Pacific Private Sector Development Initiative

Progress Report 2014–2015

• Publisher: Asian Development Bank
• Year: 2016
• ISBN:
  9789292573232
• Topic: Business
• Subtopic: Private Equity
• Index: Business

Since 2006, the Pacific Private Sector Development Initiative (PSDI) has worked to alleviate poverty and promote growth in the Pacific region through reforms that encourage private sector investment and entrepreneurship. This report describes developments and progress for PSDI Phase III's second year, and covers the period July 2014 to end-June 2015. PSDI is a regional technical assistance facility cofinanced by the Asian Development Bank, the Government of Australia, and the Government of New Zealand.

1 OVERVIEW

This is the second annual progress report for phase III¹ of the Pacific Private Sector Development Initiative (PSDI), a regional technical assistance (TA) facility cofinanced by the Asian Development Bank (ADB) (which also administers PSDI), the Department of Foreign Affairs and Trade of Australia (DFAT), and the Ministry of Foreign Affairs and Trade of New Zealand. Phase III of PSDI represents a significant expansion in terms of its time frame (6 years), budget (in excess of $30 million), and scope—competition and economic empowerment of women (EEoW) were added as new focus areas.

The goal of PSDI is to reduce poverty and raise sustainable growth rates in Pacific island countries through business environment reform that encourages private sector-led economic activity. Private sector growth promotes higher incomes and provides the resources to improve the supply of social services, such as health and education, on which the long-term well-being of Pacific island countries depends.

THE FOCUS OF THE PRIVATE SECTOR DEVELOPMENT INITIATIVE

The focus of PSDI’s work is to identify and reduce or eliminate business environment constraints that adversely impact productivity and growth. These constraints, which are discussed at great length in subsequent chapters, consist of such factors as:

(i)      limited access to finance to fund investment and entrepreneurship;

(ii)     outdated business laws that do not meet the needs of modern commerce and which hamper the ability of Pacific island businesses to engage in international trade;

(iii)    inefficient state-owned enterprises (SOEs) that utilize a significant portion of the capital stocks of Pacific island economies and supply high-cost, low-quality services to the private sector;

(iv)    limited economic opportunities for women, which wastes a substantial portion of the abilities of the labor forces of the countries in the region; and

(v)     poor frameworks for competition that do not effectively ensure either competitive markets or effective regulation in Pacific island economies.

THE PHASES OF THE PRIVATE SECTOR DEVELOPMENT INITIATIVE

PSDI III commenced in June 2013. PSDI II was still ongoing at that time as a number of initiatives it was financing were still under way and there were resources remaining. It is, therefore, not possible to attribute each reform to a specific phase of PSDI, especially since many reforms take a considerable time to come to fruition. Even for competition and economic empowerment of women, which were only added as specific focus areas for PSDI III, there was work on these issues already under way in the earlier phases of PSDI. As a result, there has been a seamless transition between the three phases of PSDI to date.

PRIVATE SECTOR DEVELOPMENT INITIATIVE REFORMS

The number of reforms coming to fruition has been increasing significantly. In the area of business law reform, three modern electronic registries are now operating, which are among the most advanced in the world and which have facilitated the creation of well over 2,000 companies in the region. Reforms of the framework for pledging moveable property as collateral for loans have led to more than 33,000 loans being registered in six countries.² SOE reforms supported by PSDI have resulted in improved operating results for state-owned enterprises, which have reduced their drain on public sector budgets in a number of countries in the region, making more funds available for social services. PSDI has also supported privatizations and public–private partnership (PPP) frameworks, which have, and will continue to, create investment opportunities for the private sector. A number of pilot projects to improve economic opportunities for women that could demonstrate how to bring women into the formal sectors of Pacific island economies are being implemented, and mainstreaming of EEoW within PSDI has intensified. Several countries have requested assistance to promote more effective competition, and a significant amount of work is now under way in this area.

WHY PRIVATE SECTOR DEVELOPMENT IS CENTRAL TO ECONOMIC GROWTH

Private sector development involves the organization of economic activity through private ownership, reliance on market forces to allocate resources, competition to ensure producers cannot exercise undue market power to obtain monopoly returns, and the prospect of earning profits to encourage investment. The private sector involves economic activities that are not undertaken by the state and consists of all for-profit firms regardless of size, activity (goods, services, or financial), or location (urban or rural). The boundary between private, for-profit institutions and private not-for-profit organizations is fluid and is part of a continuum.

The sustained growth of private firms is critical to achieving growth in gross domestic product (GDP). The private sector provides the most efficient means to identify investment opportunities and capitalize on new technologies and techniques that boost productivity on which long-term prosperity in the form of rising per capita GDP depends. Private sector development is key to reducing poverty by creating jobs, particularly jobs in the formal sector. In addition, private sector activity creates the surplus that, through taxation, allows the state to build infrastructure and provide health care and education to its citizens, thereby increasing overall welfare.

Effective markets require a well-functioning business environment, which determines the incentives under which the private sector operates. The business environment governs how, and, indeed, whether, investors and entrepreneurs are prepared to risk taking advantage of opportunities that exist in Pacific island economies, not only for domestic markets but also, increasingly, in this era of ever-closer global integration, of export opportunities through the production of niche commodities that can be supplied to world markets. This is an increasingly important issue for countries in the region, since inward-looking domestically oriented production does not allow for taking advantage of economies of scale and specialization.

Encouraging entrepreneurship and investment in Pacific island economies requires a number of factors to be in place. First, there must be some reasonable certainty that the business environment is stable—that rules affecting business will not suddenly change. A modern business law framework provides for contracting over significant distances and encourages long-term investment. Second, the capital that must be raised to cover this time gap must be rewarded because the providers of capital forego consumption and incur a risk. Access to finance is an essential part of promoting investment and growth. Therefore, raising capital requires a financial mechanism for linking savings and investment. Third, infrastructure must not significantly increase the costs of doing business. Basic infrastructure services must be available at reasonable cost. This includes power, water, and transport infrastructure. Fourth, an educated workforce provides the possibility of delivering high-quality products or services. When formal or informal barriers to utilizing skills exist, economic potential is lost. In particular, the barriers to the economic advancement of women that exist in Pacific island economies represent a substantial waste of abilities that could be harnessed to advance prosperity and sustainable growth in the region. Finally, it is important to either promote competitive markets or to have in place a regulatory framework that limits the market power of large entities, including SOEs.

In summary, the most important factors that determine the environment for doing business are:

(i)        A financial system that provides funding for successful businesses to grow. Finance is the lifeblood of business. Studies of smaller firms have shown that access to finance is especially important for the growth of smaller businesses.³

(ii)       Labor markets that do not hinder women’s economic advancement. Barriers to women’s economic advancement impose significant costs, not only to women themselves, but also to the economy as a whole.

(iii)      Infrastructure that enables inputs and outputs to access markets effectively and that supplies business inputs, such as electricity, water, and transport services, at reasonable cost. While infrastructure alone may not be sufficient for growth, it is necessary for growth, and poor infrastructure can severely reduce the impact of other reforms. In Pacific island economies, most key infrastructure is owned by the state, which often operates it inefficiently. SOE reform and increased private sector participation in the delivery of infrastructure through privatization, contracting out, and public-private partnerships is key to improving the productivity of economies in the region.

PRIVATE SECTOR DEVELOPMENT INITIATIVE PROCESSES

All PSDI interventions have a strong foundation of analytical work that identifies specific constraints to private sector activity. This is used as an advocacy and discussion instrument with private sectors and governments to arrive at an agreed-upon private sector-focused reform agenda. Frequently, reforms so identified become part of ADB’s country programs or measures that are part of grants or loans.

Awareness of the importance of private sector development in generating prosperity continues to grow in the region and underlies the increase in requests for assistance. However, all PSDI initiatives are undertaken only as a result of formal requests from the country through its minister of finance. This triggers either policy analysis or, if the analytical work has been completed, an agreed sequence of actions necessary to implement the reform.

Often, resources can be mobilized at short notice following a request. This can work in both directions, since the flexibility of PSDI also allows for the shifting of resources to other countries or initiatives in the event reforms stall as a result of a decline in political commitment or changes in other circumstances. As of mid-2015, there were about 150 requests open, and the number of requests for support from countries continues to expand.

Many reforms in the areas of business law, access to finance, and SOE reform that have been undertaken with the help of PSDI have been recognized as cutting edge, not only in the region, but in the world more generally.

THE STRUCTURE OF THE REPORT

The theme of the 2014–2015 PSDI Progress Report is financing growth and how to achieve improved funding for businesses in the region. Chapters on each of PSDI’s other four focus areas—economic empowerment of women, SOE reform and PPPs, business law reform, and competition—follow the special section on financing growth. Chapter VII outlines PSDI’s strategic management activities (analytical work, monitoring and evaluation [M&E], and communications) and summarizes management resources and spending in each of the focus areas. In Chapter VIII, PSDI reforms at the country level are described. Finally, the appendixes provide a summary of PSDI’s portfolio and PSDI’s progress to date against its design and monitoring framework.

2 RETHINKING FINANCIAL INTERMEDIATION IN THE PACIFIC

INTRODUCTION

Financial markets in the Pacific are generally underdeveloped, and many people, particularly women, do not have access to even the most basic financial services, especially in rural areas. Access to credit remains a protracted problem, despite the prevalence of excess liquidity in many Pacific financial systems and the increased availability of savings products. Without access to financial services businesses cannot grow, entrepreneurship is stifled, and people on low incomes cannot save securely to invest, pay for unexpected expenses, or move beyond subsistence living standards.

In addressing these problems, PSDI’s focus is on strengthening the commercial provision of finance through the introduction of new products suited to the reality of the Pacific and the commercial transformation of government-owned financial institutions. This work complements broader donor efforts to promote financial inclusion. PSDI has also begun to more actively address the provision of long-term investment finance in Pacific economies. The importance of this work is underscored by minimal activity in Pacific capital markets and the need for long-term savings institutions such as provident funds to make corresponding long-term investments.

A common thread through all of PSDI’s work is the attention paid to strengthening institutional underpinnings through developing policy frameworks and related legal and regulatory frameworks. As the finance program has grown, more attention has been paid to integration with other PSDI focus areas: business law reform, competition, SOE reform, and the economic empowerment of women. Rather than go into the details of these initiatives and projects (details for 2014–2015 are in Appendix 2), this chapter focuses on the distinctive structural features of Pacific financial systems, the implications for increasing the availability of finance and financial services, and the way in which PSDI is responding to these challenges.

IMPROVING ACCESS TO CREDIT

Pacific businesses consistently find it difficult to access credit, even though all 14 PSDI countries now have a banking presence of some kind (following the opening of a Bendigo-Adelaide Bank agency on Nauru).⁴ The banking presence is uneven, with the banking systems of most Pacific countries dominated by foreign-owned commercial banks. The Australian domiciled Westpac and ANZ have the dominant presence in most countries⁵ outside of the North Pacific. Bred Bank has a presence in Fiji and Vanuatu, and Bank of Guam in the Federated States of Micronesia (FSM), and there are several other cases where foreign banks operate in a single Pacific country.⁶

This is set to change with the sale of Westpac branches to Bank South Pacific (BSP)⁷ in all markets other than Fiji and Papua New Guinea (PNG), although regulatory approval had not been received in Solomon Islands and Vanuatu as of mid-October 2015. This will result in BSP becoming a major presence throughout the Pacific, in addition to its home base in PNG and existing regional presence in Fiji and Solomon Islands. Where foreign-owned commercial banks are present, locally owned banks have a minor market share. But the influence of locally owned banks is increasing in some countries. The Bank of the Cook Islands (BCI), HFC Bank in Fiji, MiBank in PNG,⁸ the National Bank of Vanuatu, National Bank of Samoa and Samoa Commercial Bank, and Pan Oceanic Bank in Solomon Islands are examples. Each of these banks, other than Pan Oceanic Bank, is wholly or majority government-owned,⁹ while HFC is 75% owned by the Fiji National Provident Fund. Locally owned finance companies have also expanded their operations. The largest is Credit Corp Group, which was established in PNG and now has wholly owned subsidiaries in Fiji, Solomon Islands, and Vanuatu. BSP also established a wholly owned finance company subsidiary in 2014, which has commenced operations in Fiji and PNG.

It is reasonable to expect that the continued growth of these locally owned banks and finance companies will alleviate the access to credit problem to some extent. But businesses will still find it difficult to access credit, while the mismatch between lending risk that exists in the Pacific and the willingness of larger banks, in particular, to take on this risk remains. PSDI’s view is that governments and central banks resorting to concessional finance and credit guarantees will not provide a sustainable solution to improving access to finance in the region. Concessional finance is distortionary and adds to existing fiscal pressures. Furthermore, it does not develop the risk assessment skills of banks, as banks act as agents of government in the process and usually do not bear any credit losses. The attraction of credit guarantees is understandable, but the Pacific experience, to date, and experience in other parts of the world strongly suggests that credit guarantee schemes have had a negligible impact on increasing credit, and the overall net economic benefits are also negligible. This experience is in line with broader international experience, which also suggests that credit guarantees have not generally been successful.

It follows that unlocking the reasons for this continued reluctance by banks, in general, to embrace Pacific risk is critical to adopting the appropriate policy response. One of the reasons for the banks’ reluctance has undoubtedly been the...