverages for almost $950,000 (20% of capacity). The company indicated a profit of only $1,000 in 2005, due to the significant FX loss recorded every year since 1999. The company initially employed 40 people full-time (36 men and 4 women).

4. Sustainability 15. The funded facilities are in very good condition and well maintained and serviced. NBU computed the subproject’s FIRR at 30.1% and its ROE at 20.2%. Environmental, social, technological, and natural resource (input supply) risks are very low. SP12 has a wasteless technology using only electro energy to operate the facility. The company has no expansion plans.

D. SP15

Company Format: Joint Stock Subloan Amount: $3,334,014 Location: Navoi City Industry: Production of beer

1. Overview

16. The company was established in 1999 in Navoi (about 500 km from Tashkent). It seems to have been extremely well run and managed from the beginning, making it one of the most successful subprojects under the REDP. The subloan was for the purchase of German equipment to produce beer, with an annual capacity of 3 million liters. Implementation was satisfactory, without delays and major cost overruns. Using modern equipment, together with imported malt, yeast, and hops, and good water treatment, the company produces high-quality beer and sells it across several regions in Uzbekistan, including Tashkent.

2. Subloan 17. The subloan was approved on 27 September 1999 for $3.3 million, with a 9.78% interest rate and 1-year grace period. The maturity of the subloan was 6 years, and the subloan was fully repaid as per original schedule.

34 Appendix 4

3. Outcome 18. The subproject currently works at full capacity. It proved to be successful under professional management. The subborrower indicated that 100% of the produced beer is sold domestically. However, management is considering exporting beer to neighboring countries. The company employs 42 people full-time (36 men and 6 women).

4. Sustainability 19. The funded facilities are in very good condition and well maintained and serviced. The company has adequate liquidity for operation and maintenance. Environmental, social, technological, and natural resource (supply of inputs) risks are relatively low since operations are monitored by the German equipment supplier. The management is looking for opportunities to attract investments to double the subproject’s capacity.

E. SP18

Company Format: Joint Venture (initially joint stock)

Subloan Amount: $4,958,318 Location: Tashkent City Industry: Shock-freezing of fruits and vegetables and jam production

1. Overview 20. The company was founded in 1999 in Tashkent for shock-freezing of fruits and vegetables. Last year, the company was transformed into an Uzbek–Swiss joint-venture company with the majority of shares belonging to the Swiss partner. The OEM could not obtain detailed information on the J/V partner. The subproject is a marginal success, using 40% of capacity. The main problem lies in its location, 300–400 km away from the fruit-rich regions mainly in Fergana valley, leading to low-quality final products because of spoilage. In addition to engaging in the shock-freezing business, the company is trying to diversify by building a slaughterhouse and greenhouse on the premises as well as by packing tea. 21. The purpose of the subloan was to purchase Italian and Austrian equipment to produce jam, with production capacity of 1,200 tons per year; 6,984 m2 of food storage refrigerators; and shock-freezing equipment with production capacity of 2,000 tons per year. The financed facilities were installed as per the original plan with no cost overruns and delays.

Appendix 4 35

2. Subloan 22. The subloan was approved on 10 December 1999 with an approved amount of $5 million. The amount disbursed was nearly $5 million, with a LIBOR-based floating interest rate plus a fixed spread initially at 9.61% and a 2-year grace period. The maturity of the subloan was 7 years. Repayments and interest payments were rescheduled because of low capacity use. The company repaid $2.5 million out of the initial $5.0 million at the time of the OEM. Management plans to repay the rest of the subloan by 2009 according to a new schedule, and currently no arrears are recorded.

3. Outcome 23. The subborrower noted that 100% of its frozen fruits and vegetables as well as jams have been exported to Russia. Last year, the company exported produce worth $1.1 million. However, the export earnings were not enough to repay the subloan, and the company recorded significant FX losses amounting to about SUM2 billion from the beginning of 2000. The company employs 154 people full-time (127 men and 27 women).

4. Sustainability 24. The funded facilities have been well maintained and serviced. NBU computed the subproject’s FIRR at 4% and ROE at 18%. The company’s procurement program has included 75–100% prepayment to farmers for fruits and vegetables 6–7 months before harvest. Unless this procurement system is rationalized, it may be difficult to significantly raise the company’s capacity use ratio.

F. SP19

Company Format: Joint Venture (initially a joint-stock company) Subloan Amount: $1,245,000 Location: Tashkent City Industry: Production of biscuits

1. Overview 25. The company was established on 17 September 1998 to produce biscuits. The subloan was used to purchase Italian equipment to produce biscuits (500 kg per hour). The facility was installed as per the original plan with no cost overruns and delays. Since 2001, the company has been facing management problems on account of disputes between the initial sponsors, resulting in suspension of its operations for 4 years. The OEM could not find the reason for the disputes. In 2005, SP20-A, an Uzbek–Kazakh J/V company, bought 100% of SP19. SP19 resumed its operations under the new management.

36 Appendix 4

2. Subloan 26. The subloan was approved on 10 December 1999 for $1.2 million, with a LIBOR-based floating interest rate plus NBU’s fixed margin initially at 9.61% interest rate and a 1-year grace period. The maturity of subloan was 5 years. The entire outstanding balance of $0.9 million was recorded as arrears at the time of the OEM. The company recorded arrears for 29 months, and NBU classified the subloan as substandard. The current management plans to repay the loan in accordance with the revised business plan that has been presented to NBU.

3. Outcome 27. This subproject can potentially be a good case of turn around made by new investors. Currently, both SP-19 and SP-20 work as one company—SP-20-A—managed by the Kazakh partner, which has five flour mills in Kazakhstan. The merger led to efficiency gains through sharing of management resources and marketing channels, and the vertical integration resulted in constant and sufficient supply of inputs. The project works at 90% of capacity. The subborrower indicated that 100% of the produced waffles have been sold domestically. The subborrower indicated that total turnover for the last 5 months was SUM447 million, with forecasted annual sales of SUM1.2 billion. The company initially employed 27 people full-time (12 men and 15 women). Management plans to start exporting to Kazakhstan and Tajikistan once the company obtains a new packing line for these products.

4. Sustainability 28. The funded facilities are in very good condition and well maintained and serviced. The company has adequate liquidity for operation and maintenance. NBU expects the company to become profitable soon and to fully repay the subloan under professional management.

G. SP20

Company Format: Joint Venture (initially joint stock) Subloan Amount: $1,495,000 Location: Tashkent City Industry: Production of waffles

1. Overview

29. The company was established in 1995, invested by SP19’s original sponsors, to produce waffles. The subloan covered the purchase of the German equipment to produce waffles (200 kg per hour). Equipment was installed as planned, with no overruns and delays. Because of the dispute among the sponsors, the company had been unprofitable since 2001. In 2005, SP20-A, an Uzbek–Kazakh J/V company, bought 100% of SP20 and merged it with SP19.

Appendix 4 37

2. Subloan

30. The subloan was approved on 29 December 1999 for $1,495,000, with a LIBOR-based floating interest rate plus NBU’s fixed spread initially at a 9.61% interest rate and with a 1-year grace period. The maturity of the subloan was 5 years. The entire outstanding balance of $1 million was recorded as arrears at the time of the OEM. The company has recorded arrears for 48 months, and NBU classifies this subloan as substandard. The current management plans to repay the loan in accordance with the revised business plan that has already been presented to NBU (see paras. 27 and 28 as to the outcome and sustainability).

H. SP21

Company Format: Joint Venture Company Subloan Amount: $4,990,000 Location: Bukhara City Industry: Production of beer

1. Overview

31. The J/V company was established in 1995 to produce beer, mineral water, and soft drinks. The OEM could not get detailed information on the company’s German partner. The subloan was for the replacement of Soviet-era equipment with modern German equipment, with an annual capacity to produce 10 million liters of beer. This was the largest subloan under the REDP. 32. Equipment supply and installation were significantly delayed. The initial reason was the change in equipment initiated by the subborrower after NBU’s approval of the loan. The company’s management persuaded a leading German manufacturer of beer production equipment to sell him the equipment at a discount, with assurances of more equipment sales in Uzbekistan. The company said that the German producer found the deal unattractive, causing a major delay in installing and fine-tuning the equipment. Consequently, it took almost 3.5 years to start production. 33. After production started in 2003, the company faced marketing problems, resulting in initial capacity use of only 15%. Despite the significant delay in operations and less-than-expected initial sales, the company managed to repay the principal amount of the loan and interest using proceeds from the owner’s other operating activities. In March 2006, following a half-year negotiation with NBU officials and direct involvement of the Prime Minister, the company restructured this loan and now operates at 60% of capacity.

2. Subloan

34. The subloan was approved on 31 December 2000. The approved and disbursed amount was $4.99 million, with an ADB-based floating interest rate plus NBU’s fixed margin of 2.96% initially at 9.66% with a 2-year grace period. The maturity of the subloan was 5 years. The

38 Appendix 4

repayment performance was satisfactory until mid-2005, after which the company went into arrears because of the lack of working capital, which had been fully used to repay the loan. The subborrower applied for restructuring at the end of September 2005 and obtained approval in March 2006 to extend the loan until 2011. The outstanding balance of this subloan was $3.4 million with no arrears.

3. Outcome

35. The subborrower indicated that 100% of the produced beer was sold domestically. However, management considers the possibility of exporting beer to neighboring countries. The company employs 48 people full-time (38 men and 10 women). The number of employees remained the same before and after the subproject. The beer industry is protected by the high excise tax against imported beer. Russian beer is about twice more expensive than the beer produced by the subborrower. The company recycles 80–90% of beer bottles.

4. Sustainability

36. The funded facilities are in very good condition and well maintained and serviced. NBU calculated the FIRR of the subproject at 9.2% and the ROE at 13%. The company has adequate liquidity for operation and maintenance. NBU expects the company to become profitable soon and to fully repay the subloan under professional management.

I. SP23

Company Format: Joint Stock Company Subloan Amount: $301,545 Location: Samarkand City Industry: Production of chicken sausage and

sausage meat

1. Overview

37. A subsidiary of one of the largest domestic producers of chicken, eggs, and meat,3 the company was established in 1999 to produce chicken sausage. SP23 subsequently merged with the parent company, which comprised two chicken farms, and has enjoyed the full benefits of vertical integration, offering a constant and sufficient supply of chicken meat. One chicken farm produces meat and the other eggs. Hens that stop producing eggs are also used to produce sausage.

38. The subloan covered the purchase of German production equipment. Daily capacity was 1.5 tons of chicken sausage selling at $2.50 per kg, for annual sales of SUM300 million. The production facility was installed as planned, with no cost overruns.

3 SP27 is also affiliated with this company.

Appendix 4 39

2. Subloan

39. The subloan was approved on 13 January 2000 for $301,545 with an ADB-based floating interest rate plus a fixed NBU margin of 2.96% initially at 9.66% and a 1-year grace period. The maturity of subloan was 5 years. The subloan was repaid 2 years ahead of maturity.

3. Outcome

40. The project currently works at 100% of capacity. The subborrower indicated that sausage might potentially be exported to neighboring countries such as Afghanistan, Tajikistan, and the Kyrgyz Republic. However, because of problems with storage facilities in those countries, the subborrower prefers to work domestically. The company initially employed 20 people (10 men and 10 women). Jobs are now available in Tashkent since the subproject moved its equipment from Samarkand. Local producers enjoy import protection benefits that allow them to compete with foreign producers.

4. Sustainability

41. NBU calculated the FIRR of this subproject at 44% and the ROE at 50%. The company has adequate liquidity for operation and maintenance. On this basis, NBU considers this subproject as financially viable.

J. SP24

Company Format: Joint Venture Subloan Amount: $4,000,000 Location: Tashkent City Industry: Production of tomato paste and fruit concentrates and purees as well as jams and juices

1. Overview of the Company

42. The J/V company was established by a domestic sponsor (40% shareholding) and partners from the United States (40%) and the Republic of Korea (20%). The company produces tomato paste, and fruit concentrates, juices, and jams. The OEM could not get detailed information on these foreign partners. The subloan covered the purchase of facilities from Italy, Germany, and the United States to produce tomato paste and 1,300 tons of fruit puree and concentrates per year. Facilities were installed on schedule with no cost overruns. With the expansion of the domestic sponsor’s other business, aggravated by FX losses amounting to SUM2 billion, the company faced a liquidity problem and applied for rescheduling of the subloan. NBU accepted this request. The company currently uses 90% of capacity.

40 Appendix 4

2. Subloan

43. The subloan was approved on 13 January 2000 for $4 million, with a LIBOR-based floating interest rate plus NBU’s fixed margin initially at 9.66% and a 1-year grace period. The maturity of the subloan was 7 years. The outstanding balance of this subloan was $2.50 million with arrears of $0.02 million as of July 2006. The company’s management noted that it planned to fully repay the subloan by the end of this year as scheduled.

3. Outcome

44. The subproject currently uses 90% of capacity. The subborrower indicated that over 80% of its fruit concentrates and tomato paste are being exported to Russia. The rest are used to produce juices and jams sold domestically. Export earnings constitute 30% of total revenue. Management plans to export juices to Kazakhstan and Tajikistan. The company initially employed 50 people full-time (26 men and 24 women).

4. Sustainability

45. The funded facilities are in very good condition and well maintained and serviced. NBU calculated the FIRR of the subproject at 26.5% and the ROE at 38.3%. The company has adequate liquidity for operation and maintenance. On this basis, NBU considers this subproject financially viable.

K. SP27

Company Format: Joint Venture (initially joint stock) Subloan Amount: $3,400,000 Location: Samarkand City Industry: Production of tomato paste and fruit concentrates and purees

1. Overview

46. The company was established in April 2000 as a subsidiary of one of the largest domestic producers of chicken eggs and meat (footnote 3). The subloan covered the purchase of Italian and German equipment to produce tomato paste and fruit puree (600 tons of tomatoes and 120 tons of fruits as raw material per day) and fruit concentrates (450 tons of apples and grapes as raw material per day). Production facilities were installed on schedule, with no cost overrun. Immediately after getting the subloan, the company was transformed into an Uzbek–American J/V to enjoy certain tax benefits provided by the Government to J/Vs. In 2005, the share of the initial founder from the US was purchased by another US company. The OEM could not obtain detailed information on the J/V partner.

Appendix 4 41

2. Subloan

47. The subloan was approved on 27 June 2000. The approved and disbursed amount was $3.4 million, with a LIBOR-based floating interest rate plus fixed NBU margin initially at 9.66% and a 1-year grace period. The maturity of subloan was 6 years. Repayments and interest payments have been on time, and the company plans to fully repay the loan by the end of this year as originally scheduled.

3. Outcome

48. The project works at full capacity. The subborrower indicated that 100% of the produced fruit concentrates and tomato paste are exported to Russia. Last year the company exported 10,000 tons of tomato paste and 1,000 tons of apple concentrates. Taking into consideration the favorable international prices for these goods last year, the project sponsors enjoyed high profits from operations partly residing in their own trading houses in Russia. The subborrower indicated an accounting profit of SUM600 million with annual sales of SUM7 billion. The company initially employed 97 people full-time (77 men and 20 women). In addition, the company seasonally employs 150 more people (75 men and 75 women). The products’ export competitiveness is proven by 100% export sales.

4. Sustainability

49. The funded facilities are in very good condition and well maintained and serviced. NBU calculated the FIRR of this subproject at 36.9% and the ROE at 60%. Environmental, social, technological, and natural resource (input supply) risks are very low, since the company owns 1,000 ha on which to grow tomatoes, and purchases the rest of the raw materials from farmers on a competitive basis. On this basis, NBU considers this subproject viable.

L. SP28

Company Format: Joint Venture Subloan Amount: $1,370,582 Location: Samarkand City Industry: Production of cookies

1. Overview

50. The startup company was founded in 1999 as a subsidiary of a wholesale trading company founded by SP27 and several individuals. The subloan covered the purchase of modern Italian facilities with an annual production capacity of 5,000 tons of cookies, assuming a selling price of $0.15 per 100-gram pack, potentially making annual sales of $5 million for at least $750,000 of net profits.

42 Appendix 4

51. The subproject failed mainly because of technical reasons. The equipment supplier failed to deliver and properly install equipment on time. The company encountered problems with technical support and maintenance, resulting in a 6-month production delay that eroded the working capital. After 4 months’ operation in 2003, the company stopped production after it failed to reschedule the subloan from NBU. NBU froze the accounts of the company as well as of its parent company in an attempt to recover the subloan. The subborrower indicated that it could not reach full production capacity because of some technical problems with the equipment. The equipment was repaired and fine-tuned by the producer twice under the warranty agreement, with some payment received from the supplier to compensate for a delay in delivery and installation. The bank used this money to repay an interest payment. The Italian producer could not fix the technical problem and the subborrower was forced to use a local engineer, who was successful. Because of these problems, the subborrower ran out of working capital and was forced to stop production. 52. The company initially employed 23 people (9 men and 15 women). All of them were laid off. The subborrower noted that it found a Kazakh investor who would buy the company and shoulder of the subloan.

2. Subloan

53. The subloan was approved on 27 June 2000 for $1.4 million, with a LIBOR-based floating interest rate plus NBU’s fixed margin initially at 9.7% and a 1-year grace period. The maturity of the subloan was 5 years. The entire outstanding balance of $1.4 million was recorded as arrears at the time of the OEM. The company has recorded arrears for 49 months, and NBU classified the subloan as substandard. The OEM questioned the appropriateness of this classification.

Appendix 5 43

ASSESSMENT OF THE NATIONAL BANK FOR FOREIGN ECONOMIC ACTIVITY OF THE REPUBLIC OF UZBEKISTAN

A. Overview

1. National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) was formed as a joint-stock company in September 1991 with 16 state-owned enterprises as the original shareholders. At the time of approval of the Rural Enterprise Development Project1 (REDP), the Government was the sole shareholder of the NBU. NBU’s charter provides that up to 40% of its shares can be sold to foreign and domestic banks, with the Government maintaining a 60% stake. The Government’s 100% shareholding of the NBU has continued to date. 2. NBU’s charter stresses two important priorities for lending: (i) to meet the Government’s foreign currency investment needs for the development of the production sector, especially for exporting goods; and (ii) to finance projects that involve transferring new technology and know-how to the country, processing agriculture raw materials, modernizing industrial enterprises, and creating jobs by producing consumer goods. NBU had a 100% tax exemption from 1991 to 1995, and a 50% tax exemption from 1996 to 2000.2 Under an operational strategy adopted in 1995, NBU has strengthened its commercial banking functions; promoted small and medium-sized enterprise (SME) lending, opened a subsidiary bank in Russia in 1996, and moved into retail banking from 1996 and deposit taking from individuals beginning in 1997. NBU has also diversified its operations into investment banking and set up several subsidiary companies engaged in leasing, insurance, and other related service businesses. As of the end of 2004, NBU comprised 54% of Uzbekistan’s banking sector’s total assets, 62% of the aggregate capital, and recorded 33% of the banking sector’s total net profits in 2004.3 3. NBU’s lending is a combination of development and commercial banking. The development banking portion of the portfolio is represented by Government-guaranteed credits and loans made at subsidized interest rates. Around 83% of NBU’s total loan portfolio is guaranteed by the Government.4 Less than 5% of NBU’s portfolio comprises loans extended at concessional interest rates required by the Government, mainly to support cotton and wheat farms and social sector initiatives. The commercial banking operations include foreign exchange (FX) loans to SMEs that have been funded by credit lines from foreign financial institutions. Most of these SME loans, including those under the ADB and the European Bank for Reconstruction and Development (EBRD) credit lines, were not guaranteed by the Government. On the liability side, however, NBU’s payable to ADB and EBRD (corresponding to these SME loans) is fully guaranteed by the Government5 reflecting its development priority. From this

1 ADB. 1996. Project Completion Report on Rural Enterprise Development Project in Uzbekistan. (Loan 1504-UZB,

for $50 million, approved in December) Manila. 2 As agreed with the Government, NBU used the tax benefits for the purchase of the headquarters building,

expansion of the branch network, and other physical development and infrastructure building. 3 Uzbekistan’s banking sector consists of 29 commercial banks, including 3 state-owned banks (NBU, Asaka bank,

and People’s Bank), 12 joint-stock banks, 9 private banks, and 5 joint-venture banks. The banks’ market share is concentrated with nearly 90% of total assets being held by five major banks.

4 The Ministry of Finance and NBU jointly appraise the applications for Government guarantees in view of eligibility and viability of projects, and the cabinet ministers make the final decision. The eligibility criteria and the special appraisal procedures for guarantees are defined in the Government Special Resolutions.

5 For this reason, NBU considers this portfolio virtually guaranteed by the Government (To be precise, the borrower of the ADB loan for REDP was the Government, while the Government relent the loan to NBU. In contrast, the EBRD credit lines were directly extended to NBU with a Government guarantee.)

44 Appendix 5

perspective, FX loans to SMEs tend to have both commercial and development banking elements. 4. In April 2005, the Government announced a comprehensive program on banking reforms, which included a set of actions to privatize6 NBU and Asaka Bank before 2007 and 2009, respectively. The privatization of these banks has been delayed to 2009 and 2007 respectively. B. Organization, Management, and Staffing 5. The structure of the top management of NBU represents bimodal collegiate system of management, comprised of the Council and the Board of the Bank, which is supervised by the Council. The Council of the Bank consists of five members: the minister of finance (chair), and representatives of the ministries of foreign economic relations, investments and trade, and of economy; of the State Public Property Committee; and of the Central Bank. The management board consists of the chair of the board, 4 deputies, and 9 executive directors of the main departments. The board consists of four executing committees responsible for (i) asset and liabilities management, (ii) bank's credit policy, (iii) conformity with internal inspections and control instructions, and (iv) operational and financial performance. These committees meet as required but not fewer than 2 or 3 times a month. 6. Deputies and members of the board report to the chair. In 2003, NBU divided its activities into four main lines of business (corporate banking, retail banking, investment banking and business development) to improve decision making and to peg the performance of each group to compensation. 7. The number of NBU bank offices has grown from a single office in 1991 to 93 full service branch offices, 100 subbranches (mini-banks), and 165 cash-point offices. The mini-bank offices offer cash, transfer, and deposit services but no lending, and are staffed by 2 to 6 employees. The cash-point offices are housed inside other institutions and serve cash, transfer, and deposit needs of individuals within that institution with staff of 1 or 2 bankers. Branch, mini-bank, and cash-point expansion occurred mainly from 2003 to 2006. As a result of the expansion of the branch network and propagation of banking products and services, the number of bank employees has grown over the last 10 years from 100 to about 6,000 at present. During 1998, staff salaries were pegged to the minimum wage, causing widespread reduction in salaries. Through 2003 salary increases were stagnant and some employee benefits were removed. The initial staff turnover in 1998 was about 15% and subsequent years saw another 15% to 25% of turnover. Since then, there have been modest salary increases and new benefits offered in order to attract and maintain staff. 8. Since 2004, there had been several replacements in NBU's top management and other management posts (including department heads). Several Operations Evaluation Mission (OEM) interviewees mentioned that the media reported links between these personnel transfers with possible incorrect conduct in NBU.7 They also pointed out that a large percentage of

6 In 2004, the Government privatized state shares in seven medium-sized banks. Under the law, a bank is

considered private if 51% or more of its shares are owned by individuals. 7 “The head of the Uzbek Prosecutor-General’s Financial Crimes Directorate, Ramazon Polatov, announced on 26

July that 14 former officials of the National Bank of Uzbekistan for Foreign Economic Relations have been sentenced in absentia to prison terms for corruption, embezzlement of state property, and bribery, Interfax and uzreport.com reported” (Uzbekistan Daily Digest, 27 July 2005. http://www.eurasianet.org/ resource/uzbekistan/ hypermail/200507/0032.shtml). However, NBU challenged the veracity of these reports and stated that in the end there was no court examination in relation to NBU employees.

Appendix 5 45

nonperforming loans have become a concern to the Government in recent years. NBU management denied it.

C. Operational Performance 9. Multiple Functions. NBU’s lending is a combination of development and commercial banking as mentioned earlier. NBU’s balance sheet does not make a distinction in its loan portfolio between Government-guaranteed credits, loans made at subsidized interest rates, and other commercial loans. Thus, the OEM could not fully verify how these loans are funded. Neither NBU’s accounting nor its organizational structure separate these loans adequately. The Ministry of Finance (MOF) noted that the proportion of state-guaranteed loans, including those funded by multilateral development agencies, has been gradually reduced in recent years. MOF expects the proportion of state-guaranteed loans to be further reduced in conjunction with the establishment of the Fund for Development and Reconstruction in 2006 (para. 14). ADB’s country strategy and program pointed out that “banks have acted as agents of the Government in enforcing monetary and fiscal policy by (i) controlling cash supply and liquidity, (ii) monitoring financial transactions of depositors, and (iii) automatically deducting outstanding taxes from depositors on behalf of tax authorities.”8 The OEM could not fully verify to what extent NBU has been relieved of these operations. The mechanism to arbitrate the multiple functions (which can be in conflict with each other in some cases) in NBU is not transparent. 10. Credit Policies. During TA 2714-UZB9 the consultant reviewed NBU’s credit policies and procedures, provided the bank with 27 specific recommendations, followed by a draft manual for NBU to use when adopting new ADB-wide procedures. Since 1998, nearly all the recommendations have been adopted in varying degree, bringing NBU’s credit policies more in line with good banking practices. 11. Loan Appraisal. In line with the credit policy and procedures, an appropriate system of authorities for loan approvals has been put in place. Branch, regional office, and the Headquarters (HQ) credit committees have each been assigned independent lending authority levels. Loans above a credit committee authority are referred to the next level, up to NBU’s council for approval of loans above 25% of tier-I capital. The originating credit officer retains responsibility for monitoring his or her loans, even when approval came at a higher level. Loans originated at a branch are maintained on the branch’s balance sheet. 12. NBU has developed its own software for managing branch operations and loan account details, which is maintained at the branch level. Only summary totals are forwarded to HQ each evening for consolidated financial statements. HQ is in the process of upgrading this system to a more robust international software package that will give the bank much better control of their loan portfolio and overall bank account information. The project appraisal software used by credit officers and provided under TA 2714-UZB has been replaced by a simplified Excel spreadsheet program, which is inadequate for the larger more complex SME projects. It is in need of upgrading to one of the more comprehensive packages now available in the market. 13. Portfolio Management. Credit officers monitor repayment on their loans daily, respond to past-due payments immediately with an initial warning letter and follow-up visits with clients.

8 Reference to ADB. 2006. Country Strategy and Program (2006–2010): Uzbekistan. Manila (see Appendix 3, para.

68). 9 ADB. 1996. Technical Assistance to the Republic of Uzbekistan for Institutional Strengthening of National Bank of

Uzbekistan. Manila (TA 2714-UZB, for $830,000, approved on 17 December).

46 Appendix 5

A monitoring visit plan is developed on a loan-by-loan basis as part of weekly credit department meetings between management and officers. Monitoring of loans that are not yet past due is not as well developed, so problems may go undetected for a long time. Software used for credit monitoring is only marginally supportive of these activities. The benefit monitoring and evaluation (BME) system implemented as part of TA 2714-UZB is no longer in use and, therefore, BME reporting on subloans to ADB is prepared manually. 14. Fund for Reconstruction and Development. The Government formed this fund with charter capital of $1 billion. The main founders of the fund are MOF and other commercial banks and domestic enterprises. Support from external funding agencies is expected. The main objective of the fund is to support large development projects considered strategic by the Government, such as agriculture, mining, oil, transportation, and the social sector. 15. Deposit Taking. The number of depositors in both national and foreign currencies grew dramatically from 15,600 accounts in 1999 to 602,000 corporate and retail customers by 2005, mostly because of NBU’s branch network expansion and move into a broader range of retail banking services. While NBU has added a large number of customer accounts since 2002, the growth in account balances has been small in comparison.

D. Financial Performance 16. Table A5.1 summarizes the key financial indicators of the NBU based on the financial statements (denominated in US dollar)10 submitted to the operations evaluation mission.

10 NBU’s annual reports included the financial statements denominated in sum. However, this PPER used the

financial statements denominated in dollars since NBU’s lending and funding are mainly denominated in the US dollar.

Appendix 5 47

Table A5.1: Key Financial Indicators ($ million, unless otherwise specified)

Year End 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 Total Assets 3,427 3,402 3,629 4,119 3,913 3,799 2,903 3,059 2,920 2,512 Net Customer Loans

1,142 1,457 1,884 2,078 2,227 2,223 2,166 2,358 2,219 1,945

Interstate Credits — 768 1,075 1,222 1,450 1,543 1,504 1,622 1,445 1,083

Deposits from Customers

— 675 623 659 440 387 349 442 499 542

Risk weighted Capital Adequacy Ratio (%)

62.1 77.6 68.6 76.0 40.4 34.8 34.0 31.0 26.0 29.1

Debt Service Coverage (%)

— 5.6 3.3 3.3 2.2 2.2 2.2 1.5 1.5 1.3

Debt to Equity Ratio

6.7 5.6 5.4 5.5 4.9 5.0 6.1 5.4 5.9 5.1

Total Revenues 252 272 291 335 334 262 189 142 150 180

Funding Cost (%) 3 3 4 4 6 5 5 3 3 5 Net Interest Margin (%)

— 14 12 12 14 11 7 4 5 7

Non-interest expense/ operating income (%)

6 13 20 21 20 25 13 37 39 23

Interest Expense/ Operating Income (%)

39 40 44 43 60 61 60 55 51 58

Return on Average Assets (%)

4.3 2.4 1.9 1.9 0.7 0.8 (3.5) 0.38 0.63 0.3

Return on Equity (%)

25.5 15.8 11.9 11.5 4.2 0.5 2.0 2.5 2.3 2.1

— = not available. Source: Compiled from data supplied by the National Bank for Foreign Economic Activity of the Republic of Uzbekistan. 17. Asset Growth and Structure. Total assets of the bank grew by 20% from 1996 to 1999, when they peaked at $4.1 billion. From 1999 to 2005, total assets have steadily declined to their current level of $2.5 billion, a 27% reduction overall. This decline has been in three areas: cash, due from banks, and loan balances. Cash saw its largest drop in 2003, of $220 million, when the Government began moving its treasury funds to the central bank and in 2004 when management of the Government’s gold and currency reserves also moved to the central bank. At the same time NBU lost its position as the only bank authorized to transfer foreign currency and as other banks took over much of this business in 2002, $634 million of their funds moved out of NBU, bringing “due from banks” from nearly $1.1 billion in 1996 to $6 million at the end of 2002. The loan portfolio initially grew 53% from 1996–2000 with the expansion of the branch network, but steadily declined from $2.4 billion at the end of 2003 to $1.9 billion at the end of

48 Appendix 5

2005.11 The Government guarantees around 80% of NBU’s portfolio, which influences the bank to lend at lower interest rates.12 18. NBU’s lending operations from 1993 to 2004 included (i) project finance amounting to $4.9 billion for 171 projects with the total cost of $6.9 billion, (ii) SME finance amounting to $226 million for 141 projects with a total cost of $443 million, and (iii) microcredit amounting to SUM3.8 billion for 967 projects. 19. NBU’s annual report 2004 indicated that its SME lending steadily increased from SUM50 million in 2001 to SUM106 million in 2004.13 However, the significantly reduced intermediation of foreign loans in 2005 (para. 21) may immediately translate into contraction of its SME lending. The heaviest concentration in the SME loan portfolio is in food industry (42%) and light industry (31%) at the time of the OEM. 20. Capitalization and Liabilities. The capital adequacy ratio of NBU has decreased over the last 10 years from 62% in 1996 to 29% at the end of 2005, but is still significantly above the ADB requirement of 8%. The large drop in the ratio during 2000 was caused by a change in the method of calculation that more properly takes into account a risk assessment on the Government-guaranteed loans, which were more than 80% of the portfolio. This ratio may still be distorted by the underestimation of risk associated with guaranteed loans. 21. As of the end of 2005, funding for NBU’s operations was sourced from interstate credits—international governments and development banks (52%),14 Government (19%), customer accounts (26%), and other liabilities (3%). The portion of interstate credits of total liabilities grew from 27% at the end of 1997 to its peak at the end of 2003 at 63% before declining to 43% at the end of 2005. Customer deposits declined from 23% of the liabilities in 1997 to 12% in 2001, but have now grown back to 26% and are slowly replacing other sources of funding. The debt–equity ratio has remained relatively stable and at the end of 2005 was 5.1. 22. Income Structure. Over the last 10 years, total revenues of NBU have significantly declined, especially from interest on loans, whereas 2005 saw a 20% increase in profits over 2004. NBU’s net interest margin has steadily dropped to its current level of 7%. The debt service coverage ratio has progressively declined from 5.6 in 1997 to 1.3 at the end of 2005, but is still above the ADB requirement of 1.25.15 Increased loan-loss provisioning was another reason for reduced earnings. In 2002, NBU began a more rigorous provisioning of its loans, which has continued through 2005. Key to this change in provisioning are the Government-guaranteed loans, which are now being partially provisioned, as opposed to 0% before 2002. NBU management noted that it strictly followed this new provisioning policy. Nevertheless, the OEM’s review of the asset classification and provisioning status of the subloans under the REDP suggested that NBU’s loan-loss provisioning may not be adequate.

11 Also in sum, the loan portfolio constantly decreased from SUM2,181 billion at the end of 2003 to SUM2,882 billion

at the end of 2005. 12 The OEM could not verify the Government’s influence over the setting of interest rates on their guaranteed loans. 13 The 2004 annual report does not indicate if these are approved or disbursed amounts. 14 NBU’s 2003 and 2004 annual reports reported these to be ADB, EBRD, International Development Bank, IFC,

Kreditanschdalt fur Widerafbau (KfW), Islamic Development Bank, Eximbank of China for the People’s Republic of China, and OPEC. In addition, the interstate credits include the Government’s cofinancing portion of the projects funded by these international financial institutions. The OEM could not verify the proportion.

15 The OEM could not independently verify this ratio because of lack of information.

Appendix 5 49

23. Funding Cost and Operational Efficiency. NBU’s funding cost of 3.3% in 1996 increased as more foreign credit lines were used through 2000 to 5% where it has remained. The spread between the cost of funds and net interest margin is only 2% in 2005, as compared to a 10% spread in 1997. Non-interest expense, as a portion of the operating income, grew steadily with the expansion of the branch network until 2005 when it began to decline again. The 2005 rate of 23% reflects the lower costs of operating in Uzbekistan as much as NBU’s efficiency. 24. Profitability. Both performance indicators—return on assets and return on equity—have declined over the last 10 years. Return on assets has declined from just 3.3% to its current 0.4%. Return on equity has declined by a more extreme degree—25.5% to 2.2%. The decline in profitability is predominantly caused by a sharp reduction in interest income starting in 2002 and increased loan-loss provisioning.

E. Portfolio Performance and Risk Management 25. Asset Classification. NBU implemented stricter asset classification than the central bank requirement on the advice of the TA consultant (Box). In the new practice, factors affecting the subborrowers potential for repayment are considered in addition to the number of days the loan is past due. From 1996 to 2002, few loans were classified below substandard and none as loss (Table A5.1). Since 2002 a more realistic proportion of loans have moved into these categories, but with the largest majority still good and satisfactory. The OEM reviewed the classification of loans under the REDP credit line and found none were placed in category 5 (loss) and a business that had not operated in 6 years was rated category 4 (doubtful). This finding may indicate under-classification in the total portfolio as well.

50 Appendix 5

Box: NBU’s Portfolio Classification System and Loan-Loss Provisioning

1. The quality of credit is subdivided into five categories—good, satisfactory, substandard, doubtful, and bad—subject to the borrower’s financial standing, creditworthiness, repayment prospects, relevant and duly registered collateral, and number of outstanding days. 2. Good Credit. Timely repayment is beyond doubt. The borrower is financially sound, has a high level of equity provision, high operating ratios, and short period of return on accounts receivable. In assessing reputation, the borrower’s attitude to previous liabilities is vital. Reliable collateral (movable or immovable property, guarantees, and warranties) is required, particularly liquid assets and liabilities enhancing the borrower's creditworthiness. A credit is considered secured when backed by collateral, sufficient to cover the principal and interest, which the bank can claim under the applicable law. All collateral documents should be registered in an established order. Credit under this category should not show signs that it will not be repaid. A general provision of 1% of the portfolio is adequate. 3. Satisfactory Credit. Considered outstanding from time to time, 30–60 days with collateral and up to 30 days with partial collateral. The borrower’s financial standing should be stable, but there may be some unfavorable circumstances or causes for concern. This category includes also loans with poorly prepared credit files or insufficient collateral documentation. Needs provisioning at 5–10%. 4. Substandard Credit. Has pronounced signs of inadequate credit quality, hampering repayment. The initial source of repayment is insufficient to service debt, and a bank is forced to look for additional sources of repayment, such as collateral, sale of fixed assets, refinancing, or injection of fresh capital. A borrower’s current financial standing or creditworthiness does not protect it. Credits have larger-than-normal risk caused by a lack of satisfactory financial information or insufficient collateral documents. Outstanding debt is 60–180 days with collateral, 30–60 days with partial collateral, and up to 30 days if unsecured. Needs provisioning at 25%. 5. Doubtful Credit. Has every weak point inherent in substandard credit, with additional characteristics such as bad collateral. Full repayment becomes highly doubtful. Losses are very likely but their classification as losses is postponed until certain significant factors are clarified. The principal outstanding period is above 180 days with good collateral, 60–180 days with partial collateral, and 30–60 days as unsecured credit. Needs provisioning at 50%. 6. Bad Credit. Repayment is impossible, and probability of recovery is low. It is inadvisable for them to be considered assets, and they have no liquidation value. Banks should stop placing them on their balance sheets. The principal outstanding amount is 180 or more days at partial collateral and registration, and 60–180 days if unsecured. Needs provisioning at 100%. Source: National Bank for Foreign Economic Activity of the Republic of Uzbekistan. 26. As at end 2004, when the OEM could obtain the most recent information, 40% of the loan portfolio was classified as good and satisfactory, 39% was substandard, 13% was doubtful, and 7% was considered a loss. Loans reaching the loss category are fully provisioned and moved off the balance sheet almost immediately.

Appendix 5 51

Table A5.2: Loan Classification by Quality (%)

Item 1996 1997 1998 1999 2000 2001 2002 2003 2004Good 77.70 91.43 91.80 90.55 — 78.80 39.57 31.96 16.61Satisfactory 10.53 4.29 6.40 7.85 — 16.00 28.36 37.84 24.21Substandard 11.43 4.09 1.80 1.56 — 4.40 12.16 7.96 38.98Doubtful 0.34 0.19 0.00 0.00 — 0.80 9.25 17.51 13.27Loss 0.00 0.00 0.00 0.00 — 0.00 10.66 4.73 6.90 100.00 100.00 100.00 100.00 100.00 100.00 100.00 100.00

— = not available. Sources: Compiled from Project Completion Report (1996–2001) and National Bank for Foreign Economic Activity of the Republic of Uzbekistan (2002–2004). 27. Provisioning. Loan-loss provisioning percentages set in NBU’s policies are appropriate for each classification, with the possible exception of Government-guaranteed loans. The Central Bank does not require any provisioning on these16 but, at the recommendation of external auditors in 2002, NBU began provisioning 25% of each asset classification category for state-guaranteed loans, except for loans classified as a loss, which are provisioned fully at 100%. The OEM could not obtain the detailed data on NBU’s actual loan-loss provisioning and the recovery ratio of state-guaranteed loans. It does not appear that MOF set aside an amount equivalent to state-guaranteed loans as contingent liabilities. Regardless, provisioning of only 25% of each asset classification may not be prudent enough. 28. Under good banking practices, loan-loss provisioning percentages are used as the minimum amount to reserve. A prudent provisioning practice would be to identify the amount of loss expected on each loan and reserve that amount. The review of the REDP loans indicates that this was not fully done and NBU’s provisioning practices are applied in a more rote fashion. 29. Restructuring of Problem Loans. Under NBU’s current management, a more conservative policy for handling problem loans has been put in place. Since 2004, there has been a trend to more quickly downgrade poorly performing projects, discontinue further lending to seriously past-due borrowers, and move into legal proceedings for asset liquidation on failed projects. There are also indications that more work is being done to restructure a project under new management rather than abandoning the project entirely.17 The OEM believes that operational and financial restructuring of problem loans needs to be further intensified. F. Key Remaining Issues 30. Remaining Weakness in Project Appraisal and Monitoring. Credit officer project appraisal and monitoring skills are extremely important in Uzbekistan’s difficult economic and business environment. While these skills have improved with the experience of the last 10 years, more skill improvement is desired in project appraisal and monitoring areas. 16 The Guidelines from the Basel Committee of Banking Supervision (BCBS) exempts banks from loan-loss

provisioning loans made against sovereign guarantees from Organization of Economic Cooperation and Development (OECD) governments. However, BCBS does not allow this exemption to non-OECD government guaranteed loans, such as in Uzbekistan.

17 Determined during review of REDP subprojects and interviews at NBU branches.

52 Appendix 5

31. Early Detection and Response to Problem Loans. An assessment of subprojects under the REDP identified a number of issues. Monitoring of loans has been weak, especially between loan repayment periods. Loan and subproject restructuring has been slow and occasionally inappropriate. There are some indications that monitoring practices have improved but they are still insufficient. Current management has issued several directives from HQ establishing procedures to discontinue new financing to problem loans, move them through the court more quickly, and find new investors, where possible. However, credit officer monitoring of loans between repayment dates is still insufficient, allowing opportunities for early workout to be missed. 32. Provisioning Levels for Potential Loan Losses. The OEM could not independently verify the NBU’s entire portfolio performance and the provisioning status. However, the OEM’s review of the asset classification and provisioning status of the subloans under the REDP suggested that NBU’s loan-loss provisioning might not be sufficient. 33. Delineation of Development Banking and Commercial Banking. There is little to no delineation between the development and commercial banking objectives at NBU. Neither staff nor management could define the difference between these two functions yet admit that NBU is engaged in both. NBU’s organizational and financial structures make no distinction between commercial bank functions and development banking. Government strategic objectives have been thoroughly integrated into many of the lending products, which will make it difficult to separate these two functions in preparation for NBU’s privatization. 34. Nonbanking Activities. Over the years, the scope of NBU’s nonbanking activities appears to have been reduced. However, most OEM interviewees outside of NBU see it as an agent of the Government explicitly or implicitly. The OEM believes that nonbank activities need to be further streamlined. 35. Road Map. To fulfill the Government’s plan to privatize NBU by 2009, significant operational and financial restructuring is needed. NBU needs to prepare a comprehensive road map covering the above issues. The Government’s support will be essential for NBU to prepare and follow the road map.

Appendix 6 53

EVALUATION OF TA 2714-UZB: INSTITUTIONAL STRENGTHENING OF THE NATIONAL BANK OF UZBEKISTAN

A. Introduction

1. On 17 December 1996, the Asian Development Bank (ADB) approved the Rural Enterprise Development Project (REDP) to Uzbekistan, for $50 million, from its ordinary capital resources with National Bank for Foreign Economic Activity of the Republic of Uzbekistan (NBU) as the Executing Agency. This was the first loan from ADB to Uzbekistan, which joined ADB in 1995. In conjunction with the REDP, ADB approved an advisory technical assistance (TA)1 for the Institutional Strengthening of NBU for $830,000. 2. The purposes of TA 2714-UZB at approval were to (i) strengthen the capacity of branch offices to screen credit proposals from clients and to help clients improve subproject design and formulate business plans that match sound criteria, including requirements for equity and collateral; (ii) strengthen credit processing procedures between branches and headquarters to reduce delays and dropout rates; and (iii) implement systems for subproject benefit monitoring and evaluation (BME).2

B. Design and Implementation

1. Formulation 3. The report and recommendation of the President (RRP) stated the rationale of this TA as follows: “NBU’s loan portfolio for lending to the private sector (including SMEs) is relatively young, having mainly commenced with the European Bank for Reconstruction and Development’s (EBRD) ongoing credit line. Under NBU’s policies and procedures, all credits in foreign exchange (FX) are approved at Headquarters (HQ), but with initial screening performed by branch offices. A high proportion of credit proposals submitted to HQ from branches require significant revision and refinement before a bankable subprojects can be considered in the form of a sound business plan. This creates delays and a high drop-out rate for credit proposals initiated at branch level. Thus, the TA will assist branch offices to develop skills for screening and processing credit applications from private sector clients. Systems for subproject benefit monitoring and evaluation are not in place. Accordingly, the TA will address these two areas.” 4. This emphasis on building the capacity of branch operations was based on the following finding stated also in the RRP:

With EBRD assistance, NBU HQ has established satisfactory subproject appraisal and credit approval procedures. This assistance is expected to be completed by the end of 1996. At present however, NBU’s loan portfolio to the non-State sector is very young, and its branch offices lack experience and skills in dealing with loan applications with non-State sub-borrowers.

5. This finding proved to be incorrect, mostly because lending procedures under the EBRD credit line were confined to assigned credit staff and was not integrated into overall credit operations. In addition, the Reconnaissance Mission and Appraisal Mission suggested the 1 ADB. 1996. Technical Assistance to the Republic of Uzbekistan for Institutional Strengthening of National Bank of

Uzbekistan. Manila (TA 2714-UZB, for $830,000, approved on 17 December). 2 The project agreement stipulated that “NBU shall monitor the financial and economic performance, and

socioeconomic and environmental benefits of Qualified Projects. NBU shall assist ADB to monitor and evaluate the long-term benefits of a random sample of five Qualified Projects.”

54 Appendix 6

inadequacy of ADB’s diagnostic study on these matters. The back-to-office report of these missions indicated a less-than-desired level of feedback from EBRD3 on the outcome of its technical corporation provided in conjunction with the first SME Credit Line approved in 1993. 6. NBU functions as both a development and commercial bank. It also performs as the government’s agent, explicitly or implicitly, by (i) controlling cash supply and liquidity, (ii) monitoring financial transactions of corporate depositors, and (iii) automatically deducting outstanding taxes from depositors on behalf of tax authorities. During the appraisal of the REDP and this TA, ADB should have assessed thoroughly the justification and feasibility of these multiple agendas imposed on the NBU. The outcome of such assessment might have led to a broader TA scope. 7. The Operations Evaluation Mission (OEM) considers ADB not to have adequately discussed with NBU its critical needs and the expected outputs, including the BME system. NBU’s eventual disregard of the BME system established under this TA and lack of effort to adequately replace it supports this assessment.

2. TA Scope, Consultants, and Scheduling 8. The TA comprised three major components: (i) a diagnostic review of NBU, (ii) strengthening of skills in subproject processing at branch levels, and (iii) design and implementation of a computerized system for subproject BME. During contract negotiations with NBU, the consultant’s terms of reference were changed to remove all non-credit-related activities from the diagnostic review of NBU’s strategic plan. The OEM believes that this change significantly narrowed the scope of the diagnostic review. 9. An international consulting firm, with experience working with banks in the former Soviet transitional economies, was selected. The consultant staff fielded was sufficiently experienced and capable of performing the terms of reference. Consultant staff were deployed on time and when the credit line was available, and so the subproject review and funding could begin immediately. 10. The planned and actual skill mix and the work duration of the consulting team are summarized in Table A6.1. As allowed in the consultant contract, some consultant staff members were reallocated to accommodate changes in the target subproject sectors and a special request from NBU for additional assistance.

3 “Little progress in Mission’s attempt at closer coordination has been achieved, to date, due mainly to lack of

cooperation from EBRD” (para. 10, Back-to-Office Report [BTOR] of the Appraisal Mission dated 9 October 1996.)

Appendix 6 55

Table A6.1: Skill Mix and Work Duration of the Consultants

TA Staffing

Planned Person- Months

Actual Person- Months Difference

Team leader/business plan specialist 10 10 0 Marketing specialist for processed foods 4 5.2 1.2 Food processing engineer–fruits/vegetables 3 3.3 0.3 Food processing engineer–dairy 3 0 (3.0) Food production management specialist– experienced in supplier/processor relationships

2 1 (1.0)

BME specialist 3 4 1.0 Financial analyst 0 1.5 1.5 Total 25 25 0

BME = benefit monitoring and evaluation, TA = technical assistance. Source: Asian Development Bank.

3. Cost and Financing 11. The total cost of the TA was estimated at $880,000, with the Government contributing $50,000 in counterpart services—domestic travel, interpreters, and office facilities for consultants and project staff. As the Executing Agency, NBU was given responsibility for making these contributions. The consultants completed their work within the remaining $830,000. The budget for this TA was appropriate and consistent with other projects of this type. Consultant remuneration was more than sufficient to ensure high quality professional bankers could be recruited for the work. The $40,000 estimated for local costs under the consultant’s contract was also sufficient.

4. Outputs

12. During the (i) inception period (by August 1997) the consultants established a project office in NBU, prescreened the pipeline of potential subprojects, began subproject appraisal and loan processing, and made the initial design of a computerized BME system; (ii) first period (before the submission of the midterm report in February 1998), the consultants began a review of NBU’s existing credit policies (strategic plan) and lending procedures, and continued to help the subborrower review business plans and process credit applications; and (iii) second period (before the submission of the final report in July 1998) the consultants completed the review and made recommendations for NBU’s strategic plan, drafted a new credit policy manual, and conducted training programs in the theory and practice of project appraisal, and finalized the implementation of the Entermod project appraisal system (EPAS) used for credit application analysis . 13. Review of the Existing Credit Policies. This output was of good quality and comprehensive. It included a thorough analysis of existing policies and procedures and discussions with NBU management. As a result, draft credit policies and procedures were left with NBU for the basis of adopting new policies for the entire credit function (Table A6.2).

56 Appendix 6

Table A6.2: Consultant Recommendations on Credit Policies and Procedures

Consultant Recommendation

Adopted/ Not

Adopted Comments The Government should not make recommendations to NBU concerning the specific enterprises that are to be recipients of loan proceeds under foreign credit lines

Adopted Applications came from clients directly

If the Government wishes NBU to continue to undertake directed lending, this portfolio should be separated from the commercial loan portfolio and any future losses associated therewith should be underwritten by the Government.

Partially adopted

Recent development funds used for special Government programs are maintained off NBU’s balance sheet.

It is recommended that NBU formulate its own credit policy statement, consistent with the law and Central Bank and Ministry of Finance Regulations but with extended coverage that will provide an improved foundation for procedure and prudent lending.

Adopted Implemented starting in 1999 or 2000

Offer standard credit products under standard lending terms and conditions with a minimum of variation to accommodate the preferences of credit line suppliers and that such variations should refer only to loan terms and conditions and not to other NBU policies or NBU procedures, rather than offer products to which different policies and procedures apply depending on the stringency of the requirements of the credit line provider.

Adopted All foreign bank credit lines have been consolidated into the main SME lending department and follow that department’s policies and procedures.

Value collateral on the basis of the discounted current market value of the assets and not on the present going concern basis in order to reduce risk.

Adopted

Introduce more rigorous and explicit conditions in relation to guarantors and subject guarantors to the same scrutiny as borrowers in order to reduce risk.

Adopted The guarantor now undergoes a rigorous review process, similar to the applicant’s.

Introduce mandatory insurance of assets purchased with loan proceeds and assets offered as collateral with NBU as the beneficiary of such insurance in order to reduce risk.

Partially adopted

Businesses are required by law to maintain insurance on their assets, so NBU does not require evidence.

Strengthen the required loan covenants to include dividend prohibition prior to settlement of debt obligations in order to reduce risk.

Adopted

Appendix 6 57

Consultant Recommendation

Adopted/ Not

Adopted Comments Introduce an internal borrower risk-rating assessment into the credit appraisal and supervision processes to compliment the relatively narrow assessment made by the compulsory Central Bank credit rating and without noncompliance with the Central Bank requirements use the borrower risk rating as a guide to the borrower’s financial condition in order to reduce risk.

Adopted Currently standard practice according to bankers.

Introduce a system of discretionary authorities in relation to all key decisions about the loan portfolio, including the lending decision, in order to reduce spans of control and create a climate of accountability and responsibility within the bank.

Partially adopted

Currently, branch and head office credit committees have authorities up to 10% of the bank’s tier-I capital, which is about $40,000 now. Loans above this amount are approved by the board of directors or bank council, depending on the amount. This consultant does not believe delegation beyond that level is inappropriate for NBU.

Enhance the Central Bank loan classification system, which is based on aged arrears, through the introduction of an internal classification system that takes into account factors other than arrears (specifically the

Mostly adopted

NBU’s current classification system takes into account most of the recommended factors and is sufficient for their needs.

financial situation of the borrower and the timeliness of availability of financial information; the performance.

Compile its own credit procedures manual, consistent with the credit policy statement, international best practice and requirements imposed by Government.

Adopted

Examine the existing and projected financial condition of the borrower as well as the incremental impact of the investment on the borrower’s financial position. In this analysis, project financing is effectively a special case.

Adopted Using the loan appraisal system implemented by the consultants, NBU now has a comprehensive appraisal system of its own that is used to perform these functions.

Revise screening procedures to undertake a broader borrower risk rating, require borrowers to clearly satisfy credit line eligibility criteria, and require borrowers to remodel their own business plans in light of NBU’s comments prior to acceptance for any further loan processing.

Adopted Loan approval process includes negotiations for business plan expectations.

Discontinue requiring applicants to provide contracts during initial screening, so signed contracts are not sought from suppliers before loan approval.

Adopted

58 Appendix 6

Consultant Recommendation

Adopted/ Not

Adopted Comments Require a minimum of three price quotations for the purchase of equipment before loan appraisal to ensure a detailed examination of competitive options. Only quotations from the actual equipment producer should be accepted, to avoid lower quality equipment being provided at a higher price by an equipment dealer.

Adopted Previously, the ministry reviewed all equipment specifications on items being imported to ensure their technical compliance. The bank now uses its own staff to review proposed purchase agreements.

Institute investment appraisal procedures used on the ADB credit line for other investment lending to make all lending of this type as rigorous.

Adopted Credit policies and procedures for entire bank are now standardized.

Consider establishing a Business Advisory Unit with specialized skills in business planning and restructuring that could provide a fee based service to businesses. A Business Advisory Unit would assist the work of Credit Officers and help fill the gap in knowledge of young entrepreneurs.

Not adopted

This idea was not captured by NBU management.

A three-tier credit approval system should be introduced where each loan is processed by a recommending officer, approving officer who has also reviewed and agreed, and approval officer who has final approval authority.

Partially adopted

Loan officer who receives the application sends it to an analysis unit for further review before submission to a credit committee. Branch and head office credit committees approve loans above branch and department limits.

Adopt a credit management system that makes a single individual credit officer responsible for a loan throughout its life.

Adopted

Enhance existing monitoring and supervision procedures by linking the frequency of supervision visits to loan classification.

Adopted Monitoring schedules and practices are linked to classification and individual situation of each borrower.

Give serious consideration to implementing relationship management, starting with head office staff and followed in branches.

In process NBU is just now installing software and working with branches to better organize operations so this is possible.

Prepare formal short courses for training in policy and procedures using formal training guides, hand-outs, case studies, and exercises that encourage more participatory training sessions.

Adopted This was not verified by the consultant, but training was common topic at every interview, showing it is a priority for the bank.

Prepare and implement a training plan to ensure that all staff participates in training at least once a year.

Adopted At least twice a year staff is selected for external training at bank training center, as well as periodic internal bank courses for specific purposes.

Appendix 6 59

Consultant Recommendation

Adopted/ Not

Adopted Comments Provide dedicated internal bank training to ADB credit line staff on credit policies and procedures.

Adopted All credit staff now receives regular training, including on policies and procedures.

Annually review training needs for each officer and prepare an annual training plan for refreshing skills of existing officers and provide induction training for new credit officers.

Adopted NBU prepares a training plan every year for its entire staff, including credit officers. New officer training is standard.

Computerize loan reporting to provide management reports that are:

- loan specific, giving detailed loan information for tracking loan performance;

- position specific, so each loan officer receives detailed reports on their portfolios for monitoring loans;

- sector specific, so the performance of particular sectors can be better monitored and portfolio priorities set;

- comparative, so each management level can compare the performance of loans in an area under their supervision and other regions.

Marginally adopted

While the review of NBU systems was brief, it seemed to indicate that most reports continue to be prepared by hand, using Excel spreadsheets. The new Globus software has been installed at the head office and is scheduled for branches in 2007. This software is designed to do all recommended reporting, but their actual production is dependent on how comprehensively NBU chooses to make their installation of Globus.

NBU = National Bank for Foreign Economic Activity of the Republic of Uzbekistan. Sources: Consultant report of TA 2714-UZB and Operations Evaluation Mission.

14. Project implementation units (PIU) and Assistance to Subproject Appraisal. Staff members of the PIU at HQ were well trained and received sufficient assistance from the consultant to assess subproject applications using sound banking practices. The entire pipeline of about $200 million of subprojects was prescreened and none met the agreed financing criteria. New applications were accepted and a resulting 17 subprojects were reviewed by PIU staff at HQ, under consultant supervision. However, minimal consultant support was given to branch staff, the targeted audience under the terms of reference. This change in focus from branch credit officers to the HQ PIU staff was likely necessary because of the unexpected need to first train HQ staff. 15. Project Appraisal Training. NBU staff received training in (i) operations of the two software systems provided by the consultant, and (ii) credit appraisal techniques. Training given by the consultant was evaluated by participants, but those evaluations were not available for this review. One former NBU credit officer, who worked closely with the consultant and participated in the training, reported that it was thorough and relevant to his work on the credit line. 16. Entermod Project Appraisal System. The software was representative of good project appraisal systems available at the time of implementation. It provided a set of tools for analyzing business applicants’ existing financial performance and forecasting project proposals, including financial ratios such as internal rates of return. However, the EPAS was designed on an Excel spreadsheet structure, which left it open to problems during operation and use by PIU staff. As a result, a number of changes and improvements were required during implementation. In the last 10 years, much more robust software has become available and should be adopted by NBU.

60 Appendix 6

17. Benefit Monitoring and Evaluation (BME) Software. The BME software provided tools for determining direct and indirect financial, economic, and socioeconomic benefits by identifying increased (i) balance of payments from foreign exchange earnings, (ii) employment, (iii) agricultural production, and (iv) financially sound private enterprises. The BME system provided an adequate tool for monitoring subprojects but was also quite complex and not easy to operate by PIU staff. 18. Consultant Reports. Some reports were delayed but these may have been authorized and not noted in ADB’s files. The reports were heavy on appendixes illustrating details of computer system design, and somewhat light on narrative that might have more fully described work completed by the food-processing specialists. This area of work was almost completely absent in the consultant reports.

C. Performance Assessment

1. Overall Assessment 19. Overall, this TA is rated partly successful. This overall rating reflects weighted averages of the individual ratings for four criteria: relevance (20%), effectiveness (30%), efficiency (30%), and sustainability (20%). Individual criterion ratings are in whole numbers from 0 to 3, in increasing order of project performance.4 The TA is rated partly relevant, less effective, inefficient, and with less likely sustainability.

Table A6.3: Overall Performance Assessment of REDP

Criteria Assessments 1. Relevance 1 2. Effectiveness 1 3. Efficiency 1 4. Sustainability 1

Total Ratinga 1 a Highly successful > 2.7; successful 2.7 ≥ S ≥ 1.6; partly successful 1.6 >

PS ≥ 0.8; unsuccessful < 0.8. Source: Operations Evaluation Mission.

2. Relevance 20. This TA is rated partly relevant because, although it strongly supported the REDP, it also had (i) weak at-entry assessment and inadequate discussion between NBU and ADB on the TA’s expected outputs and outcomes during processing, (ii) inappropriate focus and purpose setting, and (iii) inadequate TA scope and duration. It is evident that the TA purpose should not have been confined to NBU’s branch operations. The OEM believes that preparing a medium-term corporate strategy covering all of noncommercial lending activities (state guaranteed loans, subsidized lending, directed loans, tax collection, among others) should have been within the scope of this strategy. The OEM also believes that project monitoring and portfolio management should have been included as another TA component.

4 For example, irrelevant = 0, less relevant = 1, relevant = 2, and highly relevant = 3.

Appendix 6 61

3. Effectiveness 21. This TA is rated less effective despite the largely satisfactory implementation of the consultants’ recommendations on credit policy because of (i) limited use of the EPAS and BME systems, and the (ii) subsequent resignation of all PIU staff members and most training seminar participants. 22. The OEM interviews with NBU staff regarding current NBU credit policies and procedures revealed that nearly all of the consultants’ recommendations are now in place. The documented credit procedures were integrated into the bank’s operations, but credit skills taught by mentoring PIU staff have been lost. NBU has implemented a more basic version of the loan appraisal software that is used bank-wide and BME is done in a simplified manual operation that may be more efficient for their needs. Improved training systems were identified by the consultant as an important function needing NBU’s attention, and the bank is currently well developed in that area.5 23. Of the 16 subprojects reviewed by the consultant only 5 received financing (Table A6.4). The remaining 11 subprojects were unable to make the 25% equity contribution required by ADB. Of the 5 subprojects that were financed only 2 have repaid their loans and 3 are no longer operating. In none of the problem subprojects was the source of the difficulty something that should have been detected by the consultant at the time of appraisal. However, in all cases, the subproject may have been able to receive more timely intervention from NBU had the consultant still had staff working with the bank and advising on monitoring strategies.

Table A6.4: Consultant-Assisted Subprojects

Subproject

Loan Amount

($) Current Status OEM Comments SP2 (ice cream producer) 288,557 Repaid SP1 (tomato paste and fruits puree producer)

1,182,000 Nonperforming Disputes between project sponsors, problems with supply of raw materials, no working capital

SP7 (tomato paste and fruits puree producer)

2,478,637 Nonperforming Disputes between Uzbek and Bulgarian sponsors; put up for sale for SUM2 billion

SP3 (edible oil producer) 524,680 Repaid SP5 (ice cream producer) 1,212,689 Nonperforming Owner imprisoned for drug

trafficking. NBU looking for buyer of business.

Sources: National Bank for Foreign Economic Activity of the Republic of Uzbekistan and Operations Evaluation Mission.

24. NBU’s current project appraisal and portfolio management systems are locally designed and unsophisticated. If fully implemented, NBU’s new banking software will meet its needs for portfolio management, but a new, more robust project appraisal system is needed. The TA helped the bank begin to understand the need for good software to support its operations, but

5 Interviewed NBU staff members often referred to department and bank-wide training activities.

62 Appendix 6

not its full application. In terms of BME, NBU abandoned any effort to automate this function and currently does not include BME in its normal operations. Because of this, the OEM could not fully update the subprojects’ developmental impacts. 25. From 1998 through 2003, NBU saw a significant turnover in staff due to compensation issues. During 1998 staff salaries were pegged to the minimum wage, causing widespread reductions. Through 2003 salary increases were stagnant and some employee benefits were removed. The initial staff turnover in 1998 was about 15% and subsequent years saw another 15% to 25% in turnover. Since then, there have been modest salary increases and new benefits added to attract and maintain staff.

4. Efficiency

26. The TA is rated less efficient mainly because (i) the institutional impact of this TA is considered limited, a large portion of NBU’s loan portfolio remains to be guaranteed by the Government, and NBU maintains its nonlending activities; (ii) the portfolio performance of subloans under the REDP was less than satisfactory; and (iii) the expenses for the BME cannot be justified as NBU no longer uses the BME system developed under the TA. The OEM felt that ADB should have addressed this BME issue in conjunction with the follow-on SME Development Project.

5. Sustainability 27. The TA is rated less likely sustainable. NBU may not have accepted immediately the consultants’ recommendations on credit policies but they were eventually largely adopted and have not been reversed. Over the last few years, NBU management has continued to implement more prudent practices for the classification, provisioning, and recovery of problem loans. However, the OEM observed the remaining weaknesses in NBU’s lending operations, especially in commercial risk assessment, portfolio management, and management information systems. Moreover, the fundamental issues remain in NBU’s operations related to its persisting nonbanking activities as a Government agent, as well as its noncommercial lending activities. The OEM believes that all these factors hamper NBU’s operational efficiency, loan portfolio performance, and deposit mobilization. In particular, the current level of underperforming loans calls into question the viability of NBU’s operations. On this basis, the TA is rated as less likely sustainable.

`

MANAGEMENT RESPONSE TO THE PROJECT PERFORMANCE EVALUATION REPORT FOR THE RURAL ENTERPRISE DEVELOPMENT PROJECT IN UZBEKISTAN

(Loan 1504-UZB)

On 7 March 2007, the Director General, Operations Evaluation Department, received the following response from the Managing Director General on behalf of Management:

1. Management agrees with the overall findings and assessment of the report, which rated the Project as partly successful. Management agrees that more attention should have been paid during project design to (i) financial sector and banking intermediation related issues, particularly in transitional economies, and (ii) handling of foreign exchange risk by subprojects and particularly so by those engaged in import substitution. Management agrees that financial and risk management covenants should have been incorporated into the project’s design. Improved overall financial sector legislation and fixed policies in Uzbekistan could improve the enabling policy and regulatory environment for small and medium enterprises, which could improve REDP’s sustainability.1 Management concurs with the PPER’s assessments on its lessons learned. Comments on the various issues raised in the PPER are stated below. A. Exchange Risk Borne by the Sub-borrowers 2. Para. 18 states that given the early stage in Uzbekistan’s transition to a market economy, it was not reasonable for sub-borrowers or the National Bank of Uzbekistan (NBU) to appreciate the magnitude of the foreign exchange risk. Depreciation of the local currency could create exchange risk for the sub-borrower and a credit risk for NBU. Management agrees that ADB should have incorporated a risk mitigating mechanism into the project design. B. Institutional and Policy Impact 3. Paras. 68 and 69 point to NBU’s non-banking activities (inherited from the era of central planning) impinging on its overall effectiveness. While this may be true, its impact on the subprojects financed under the ADB loan remains tenuous. Subloans to subprojects were granted in foreign exchange, with NBU adding a margin over its cost of funds, depending on the risk of each case. There were no subsidies in lending to subborrowers under ADB’s loan. However, ADB’s loan could not have helped NBU generate customer deposits in Uzbekistan given the banking sector’s trust gap as is manifested by the low M2/GDP ratio (at less than 15%)2 in Uzbekistan. Indeed, NBU’s lack of adequate dollar customer deposits coupled with high demand for credit by small and medium enterprises justified the ADB loan. C. Conclusion 4. Management otherwise generally concurs with the PPER’s thrust.

1 This argument is supported by the PPER’s observations in para. 32 that Uzbek companies have

a competitive advantage in processed food and vegetable products’ exports with professional management and raw material supply.

2 Para. 77.