Due Diligence Report on Indonesia and Philippines for the ADB Inclusive Business Fund Initiative

Key Findings

SUBMITTED BY NOAH BECKWITH ADB BOP INVESTMENT FUNDS INITIATIVE DATE: 17 JANUARY, 2013

Table of Contents
Section I. Introductory Remarks II. Indonesia III. Philippines IV. Key Issues and Recommendations Page No. 3 3 12 16

I.

Introductory Remarks

This report follows detailed due diligence on Indonesia and the Philippines to assess the viability of establishing a fund focused on improving peoples lives at the base of the pyramid (BOP) by investing in inclusive businesses. The challenges of making investments, whether debt or equity, of $500,000 to $10m in private businesses in Indonesia and Philippines are not insignificant. In the case of Indonesia, political instability and security issues, currency depreciation and structural imbalances between very large, dominant parastatals and large corporations on the one hand, and small and medium sized enterprises (SMEs) on the other (among other issues) make for a testing operating environment. In Philippines, despite significant inroads made by microfinance in recent years, access to debt and equity for SMEs remains difficult, hampering expansion in the supply chain among companies that could be drawn more closely into the production activities of larger corporates. Notwithstanding, the strong conclusion of this report is that there is an opportunity for the Asian Development Bank (ADB) to sponsor the establishment of a debt facility (the Facility) which both contributes to poverty alleviation by addressing production, supply, consumption and employmentrelated challenges that affect the BOP in Indonesia and the Philippines, and helps to build the base of well-managed, profitable businesses in both countries.

II. Indonesia
Macroeconomic and Political Landscape and Structural Challenges Despite intermittent bouts of terrorist activity which continue to concern investors, Indonesia has made significant inroads in modifying the image of the country as a more stable environment in which to do business, with relatively sound macro-economic fundamentals. Although currency depreciation remains a significant concernimportant in the context of the ADB initiative because of the impact on returns, whether debt repayments or realisation of equity stakesthe elevation of the countrys sovereign credit rating to investment grade by two of the three biggest international rating agencies in 2012 was a significant cross-roads. To some extent, this reflects the emergence, within the burgeoning population of over 200 million people, of more and more incumbents of the middle class, all with aspirational demand tastes that are driving consumption and the development of deeper domestic production markets. With specific regard to the ADBs inclusive business (IB) initiative, one of the biggest challenges posed by the structure of the Indonesian economy is the vast gap between quasi-oligopolistic large 3

corporates and parastatal companies on the one handand not simply in the energy sectorand the vast swath of SMEs on the other, with little in between. The groundwork for these structural imbalances was laid in the 1960s, when the so-called new order, or more modern approach to economic development, was initiated. Decades later, the lasting impact is that it is very difficult and unusual for SMEs to be drawn into the supply chains of larger corporates in a meaningful way that enables the former to increase their value added activities. These structural asymmetries are further exacerbated by the fact that the Indonesian economy is heavily intermediated by small-scale traders and distributors. In some ways, it could be argued that this is a proxy for the lack of conducive physical infrastructure (with the exception of the greater Jakarta and Surabaya areas) and the inherent challenges of moving goods and services around such a vast archipelago. Be that as it may, however, from the perspective of inclusive business, the salient point is that it affects the way in which goods are procured from the SME sector by larger companies, and partially explains why few SMEs are successful at developing export markets for themselves. There are some exceptions to this, where buyer-driven trade networks have developed in sectors such as furniture and garments in Jakarta, and garments and carved wooden furniture in Bali, but given that the SME sector accounts for over 90 per cent of employment in the country and that its rapid growth will therefore be critical to any lasting poverty alleviation, more concerted efforts are required to address these structural challenges.

The Financial Landscape and Inclusive Business In recent years, the central bank of Indonesia has strengthened the regulatory framework and supervisory arrangements for the banking sector, which has increased confidence significantly since the Asian financial and economic crisis of 1997-1998. The focus, more recently, has turned to further development of the financial markets and new investment vectors and disciplines, such as venture capital, private equity, microfinance and angel investing. Importantly, the ministry of finance is looking to strengthen entry regulations for non-bank financial institutions (NBFIs), their transition to regulated entities, licensing arrangements more generally, and capital requirements for all actors in the financial sector. This is important to the ADBs IB initiative because SMEs pervasive inability to access finance from formal financial institutions means that they are often left at the mercy of predatory, unregulated, semi-formal purveyors of finance that charge punitive rates for loans. Also significant from the inclusive business perspective is the governments decision to grant venture capital firms tax exemptions for investing in certain sectors. Although there are concerns that this 4

could distort the allocation of capital and promote rent-seeking behaviour among some players, the overarching recognition that alternatives to bank finance from heavily collateral-focussed institutions for SMEs and the non-corporate sector more generally is critical to more broad-based growth in the country.

An Inclusive Business Facility in Indonesia: A Natural Focus on the SME Sector The ADBs IB initiative in Indonesia will, naturally, have a significant focus on the SME sector. With the exception of the oil and gas sector, over 90 per cent of all firms in the country are SMEs, providing livelihoods for more than 90 per cent of the population. Moreover, the SME sector accounts for nearly all new employment creation in the country, according to the Organisation for Economic Co-operation and Development (OECD). With regard to the crucial agriculture sector, according to data published by the Ministry of Co-operatives and SMEs, 87% of output is attributable to micro-, small and medium-sized enterprises. It is therefore clear that in order for the strategy of an IB initiative in Indonesia to be meaningful, it must have a significant focus on the agriculture sector and an emphasis on strengthening the linkages between small producers and larger aggregators and processors. The challenges to improving the competitiveness and dynamism of Indonesias SME sector are familiar in the South-East Asian context. SMEs tend to have relatively high production costs, low levels of efficiency, and struggle to invest consistently and meaningfully in human resources, technology, machinery and other vital fixed assets. As a result, their ability to capture greater value by producing more semi-finished and finished goods is compromised which, in turn, often keeps incomes relatively low. Part of an IB strategy for Indonesia must therefore concentrate not just on the more effective incorporation of SMEs into supply chains, but creating opportunities for them to add and retain value themselves. The Indonesian government has recognised the importance of incentivising larger companies to reach into the supply chain and incorporate SMEs, especially in the non-oil and gas sectors. Indeed, there have been some important policy initiatives around incentivising larger companies to create clusters of SME producers and suppliers since the late 2000s. By the same token, however, some small firms are protected under Indonesian law through the reservation of certain industries for them. This, in turn, requires larger companies, especially foreign ones, to partner with them in order to gain access to foreign direct investment (FDI) opportunities. The concern, nevertheless, is that this

could discourage FDI inflows to sectors which are particularly SME-intensive because SMEs are unfamiliar with and vulnerable to exploitation by larger companies.

Constraints to Growth in and Inclusion of the SME Sector In addition to access to finance (see below), there are several important constraints to faster growth in the SME sector which are critical to note in the context of the IB initiative. This is because their hampered growth is, to a large extent, the result of their lack of inclusion. First, SMEs ability to invest and grow organically is impeded by price fluctuations for raw materials, marketing challenges, transportation and distribution difficulties, high energy prices and supply interruptions and often high labour costs. Given that all of these challenges, in the aggregate, signify a relatively high expense-base in which to operate, savings are often made by avoiding formalisation. Whilst on the one hand this enables them to remain below the radar of tax authorities, on the other hand it damages them in the long term because it makes them harder for larger companies to identify, engage with and draw into their supply chains. Second, this naturally limits export development opportunities and translates into poor export performance. Indeed, the OECD notes that Indonesian SMEs are among the least likely in South-East Asia to export directly to buyers; i.e., to the extent that there are linkages forged with SME markets abroad (and even domestically), these tend to be brokered through intermediaries such as traders or trading companies. Third, productivity levels remain low because turnover and profit does not increase sufficiently to enable business owners to afford new machinery, modern tools, information, technology and other inputs. Ironically, some of these structural and systemic challenges have been obscured by the steady depreciation of the rupiah, which flatters the performance of the SME sector in local currency terms. However, in the long run, the inflationary impacts of depreciation far outweigh the benefits which SMEs might perceive in nominal local currency.

Improved Access to Finance: The Key to Inclusive Business in Indonesia Bearing in mind the contribution of the SME sector to Indonesias economic output and the fact that many of Indonesias poor are, by definition, engaged in micro- or small enterprise, then in can be argued that rapid growth in the SME sector is vital to poverty alleviation. This, in turn, could be accelerated by greater inclusion of the SME sector in economic activity, but only if SMEs ability to access finance is vastly improved. There is an enormous opportunity, therefore, for ADBs IB initiative to work with financial institutions to create, or further develop, products offered by 6

financial institutions that help to alleviate bottlenecks in access to finance. Before considering the nature of such products, it is important to highlight the main factors which, inter alia, impede SMEs access to finance in Indonesia: Insufficient collateral: Like many South-East Asian countries, and particularly since the Asian Crisis of 1997-98, Indonesian banks are most comfortable with collateral-based lending, which proves a high hurdle for most SMEs (especially in frequent cases of inability to use individual or communally-owned land);

Incomplete or sub-standard financial records: Banks generally require at least three years historical financial information from prospective borrowers. SMEs often lack the financial and accountancy training to prepare this information to standard;

Reticence to consider cash flow-based lending: Given the high concentration of SMEs in the agriculture sector, the combination of exogenous risk factors such as weather fluctuations and risk of natural disaster with seasonality and volatility of earnings makes banks very nervous about lending against future cash flows; and

Inflexible repayment terms: Similarly, most banks are unwilling to consider accommodating the irregular cash flows of prospective SME clients in repayment schedules, again excluding them from the formal financial system.

The World Bank recently highlighted SMEs inability to access finance regularly and in meaningful amounts as among the top impediments to more rapid, broad-based growth and private-sector development in Indonesia. The reason for this is that SMEs must rely on either retained earnings, finance from family and friends, or loans at punitive interest rates from money lenders, loan sharks or other highly informal sources to fund basic working capital needs. As a result, professionalisation, up-skilling, human resource-development, improving technology and gaining access to new technology, product development, more effective marketing strategies and other key business needs suffer. Additionally, the chances of SMEs being drawn into larger, deeper, more lucrative supply chains are reduced. The short-circuiting of SMEs access to finance also limits their ability to develop export opportunities. Unlike some other South-East Asian countries, for instance Vietnam and Thailand, there is a notable lack of direct contact between Indonesias SME sector and foreign buyerswith the exception of some sectors such as wood products, garments and textilesmeaning that the 7

export sector as a whole is dominated by larger players. As highlighted above, marketing linkages tend to be forged between SMEs and trading houses, distributors and other local intermediaries, with the result that income-growth and employment-generation potential is muted at the SME level. In addition, SMEs lack the information and expertise to penetrate export markets, are unable to adapt to rapid changes in foreign market conditions or tastes and, above all, struggle to accommodate time lags in payments often due to long shipment times. There is some evidence that rising internet connectivity is helping current and prospective exporters to access information on sales opportunities, inputs, raw materials, new technologies and machinery, but given Indonesias vast geography and significant disparities in connectivity and literacy across the archipelago, improvements are patchy. Another important factor which impedes more consistent export development among SMEs is that, since the financial crisis of 2008-2011, exporters are no longer able to collect payments by showing a bill of lading to their bank. Due to tighter regulations, banks are forcing them to await remittance of payments by the issuing banks into their accounts before releasing funds. Not only does this represent a significant time lag for cash flow-sensitive SMEs, but also, the slow turnover in cash means that they are unable to plan and initiate other activitiesfor example, servicing future orders in adjacent or even independent business linesuntil payment has been received.

Opportunities for the ADB IB Facility Whilst the litany of inefficiencies and structural and systemic imbalances highlighted above may appear to indicate that Indonesia is not suitable to an IB Facility, in fact, due diligence suggests that significant opportunities would present themselves for a vehicle, particularly if focused on debt (see Section IV below). Before briefly presenting them below, it should be mentioned, however, that it would be advisable for Facility interventions in Indonesia to take the form of debt rather than equity, although it may be possible to deploy equity in some specific cases. This is for two main reasons: first, because it is arguably on the SME sector that an IB initiative should focus; and second, because SMEs, by and large, have little familiarity with equity and are loath to allow external shareholders into their ownership structures. Furthermore, may are not sufficiently sophisticated to even have shareholding structures, which significantly augments the risk for external investors. Due diligence revealed that the following sectors, inter alia, would be particularly well positioned for debt allocations by an IB Facility:

Financial Services: Although access to financial services has improved significantly in Indonesia at the individual credit level in recent years, primarily through the medium of microfinance provided by institutions such as Bank Rakyat Indonesia (BRI), as discussed above, all but the largest corporates and parastatals struggle to get access finance from formal institutions. The IB Facility could, therefore, work with financial institutions to develop products which are inclusive in the sense of enabling BOP incumbents to participate more fully in production and supply chains. Such products might include:

Agricultural finance: including contract finance, warehouse finance, factoring, reverse factoring and products that facilitate access to improved inputs such as seeds, fertilizers, herbicides, pesticides, insecticides, machinery and so on;

Access to energy and clean energy more generally: including solar lighting, waste to energy initiatives, small-hydro, bio-gas etc.;

Cash flow-based products: At the more sectorally agnostic level, there is an opportunity to help financial institutions to create cash flow-based lending windows which would enable vast numbers of SMEs, currently excluded due to a lack of collateral, to get access to credit. With strategically-deployed technical assistance for training and implementation of risk management systems, financial institutions could begin to provide unsecured lending productsadmittedly, probably more to medium-sized than to small businesses in the first instancethe idea being that, over time, the institutions gain comfort with cash flow-based lending and credit risk assessment more generally.

Agri-business and agro-processing: In light of the dominance of the agriculture sector, and the vast potential for local producers to be drawn into domestic supply chainslet alone to develop export opportunitiesthere will be enormous opportunities in agri-business and agro-processing. As more Indonesians enter the middle class, tastes are changing, meaning that demand for processed vegetable-based foods and dairy products has increased significantly. This presents opportunities for the IB Facility from two angles. First, it could look to lend at the medium-sized, and in some cases small business level. But second, it could look to lend to larger producers based in or near cities like Jakarta and Surabaya, that

understand the long-term benefits of engaging with the SME sector in order to strengthen local supply chains and, in some cases, begin to go organic;

Value-added niche agriculture and aquaculture: Given the enormity of the Indonesian archipelago and its varied topography, small-scale producers of niche products such as spices, balms, essential oils, extracts and the like need to be connected not only with aggregators in urban centres, but also larger international producers of foods, cosmetics, medicines and luxury products. In many cases, such companies require urgent investment and technical assistance in branding, marketing, certification and so on. They also need to be connected with international purchasers;

Wood products: There is a clear opportunity in Indonesia to contribute to the development of sustainable use of timber resources by helping craft makers, furniture manufacturers and providers of flooring, wood panelling and other wood to procure raw materials from sustainable sources. A more sophisticated IB approach, additionally, would also help such businesses to work with local communities so that the latter are engaged in a more consistent way in supply chains, thereby improving the consistency and quality of supply to IB investees, whilst translating into increased incomes for local households;

Utilities: SMEs in many rural and peri-urban areas desperately lack consistent, quality utilities such as water, sanitation and energy. This provides an opportunity to lend to secondary and tertiary irrigation developers, waste water management companies, smallhydro and bio-gas companies and the like;

Manufacturing: Since the 1990s, Indonesia has successfully and prominently inserted itself into global supply chains of automotive parts and other components manufactures. This dynamic has been accelerated by off-shoring and out-sourcing from North Asian companies located in Japan and Korea, and even China, more recently, which have seen domestic manufacturing costs rise considerably. The opportunity for the IB Facility is twofold: supplychain focused BOP engagement models looking to incorporate smaller producers of specific, often high-value added components into their supply chains; and employee-based BOP engagement models where there is an opportunity to influence the lives of significant numbers of workers; and

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Transportation and Infrastructure:

Although it might be assumed that transport and

infrastructure investments would be too large for the Facility, given the geography of Indonesia and the need for highly-localised solutions, there may be opportunities to invest in smaller, transportation companies and infrastructure developers that are focused on areas that will significantly improve physical access for the poor, both in the personal and economic capacities. (See Section IV below for a discussion of the suggested size and key characteristics of an IB Facility for Indonesia, including returns, size, tenor and so on). ________________________

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III. Philippines
Macroeconomic and Political Landscape and Structural Challenges Although the election of Benigno Aquino III has been welcomed by many as a watershed moment in macroeconomic management and, crucially, the tackling of corruption in the Philippines, the country remains somewhat of a laggard compared to other members of the Association of South-East Asian Nations (ASEAN)-6 region. Not unlike Indonesia, this can partly be attributed to geographical challenges posed by an archipelago comprised of thousands of islandsthe cost of transportation and logistics in Philippines is exorbitant, for examplehowever, independent economic analysts and ratings agencies concur that the outlook for the country is increasingly bright. The combination of a relatively well-educated population, much of which, in the service sector, speaks excellent English, has helped to make services exports a thriving sector in recent decades. Additionally, the Philippines has been able to make inroads in the development of a distinctive tourism destination brand, helped by security concerns in Indonesia and intermittent political instability in Thailand, its two major competitors. The agri-business sector is also well-placed to capitalise not just on burgeoning domestic demand and increasingly sophisticated tastes and desire for processed foods, reflecting growing upward movement into the middle class, but also, greater regional demand (China is a notable source) for both raw and processed agricultural products. Importantly, at the structural level, the government has been successful in taming inflation, which is now well in single digits, and rapid currency depreciation is no longer a problem. On the contrary, the consistent appreciation of the peso since the late 2000s has eroded some of the artificial competitiveness which Philippine exports have traditionally relied upon. The longer-term advantage of this, however, is that it is forcing Philippine exporters to focus on productivity and efficiency gains, opportunities to move up the value chain and improve quality as a means of safeguarding existing export markets and creating new ones.

Structural Issues Affecting the SME Sector Given the preponderance of micro-, small and medium-sized enterprises (MSMEs) in the Philippines, and a significantly more populated middle ground between MSMEs and large corporatesthis is important with regard to the prospects for drawing the former into supply chainsthe prospects for an IB Facility are broadly favourable. The challenge, however, is that of the 761,000 enterprises registered in 2008, nearly 92% of them were micro-enterprises. This implies a degree of informality 12

and lack of critical mass which makes it very challenging for formal institutions and larger companies to work with. In recognition of this, from the 1970s the government began to focus on providing access to finance and technology transfer to SMEs, and on improving information flowing to them. Few formal institutions would touch the sector, however, because of the perceived risk levels, even though the government had implemented protectionist measures to stimulate it. By the 1980s and 1990s economic policy focused on trade liberalisation, promoting competition among SMEs and helping them to gain market access. The focus on creating sub-contracting linkages with larger companies and the provision of financing and guarantees to exporting SMEs did begin to achieve more rapid and lasting growth rates in the sector, along with improvements in physical infrastructure (although patchy, depending on location), which facilitated access to markets. Despite the foregoing, the Philippine Development Plan (PDP) of 2011-2016 plainly acknowledges that the country has fallen short of its targets both for the SME sector as a whole, and inclusive growth more generally. Importantly, it recognises access to finance as one of the key obstacles to SMEs being able to play a more robust role in the economy and insert themselves into production chains more consistently. Whilst recognising that programmes such as the SME Unified Lending Opportunities for Growth, established in the early 2000s, which funds export finance initiatives and provides short-term working capital loans to SMEsmore than $600m of loans have been approved since 2003the PDP also acknowledges that all of the accompanying hand holding and value addition that SMEs desperately require, especially in the area of financial management and strategic planning, has been absent.

Access to Finance Unsurprisingly, at the heart of the stunted growth record of SMEs lies the challenge of access to finance. Disappointingly, despite the many initiatives launched since the 1990s and 2000s, the volume of financing has proven too small, it has been skewed by the mandatory nature of credit allocation stipulated by various policy directives, and chiefly, has failed because a large proportion of government funds goes to livelihood, small-holder and micro-enterprise projects that often fail to achieve critical mass. Additionally, the Small Business Corporation (SBC) established by the government has relatively limited geographical coverage, and applicants complain of lengthy proposal evaluation times, general bureaucracy and an unwillingness to consider early-stage or start-up companies.

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At the same time, the banking sector has broadly complied with mandatory lending directives focused on the SME sector. The problem, however, is that much of the funding gravitates towards larger small enterprises and medium-sized enterprises, many of which are actually large enterprises that deliberately under-state their assets in order to qualify for funding. The general structure of the banking sector also exacerbates access to finance challenges. Banks in the Philippines are divided into commercial, rural and thrift banks, the idea being that this helps to ensure that credit does not flow only to large borrowers. From their establishment, thrift and rural banks were incentivised to lend to SMEs through mechanisms like lower capital and reserve requirements and access to rediscount facilities from the central bank. The problem is that even they are far too exigent vis--vis SMEs: familiar requirements of three years historical financials, lengthy business plans, cumbersome additional documentation requirements and so on. Banks also complain of the very high transaction costs associated with servicing the SME sector, choosing to focus instead on larger, safer clients. The governments MSME plan for 2010-2016 has once again highlighted access to finance as a key obstacle to faster growth in the SME sector and, encouragingly, mentions the importance of promoting inclusiveness as part of the MSME development and modernisation strategy. It points out that MSMEs are unable to meet the stringent and voluminous requirements of banks, that funds for start-ups are unavailable, and that interest rates still remain on the high side for many. It also highlights the fact that, theoretically, there should be sufficient funds in the banking system to meet the needs of SMEs, given that banks are mandated by law to allocate 8% of their loan books to SMEs.

Opportunities for an IB Facility in Philippines As in the case of Indonesia, the inimical operating environment and structural challenges that SMEs face in the Philippines creates opportunities for an inclusive business Facility. Perhaps even more than in Indonesia, however, significant technical assistance will be required in the Philippines to address issues such as sub-standard or non-existent financial record-keeping, poor or absent business plans, weak financial management, lack of understanding of sound cash flow management, poor marketing and client-outreach strategies and so on. The opportunities for IB in Philippines are not, however, limited to the SME sector. The linkages between larger corporates and aggregators are far more robust that in Indonesia, especially in the greater Manila area and in other major conurbations. In summary, this would enable to IB Facility to engage with the BOP through almost all

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recognised models. They are presented below, along with the sectors that might be categorised under them, although naturally, there will be cross-over in many cases: BOP as employee models: Partly because of the preponderance of good English speakers, and also because of the service-orientated culture, Philippines has developed a prowess in call centres and related information services. This has provided the opportunity for many incumbents of upper echelons of the BOP to gain access to employment opportunities. Not only could the IB Facility look to invest in new labour-intensive facilities, especially those beyond metro-Manila, but also, it could explore opportunities in:

transcription services: including the medical sector, legal profession, accounting, banking and so on. Some medium-sized firms are emerging (in contract to much larger call-centres) that are servicing regional and international (mostly US) corporates and financial and medical institutions. Such firms tend to be relatively labour intensive.

BOP as supplier models: Given the importance of agriculture and aquaculture to the Philippine economy, the IB Facility should definitely focus on incorporating small and medium-sized players into the supply chains of aggregators and producers. But the BOP as supplier model can incorporate other sectors in Philippines, notably the electronics and similarly semi-sophisticated manufacturing sectors (not to overlook more opportunities in more traditional manufacturing). As the trend of North Asian companies out-sourcing and off-shoring production of items such as chip boards and semi-conductors has intensified, Philippines has emerged as a major producer of semi-finished or interim goods that lie below the high-tech prowess of Japan, Singapore and Korea. Such businesses tend to involve significant up-skilling of labour which, in turn, enables workers to command higher wages and preserves retention rates.

BOP as consumer models: The delivery of key goods and services for the poor remains a challenge throughout much of non-urban Philippines. Given the geography of the country, franchise models are particularly relevant in segments such as primary and secondary education and healthcare. Similarly, demand for nutritional foods and beverages has skyrocketed in the country, and not just among the middle classes, creating opportunities for more domestic production. Due diligence also revealed opportunities in the provision of

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essential utilities, such as energy (small hydro, waste-to-energy projects, solar), irrigation, waste-water management and so on.

BOP as distributor models: Again, in light of the geography of the country, franchising and devolved, localised distribution models are essential in order for companies to achieve scale domestically. The Facility will be well-placed to explore opportunities in key pro-poor market segments such as provision of solar lighting, remote medical diagnostics, e-learning and the like.

Access to finance: A cross-cutting theme opportunity which would provide significant investment opportunities in the Philippines is providing debt to financial institutions to develop new, inclusive financial products for BOP incumbents. The characteristics of such products are no different to those highlighted in Section II above.

IV. Key Issues and Recommendations

Due diligence revealed a compelling case for establishing an ADB inclusive business Facility in Indonesia and the Philippines. Given that so many SMEs still struggle to access finance from formal institutions, and that larger, more forward-looking companies are becoming more familiar, even if gradually, with the concept of inclusive business, there is scope to establish a Facility of up to $100 million with the following key features: Focus on debt finance: Especially at the SME level, but also in many larger companies, there is an unfamiliarity with equity and an unwillingness to open shareholding structures to outsiders. Debt is a much more familiar modality, and from the Facilitys perspective, especially where smaller borrowers are concerned, it is important to establish the discipline of regular repayment;

Prudent currency-risk management: Although the Philippine peso has appreciated significantly for the last four years, this will not necessarily be the case over the life of a facility, and the Indonesian rupiah certainly tends to depreciate fairly consistently. For this reason, the advantage of a debt-focused Facility is that cash flows will accrue throughout its life, meaning that they can be translated back into hard currency at the earliest possible juncture. This will not eradicate the impact of currency depreciation, but will help to reduce

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the effect on overall returns. This, in turn, is important from the perspective of replicability and scalability of future facilities;

Loans of $500,000-$10 million: Part of the rationale for incorporating Indonesia and the Philippines into a wider South-East Asian initiative is that both countries have the critical mass to provide larger opportunities that counter-balance smaller, and arguably riskier transactions in the Mekong region. It is even possible to conceive of larger loans beyond $10 million in the case of consumer and employee-orientated BOP plays in both Indonesia and the Philippines;

Fund management options: Neither country has a particularly well-developed private equity fund management sector. Many of the large, international houses do undertake transactions in both countries, but they tend to focus on deals that are far beyond the scope of the Facility. Due diligence has, however, identified managers based in Singapore and Thailand with deep relationships in both countries and expertise in completing transactions there. A prudent strategy for the Facility might therefore be to stipulate that such managers either establish a small, local presence in Indonesia and the Philippines, or enter into partnership with investment boutiques in which capacity can be built in inclusive business and undertaking relevant transactions.

Returns: Given that the Facility would likely have a debt orientation, with equity possibly to be used in a few, limited cases, it is likely that returns would be in the region of 4-7% per annum. In the event that quasi-equity instruments are used where some sort of equity kicker is possible, slightly higher returns might be feasible.

Potential Investors: To some extent Indonesia and the Philippines fall between two stools. On the one hand, development finance institutions (DFIs) are experiencing unprecedented pressure on budgets, along with pressure from sovereigns to prove that they are investing in the poorest countries. On the other, there is certainly increasing interest in both countries among more traditional investors who are looking beyond the BRICs (Brazil, Russia, India and China) given the challenges experienced in the latter since the late 2000s. The trick will be to persuade the DFIs that including both countries into a greater Mekong Facility provides a welcome counter-balance to the Mekong countries, and that this stability will enable them

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to access investments more effectively via a pooled vehicle focused on broader developing South-East Asia. ________________________

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