Documentof The World Bank FOR OFFICIAL USEONLY ReportNo: 36272 - ET PROJECTAPPRAISAL DOCUMENT ONA PROPOSEDIDA GRANT INTHEAMOUNT OFSDR 10.3MILLION (US$15 MILLIONEQUIVALENT) TO THE FEDERALDEMOCRATIC REPUBLIC OF ETHIOPIA FOR A FINANCIALSECTORCAPACITY BUILDINGPROJECT May23,2006 Financial Sector Unit Africa Region This document has a restricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosedwithout World Bank authorization. CURRENCY EQUIVALENTS (ExchangeRateEffectiveApril 30, 2006) CurrencyUnit = EthiopianBirr 8.69ETB = US$1 US$1.4614 = SDR1 GOVERNMENTFISCALYEAR July 8 - July7 ABBREVIATIONSAND ACRONYMS AfDB African Development Bank AFRITAC East East Africa RegionTechnical Assistance Center AMPFI Agency for the Monitoring o f Public Financial Institutions ASC Audit Services Corporation B&FE Banking and Foreign Exchange BMERD Bank Modernization and ExternalRelations Directorate BOP Balance o f Payments BPR Business Process Re-engineering BSD Banking Supervision Department C A R Capital Adequacy Ratio CAS Country Assistance Strategy CBB Construction and Business Bank CBE Commercial Bank o f Ethiopia CGAP Consultative Group to Assist the Poorest CIDA Canadian InternationalDevelopment Agency CUDP Coalition for Unity and Democracy Party DAG Development Assistance Group DBE Development Bank o f Ethiopia D C I Development CooperationIreland EEPCO Ethiopian Electric Power Corporation EIBI Ethiopian Institute o f Banking and Insurance EMCP Ethiopian Management and Control sub-Program EPRDF Ethiopian Peoples Revolutionary Democratic Front ERMPD Economic Research and Monetary Policy Directorate ESAMI Eastern and Southern African Management Institute FA Fiduciary Assessment FIS Finance and Information Systems Directorate FM Financial Management FMRs Financial Management Reports GDP Gross Domestic Product GIMPA Ghana Institute o f Management and Public Administration HRASD Human Resources and Administrative Services Directorate IAD Internal Audit Department ICB InternationalCompetitive Bidding IDA InternationalDevelopment Association IFAD InternationalFundfor Agricultural Development IMF InternationalMonetary Fund ISD Insurance Supervision Department JBAR Joint Budget and Aid Review K P M G KlynveldPeat Marwick Goerdeler M&E Monitoring and Evaluation MFD Monetary and Financial Systems Department, IMF MFIs Microfinance Institutions MoFED MinistryofFinance and EconomicDevelopment NBE National Bank o f Ethiopia N M S A National Meteorological Services Authority NPLS Non-performing loans ODA Overseas Development Assistance OFAG Office o f Federal Auditor General OM Operational Manual PASDEP Plan for Accelerated and Sustained Development to End Poverty 'PCC Project Coordination Committee PDO Project Development Objective P F M Public Financial Management PIP Project Implementation Plan PSCAP Public Sector Capacity BuildingProgram PTSD Procurement and Transport Service Division ROA Return on Assets RUFIP Rural Finance IntermediationProject SA Special Account SACCOs Savings and Credit Cooperative Societies SBD Sample BiddingDocument sc Steering Committee SDPRP Sustainable Development and Poverty Reduction Program SIDA Swedish InternationalDevelopment Authority SME Small and Medium Enterprises SRP Strategic RestructuringPlan TA Technical Assistance USAID United States Agency for InternationalDevelopment Vice President: Gobind T. Nankani Country ManagedDirector: Ishac Diwan Sector Manager: Antony Thompson Task Team Leader: Priya Basu ETHIOPIA FinancialSector CapacityBuildingProject CONTENTS A. STRATEGIC CONTEXT AND RATIONALE ..................................................... 1 1. Country and Sector Issues....................................................................................... 1 2. Rationale for Bank Involvement............................................................................. 5 3. Higher Objectives to Which the Project Contributes .............................................. 6 1. Instrument............................................................................................................... 6 2. Project Development Objective and Key Indicators............................................... 6 3. Project Components ................................................................................................ 7 4. Lessons Learned and reflected inthe project design .............................................. 9 5. Alternatives considered and reasons for rejection ................................................ 10 C. IMPLEMENTATION ............................................................................................ 10 1. Partnership arrangements ...................................................................................... 10 2. Institutional and implementation arrangements.................................................... 11 3. Monitoringand evaluation o f outcomes/results .................................................... 12 4. Sustainability......................................................................................................... . . . 13 5. Critical risks and possible controversial aspects................................................... 13 6. Grant conditions and covenants ............................................................................ 14 D. APPRAISAL SUMMARY ..................................................................................... 15 1. Economic and financial analyses .......................................................................... 15 2 Technical............................................................................................................... 15 3. Fiduciary ............................................................................................................... 15 4. Social..................................................................................................................... 16 5. Environment.......................................................................................................... 16 6. Safeguard policies................................................................................................. 16 7. Policy Exceptions andReadiness.......................................................................... 16 Annex 1: Countryand Sector Background ................................................................. 17 Annex 2: Major RelatedProjectsFinancedby the Bank and/or other Agencies .....29 Annex 3: ResultsFrameworkand Monitoring ............................................................ 30 1 Annex 4: DetailedProjectDescription .......................................................................... 37 Annex 5: ProjectCosts ................................................................................................... 46 Annex 6: ImplementationArrangements ..................................................................... 48 Annex 7: FinancialManagement and DisbursementArrangements ......................... 49 Annex 8: Procurement .................................................................................................... 54 Annex 9: Economicand FinancialAnalysis ................................................................. 68 Annex 10: SafeguardPolicyIssues ................................................................................ 69 Annex 11: Project Preparationand Supervision ......................................................... 70 Annex 12: Documents in the Project File ..................................................................... 71 Annex 15: Maps ............................................................................................................... 76 2 ETHIOPIA ETHIOPIA - FINANCIAL SECTOR CAPACITY BUILDINGPROJECT PROJECT APPRAISAL DOCUMENT AFRICA AFTFS Date: May 23, 2006 Team Leader: Priya Basu Country Director: Ishac Diwan Sectors: General finance sector (100%) Sector ManagerIDirector: Antony Thompson Themes: Other financial and private sector development (P);Regulation and competition policy (S) Project ID: PO94704 Environmental screening category: Not Required LendingInstrument: Specific Investment Loan Project Financing Data [ ] Loan [ ] Credit [XI Grant [ 3 Guarantee [ ] Other: . Source Local Foreign Total RECIPIENT 0.62 0.00 0.62 IDA Grant 2.16 12.84 15.00 Total: 2.78 12.84 15.62 Recipent: Ministry of Finance and Economic Development P.0 Box 1905 Addis Ababa Ethiopia Tel: 22-66-98 Fax: 55-13-55 Responsible Agency: NationalBank o f Ethiopia P.O. Box 5550 Addis Ababa Ethiopia Tel: 51-74-30 Fax: 51-45-88 FY 2006/07 2007108 2008/09 Annual 3.0 6.0 6.0 Cumulative 3.0 9.0 15.0 Project implementationperiod: Start September 25,2006 End: June 30,2009 Expected effectiveness date: September 22,2006 Expected closing date: December 31, 2009 Does the project depart from the CAS incontent or other significant respects? Re$ PAD A.3 [ ]Yes [XINO Does the project require any exceptions from Bank policies? Re$ PAD D.7 [ ]Yes [XINO Have these beenapproved by Bank management? [ ]Yes [ IN0 I s approval for any policy exception sought from the Board? [ ]Yes [ NO Does the project include any critical risks rated "substantial" or "high"? Re$ PAD C.5 [XIYes [ ] N o Does the project meet the Regional criteria for readiness for implementation? Re$ PAD D.7 [XIYes [ ] N o Project development objective Re$ PAD B.2, TechnicalAnnex 3 The project will assist inbuildingthe foundation for a more transparent, well-governed, well- regulated, and competitive financial sector that allocates resources to the private sector more effectively and efficiently, and helps ensure better.access to finance for all. Project description Re$ PAD B.3.a, TechnicalAnnex 4 The project includes the following five components: (a) Component One: NBE Capacity Building (US$3-79million): This component will primarily help strengthen the human and institutional capacity o f the NBE so that it can discharge effectively its key functions o f regulating and supervising financial intermediaries, undertaking economic research, and formulating and implementing monetary policy. It will provide financial and technical assistance (including training and exposure programs) to build up NBE's capacity inthe following main areas: (i) banking and insurance regulation and supervision and corporate governance o f financial institutions; (ii)economic research, policy formulation and implementation functions; (iii) internal audit and finance; (iv) legal; (v) IT; (vi) human resource management; and (vii) bank modernization. (b) Component Two: StrengtheningFinancial Sector Infrastructure (US$ 4.28 million): This component will assist indeveloping the financial sector infrastructure to underpina well- functioning financial system. It will provide financial and technical assistance for: (i) payment systemmodernization; (ii) improving the credit information center; (iii) developing the capital markets infrastructure; and (iv) settingup an asset/collateral registry to facilitate secured loan transactions. (c) Component Three: Developing New Financial Products (US$5.OO million): This component will support the development o fnew financial products that are critical to improving access to finance and fostering financial sector broadening and deepening. It includes the folllowing 2 complementary and mutually reinforcing sub-components for which the project will provide assistance: (i)housing finance; (ii) finance; (iii) and medium enterprise (SME) leasing small financing; (iv) agricultural risk insurance/management; and (v) other products, such as a venture capital fund and credit cards. (d) Component Four: EnhancingProfessional Skills inthe Financial Sector (US$1.36 million): This component will focus on: (i) developing in-country training capacity, including strengtheningo fthe Ethiopian Institute ofBanking and Insurance, to buildup the skills of financial sector professionals, including bankers, insurers, leasing experts, mortgage specialists, securities brokers and issuers, accountants and auditors; and (ii)buildingup the capacity o f financial sector professional associations, including the bankers association, insurers association, microfinance association, accountants association, etc. (e) Component Five: Implementation and Monitoring Component (US$l -19million): to support project related implementation, and monitoring and evaluation activities. Which safeguard policies are triggered, if any? None. Significant, non-standard conditions, if any, for: None. Boardpresentation: None Grant effectiveness: (a) The Subsidiary Agreement has been executed on behalf o f the Recipient and the Project ImplementingEntity. (b) The Project Coordinating Committee (PCC) and a Steering Committee (SC) have been established by the Recipient inaccordance with Part B.2 o f Section Io f Schedule 2 to this Agreement. (c) The Recipient has adopted the Project Operations Manual, inform and substance satisfactory to the Association. (d) The Recipient has caused the Project ImplementingEntityto recruit specialists including a finance officer, procurement officer, project officer and an administrative assistant for appropriate training to assist with various aspects o fproject implementation, reporting, monitoring and evaluation. Covenants applicable to project implementation: (a) The PCC shall ensure that a financial management system i s maintained within NBE, audits are carried out, and Financial Monitoring Reports are furnished to IDA in the agreed formats and periodicity. (b) The mid-termreview o fthe project shall be carried out inOctober 2007. 3 A. STRATEGIC CONTEXT AND RATIONALE 1. Country and Sector Issues 1. Ethiopia's first Poverty Reduction Strategy, the Sustainable Development and Poverty Reduction Program (SDPRP), as well as the newly adopted Plan for Accelerated and Sustained Development to End Poverty (PASDEP), emphasize the importance o f private sector development to support enhanced economic growth that i s critical to achieving the overarching objective of reducing poverty. Within this framework, it i s also recognized that a developed and well-functioning financial sector can play an important role in facilitating private sector development and sustained growth, and that there i s an urgent need to ensure that private enterprises receive effective support from financial intermediaries and markets. 2. The SDPRP formed the basis for the Country Assistance Strategy (CAS), discussed by the Board on March 24, 2003, covering the period FY03-05. A CAS Progress Report, discussed by the Board on August 24, 2004, recommended a continuation o f the existing program until a new strategy was prepared. The World Bank had originally planned to prepare a new results-based CAS for Ethiopia for FY06-08. This CAS would have beendeveloped in alignment with Ethiopia's PASDEP, and under the assumption o f a scaling-up o f Bank and donor financing to Ethiopia in line with the Gleneagles commitments. 3. Inlight ofthe postponement of scaling-up inthe near term, and inorder to allow for a short pefiod where Government, stakeholders, the World Bank, and partners can develop consensus around a strengthened governance agenda for the development effort, the World Bank has prepared an Interim CAS covering FY06-07', for discussion by the World Bank's Board on May 25, 2006. The InterimCAS sets out a program o f assistance for Ethiopia designed to focus the Bank's engagement more centrally on the twin pillars o f pro-poor growth and good governance-with the hope that better political and economic governance will allow a more timely returnto the CAS program. 4. As pa8 of a multi-donor effort, the Interim CAS' overarching objective i s to support Government in developing, achieving consensus with citizens on, and implementing,a strengthenedprogram o f institution buildingand governance reform that will help in its efforts to accelerate and sustain pro-poor growth. The Interim CAS recognizes the critical importance o f good governance to support economic growth by raising investor confidence, and continued progress with key structural reforms, including in the financial sector, that are crucial to achieving and sustaining private sector-led growth. ' Inthis document the termFiscal Year refer to the World Bank's fiscal year, unless otherwise mentioned. The current World Bank fiscal year 2005106 (FY06) corresponds to the Ethiopian Fiscal Year 1997198 (EFY98) although the Ethiopian Fiscal Year spans July 8 to July 7, whereas the Bank's Fiscal Year spans July 1 to June 30. 1 5. The Ethiopian financial sector2 is dominated by the banking sector, which accounts for about 94% o f total financial sector assets, with remaining assets accounted for by the insurance sector (3%) and microfinance institutions (3%). The Ethiopian banking sector comprises one development bank (DBE), two state-owned commercial banks, namely, Commercial Bank o f Ethiopia (CBE) and Construction and Business Bank (CBB), and Seven private commercial banks. Private banks' participation has increased gradually, and they currently account for 23.5% o f commercial banking assets, with the remainder being the share of the two public sector commercial banks. CBE dominates, representing over 74% o f commercial banking assets3. 6. As in most developing countries, financial sector policy in Ethiopia aims at achieving more effective intermediation, and improving soundness and depth. The Ethiopian authorities have chosen to pursue these goals within a distinctive strategic framework for the financial sector, which i s inline with the Interim CAS, and emphasizes the importance o fbuilding and protectingpro-growth institutional capital inthe financial sector, further strengthening corporate governance and accountability o f financial institutions, and boostingthe capacity o f financial sector professionals. 7. Although the financial sector reforms are aimed at ensuring consistency with market forces, the liberalization strategy chosen by the authorities envisages accomplishing most o f the reforms behind the protection o f strict capital account exchange controls. Furthermore, although they have for several years already been exposed to vigorous competition from private entrants, the still-dominant state-owned intermediaries (especially the CBE) are being retained in government-ownership while their balance sheets, internal governance and management are being reformed. The authorities have also decided to forgo the potential benefits o f allowing the entry o f foreign-owned' intermediaries, to minimize the perceived macroeconomic risks arising from a more open financial sector, preferring to seek the transfer o f foreign financial technology and know-how through advisory assistance. 8. While the effectiveness and viability o f Ethiopian exchange controls will likely diminish over the longer run, the overall financial sector strategy adopted by the authorities seems sustainable for the present and likely to provide an adequate platform for the neededreforms. There may even be a partially compensating benefit in a reduced vulnerability to exchange rate and interest rate volatility that could otherwise result from some weather-related or other macro shocks. 9. Within the overall strategic framework for the financial sector, the authorities' approach increasingly responds to market forces. Since the opening up o f the banking sector in 1994 to domestic private banks, their market share has gradually risen and they have played an increasingly important role in providing credit to the private sector. Private banks'.credit to the private sector grew by 36% from June 2004 to June 2005. Defined here to include: the Development Bank o f Ethiopia, two public sector commercial banks, six private commercial banks (a seventh private bank was licensed earlier this year, but data for this bank are not yet available), nine insurance companies, and 23 microfinance institutions. The definition of commercial banks excludes DBE. 2 Over this period, the share o f private bank credit in total bank credit extended to the private sector increased from 46% to 55%. The share o f private bank credit in total bankingsector credit increased from 38% to 42%, over the sameperi~d.~ 10. The focus on market-oriented reforms is also conspicuous in respect o f the restructuring of the dominant state-owned bank, CBE, a centerpiece o f the current phase of the reforms. Strong efforts to reduce CBE's non-performing loans (NPLs) through foreclosure, loan restructuring and/or write-offs, have resulted in a significant improvement in the bank's NPL position. In absolute terms, CBE's NPL portfolio as o f June 30, 2005 stood at Br 2.6 billion, only slightly above the target o f Br 2.5 billion set by the bank's Strategic Restructuring Plan (SRP). The share of NPLs in total loans outstanding declined from 61% in June 2002 to 27% by June 30, 2005, and while the SRP requires CBE to reduce its NPL ratio to 15% by June 2007, CBE believes it can achieve this target by June 30, 2006. In addition to the aggressive resolution o f the sizable non-performing part o f CBE's portfolio, the mandate o f this bank and its management structures and procedures have been revamped to transform it into a fully commercial bank. 11. A Business Process Re-engineering(BPR) plan for the muchsmaller CBB is also under way-with a focus on streamlining the credit delivery process and improving customer services. 12. Policy lending i s to be confined to the development bank, DBE, which has also prepared a detailed Business Process Re-engineering Plan, which has been submitted to the Agency for the Monitoring of Public Financial Institutions (AMPFI). Measures have already been taken by DBEto: (i)reduce NPLs, through foreclosure, restructuring, and/or write offs (the reported NPLratio was 36% at June 2005, and the target is to reduce it to 24% by June 2006); (ii)streamline critical procedures (for example, the time taken to process loan applications has been reduced from 170 days to 36 days); and (iii) improve service delivery to clients. 13. Focused on the rural sector, the country's microfinance institutions (MFIs) continue to expand. Currently, there are some 23 microfinance institutions serving about 1.5 million households. In 2004105 FY, the number o f clients grew by about 26 percent, while the volume of credit extended grew by more than 50 percent over the preceding year, The average credit to deposit ratio o fMFIs stands at over 200%. 14. As the financial sector i s opened up to domestic competition, the authorities have become ever more aware o f the need to create an enabling environment for increased effectiveness and penetration o f financial intermediation responding to market demand. A financial leasing legislation was recently passed. A Five Year Strategic Plan for the National Bank of Ethiopia WE)-the country's central bank and financial sector regulatory and supervision authority-was approved in October 2004, and an Implementation Plan finalized in February 2005. Important steps taken so far have included an organizational restructuring of NBE, with the creation o f new departments The public sector continues to rely entirely on state-owned banks for its credit needs. 3 such as the Internal Audit Department (in January 2005), and a comprehensive revision ofthe salary structure and pay scales for NBE staff, which has helped boost the morale o f employees and attracted a large number o f new, qualified staff. Other important steps taken by NBE include: the establishment o f a credit information center, which provides banks with valuable data to assist with credit decisions; improvements to micro finance regulation and supervision, supported by the IFAD and AfDB Rural Finance Intermediation Project (RUFIP); and progress in strengthening foreign exchange reserve management operations and procedures. 15. While recent progress should not be underestimated, Ethiopia's financial sector i s s t i l l in its infancy, and important challenges remain. Over the years, Ethiopia's banking sector has been quite successful inmobilizing deposits; the ratio o f bank deposits to GDP stood at 39.1% at June 2005. However, banks, and particularly the state-owned banks, have tended to deploy a substantial share o f their resources-much inexcess of statutory requirements-in safer government assets (Treasury Bills), or in cash reserves at the NBE, despite the low returns from such investments.This `excess liquidity' has imposed a tax on banks and their potential clients, crowding-out credit for productive purposes. The loan-to-deposit ratios are particularly low for the state-owned banks, averaging 37% at June 2005 (private banks reported an average loan to deposit ratio o f 76.2% at June 2005). 16. Against this background, investing in the effectiveness o f the financial system i s especially important. Pushing the frontier o f financial sector effectiveness requires enhanced capacity-both skills and institutional capacity, an enabling environment and the necessary infrastructure, and new financial products that are better tailored to borrowers' needs and can help lower the risks and costs faced by both borrowers and lenders. 17. The authorities' medium-termreform program for the financial sector recognizes these priorities (see Annex 1). While the different elements o f the reform program will overlap in time, a clear sequencing o f financial sector development over the coming five years i s evident. 18. The first theme, both in importance and time-sequencing, i s the banking system. The portfolio clean-up, governance and management reform, and technological strengthening o f the government-owned banks is the ongoing initial stage. Following entry liberalization and the rapid growth o f private banks, a strengthening o f the institutional capacity and functioning o f bank regulation and supervision has become ~rgent.~ Finally the technical performance o f the payments system leaves much to be desired. By 2010, the authorities envisage a contestable banking system operating in a fully commercial and technically efficient manner, with the private banks likely having overtaken CBE inmarket share (though no goal has been set for this share). 19. The second theme i s the development o f the insurance industry. Following entry liberalization, a strengthening o f the institutional capacity and functioning o f insurance ~ Including the move to risk-basedsupervision. 4 regulation and supervision has become important. In the next three years, the authorities envisage a move from compliance-based to risk-based supervision and improvements in on-site and off-site surveillance, financial reporting and analysis. 20. The third theme is the development o f capital markets. Inthis area the money and bond markets are seen as the first priority, given their importance in achieving and maintaining monetary policy effectiveness. By 2010, these wholesale markets should have developed and deepened, providing also the framework for a secondary mortgage market with the participation o f pension funds. As necessary, the institutional, legal and regulatory measures for the orderly development o f the stock market should have been completedby that date. 21. The fourth theme is rural and low-income finance. It is envisaged that the four large existing MFIs will continue to diversify their product mix, possibly becoming limited-service banks. Other institutions that provide financial services to the low- income population will also continue to find a role in the mediumterm, and a regulatory strategy for these institutions, particularly for savings and credit cooperatives, will be elaborated in a consultative manner and implemented by 2010. The potential for modem agricultural risk insurance products as well as products to increase financing to small and medium enterprises (SME) will be explored and piloted with a view to a fuller roll-out before 2010. 22. The fifth theme focuses on the legal, judicial and information environment. This will include, for example, improved foreclosure laws, enabling legislation for leasing, establishment o f a registry o f assets and enhancement o f the credit information bureau and a major improvement in the quality and reliability o f accounting information.6 Ongoing capacity development and legislative reforms here will take time. 23. Within the context o f this medium-term roadmap, and to support the priorities identified, the Government o f Ethiopia has requested the Bank's assistance through a financial sector development program. The first phase o f this program, to be delivered through the proposed project (the Financial Sector Capacity Building project), will encompass carefully targeted interventions aimed at supporting immediate priorities, therebybuildingthe foundation o f a modem and well-functioning financial sector. 2. Rationale for BankInvolvement 24. The Interim CAS includes an increased emphasis on protecting pro-growth institutional capital, further strengthening governance and accountability, and accelerating dialogue with the private sector and civil society, while also boosting the capacity o f private sector and civil society organizations. Within this strategic agenda, there i s a significant role for instruments that can help build a more transparent, well- governed, well-regulated, and competitive financial sector that allocates resources to the The lack o f confidence inaudited accounts at present has prompted the authorities to explore possible ways of providing an disincentive to firms against producing different sets o f accounts for the tax authorities and the banks. 5 private sector in a more effective and efficient manner. The proposed Financial Sector Capacity Buildingproject (referred to henceforth as the `project'), which aims to build the foundation for such a financial sector that can ensure better access to finance for all, i s closely aligned with the Interim CAS and responds to a request from the Government after several years of limitedengagement on financial sector issues. 25. Given the limited forms o f bilateral donor support for financial sector development in Ethiopia, the Bank's comparative advantage lies in its ability to deploy a wide range o f instrumentsin supporting financial sector development (advisory services, training, finance), that draw on global sound practices and lessons o f experience from other countries and also leverage off related Bank projects in Ethiopia (see Annex 2). However, project preparation has involved coordination with other development partners active in Ethiopia, including the International Monetary Fund (IMF), African Development Bank, CIDA, SIDA, USAID and Development Cooperation Ireland. 3. Higher Objectivesto Which the Project Contributes 26. The project, by putting in place the basic building blocks for financial sector development, should be viewed as an important step in creating a sound, deep, and effective financial sector which would contribute to better access to finance for all and, over the mediu'm-to-longer term, to sustained, pro-poor growth. B. PROJECT DESCRIPTION 1. Instrument 27. Total project costs amount to US$15.62 million, consisting o f an IDA Grant of US$15 million and Government counterpart funding o f US$0.62 million (equivalent, in kind).' The funds will finance advisory services, training and goods. 2. ProjectDevelopmentObjectiveand Key Indicators 28. The project will assist in building the foundation for a more transparent, well- governed, well-regulated, and competitive financial sector that allocates resources to the private sector more effectively and efficiently, and helps ensure better access to finance for all. 29. Achievement o f the PDO will be measured interms o f sustained improvements in financial sector soundness and effectiveness, and improvements in access to financial services. Specifically, key indicators to monitor progress will be: (i)Reduction in commercial banks' NPL ratio from 20% in end FY05/06 to 10% by end FY08/09; (ii) Increase in the ratio o f financial sector assets to GDP from 126.7% in end FY05/06 to 131.1% by end FY08/09; (iii) Increase inthe private sector credit to GDP ratio from 20% inendFY 05/06 to 24.8% by endFY 08/09 (see Annex 3). 'The IMF may provide complementary technical assistance to support selected areas under the project, 6 3. ProjectComponents The project includes the following main components (see Annexes 4, 5): Component One: NationalBank of EthiopiaCapacityBuilding(US$3.79 million) 30. This component will primarily help strengthen the human and institutional capacity o f the National Bank o f Ethiopia (NBE) so that it can discharge effectively its key functions o f regulating and supervising financial intermediaries, undertaking economic research, and formulating and implementingmonetary policy. This component will provide financial and technical assistance (including training and exposure programs) to build-up NBE's capacity inthe following main areas: Banking Regulation and Supervision function, which will focus, inter alia, on: (a) upgrading prudential regulation and market conduct rules, and their monitoring and enforcement by supervision staff, including through better on-site inspection and off- site surveillance; (b) developing a framework, policies and implementation skills for problem bank resolution and the treatment o f depositors; (c) assisting a move from compliance-based to risk-based supervision, and strengthening the skills o f supervisors to undertake risk-based supervision; (d) upgrading IT capability o f the Banking Supervision Department; and (e) support to strengthen corporate governance o f financial sector institutions. Insurance Regulation and Supervision function, which will focus, inter alia, on: (a) upgrading prudential regulation and market conduct rules, and their monitoring and enforcement by supervision staff, including through better on-site inspection and off- site surveillance; (b) assisting a move from compliance-based to risk-based supervision; (c) developing a technical library for insurance supervision; and (d) upgrading I T capability inthe Insurance Supervision Department; Economic Research, Policy Formulation and Implementation function, which will focus, inter alia, on: (a) monetary policy and liquidity forecasting; (b) financial market development; (c) macroeconomic modeling and analysis; (d) balance o f payments (BOP) analysis. Since these functions are closely linked to some o f the functions o f the Banking and Foreign Exchange Directorate, the project will include selective support in the areas o f improving reserve management, currency management and forex operations, and BOP and foreign trade statistics. In addition, carehlly targeted support will be provided to NBE to strengthen the capacity o f its Internal Audit, Finance, Legal and IT Departments, and in the areas o f human resource management and bank modernization, to improve performance measurement and management, viewed as critical to the sustainability o f the capacity built through the project. 7 Component Two: StrengtheningFinancialSector Infrastructure(US$4.28 million) 31, This component will assist in developing the financial sector infrastructure to underpin a well-functioning financial system. It will provide financial and technical assistance inthe following areas: Payment system modernization, which will focus on: (a) creation o f a national payment systems framework and developing a policy/oversight function for the NBE; (b) introducing a new non-electronic payment systems (e.g., for remittances, in-country money transfers, etc.) and, over the medium term, introducing a large value electronic payment system; (c) building skills in payments risk analysis and oversight; (d) upgrading/automating the Addis Ababa Clearing House; and (e) establishingregional clearing houses. Improving the credit information center, including: (a) upgrading/automating the existing credit bureau; (b) enhancing the coverage o f the existing data base; (c) building skills o f NBE staff in the effective use of the data base and skills o f commercial bank staff and other parties in the provision o f credit information; and (d) raising public awareness on the importance and usage o f credit reporting systems, through a systematic public awareness campaign. Developing the capital markets infrastructure, including: (a) establishment o f a centralized depository/clearance and electronic settlement mechanism for government debt and corporate bonds; (b) supporting the establishment o f a stock exchange and developing, in cooperation with the authorities, a framework for stock market regulation; and (c) preparing a strategy and action plan for the development of the government and corporate bond markets. Setting up an asset/collateral registry to facilitate secured loan transactions. Component Three: DevelopingNew FinancialProducts(US$5.0 million) 32. This component will support the development o f new financial products that are critical to improving access to finance and fostering financial sector broadening and deepening. It includes five complementary and mutually reinforcing sub-components for which the project will provide financial and technical assistance: Housing finance-Support in this area will be provided through developing and piloting innovative financing mechanisms and instruments to address the critical bottlenecks to housing finance for middle income households. This will include: (a) building linkages between banks and grassroots financial intermediaries, such as credit unions or MFIs; (b) introducing instruments to help banks manage their liquidity; and (c) promoting real estate developer finance schemes. Support inthese areas will be accompanied by capacity building assistance to lenders. Leasing finance-The project will examine and recommend measures needed for the development o f a financial leasing industry. Small and medium enterprise (SME) financing-Support in this area will focus on developing a partial credit guarantee facility to encourage lendingto SMEs by banks and other grassroots financial institutions, such as credit cooperatives and MFIs, with 8 a focus on lesser-served regions. Support under the project will include preparation of feasibility studies followed up by TA, as necessary. Agricultural risk management-Support in this area will include introducing index based weather insurance into the Ethiopian market. The project will support the piloting o f this product and assess its scalability and potential linkages to agriculturalhput financing. The project will also analyze the needs o f the National Meteorological Services Authority (NMSA). The project will provide TA and infrastructure investments as necessary for the potential scale-up o f weather insurance products to insurers, banking professionals, and the NMSA. Additional support will take the form o f feasibility studies on other agricultural risk management products, for example, developing a warehouse receipt system. Other products that the project may help develop, through technical and/or financial assistance,include: a venture capital fund, in collaboration with Government and private sector partners and credit cards. Component Four: Enhancing Professional Skills in the Financial Sector (US$1.36 million) 33. This component will focus on developing in-country training capacity to build up the skills o f financial sector professionals, including bankers, insurers, leasing experts, mortgage spec.ialists, securities brokers and issuers, accountants and auditors, and so forth, and also to build up the capacity o f financial sector professional associations. It includes financial and technical assistance inthe following areas: i).SupporttotheEthiopianInstituteofBankingandInsurance(EIBI),totransformEIBI into a center of excellence for training in banking and finance. This will include support to EIBI for developing training curricula and manuals as well as for introducing certification programs (in collaboration with local industry associations) to enhance the capability and professional skills o f financial sector professionals; ii).Buildingtheresearchcapacity ofindustryassociations, includingtheAssociationof Accountants, Bankers' Association, Insurers' Association, and Microfinance Association; iii). Targeted training for financial sector professionals in banking, insurance, and microfinance. Component Five: Implementation and Monitoring Component (US$1.19 million) to support project implementation, monitoring and evaluation activities. 4. LessonsLearnedand reflectedin the projectdesign 34. One o f the key lessons learned from past projects i s that client ownership and commitment are paramount for capacity building efforts to be sustainable. The project design was strongly demand-driven; the team encouraged beneficiaries to identify capacity building priorities, and provide detailed input into the selection o f specific capacity building activities. Particular attention was paid to aligning the project closely with ongoing capacity building activities, especially the NBE Business Process Re- 9 engineering and the Strategic Plan Document. The final design was also shared with beneficiaries for further comments and suggestions. This process o f consultation and collaboration with government and other beneficiaries has resulted in a high level of ownership and commitment to the goals and components o f the project. In addition, the project design aims to maximize the involvement o f interested Development Partners, and harmonize their contributions. 35. Also, the project design i s as simple as possible with concentration on carefully targeted components. There are only four main components with related capacity building activities grouped together to maximize synergies. This approach is aimed at avoiding implementation and supervision problems that have plagued financial sector projects with a large numbero f components containing disparate activities. 36. Further, recognizing that lack o f sustainability has been a major problem o f many Bank projects focused on capacity building, the proposed project i s anchored on complementary changes in the beneficiary institutions that are aimed at retaining whatever capacity has been developed. For instance, the NBE recently increased its salary scale for staff, significantly improving the monetary incentives to attract and keep competent staff. In addition, efforts are underway to define job descriptions and define career paths, thus making the NBE a more interestingplace to work. As a result, NBE has been able to reverse staff turnover, attracting over 80 new professionals in the last 12 months. 5. Alternatives consideredand reasons for rejection 37. As the first phase o f a longer term engagement with the Government on financial sector development, the team considered incorporating a set o f policy reforms. However, it quickly became clear that there was a serious shortage o f client capacity to make informed choices or to implement financial reforms. The project team therefore decided to focus substantially on strengthening the capacity o f key players in the financial system (NBE, EIBI, financial sector professional associations), kick-start the development of new financial products, and strengthen critical financial sector infrastructure (notably, payments and credit information systems, capital markets infrastructure and an asset registry) with system-wide benefits. This should provide a firm foundation on which to build future financial development efforts. Specific restructuring support for state-owned banks was not included in the project because restructuring plans for the three state- owned banks are already under way under separate initiatives and are being closely monitored. C. IMPLEMENTATION 1. Partnership arrangements 38. The project was designed and will be carried out in close collaboration with other donors. Specifically, in the areas o f NBE capacity building and financial infrastructure 10 strengthening, support under the Project will ensure coordination, as required, between the Bank, the IMF (MFD and AFRITAC East) and IFAD, to avoid gaps and overlaps. In product development, support under the Project will ensure coordination between relevant development partners (IDA, IFC, IFAD, CGAP, DFID, CIDA, SIDA, Irish Aid and USAID) that are either already involved in the sector (e.g., IFAD and U S A I D in rural/agricultural finance), or have expressed an interest in assisting specific product areas (e.g., IFC inhousing finance and leasing). Training programs under the project will leverage on the expertise o f the World Bank Institute. 2. Institutionaland implementationarrangements 39. The NBE, as the Project Implementing Entity, will be responsible for the overall implementation o f the project (see Annex 6). The overriding principle guiding the institutional and implementation arrangements for the project i s the `mainstreaming' o f operational responsibility to NBE. The Economic Research and Monetary Policy Directorate in the NBE will be the coordinator o f the project with day-to-day assistance from other departments in NBE, such as the Finance Department, Administration Services Department, and Human Resources Department. 40. T o bolster its capacity for project implementation, NBE will recruit three to four staff (including a Procurement Officer, a Finance/Accounts Officer, a Project Officer, and an Adminstrative Assistant).' These staff will be assigned to the appropriate functional units within NBE, be supervised by their unit heads, and receive the necessary training, as appropriate. Salaries and training o f these staff may be financed from the project resources. 41. A `Project Coordination Committee' (PCC), consisting o f senior representatives from the relevant units within NBE, will be responsible for project implementation. The PCC will meet frequently, as needs arise. It will be supported by a small secretariat o f one or two staff, includingthe Administrative Assistant to be hired under the project. 42. The PCC will report to a `Steering Committee' (SC), which will be established for the purpose o f project oversight and to ensure effective coordination among the different beneficiaries. The SC will consist o f representatives from key institutions benefiting from the project, either directly or indirectly (including NBE, MoFED, Agency for the Monitoring o f Public Financial Institutions, Ministry o f Trade and Industry, and the industryassociations, such as the Bankers' Association and InsurersAssociation). The SC will meet once every quarter during the first year o f project implementation, and thereafter, twice a year. 43. The project will have an implementation period o f three years. A detailed Project Operational Manual (OM), including the Project Implementation Plan (PIP), Financial Management Plan, and Procurement Plan, will be finalized before effectiveness. The OM will include all periodic reporting, monitoring and evaluation arrangements throughout the life o f the project. A mid-tern review date o f October 30, 2007 has been agreed upon * The plan is for NBEto retain these staff even after the completion o f the project. 11 with the objective of assessing progress and, if necessary, to re-direct the project by integrating additional lessons learned and ground realities. 3. Monitoring and evaluation of outcomes/results 44. Progress on project outcomes, activities and inputs will be monitored through regular reviews, including the mid-term review (in October 2007). These reviews will require dialogue at a number o f different levels. NBE will lead and co-ordinate this dialogue from the Government's side. NBE's regular reports will be a key element o f the M&Esystem for this project. While based on existing systems, the formats ofreports will be enhanced. Moroever, to ensure enhanced independence, M&E under the project will also draw on other sources, including surveys implemented under the project to gather data inrelevant areas, financial statements o f financial institutions, etc. NBE will furnish the World Bank with audited financial statements for all financial institutions within nine months o f the end o f each financial year. 45. Progress on each component will be monitored, and results evaluated, against several criteria. The project will put inplace systems to monitor on-going progress and to evaluate the longer-term impact o f activities under each component, as set out in the Results Framework and Monitoring (see Annex 3). Progress on Component 1 will be monitored, and results evaluated, against the following criteria: (i) improved prudential regulatory standards and rules o f market conduct in alignment with international standards and best practices; (ii) improved monitoring and enforcement o f rules through better off-site surveillance and on-site inspections; (iii)improved compilation and monitoring o f foreign exchange statistics; (iv) regular and accurate liquidity forecasting; (v) improved balance o f payments statistics and analysis. Data collection and reporting to monitor and evaluate progress against these criteria will be coordinated by the NBE. Its regular reports will be a key element o f the M&E system for this component. While based on existing systems, the formats o freports will be enhanced. Progress on Component 2 will be monitored, and results evaluated, against the following criteria: (i) increase in value o f non-cash transactions in FY06-07, 07-08 and 08-09; (ii) target for the establishment and operationalization o f regional annual clearing houses; and (iii) automation o f the credit information center at NBE by end June 2009. NBE's regular reports will be a key element o f the M&E system for this component. While based on existing systems, the formats o f reports will be enhanced. Progress on Component 3 will be monitored, and results evaluated, against the following criteria: (i) preparation for a pilot SME guarantee facility completed, and the required training and T A delivered; (ii) agricultural risk insurance pilot scaled-up; and (iii) housing finance facility feasibility study completed. Information to monitor and evaluate progress on (i) and (iii) be collected and reported by the PCC. The will M&E for (iii) involve surveys on household access to agricultural insurance will 12 whose baseline will be completed by end December 2006, with a follow-up survey completed by end March2009. Progress on Component 4 will be monitored, and results evaluated, against the following criteria: (i) certification programs introduced for bankers and insurers by EIBI; and (ii) regular training by EIBI o f finance professionals using revised and updated curricula. EIBI's annual reports will be a key element o f the M&E system for this component. While based on existing systems, the format o f reports will be enhanced. In addition, the M&E system for this component will involve feedback from financial sector industry associations and individual end-users, through surveys whose baseline will be completed by end September 2006, with follow-up surveys completed by end September 2007, end September 2008, and end March 2009. 4. Sustainability 46. The project supports the Government's commitments in the areas o f private sector development, financial sector development, growth and poverty reduction. Thus, a high degree o f commitment i s expected in the implementation of project activities. The importance o f the project has been recognized by Government and i s perceived by the private sector as being critical. The project's components are strongly demand-driven. Nonetheless, to ensure appropriate project design and flexibility during implementation, both o f which are critical to the sustainability of the project's results, a participatory process with strong involvement o f concerned stakeholders will be employed. This approach will also help achieve enhanced transparency and accountability. Furthermore, to ensure sustained capacity building, and in particular, to reduce the risk that capacity building resources from the project feed the exodus o f skilled personnel to the private sector or out o f the country, the project includes a strong focus on strengthening performance-based incentive systems and remuneration policies at NBE. It also includes efforts to strengthenin-country training capacity. 5. Critical risks and possible controversialaspects Risk Risk Risk Mitigation Measure Rating 1.Deterioration in governance M Inclusiono f governance indicators in new PRSP (PASDEP) environment resultiag in callsfor matrix and enhanced dialogue on governance suspension of theproject. Strong pro-poor bias o f the project's PDO Strong involvement of stakeholders, including various financial industry associations, and donors, in the design and delivery o f the project, with regular consultative events (missions, reviews) planned during implementation 2. Government S readiness to tackle M Approach taken is to engage with the authorities in areas where effectively financial sector reform they are willing to make changes inresponseto market forces. issues. These will have a positive impact, regardless o f developments inthe broader liberalization agenda. Moreover, the project will help enhance the preparedness and capabilities o f financial sector policy makers and professionals to respond to a more open financial sector, as it evolves. Also, it will help expose key players to sound practices and lessons o f international experience, creating greater awareness among stakeholders. 13 With its focus on engagingwith professional associationsand civil society, the project will help promotea more conducive atmosphere for initiating and sustainingfinancial sector reforms. 3. Non-aligned expectations and M The approach chosen, which involvesstrong effortstowards ineflciency among various donors harmonization of donor involvementinthe sector, shouldhelp contributingtojkancial sector mitigatethis risk. development, arisingfrom lack of coordination. 4. Complex reportingprocedures M Reportingrequirementshavebeenbuilt on existing systems to may be too burdensome, leading to a the extent possible. slowdown or halt in implementation. Timing has been synchronized/coordinated to minimize transaction costs Adequate time lag for reportingdata on financial institutions. 5. Key entities may lack capacity to M Through its various components,the project includes a strong carry out obligations. focus on capacitybuilding within NBE and across the financial sector. PSCAP implementation. 6. Retaining skilled staffat NBE. S As part of its Strategic Restructuring, NBEhas recently reviewed andrevisedits incentivesystem and remuneration policy. Furthermore,the projectwill includestrengtheningstaff performancemonitoringandmanagement at NBE. Inso far as the projectwill support the trainingoffinancial sector professionalsoutsideof NBE, the risk that these efforts will feed the exodus of skilled staff from public sector banks is mitigatedby the fact that efforts are also under way in the public sector banks and other public sector financial institutionsto reviseincentive systems and remuneration policies. The emphasis on building in-countrytraining capacityshould also support sustainability. Risk Rating- H (High Risks), S (Substantial Ris , M (ModerateRisk), N(Negligible or Low Risk) 6. Grant conditionsand covenants Effectiveness Conditions: (a) The Subsidiary Agreement has beenexecuted on behalf o f the Recipient and the Project ImplementingEntity. (b) The Project Coordinating Committee (PCC) and a Steering Committee (SC) have been established by the Recipient in accordance with Part B.2 o f Section Io f Schedule 2 to this Agreement. (c) The Recipient has adopted the Project Operations Manual, inform and substance satisfactory to the Association. (d) The Recipient has caused the Project ImplementingEntityto recruit specialists including a finance officer, procurement officer, project officer and an administrative assistant for appropriate training to assist with various aspects o fproject implementation, reporting, monitoring and evaluation. 14 Other Covenants: (a) The PCC shall ensure that a financial management system i s maintained within NBE, audits are carried out, and Financial MonitoringReports are furnished to IDA inthe agreed formats and periodicity. (b) The mid-termreview ofthe project shall be carried out inOctober 2007. D. APPRAISAL SUMMARY 1. Economic and financial analyses 47. Significant net economic benefit i s expected to be derived from the Project. The Project will help build the foundation for improved financial sector soundness and effectiveness, thereby supporting better access to finance for the private sector, including low-income households and other segments o f the economy that are currently underservedby the formal financial sector, or entirely excluded. Over the medium-term, the project is expected to generate substantial benefits for private sector development, overall economic growth, and poverty reduction. 2 Technical 48. The project design draws on the results o f relevant economic and sector work, and incorporates the lessons from other Bank Group capacity building projects contained in IEG's recent review. One common problem with capacity building projects has beenthe absence o f a results framework with targets, baseline and monitorable indicators; the project addresses this through a detailed results framework with measurable targets and monitorable indicators. 3. Fiduciary 49. The NBE's Finance Department will be responsible for overall financial management o f the project. The NBEfinancial management system will be usedinthe implementationof the project. NBEhas a good financial management system, as i s expected from a financial institution. NBEuses International Financial Reporting Standards inpreparing its financial statements. NBE's accounts for the year ended 7 July 2005 arebeing audited by external auditors. NBEnormally issues its audited financial statements six months after the end o f each fiscal year (see Annex 7). 50. One Special Account (SA) inUnited States Dollar will be opened inthe NBE. World Bank's share o f eligible expenditures will bepaid from the SA. Replenishmento f the SA will be based on Quarterly Financial MonitoringReports (FMRs),based on the agreed format. The external auditors o f the project will include the movement o f the SA intheir annual audit. 5 1. The financial transactions o fthe project will be included inthe annual accounts o f the NBE.The notes to accounts o fthe NBEaudited accounts will show the financial 15 transactions o f the project. The audited accounts o f NBE will be submitted to the World Bank six months after the end o f each fiscal year. 52. The bulk o f procurement under this project i s services, rather than goods. A procurement plan for the first 18 months has been agreed with the authorities (see Annex 8). 4. Social 53. N o specific social safeguard issues have been identified at present. 5. Environment 54. The project i s designated in `Category C' for environmental screening where the responsibility for (potential future) safeguard review and clearance has been transferred to the Sector Manager. 6. Safeguard policies 7. Policy Exceptions and Readiness 55. The project does not require any exception from Bank procedures. Assessments and preparationof fiduciary arrangements, staff and consultant selection, monitoring and evaluation systems, and implementation and procurement plans meet the regional criteria for readiness o f implementation. 16 Annex 1: Country and Sector Background ETHIOPIA: FinancialSector CapacityBuildingProject Country Background: Country political context On May 15, 2005, the first openly contested elections in Ethiopia's history were held. Official election results showed that the ruling EPRDF had retained a majority in Parliament, while the opposition increased its number o f seats from 12 to 175 seats out o f 547, and gained control o f the Addis Ababa city government. The groups monitoring the elections (the European Union, the African Union, and the Carter Center) found a number of areas where the election did not conform to international standards. Much o f the opposition disputes the result. However, the aftermath of the elections has demonstrated the fragility o f the democratizationprocess. Election-relatedviolence began inJune. Many memberso f the largest opposition party, the Coalition for Unity and Democracy Party (CUDP), boycotted Parliament, and refused to take up the administration o f Addis Ababa. The simmeringtensions boiledover again inearly November, when clashes occurred between civilians and government security forces in Addis Ababa and several other cities, Thousands o f civilians were arrested, including journalists and key opposition leaders such as the CUDP's President and Chairman. The recent evolution of the political situation points to possibilities for both positive and negative developments in the near term. On one hand, while most o f the opposition initially boycotted Parliament, now only about 20 o f 172 elected opposition parliamentarians have not taken up their seats. There has been progress towards the formation o f an opposition-led city government in Addis. While Government had changed parliamentary rules after the election to limit the power o f the opposition, authorities are now open to reversing these restrictions, as well as revising the media law to be more in line with international best practice. On the other hand, key opposition leaders and journalists still remain jailed, and trials on charges o f treason began on February 23, 2006. The political climate remains characterized by a lack of trust among the parties and the possibility o f further unrest remains. Macroeconomic context Ethiopia's economic growth performance over the past two years has been very strong and broad based. After a significant drought-induced contraction, Ethiopia's economy rebounded in 2003104 and 2004105 with rapid broad-based growth driven by strong agricultural performance. Real GDP growthwas 8.9 percent in 2004105, following an 11 percent growth rate rebound in 2003104 (table 1). Growth was driven by a strong agriculture sector (12.1 percent growth) but also reflects good performance across sectors (6.6 percent in industrial production, and 5.8 percent in services). The IMF expects growth o f 5.1 percent in 2005106, though Government expects higher growth of 7 percent. At the end o f December 2005, consumer prices had risen by 11.7 percent inthe 17 previous twelve months, compared to 6.8 percent in June. Food prices have been increasing more rapidly than the overall level o f inflation. Table 1: Selected Macroeconomic Indicators 1998199 I999100 2000101 2001102 2002103 2003104 2004105 2005106 I_.-- (prelim.) __-_ (prelim.) -__ ___ (prelim.) (proj.) (percent growth) GDP at factor cost 7.1 5.3 7.4 -0.3 -3.8 11.3 8.9 7.5 Agriculture 4.3 3.2 10.7 -2.3 -11.6 17.7 12.1 7.9 Industry 7.1 3.6 4.8 5.1 5.5 6.8 6.6 7.3 Services 11.5 8.9 3.8 0.5 3.3 5.8 5.8 5.0 Inflation (CPI) 4.8 6.2 -5.2 -7.2 15.1 8.6 6.8 11.9 Food CPI 9.0 8.6 -10.6 -12.7 24.8 11.8 7.7 14.2 Non food CPI -2.0 1.8 1.9 0.9 0.5 2.8 5.2 7.6 External sector Exports (GNFS) -12.3 8.2 -0.25 0.2 16.0 31.4 22.1 20.7 Imports (GNFS) 13.8 -7.0 6.8 11.6 13.2 35.1 37.7 20.9 (period average) Exchange rate 7.51 8.15 8.33 8.54 8.58 8.62 8.65 8.75 (Birr/US$) Source: National Bank o f Ethiopia, May 2006. Macroeconomic stability has been a critical underpinning both to the foundations for economic growth, and increased levels o f development assistance that have flowed through the budgetuntilrecently. However, a confluence o f negative factors has recently required the Government to take decisive action to ensure continuation o f the long-run trend o f macro-stability. While exports grew strongly in 2004/05, imports have grown even faster. Due to rising oil prices, increased demand for imports due to fast economic growth, and an ambitious infrastructure investment program, Ethiopia's balance of payment situation has shown increasing fragility. Government has made concrete proposals for delaying portions o f its public investment plan (in energy and telecom) in light o f the needto bridge a BOP financing gap, indicated that the oil import bill i s expected to be lower than initially estimated, and that Government borrowing from NBE for deficit financing will be held at a lower level than initiallyproposed. Poverty Although the country has abundant resources and good potential for development, most o f Ethiopia's population lives in absolute poverty. Poverty i s pandemic and often linked to environmental and natural resource degradation. The ongoing update by the Government o f the Household Income, Consumption, and Expenditure Survey (H1CES)-expected inthe coming months-will provide the first comprehensive update 18 on the progress achieved in poverty reduction since 1999/00, when the poverty rate was measured at about 44 percent. The recently completed Poverty Assessment suggests that poverty may have shown a small decline in recent years. Still, the Poverty Assessment notes that the overall progress in reducing poverty since 1992 remains limited, due to weak and highly variable agricultural growth accompanied by the rapid expansion in the country's population. Good performance by the current Government in implementing Ethiopia's Sustainable Development and Poverty Reduction Program (SDPRP) means that there i s much to be lost ifthe country recent progress on growth, poverty, and human development stalls or i s reversed. Indeed a key development challenge facing Ethiopia in the aftermath o f the May 2005 elections i s to continue the progress made in recent years toward the MillenniumDevelopment Goals (MDGs) in a more polarized society, and inthe absence o f direct budget support and scaling-up o f donor resources. To finance the increased spending needed to meet the MDGs, increased O D A i s critical, since fiscal deficits and taxation are already high, eventhough Government expects highlevels o f growth. Central to meeting Ethiopia's development challenge i s the role o f good governance, which i s crucial not only for restoring an upward trend in donor financial support, but also, for enabling the effective delivery o f services, promoting peaceful and consensual resolution o f conflict, and improving business confidence-without which Ethiopia will not be able to make significant progress toward the MDGs. Even before the recent developments, the Government (and the World Bank) were placing a strong emphasis on interventions to help strengthen key areas o f economic governance-such as building institutional capacity in support o f decentralization, supporting private sector growth, and improving transparency and accountability. Since the May 2005 election, there i s a broad consensus that a deepened understanding o f the political economy dynamics will shape the effectiveness o f development interventions-particularly in relation to how political governance translates into the economic sphere. FinancialSector Background: A well-governed, well-regulated, and competitive financial sector that can allocate resources to the private sector more effectively and efficiently, and help ensure better access to finance for all, i s central to achieving private sector development, high and sustained growth, and poverty reduction inEthiopia. Banking Sector The Ethiopian financial sector is dominated by the banking sector, which accounts for about 94% o f total financial sector assets. The banking sector comprises one development bank (DBE) and nine domestic commercial banks (two public sector banks, namely, CBE and CBB, and seven private banks). CBE dominates, representing over 74% o f commercial banking assets9. Private banks currently account for 23.5% o f commercial 19 banking assets, with the remainder being the share o f the two public sector commercial banks. However, recent months have seen an increased role for private banks. Private banks' credit to the private sector grew by 36% from June 2004 to June 2005. Over this period, the share o f private bank credit intotal bank credit extended to the private sector increased from 46% to 55%. The share o f private bank credit in total banking sector credit increased from 38% to 42%, over the same period.10 Commercial banks as a group appear to be adequately capitalized, based on reported data. As o f June 2004, the reported average capital adequacy ratio (CAR) was 12.3% for all commercial banks, 11.7% for the public sector banks, and 13.7% for the private banks, well above the Basle norm o f 8%. The predominance o f a relatively stable base o f core deposits is a positive feature of the Ethiopian banking sector. At June 2004, deposits accounted for 80% o f commercial banks' liabilities. Savings and fixed-term deposits accounted for 41% o f total liabilities for all commercial banks, 36% for public sector banks and 60% for private banks, Deposits recorded a 21% growth during the year ending June 2004, signaling the start o f an economic recovery process and possibly renewed confidence in the banking system; the private sector banks recorded a much higher deposit growth rate (49%) than the public sector banks (14%). Commercial banks, and particularly public sector banks, have tended to deploy a substantial share o f their resources in safer assets, such as T-bills, or in reserves at NBE. InJune 2004, net loans and advances accounted for a relatively small proportion (24%) o f the total assets o f public sector banks, in contrast to the private banks (58%). The loan to deposit ratio o f public sector banks was 39%, while the corresponding figure for private banks was 76%. T-bill holdings and reserves at NBE constituted 40% o f public sector banks' total assets; the corresponding figure for private banks was 18%. The high volume o f non-performing loans (NPLs) on the balance sheets o f commercial banks, and particularly public sector banks, remains o f serious concern. However, NPL ratios have been reduced in recent years, through strong efforts to foreclose, restructure and/or write-off NF'Ls. The NPL ratio for commercial banks as a group declined from 44.2% in 2002 to 20% in 2005. In absolute terms, too, N P L s have been declining, by about 29% for all banks, 31% for public sector banks and 5% for private banks between FY03 and FY04. Insurance The insurance sector is small, accounting for just 3% o f financial. system assets. The sector comprises one large state-owned company, representing 50% o f the market, and eight small privately owned companies, established since the opening o f the sector in 1994. The sector i s dominated by the non-life industry, which accounts for about 95% o f the total gross premiumscollected. The stability of the insurance sector is closely tied to that o f the banking sector. Insurance companies are dependent on banks as a marketing source. The balance sheets o f insurance companies are also over-exposed to and over loThe public sector continues to rely entirely o n state-owned banks for its credit needs. 20 concentrated in the banking sector, with over 40% of assets exposed to the banking sector. A major problem threatening solvency relates to unpaid premiums.Most companies hold large uncollected premiums on their balance sheets which are, o f course, erroneous assets. The legal framework (embodied in the Commercial Code o f 1960) makes it difficult for insurance companies to cancel a policy in the event of unpaid premiums, Furthermore, declining premiumrates, inthe face o f increased competition, have resulted ina steady decline inprofits. The average ROA for the sector declined from 6% in2002 to 3% in2004. Microfilz ance The relatively new but fast-growing microfinance sector accounts for about 3% o f financial system assets. The 23 microfinance institutions (MFIs) serve approximately 1.5 millionhouseholds, through a network of over 500 branches and sub-branches. The four largest MFIs, representing 90% o f the sector, are partially owned by regional governments, while the others are mostly owned by local nongovernmental organizations. As of June 2004, the sector as awhole was adequately capitalized, with a capital-to-assets ratio of about 34%. However, inadequate provisioning against NPLs means that MFIs' reported capital i s likely to be significantly overstated. The average NPLratio for the 23 MFIs was reported at 15.4%, which is very high compared to international best practice benchmarks for the industry (under 1%).Moreover, some MFIs have NPL ratios as high as 50%. The sector has witnessed a sharp increase in credit growth in recent years: MFIs' net loans increased by 32% from June 02-June 03, and by 63% for the period June 03 - June 04. Clients' savings balance grew by 14% during June 02-June 03, and by 24% during June 03-June 04. The credit to deposit ratio stood at over 200%. A few MFIs have recently managed to achieve positive ROAs; however, the ROAs even for the relatively better MFIs oscillate between 0.2% and 1.l%, i s relatively low compared to the which international best practice benchmarks o f 5.5%. At this point, only a handful o f MFIs appear to be financially sustainable. Savings and Credit Cooperative Societies (SACCOs) There are some 1,027 registered Savings and Credit Cooperatives Societies (SACCOs)' inEthiopia, with around 156,000 members, operating mostly inurbanareas and typically targeting urban wage earners. About 92% o f SACCO clients are urban wage earners, and about 53% o f registered SACCOs and 72% o f total members are located in Addis. The monthlycontribution of membersranges between3% and 6% o ftheir salary, and the first month's contribution i s credited as share capital. Interest on savings i s 3%. In 2002, member's savings. Interest on loans is around lo%, the period of repayment is 12-24 SACCOs mobilized Br 597 million in savings. Loan amounts may go up to two times the months, and repayment installments are deducted directly from the members' salaries. The operations o f most SACCOs runrelatively smoothly. Going forward, a key challenge "ThisexcludesthemorerecentlyestablishedruralSACCOs. 21 is to extend the coverage o f SACCOs beyond urban wage earners to cover also informal sector and rural economy. Efforts inthis direction have commenced under RUFIP. Securities Ethiopian securities comprise Treasury Bills (T-bills), a handful o f bonds issued by public enterprises, and a small inter-bank forex market. There i s no secondary trading in these securities, and there i s currently no stock market inEthiopia. The Government issues T-bills with three types o f maturities: 28 days, 91 days and 182 days. Of the T-bills issued during the period June 04-AprilO5, 54% had a maturity o f 28 days, 31% had a maturity o f 91 days and 15% had a maturity o f 182 days. T-bills are sold through auctions managed by NBE, and banks are the major subscribers o f T-bills; banks bought 92.5% o f the T-Bills issued during the period June 04-April 05. The weighted yield for 182 days bills was 0.074% in the first nine months o f 2004/05, declining to 0.036% in April 2005. That o f 91 day bills was 0.124% in the first nine months of 2004105, and it declined to 0.048% inApril 2005. The average annual weighted yield o f 28-day bills was 0.227% in the first nine months o f the current fiscal year, further declining to 0.065% in April 2005. Thus, the average weighted yield on all types of T- bills was 0.05% in April 2005. There is no secondary market in T-bills, largely because the requiredinfrastructure (centralized depository, electronic clearance and settlement) i s not inplace. Ethiopia has a small inter-bank forex market. The number o f inter-bank transactions increased to 1,236 in the period June 04-April 05, from 899 in June 03-April 04, but the amount o f foreign exchange traded in the inter-bank market declined to U S $ 125.75 million from US$219.14 million. An inter-bank money market was introduced about five years ago, but excess liquidity in the banking sector has meant that the market has not really grown. No government bonds were issued in the last year. A few corporate bonds have been issued in recent years, including by EEPCO, ETC and DBE. However, there is no secondary trading o f corporate bonds, and the underlying infrastructure (clearing and settlement mechanism) i s not inplace. Ethiopiahad a functioning stock market (operating through `shareholding groups') during the reign o fthe Emperor,but the market ceased to operate under the Derg era and has not been revived officially since then. However, there is an informal market in shares. The private banks and insurance companies have issued shares to some 25,000 individuals; these shares earn dividends to the tune o f 20-25%. Limited trading o f these shares takes place on an informal, . one-on-one, basis. Formalizing this market through the establishment o f a small stock exchange and a set o f regulations governing stock market activities could reap several benefits, not least the promotion o f greater financial sector stability. A well-functioning, formal stock market would allow companies, financial and non-financial, to raise the capital that is so necessary for the expansion o f private sector activity, economic growth and prosperity. 22 Outlineof the.Financia1Sector Strategy and Roadmap: As in most developing countries, financial sector policy in Ethiopia aims at achieving sound, deep and more efficient intermediation with better access to finance for large segments o f the economy that remain under-served. The Ethiopian authorities have chosen to pursue these goals within a distinctive strategic framework. Although the reforms are aimed at ensuring consistency with market forces, the liberalization strategy chosen by the authorities envisages accomplishing most o f the reforms behind the protection o f strict capital account exchange controls. Furthermore, although they have for several years already beenexposed to vigorous competition from private entrants, the still-dominant State-owned intermediaries (especially the Commercial Bank o f Ethiopia, or CBE and the Ethiopian Insurance Corporation) are being retained in State-ownership while their balance sheets, internal governance and management are being reformed, and for the foreseeable future. While the authorities have selectively allowed foreign entry in leasing, they have decided to forgo the potential benefits o f allowing the entry o f foreign- owned intermediaries inother segments o f the financial sector, to minimize the perceived macroeconomic risks arising from a more open financial sector. They have preferred instead to seek the transfer o f foreign financial technology and know-how through advisory assistance and consultancy contracts. Although the effectiveness and viability o f Ethiopian exchange controls will diminish over time, the overall strategy adopted by the authorities seems sustainable for the present and likely to provide an adequate platfonn for the needed reforms. There may even be a partially compensating benefit in a reduced vulnerability to exchange rate and interest rate volatility that could otherwise result from some weather-related or other macro shocks. In the longer term, the closed external capital account will become unsustainable, and current reforms should envisage - and prepare for - the eventual removal o f exchange controls so that this transition can be accomplished smoothly in due course. In the interim, maintenance o f the hoped-for stability crucially requires stable and coherent monetary and fiscal policies. Within these constraints determined by this overall strategic framework, the authorities' approach increasingly responds to market forces. This is conspicuously the case in respect o f the restructuring o f the CBE, a centerpiece o f the current phase o f the reforms. Inadditionto the aggressive resolution ofthe sizable non-performing part of CBE's loan portfolio, the mandate o f this bank and its management structures and procedures have been revamped to transform it into a fully commercial bank. Policy lending is to be confined to the,much smaller DBE. The authorities have not established any quantitative goals for the allocation o f credit to different sectors o f the economy. Instead, their approach i s to create an enabling environment for increased effectiveness and penetration o f financial intermediation responding to market demand. 23 While different elements o f the reform will overlap in time, a clear sequencing o f financial sector development over the coming five years i s evident. The first theme, both in importance and time-sequencing, is the banking system. The portfolio clean-up, governance and management reform, and technological strengthening of the government-owned banks i s the ongoing initial stage. Following entry liberalization and the rapid growth o f private banks, a strengthening o f the institutional capacity and functioning o f bank regulation and supervision has become urgent.I2 Finally the technical performance o f the payments system leaves much to be desired. By 2010, it i s envisaged that Ethiopia will have a contestable banking system operating in a fully commercial and technically efficient manner, with the private banks likely having overtaken CBE inmarket share (though no goal has beenset for this share). The second theme i s the development o f the insurance industry. Following entry liberalization, a strengthening o f the institutional capacity and functioning o f insurance regulation and supervision has become important. Inthe next three years, the authorities envisage a move from compliance-based to risk-based supervision and improvements in on-site and off-site surveillance, financial reporting and analysis. The third theme is the development o f capital markets. Inthis area the money and bond markets are seen as the first priority, given their importance in achieving and maintaining monetary policy effectiveness. By 2010, these wholesale markets should have become deeper and more developed, providing also the framework for a secondary mortgage market with the participation o f pension funds. As necessary, the institutional, legal and regulatory measures for the orderly development o f the stock market should have been completed by that date. The fourth theme is rural and low-income finance. It is envisaged that the four large existing MFIs will continue to diversify their product mix, possibly becoming limited- service banks. Other institutions that provide financial services to the low-income population will also continue to find a role inthe mediumterm, and a regulatory strategy for these institutions, particularly for savings and credit cooperatives, will be elaborated in a consultative manner and implemented by 2010. The potential for modem agricultural risk insurance products and small and medium enterprise (SME) finance products will be explored and piloted with a view to a fuller roll-out before 2010. The fifth theme refers to the legal, judicial and information environment. This will include, for example, improved foreclosure laws, enabling legislation for leasing, establishment of a registry o f assets and enhancement o f the credit information bureau and a major improvement in the quality and reliability o f accounting inf~rmation.'~ Ongoing capacity development and legislative reforms here will take time. '*Including the move to risk-based supervision. l3The lack o f confidence inaudited accounts at present has prompted the authorities to explore possible ways of providing an disincentive to firms against producing different sets o f accounts for the tax authorities and the banks. 24 Measuring the success of the reform program: 0 Soundness: improved prudentialratios; reduced NPLratio; reduced assetAiability mismatches 0 Effectiveness: increased credit to deposit ratio; increased share o f private banks inoverall loans, deposits; reduced excess liquidity in the banking system 0 Access and diversification: higher share o f non-bank institutions intotal financial system assets; increase inthe share o f private sector credit to GDP; better access to finance for under-served segments (rural borrowers, SMEs, etc.) as measured, for example, by increase inthe ratio ofbankcredit to SMEs; higherproportionofthe ruralpopulation with access to deposit accounts and formal credit; higher proportion o f middle-income households with access to housing finance. etc. 25 The Roadmap Indicative targets for FY 2005/06 - 2009/10 Theme A: Banking Sector Reform of state-owned banks e Tiirit-~roii~id peifi)rrtiance of CBL, CUB and DUE the CBE Actions: o Years 1-2: Restructuring implemented; increased contestability in the banking system o Years 3-5: Progress achieved inYears 1-2 maintained. DBE Actions: o Immediately: Business process re-engineering review completed, on the basis o f which, an action plan prepared and implementation to be completed inthe following areas: HR, top management, financing, products o Year 2: BPR fully implemented o Years 1-5: Strategic Planning and Management (SPM) implemented CBB Actions: o By Dec 2005: Businessprocess re-engineering plan fully implemented o Year 2: Strategic focus redefined o Year 3: SPM implemented e Credit appraisal procedures, practices and skills improved togetlier with risk rnunagernerit Actions: o Years 1-3: (a) Shift from collateral-basedto cash-flow based (forward looking) credit appraisal; (b) Introduction o f risk-based pricing o f loans; (c) Upgrade risk assessment, monitoring and management (of credit risk, market risk) e NPLposition strengthened Actions: o Years 1-3: Continued efforts to reduce NPLs and to recover maximum value o f underlying collateral o Years 3-5: Maintain low NPLs and maximum recovery on collateral e Ciistonier-Jiieizr~services irztvotiircetl Actions: Years 1-5: Streamlined procedures for opening savings accounts, getting loans. Strengthening institutional capacity for bank regulation and supervision Banking regulation arid supervision upgraded Actions: o Years 1-3: (a) Upgrade prudentialregulationand market conduct rules, and their monitoring and enforcement by supervision staff, including through better on- site and off-site surveillance; (b) develop a framework, policies and implementationskills for problembank resolution and the treatment o f depositors; (c) move from compliance-based to risk-based supervision, and 26 strengthen the skills o f supervisors to undertake risk-based supervision; and (d) upgrade IT capability o f the Banking Supervision Department; o Years 4-5: Implement the new frameworks for problem bank resolution and the treatment o f depositors. Paymentssystem upgrading 0 Ethiopian payments system modernized Actions: o Year 1: Establish a National payments System Council o Years 1-3: (a) create a nationalpayment systems framework and develop a policyioversight function for the NBE; (b) introduce a new non-electronic payment systems (e.g., for remittances, in-country money transfers, etc.); (c) buildskills inpayments risk analysis and oversight; (d) upgradeiautomatethe Addis Ababa Clearing House; and o Years 4-5: (a) introduce a large value electronic payment system; (b) establish regional clearing houses. New bankingproducts 0 Introduction ojcreilit cards Actions: o Years 1-2: Banks to investinautomation; Government to support by developing the necessary payments infrastructure (see above) Theme B: Insurance Strengtheninginstitutionalcapacity for insuranceregulation and supervision 0 Insurance regulation and supervision upgraded Actions: o Years 1-3: (a) Upgrade prudential regulation and market conduct rules, and their monitoring and enforcement by supervision staff, including through better on- site and off-site surveillance; (b) move from compliance-based to risk-based supervision, and strengthen the skills o f supervisors to undertake risk-based supervision; and (c) upgrade IT capability o f the Insurance Supervision Department; (d) improvements in on-site and off-site surveillance, financial reporting and analysis. o Years 4-5: Continued strengthening o f insurance regulationand supervision. Theme C: CapitalMarkets 0 Develop a long-term debt market Actions o Year 1:Finalize a study for development o f securities market operations o Years 1-3: Develop the infrastructure for bondmarkets through establishment of (a) a centralized depositoryiclearance and electronic settlement mechanism for government debt and corporate bonds; and (b) a trading platform; o Years 4-5: Support lengthening o fmaturities and yield curve throughnew issuances. 0 Deselop mortgage market Actions: o Years 1-2: Prepare feasibility studies for a housing finance facility o Year 3: Pilot a housing finance facility o Years 4-5: Scale-up housing finance facilities. 27 o Year 1: identify and address any remaining obstacles to the development o f the financial leasing industry. e Develop the stock nwrket Actiorzs: o Years 1-2: Develop the necessary institutional, legal and regulatory framework for stock market development, as needed; o Years 3-5: Beginimplementation o f the above Theme D: Rural, SME and low-income finance o Years 1-3: (a) Diversify product mix o f MFIsto support their transformation towards limited service bank ; (b) Develop and establish a pilot agricultural risk insurance facility; (c) Develop and establish a pilot SME finance facility o Years 3-5: Improve outreach o f savings & loans institutions (SACCOs and RUSACCOs)by strengthening their capacity and improving the regulatory and supervisory framework for these institutions Theme E: Legal and information infrastructure e Indepideiit credit information IJUIYWU estahlislieri Actions: o Years 1-3: Upgrade the existing credit information bureau within NBE so that it can better serve the credit information needs o fbanksiother financial institutions o Year 3: Amend the Banking Proclamation so as to allow the credit information bureau to share information with the public; hrther upgrade the credit informationbureau to prepare it for sharing data with the public (i.e., beyond financial institutions) o Year 4: Establish an independent credit information bureau, outside NBE e Setting 11p (in asset/collaterrrl registry toJircilitate secured lorriz trarrsactioris Actions: o Years 1-3: Develop a feasibility study for the asset registry, amend any lawslregulations, as necessary o Years 3: Establish the asset registry e Out-of-court settlemerzt of had assets and collateral recovery iitiprosed Actions: o Years 1-3: Improve asset valuation and asset disposal framework 28 Annex 2: Major Related ProjectsFinancedby the Bank and/or other Agencies ETHIOPIA: FinancialSector CapacityBuildingProject RelatedLendingprojectsin Ethiopia: ET-Private Sector Development Capacity BuildingProject (FY04) ET-Public Sector Capacity BuildingProgram Support Project (FY04) ET-Rural Finance Intermediation(FY02) ET-AGResearch and Training (1998) RelatedNon-lendingprojectsin Ethiopia: ET-Banking Study (AFR-Funded)(FY04) ET-Investment Climate Surveys (FY04) ET-Capacity Building(FY99) ET-Financial Sector (FY98) RelatedLending/TAprojectsin other countries: Ghana-Micro, Small & SME project (FY06) Ghana-IFAD Rural Finance Project India-SME Financing andDevelopment Project (FY04) Kenya-Financial andLegal Sector TA (FY04) Kenya-Micro. Small and Mediumenterprise project (FY04) Mexico-Finance & GrowthDPL(FY06) Nicaragua-Broad-based Access to Financial Services (FY04) Niger-Financial Sector TA (FY04) Tanzania-Private Sector Competitiveness Project (FY05) Uganda-Private Sector Competitiveness I1(FY04) 29 Annex 3: ResultsFramework and Monitoring ETHIOPIA: FinancialSector Capacity BuildingProject PDO OutcomeIndicators Use of OutcomeInformation The project will assist in Soundness: Y R l t o 3 3uilding the foundation for a Reduction in commercial banks' 3utcome information will inform continued nore transparent, well- NPLratio from 20% in end lialog with Ethiopian authorities to encourage ;overned, well-regulated, and 2005106 to 10% by end 2008109 Furtherreforms :ompetitive financial sector :hat allocates resources to the Effectiveness: Y R 2 xivate sector more effectively Increase in the ratio of financial Mid-term review o f progress will use outcome mdefficiently, and helps sector assets to GDP from informationto determine needfor changes in :nsure better access to finance 126.7% in end 2005106 to 131.1% project implementation (ifrequired). for all. by end 2008109 Increasedcredit to deposit ratio Increasedmarket share o f private banks inlending Access: Private sector credit to GDP ratio increases from 20% in end 2005106 to 24.8% by end 2008109. IntermediateResults ResultsIndicatorsfor Each Use of ResultsMonitoring Component Component One: Component One: Component One: Enhanced capacity o f NBE to Improved prudential regulatory conduct banking and insurance standards and rules o f market Y R 2 supervision and other central conduct inalignment with Review capacity building activities if NBEhas banking functions international standards and best not started regular off-site surveillance and on- practices. site inspections. Improved monitoring and enforcement o f rules through better YR 2-3 off-site surveillance and on-site inspections. Assess NBE enforcement o f prudential and Improved compilation and market conduct rules and norms monitoring o f foreign exchange statistics Regular and accurate liquidity forecasting and balance o f payments analysis 30 Component Two: Component Two: Component Two: Enhanced efficiency of I. Substantial increase involume of YRlto3 financial transactions due to non-cash transactions Limitedusage o fnewpayment systemwill modernization o f payment !. Regional clearing houses trigger more intense public awareness efforts systems established and operational incollaboration withkey stakeholders 1. Credit information center upgraded Component Three: ComponentThree: ComponentThree: Preparationo f feasibility 1. Feasibility study for pilots YR2 studies, provision o f training completed and training and TA Ifthere is slowprogress, initiate consultations and technical assistance to provided for SME, agricultural with concerned partners. support the introduction o f new insurance, housing finance and products, e.g., for SME other new products. YRlto3 finance, agricultural risk Use the studies to raise awareness o f the need insurance, and housing finance. for continued financial sector diversification. ResultsIndicatorsfor Each Use of ResultsMonitoring ~~ IntermediateResults Component Component Four: Component Four: Component Four: Substantial increase inthe 1. Certificationprograms introduced YR2 quality and quantity of for bankers and insurers Review training-of-trainers program if cohort financial sector professionals in 2. EIBIconducts regular training for o f instructors remains small. Ethiopia. finance professionals using revised and updated curricula. YR3 Failure to establish certificationprogram will trigger strategic review inconsultation with financial sector industry associations. 31 rl n w w z 2 2 s 0 N M m 11 Z 2 t. d M v, M L Annex 4: DetailedProjectDescription ETHIOPIA: FinancialSector Capacity BuildingProject ProiectComponentl---NBE CapacityBuilding The NBE i s hampered by limited capacity and is unable to discharge effectively its key functions o f regulating and supervising financial intermediaries, undertaking economic research, and formulating and implementing monetary policy. In recognition o f this shortcoming, NBE commissioned a Comprehensive Restructuring Study, undertaken by an independent consulting firm, KPMG.Following the completion o f the study, NBEinOctober 2004 issued a Strategic Plan Document, detailing key strategies and an action plan to strengthen NBE's organization, operations and capacity over the next five years. It is expected that implementation o f the Strategic Plan will begin the process o f transforming NBE into a modern central bank, capable of performing its functions effectively and delivering on its core mandates. As part o f the Strategic Plan, the NBE has significantly enhanced employee remuneration and benefits, creating the right monetary incentives to attract and retain staff. This component aims to support the ongoing NBE modernization and restructuring effort in the following critical areas: (a) Improving banking regulation and supervision; (b) Strengthening insurance regulation and supervision; (c) Strengthening economic research, policy formulation and implementation. (a) strengthening Banking Regulation and Supervision NBE's Banking Supervision Department (comprising o f 20 staff members), i s charged with the regulation and supervision of 10 banking institutions, (including 7 private banks and 3 government-owned banks), with a total of 380 branches. Unfortunately, the Banking Supervision Department has struggled to regulate and supervise the banking sector effectively. The off-site function lacks the capacity to analyze bank returns and i s therefore unable to detect problems early enough for remedial measures to be implemented, On-site examinations are irregular and NBE i s only able to examine halfo f the banking industryeach year. Examinations are compliance-oriented and do not focus on identifying or preventing prudentialproblems infinancial institutions. It is therefore not surprising that the banking sector is saddled with high levels of non- performing loans, amounting to 27.4% o f total loans and advances in2004. This i s however a significant reduction compared to the 44.2% NPLs recorded in2002. 37 The NBE i s taking steps to strengthen banking regulation and supervision, issuing new regulations to tighten loan classification and provisioning requirementsand imposing stricter controls on recognition o f interest income from non-performing loans. This sub-component will therefore support the NBE to strengthen banking regulation and supervision substantially by undertakingthe following activities: First, the project will provide advisory services and training to upgrade prudential regulation and market conduct rules, and their monitoring and enforcement by supervision staff, including through better on-site and off-site surveillance. This will be supplemented with exposure programs to familiarize Ethiopian bank supervisors with supervisory processes in more advanced bank supervisory agencies. Second, advisory services and training will be provided to develop a framework, policies and implementation skills for problem bank resolution and the treatment o f depositors. Third, using a combination o f training and advisory services, the project will assist a move from compliance-based to risk-based supervision, and strengthen the skills o f supervisors to undertake risk-based supervision. Fourth, the project will upgrade IT capability o f the Banking Supervision Department, involving the deployment o f advisory technical assistance and investment in hardware and software to meet identified needs. A computer literacy program will be implemented to complement the IT upgrade effort. Fifth, support will be provided for strengthening the corporate governance o f banks, through: developing a code o f conduct for Board members; drafting guidelines on internal controls, internal audits, and external audits; training o f NBE staff on these guidelines; and training o f Board members. (b) StrengtheningInsurance Regulation and Supervision Upgraded in2004 from a division to a department, NBE's Insurance Supervision Department comprises o f 14 staff members, 7 o f them new recruits. I t i s charged with the regulation and supervision o f 9 insurance companies, 8 o f them privately-owned. The department has been unable to conduct any meaningful supervision o f the insurance industry, due to a lack of insurance supervisory skills. It has therefore been unable to determine the financial condition of insurance companies and has limited information on their operations in general, as its staff does not possess the necessary skills to analyze insurance returns. Staff training has been ad hoc with staff receiving some training in operational aspects o f insurance rather than in techniques o f insurance supervision. This sub-component will therefore support the NBE to strengthen insurance regulation and supervisionby undertaking the following activities: First, the project will provide advisory services and training to upgrade prudential regulation and market conduct rules, and their monitoring and enforcement by supervision staff, including through better on-site and off-site surveillance o f insurance companies. This will be supplementedwith exposure programs to familiarize Ethiopian insurance supervisors with supervisory processes in more advanced supervisory agencies. Second, using a combination of training and advisory services, the project will assist a move from compliance-based to risk-based insurance supervision, and strengthen the skills o f supervisors to undertake risk- 38 based supervision. Third, the project will develop a technical library for insurance supervision, through advisory technical assistance and some investment in equipment. Finally, the project will upgrade IT capability o f the Insurance Supervision Department, involving the deployment of advisory technical assistance and investment in hardware and software to meet identified needs. A computer literacy program will be implemented to complement the IT upgrade effort. (c) StrengtheningEconomic Research, Policy Formulation and Implementation Conducting economic research and providing input into policy formulation and implementation are critical functions o f modem central banks around the world. ME'S Economic Research and Monetary Policy Directorate (ERMPD) i s charged with providing economic advice to the government on topics such as monetary policy, exchange rate management, interest rate management and fiscal policy. At present, ERMPD i s unable to perform its functions effectively due to lack o f research and analytical skills, high staff turnover, inadequate information technology, and poor quality o f its economic database. The project will therefore use a combination o f advisory technical services, training and exposure programs to strengthen ERMPD in the following areas: i)monetary policy and liquidity forecasting; ii)financial market development; iii)balance of payment analysis; iv) macroeconomic modeling and analysis. In addition to the foregoing, the project will upgrade available information technology in the ERMPD, including hardware, relevant software for research and modeling. Given the fact that ERMPD utilizes key balance o f payments and foreign trade data, the project will also provide support to the Banking and Foreign Exchange Directorate inthe areas o f compilation and monitoring o f such data along with support in the reserve management area. Inaddition to the above core areas, the project will also provide carefully targeted support to the functional areas o f Internal Audit, Finance and Information Systems, Legal, Human Resource Management and Administrative Services, and Bank Modernization, considered critical to the sustainability o f the capacity developed under the project. ProiectComponent2---StrengtheningFinancialSector Infrastructure The stability and development o f financial systems dependto a large extent on the quality o f financial sector infrastructure available to support the operations o f financial intermediaries and markets. There i s a need to strengthen Ethiopia's financial sector infrastructure in four notable areas: i)payments systems; (ii)credit information systems; iii)capital markets infrastructure; and (iv)asset registry systems. The project's support to enhance these four elements i s expected to lay the basis for significant improvements in access to financial services. (a) Payment SystemModernization Ethiopia's payment system i s cash-based and manually operated, with cash physically moved from region to region to meet the economy's transaction needs. The NBE i s unable to operate 39 this system by itself and has enlisted CBE's branch network in distributing currency and effecting payments across Ethiopia. There are no ATM networks and the usage o f non-cash payment instruments (checks, debit and credit cards) i s minimal. The project will therefore pursue payment system modernization, focusing on: (i) advisory services to create a national payment systems framework for Ethiopia (including legal framework and institutional arrangements) and develop a policy/oversight function for the M E ; (ii) training and advisory services to develop NBE staff skills in payments risk analysis and international standards for operating and overseeing the payment systems; (iii)advisory services and IT investments to upgrade and automate the Addis Ababa Clearing House, including revisions to rules and procedures; (iv) advisory services to introduce new non- electronic payment systems (e.g. for remittances and in-country money transfers) and, over the medium term, introducing a large-value electronic payment system; (v) advisory services and IT investment (hardware and software) to establish regional clearing houses and other national payment systems, and make them operational. Given the project's objective o f developing public and corporate debt markets (see Component 3) this sub-component will also establish a centralized depository, clearance and settlement mechanism through advisory technical assistance as well as investment inrelevant hardware and software. (b) Strengthening the Credit I nformation Center The creditinfonnation center, located in NBE's Supervision Directorate, i s relatively new, with gaps in its operating framework and limited local skills for continuous operation. The project will provide support in the following areas: i)advisory services to assess the system and identify key weaknesses; ii)advisory technical assistance and investment in hardware and software to upgrade and further automate the credit bureau; iii)advisory technical assistance to enhance the coverage o f the existing database; iv) training activities to develop the skills o f NBE staff in the effective use o f the database and sills o f commercial bank staff and other parties in the provision o f credit information; and v) a systematic public awareness campaign to raise public awareness on the importance and usage o f credit reporting systems, (c) CapitalMarket Infrastructure Given the need to develop capital markets as a source o f long-term financing inEthiopia, the project will provide support to develop the following key elements o f capital market infrastructure: i)advisory services to prepare a strategy and action plan for the development of the government and corporate bond markets; ii)advisory services to prepare a feasibility study and implementation plan for the establishment o f a stock exchange; iii)advisory services as well as investment inhardware and software to establish a trading platform and a centralized depositoryiclearance and electronic settlement mechanism for government debt and corporate debt and equity markets; and iv) developing the legal, regulatory and supervisory framework for securities markets. 40 (d) Strengthening theAsset Registry Given the prevalence o f collateral lending in the country, developing an asset registry i s important for expanding the scope o f secured lending transactions and improving access to financial services. The project will provide advisory services in: i)reviewing the legal and institutional framework for an asset registry; ii)designing the registry architecture and other operational elements; and iii)providing the necessary IT equipment to make the registry operational; and iv) awareness-raising program on the uses and benefits o f an asset registry system. ProjectComponent3---Developmentof New FinancialProducts The Ethiopian financial system is overwhelmingly dominated by banking institutions. The range o f financial saving vehicles available i s narrow and bank deposits represent the major forms o f financial savings. The project will promote greater financial diversity in Ethiopia by supporting the development of new financial instrumentsand products. This will include products to enhance the availability o f long-term finance (housing finance and capital market development) and products designed to improve SME access to finance (e.g. leasing, risk guarantee schemes). (a) Housing Finance Development While unsatisfied needs for housing are huge in Ethiopia, hardly any financial means are provided for that purpose by the financial sector, with the consequence that a large proportion o f middle-or moderate income households are excluded from decent housing, even at price levels they could theoretically afford. Banks have started recently to develop housing loans, but they target upper income groups, and the traditional specialized lender, CBB, i s diversifyingits business out o f this area. At the other end o f the income spectrum, MFIs provide finance related to housing for small amounts. Between these two extremes, nothing i s available except for lending by Savings and Loans Cooperatives (SACCOS), which have limitedcapacities. The main reason behind this paucity are (i) the novelty o f this lending activity for most lenders, (ii)business strategies- or regulatory business constraints inthe case o f FMIS-,and (iii) factthatshorttermdepositsconstitutethesolefundingsource ahandicapthatleads the - financial institutions to offer short, and hence little affordable, loan maturities ( 5 to 8 years i s the norm) and to limit their total volume. The project will provide support to the growth o f lending for housing and its expansion to a much broader audience by addressing the most acute obstacles that presently impede such financing. Specifically, it will include support inthe following areas: a) The establishment o f linkages betweengrass-root lenders- savings-and -loans, MFIs - and traditional banks will be developed in order to channel some o f the excess liquidity held by banks or investors towards financial institutions that cater to the needs o f intermediate income groups. At the same time, opening access to better finance will be used as a lever to promote sound lending practices among the latter type o f institutions. The project will assess 41 the viability o f different options that can be considered for that purpose: guarantee schemes, collateralized debt, brokerage arrangements or new, intermediary institution. b) The project will support the introduction o f new mechanisms or instruments that will facilitate the management o f liquidity by lenders without waiting for the capital market to be developed. The ability to issue relatively long term debt other than securities, and the possibility o f exiting solutions for loan portfolios should largely overcome the reluctance of lenders or investors, although cash rich, to invest in long term assets. Drawing on the experiences o f other countries with small or inexistent capital market, the project will identify what tools would be most appropriate among the various possible options: collateralized interbank debt instruments, disposition o f portfolios or loans through sale or pledging agreement, repurchase agreement facility. The various technical options will be combined with the credit enhancement possibilities offered by the first mechanism. c) The project will support preparation for the establishment o f a developer finance scheme, which will be prepared to organize a seamless circulation o f resources between banks, real estate developers and borrowers. The purpose o f such a scheme will be to secure advance payments, make early take-out finance for new units possible, and expand the boundaries of the potential market for developers. The project will first assess in each case the viability and appropriateness o f the different options available; then offer assistance to the decision making process by the Ethiopian authorities; finally, provide T A to help initiate the implementation o f the solutions that will have been decided. Inparallel, lenders will be supported in the capacity buildingundertakings requiredby the development o f a recent business line. Areas that will be considered for such support will include: (i) design and pricing o f products, in particular the promotion o f risk based the approach, and the reflection o f funding constraints, (ii) risk assessment and management techniques, both at the origination an servicing level, and (iii) the development o f marketing capacities and the design o f adequate organization and procedures. (b) Leasingfinance The project will examine and recommend measures needed for the development o f a financial leasing industry. (c) Small and medium enterprise (SME)financing The project will involve the preparation of a feasibility study for an SME credit guarantee fund, to be followed up, through TA, with the detailed design o f a pilot fund that can immediately accelerate lending to SMEs by banks and possibly, grassroots financial institutions, like credit cooperatives and MFIs. 42 (d) Agricultural risk insurance The project will provide support to introduce index based weather insurance into the Ethiopianmarket. The project will pilot these products indifferent woredas by providing TA to insurance companies and potential clients. In addition, feasibility studies will be carried out to determine the scalability o f index based weather insurance products for additional woredas/ crops and to explore potential linkages to input financing. Support will also be provided to determine the capacity and infrastructure investments necessary for the National Meteorological Services Authority (NMSA) to provide sufficiently robust data for the expansion o f index based products. Support will be provided as necessary for capacity building and infrastructure needs for the potential scale-up o f weather insurance products including TA and infrastructure investments in the banking and insurance sectors. This will include curriculum creation for courses on index based weather insurance for insurers and workshops on the impact o f index based insurance on risk assessment for bankers. Additionally, based on needs identified through the feasibility study o f NMSA, investmentscould be made for infrastructure such as weather stations and capacity building surrounding data management. Support will also be provided as necessary to the insurance supervisor in order to develop any necessary regulation for index based products. (e) Otherproducts Other products that the project may help develop, through technical andor financial assistance include: i)a venture capital fund, in collaboration with Government and private sector partners; and ii)credit cards. ProjectComponent4---Enhancing;ProfessionalSkills in the FinancialSector Sustainable financial development requires the availability o f a sufficient number o f high- quality financial sector professionals, including bankers, insurers, leasing experts, mortgage specialists, securities specialists and so forth. Ethiopia faces immense constraints inthis area, with substantial shortages o f qualified professionals throughout the financial sector, The project will therefore aim to expand the cohort o f financial professionals substantially by providing support inthe following areas: (a) Strengthening the Ethiopian Institute of Banking and Insurance Established in 1975, the Ethiopian Institute o f Banking and Insurance (EIBI) has the objective o f providing basic education and various short-term training programs in banking and insurance to upgrade the skills o f employees o f the banking and insurance industry as well as employees o f the NBE. EIBI runs three-year diploma programs, short term training courses (up to six weeks) and a management development program to train financial sector managers. 43 Although the EIBI has contributed substantially to training financial sector professionals in Ethiopia over the past three decades, it faces serious capacity issues itself. Its curriculum i s outdated; i t has a limited pool o f part-time trainers, who are not very conversant with modern methods o f training and need familiarization with cutting-edge issues in banking and insurance, It lacks up-to-date teaching materials and the use o f information technology to conduct training programs i s limited. Although EIBI also has the mandate to design and deliver training activities for the NBE, it currently does not have the capacity to do this on a consistent basis. Courses designed for the banking and insurance professionals are often merely recycled for NBE staff, even though the capacity building needs are substantially different. These constraints need to be addressed if the EIBI i s to fulfill its objective o f becoming a provider of cutting-edge financial training to professionals and policy makers in Ethiopia. The project will therefore support the strengthening o f the EIBI inthe following areas, with a view to transforming it into a Center o f Excellence for training in banking and finance: i) advisory services to review and revise EIBI's current curricula in banking, insurance, microfinance and management development; ii)advisory services to develop relevant curricula for NBE staff; iii)advisory services to develop relevant training manuals; iv) advisory services and training to enhance EIBI skills in curriculum development, training evaluation, development o f teaching materials and evaluation techniques; and v) training-of- trainers programs in selected areas, including risk management for banks, banking supervision, insurance supervision, and microfinance. (b) Certification programsfor financial sectorprofessionals An essential component o f financial sector capacity development is ensuring that professionals in the sector are o f the highest quality. In collaboration with EIBI, the project will therefore provide advisory services to develop certification programs for professionals in the banking and insurance industries. Certification programs will be complemented with continuing education programs to ensure that professionals stay abreast o f latest knowledge and techniques intheir industries. (e) Strengthening Financial Sector Professional Associations Professional associations have a key role to play in monitoring trends in financial sector development and identifying relevant areas for policy and institutional reform. Inrecognition of this, the project will provide advisory services and training to develop the research capacity o f professional associations, with possible matching grants from the relevant industryassociations. This will also involve support for associations o f institutions providing financial services to low-income population in urban areas, as this type o f institutions are not incorporated in the Rural Financial Intermediation Program (RUFIP) currently funded by IFADandAfDB.I4 l4RUFIP providestraining and advisory services to develop the capacity of rural MFIs and Rural Savings and Credit Cooperatives(RUSACCOs). However, there i s a growing and important sector of (non-rural) SACCOs which i s inneedof similar support. 44 (d) Financial Sector Training: The project will provide short-term training in selected areas for financial sector professionals in the areas o f banking, insurance and microfinance. Possible topics include risk management, insurance underwriting, microfinance and bond market development. ProjectComponent5---Implementationand Monitoring This component will provide support to ensure smooth implementation o f the project, and effective and efficient reporting, monitoring and evaluation o f the project. 45 Annex 5: Project Costs ETHIOPIA: FinancialSector Capacity BuildingProject TABLE 1 1. NBE Capacity 0.28 3.5 1 3-79 Building 2. Strengthening 0.75 3.53 4.28 financial sector infrastructure 3. New financial 0.85 4.15 5.00 products 4. Enhancing 0.36 1.00 1.36 professional skills inthe financial sector 5. Project 0.54 0.64 1.18 monitoring& implementation Total Baseline 2.77 12.83 15.60 cost Contingencies' : 0.01 0.01 0.02 Total Project 2.78 12.84 15.62 cost 1/ These includephysical andprice contingencies. Itmay be noted that, to ensure flexibility, the project designincludes aprovisionfor reallocation across components subject to the findings of the mid-term review, and agreement with IDA. 46 TABLE 2 (inU S $ millions) 1. Consultant 1.00 0.93 0.07 7.70 services 2. Training and 0.39 0.26 0.13 1.97 workshops 3. Goods 0.97 0.89 0 08 3.16 4. Operating costs 0.42 0.08 0.34 0.00 Total: 2.78 2.16 0.62 12.84 I/LocalcostsfinancedthroughIDAGrantandRecipient's(GoE)`in-kind'contribution. TABLE 3 (inUS$ millions) 1. NBE Capacity Building 0.19 3.60 3.79 2. Strengthening financial 0.09 4.19 4.28 sector infrastructure 3. New financial products 0.09 4.91 5.00 4. Enhancing professional 0.16 1.20 1.36 skills inthe financial sector 5. Project monitoring & 0.09 1.09 1.19 implementation Total: 0.62 15.00 15.62 TABLE 4 IDA 96.0% 96.0% 96.0% Total: 100% 100% 100% ll In-kindonly. 47 Annex 6: ImplementationArrangements ETHIOPIA: FinancialSector Capacity BuildingProject The overriding principle guiding the institutional and implementation arrangements for the project i s the `mainstreaming' o f operational responsibility to NBE, which i s the project implementing agency. To bolster its capacity for project implementation, NBE will hire three to four staff (including a Procurement Officer, a Finance/Accounts Officer, a Project Officer and an Administrative Assistant)", who will be assigned to the appropriate functional units within NBE and be supervised by their unit heads. These staff will continue to be permanent staff of the NBE even after the project closes. The Project Officer will also perform monitoring and evaluation tasks. The salaries and training o f these staff in relevant areaswill be covered by project resources. A `Project Coordination Committee' (PCC), consisting of senior representatives from the relevant units within NBE, will be responsible for project implementation. The PCC members include Directors o f Economic Research and Monetary Policy Directorate (ERMPD), Supervision Directorate (SD), Human Resources and Administrative Services Directorate (HRASD), Head o f the Administration Services Department, Director o f the Ethiopian Institute o f Banking and Insurance (EIBI), Director o f the Banking and Foreign Exchange Directorate (B&FE), Director o f the Bank Modernization and External Relations Directorate (BMERD), Director o f the Finance and Information Systems Directorate (FIS), and Manager o f Internal Audit (IAD). The PCC will be supported by a small Secretariat; the Project Officer will serve as secretary and member o f this committee, and will be assisted in day-to-day work by an Administrative Assistant to be hiredunder the project. The PCC will meet frequently, as needs arise. The PCC will report to a high-level `Steering Committee', which will be established for the purpose o f guiding the smooth operation o f the project and to ensure effective coordination among the different beneficiaries. The Steering Committee will be composed of high-level representatives from the NBE, MOFED, Bankers' Association, Insurers Association, AMPFI, MOTI, and others as the case may be. The chairman o f the coordinating committee and project officer may also sit in the committee. The Steering Committee will meet once every quarter during the first year o f project implementation, and thereafter, twice a year. The project will have an implementation period o f three years. A detailed Project Operational Manual (OM) including the Project Implementation Plan (PIP), Financial Management Plan, and Procurement Plan, will be finalized prior to effectiveness. The OM will include all periodic reporting, monitoring and evaluation arrangements throughout the life o f the project. A mid-term review date of October 30, 2007 has been agreed upon with the objective of assessingprogress and, ifnecessary, to re-direct the project by integrating additional lessons learned and ground realities. l5The plan is for NBEto retain these staff even after the completion o f the project. 48 Annex 7: FinancialManagementand DisbursementArrangements ETHIOPIA: FinancialSector CapacityBuildingProject Introduction The financial management assessmenti s done inline with the guidelines issued by the FM Board on June 30,2001 and revisedon October 1,2003. The objective o f the FM assessment i s to determine whether the project has acceptable financial management arrangements, which will ensure: (1) the funds are usedonly for the intendedpurposes inan efficient and economical way, (2) the preparation o f accurate, reliable and timely periodic financial reports, and (3) safeguard the entities' assets. Country Issues The recently completed Joint budget and Aid review (JBAR) and the Fiduciary Assessment (FA) show that Ethiopia has made significant progress in strengthening public financial management inrecent years. As part o f the JBAR, the World Bank, in collaboration with the JBS donors, conducted a Public Financial Management (PFM) status review using the PEFA fi-amework. Out o f the sixteen indictors covered under this review, fourteen o f them cover the government's systems for public expenditure planning, budgeting, and, reporting. The remaining two indicators are meant to assess donor performance. Ethiopia met seven of the fourteen indictors related to the planning, budgeting and reporting systems. Generally Ethiopia scores high in macroeconomic management, including aggregate fiscal discipline and minimizing fiscal risks. Satisfactory progress was also noted in budgeting and accounting reform, though the adequacy and quality o f budget reporting leaves room for improvement and remains a key concern. The FA, which was completed inearly 2005, notes that considerable progress has beenmade inimplementingFMreforms inboth federal and regional level administrations. The areas of improvements include budget processes, internal controls and cash management. Also, some steps have been taken in reforming internal and external audits. Nevertheless, there are some weak areas that require attention. These include delays in financial reporting (both in-year and annual), inadequate capacity o f the auditors-general to discharge their responsibility; and weakness inlegislative scrutiny o f audited financial reports. Ethiopia's public financial management reforms have been managed by the Expenditure Management and Control sub-program (EMCP) o f the government's civil services reform program. EMCP has developed a revised strategic plan to implement the nine components of the sub-program Mobilization behind the EMCP (in terms o f financial and human resources), as a key component o f the Public Sector Capacity BuildingProgram (PSCAP), i s now be a priority area. FundsFlow One Special Account (SA) inUnited States Dollar will be opened inthe NBE.World Bank's share of eligible expenditures will bepaid from the SA. 49 RiskAssessment There are other institutions benefiting from the project. The NBE will be responsible for effecting payments after obtaining confirmation o f completion o f tasks by the beneficiary institutions. This may create some delays inprocessing payments. Strengthsand Weaknesses The NBE has many years experience in handling government resources and also managing structural adjustment credits. The NBE has well experienced staff in its Finance Department. This project will be implemented using the NBE's FM systems and with the involvement o f NBE's finance staff. Retaining skilled staff i s one of the challenges facing NBE. In order to overcome this problem, NBE i s in the process o f reviewing and revising its incentive system and remuneration policy; and this project includes a component to strengthen the human and institutional capacity o f the NBE. AccountingPoliciesand Procedures The NBE uses International Financial Reporting Standards (IFRS) inrecording and reporting its financial transactions. The NBE uses accrual basis o f accounting on double entry accounting. There are operational manuals used by each o f the departments inthe NBE. The Finance Department inthe NBE has its own operational manual, which i s being followed by all staff in the department in their day-to-day transaction processing. There i s a clear segregation o f duties inthe Finance Department. Every staff inthe Finance Department has a job description. The manual i s currently being updated to include recent developments in NBE and elsewhere. The NBEuses bank maker software to record and report financial transactions. Usingthis software, the NBEhas beenproducing its annual financial statements on time. The software i s beingusedby other banks in other countries. InternalAudit The Head o f the Internal Audit Department (IAD) in the NBE directly reports to the Governor o f the. NBE. The IAD has adequate and qualified staff to discharge its responsibilities. In order to further strengthen the IAD o f the NBE, this project will support the department to upgrade the skills o f the internal auditors. The IAD will also audit the financial transactions o f the project as part o f the NBE financial transactions. ExternalAudit According to the Ethiopian Constitution, the Office o f Federal Auditor General (OFAG) i s responsible for the audit o f financial transactions o f federal government and subsidies to the regions. The OFAGdelegates its responsibility mostly to the Audit Services Corporations, a government owned audit firm, and in some cases to private audit f i m s to carry out audit o f projects fundedby international donors. Currently, the Audit Services Corporation (ASC) i s an external auditor o f the NBE. The ASC expressed a qualified opinion on the NBE accounts for the year ended 7 July 2004. The non- provision for doubtful debts was the only qualification point. The financial transactions o f the 50 project will be included in the NBE annual accounts and the World Bank will accept the NBE audited accounts. The external auditors will include a note on the movement o f the SA inthe NBE accounts. The TOR for external audit were agreed duringnegotiation. The NBE audited accounts will be submittedto the World Bank six months after the end o f each fiscal year. Reportingand Monitoring The NBE will generate Financial Management Reports (FMRs) and submit them to the World Bank as part o f the project progress report. These reports are made up of: 1. Financial Reports: include sources and uses o f funds and expenditures by project components. 2. Physical Progress Reports: include narrative information and output indicators linking financial information with physical progress for the major activities under each o fthe project components. 3, Procurement Reports: providing information on the procurement o f goods, services, training and selection o f consultants showing procurement performance against plan, including information on all authorized contract variations. These reports should be submitted to the World Bank in the agreed format within 45 days from the end o f calendar quarter. Action Plan The NBE will recruit one Finance Officer, who will be primarily responsible for the project and he/she should receive adequate training on World Bank reporting requirements. SupervisionPlan The World Bank will field two implementation support missions every year to evaluate the progress o f the project. DisbursementArrangements The project costs will be funded by an IDA Grant and counterpart funds (inkind only). One Special Account inUSD will be opened inthe NBE. The allocation of the IDA Grant proceeds by expenditure categories and financing percentages are summarized inTable 1below: 51 TABLE 1 Allocation of Grant proceeds 1. Consultant services 8.64 100% 2. Training and 2.23 100% workshops 3. Goods 4.05 100% 4. Operating costs 0.08 100% Total: 15.00 Method of Disbursement Disbursemento f IDA funds to the NBEwill be done based on Financial MonitoringReports (FMRs) that integrate financial reporting, procurement and contract management with physical implementation progress. An advance will bemade into the Special Account (SA) immediately after effectiveness. The advance will cover project expenditures for 6 months as indicated in the initial six-month cash flow forecast. Subsequent replenishments to the SA will be made on quarterly basis. The NBEwill submit quarterly FMRs, SA activity statement, summary o f SA statements o f expenditures for contract subject to prior review and expenditures below the prior review threshold, and expenditure forecast for the next six months to the World Bank for replenishment. The projected cash requirement from the World Bank will be the Bank's share of expenditure forecast for the next six months less balance in the Special Account at the end o f the quarter. The option o f disbursing the funds through direct payments and special commitments from IDA on contracts above a pre-determined threshold will also be available. Withdrawal applications for such payments will be accompanied by relevant supporting documents such as copies o f the contract, suppliers' invoices and appropriate certifications. Detailed disbursementprocedures are available inthe disbursement handbook (October 2005) and the disbursementguidelines issued by the World Bank inMay 2006. Special account To facilitate project implementation and reduce the volume o f withdrawal applications, one Special Account inUSD will be opened inthe NBE. The initial deposit will cover six months estimated eligible expenditures. To the extent possible, all o f the Bank's share of expenditures should be paid through the special accounts. The Special Account will be replenishedthrough the submission o f withdrawal applications on a quarterly along with the FMRsand other reports indicated above. 52 Counterpart funds The NBE's contribution to the project costs will be wholly `in kind'. The NBE will contribute a total ofUS$0.62 million (equivalent) inkindto the project costs. 53 Annex 8: Procurement ETHIOPIA: FinancialSector Capacity BuildingProject Genera1 Procurement for the proposed project would be carried out in accordance with the World Bank's "Guidelines: Procurement Under IBRD Loans and IDA Credits" dated M a y 2004; and "Guidelines: Selection and Employment o f Consultants by World Bank Borrowers" dated M a y 2004, and the provisions stipulated in the Legal Agreement. The various items under different expenditure categories are described ingeneral below. For each contract to be financed by the Project, the different procurement methods or consultant selection methods, the need for pre-qualification, estimated costs, prior review requirements, and time frame are agreed between the Recipient and the Bank in the Procurement Plan. The Procurement Plan will be updated at least annually or as required to reflect the actual project implementation needs and improvements in institutional capacity. Procurement of Goods: Goods procured under this project would include: office equipment, books, journals, computers (hardware), software, and office supplies. The procurement will be done using the Bank's SBD for all ICB and National SBD agreed with or satisfactory to the Bank. Selection of Consultants: Consultants services shall include; (i) strengthening the human and institutional capacity of NBE, (ii)developing the financial sector infrastructure; (iii) development o f new financial products, (iv) developing in-country training capacity to build up the skills o f financial sector professionals and (v) strengthening implementation and monitoring and evaluation activities and (vi) training. Short lists o f consultants for services estimated to cost less than $ 200,000 equivalent per contract may be composed entirely of national consultants in accordance with the provisions o f paragraph 2.7 o f the Consultant Guidelines.Consultant services will be selected usingBanks SRFPs. The procurement procedures and SBDs to be used for each procurement method, as well as model contracts for works and goods procured, will be presented inthe Procurement Manual, Assessment of the Agency's Capacityto ImplementProcurement Procurement activities will be carried out by the NBE. The Procurement and Transport Service Division (PTSD) that i s under the Administration Services Department would have the primary responsibility for management o f all procurement activities. The procurement section under the division that would be handling day to day procurement processing issues has two purchasers and transit staff in addition to the Section Head. The tender committee of the NBEwill be responsible for reviewing and making decisions o n tenders. 54 An assessment of the capacity of the Implementing Agency to implement procurement actions for the project has been carried out by the Bank's procurement specialist on October 20,2005. The assessment reviewed the organizational structure, procurement procedures and methods, staffing and the interactionbetweenthe procurement section and other units. The overall project risk for procurement was found to be high. K e y issues/ risks related to procurement under the project that have been identified are as follows: (i)insufficient number o f procurement staff at NBE; (ii) NBE's procurement staff do not have sufficient expertise and experience, and they have not, in the past, received adequate procurement training; (iii)limited experience o f NBE's procurement staff, especially in the selection of consultants and international procurement; (iv) NBE uses an unacceptable merit point system for evaluation o f bids (comprising o f 40% price, 40% technical and 20% other issues) in evaluating tenders. It was agreed that the following actions would be carried out to enhance the procurement capacity o f the NBE: The NBE has a procurement manual that provides detail information to guide procurement management in the NBE.The manual provides information on: (i) Roles and duties o f tender committee, (ii) procurement methods and procedures and (iii) Content o f tender documents. The manual, however, addresses mainly procurement of goods and works and has provisions that are not acceptable. Therefore, it has been agreed that the manual would be reviewed in detail and an updated manual would be developed for the project. One Procurement Officer with adequate qualification and experience would be employed /assigned at the NBE on a full time basis with primary responsibility being management o f procurement activities under the project. The TORSwould be agreed by negotiation and the employment/assignment o f the specialist would be completed before effectiveness. The Procurement Officer should, as a minimum, have a first degree and three years experience in procurement involving selection o f consultants and goods 'procurement. The responsibilities o f the Procurement Officer would include, preparing and monitoring procurement plans, bidding documents, bid evaluation reports, and contract documents. The procurement staff would report to the Manager, Administration Services Department and would be provided with full time access to a personal computer with printer. The tender committee o f the NBE has the following members: (i)Manager, Administrative Services Department, (ii)Manager, Finance Department, (iii) Manager, Legal Department, (iv) Procurement Officer, (v) representative o f concerned entity (on an ad hoc basis, as needed), and (vi) technical staff (on an ad-hoc basis, as needed). Ifaprocurementpersonwithadequatequalificationisnotfoundthebestqualified person would be selected and made to participate o n a comprehensive and intensive Procurement Training Program at one o f the regional (ESAMI or GIMPA) or other similar training programs as soon as possible. In addition one or more staff from NBE would participate in an intensiveprocurement training program. (v) A comprehensive procurement training program would be organized for staff that would be involved in the procurement decision making process including key staff from the beneficiary institutions and tender committee members. ProcurementPlan The Recipient, at appraisal, developed a procurement plan for project implementation which provides the basis for the procurement methods. This plan was agreed at negotiations and i s available from M E . It will also be available inthe project's database and inthe Bank's external website. The Procurement Planwill be updated in agreement with the Project Team annually or as required to reflect the actual project implementation needs and improvements ininstitutional capacity. Frequencyof ProcurementSupervision Inaddition to the prior review supervision to be carried out from Bank offices, the capacity assessment of the ImplementingAgency has recommended annual supervision missions to carry out post review o fprocurement actions. 56 J E8 3 z4 0 z Q 0 I & Z Q 2 n Z 2 - 3 3 3 3 8 3 3 3 s 0 3 3 N c; ? 0 - Y z a ", 0 5 m 8CJ 0 0 8 s r- 0 0 N Y w B 3 b 2 N 0 0 b 0 0 b 0 N 0 N Li +a 0 a U ne, m ." 3b `C b e, a E 0 5c m a 0 ." 0 8 Y Y v3 Y u e, i m Q) - 3 3 m m 0 0 3 3 8 3 0 m vr d d N m N 00 9 > 0 3 3 0 3 N 3 N N cd d 4 c1 3 5 0 Z - * L a Es 2 li 2 0 - 0 3 3 0- 3 0 10 0 r- m U 0 i r- r- 0 0 0 c.I 0 c.I 4 Cd c` e, a cl m - s `C s a .I& 3 3 3 n T Qo 0 0 N !i h 2 s .e L E &8 2i m m z: M 2 M - 3 0 0 3 0 0 3 0 p 0 IA r- 0 10 0 m b L N E 0 .I F Y n B 2 .c, .I Y G 0 e 1 1 + a .I L a" v1 u xh * .I Y \ Y Q) 8E 8B Y Y u Q) w i? - 00 0 0 hl >>4 U 5 ? b 5 'i Annex 8: Procurement(contd.) ETHIOPIA: FinancialSector CapacityBuildingProject FinancialPlan for FinancialSector Capacity Building Oct. 2006 -June 2008 (InUS Note: Total cost in 18 monthsi s USD 5,955,909. HRASD: Human Resource and Administrative Services Directorate EIBI: Ethiopian Institute o f Banking and Insurance FISD: Finance and Information Systems Directorate ERMPD: Economic Research and Monetary Policy Directorate IAD: InternalAudit Department BFED: Banking and Foreign Exchange Directorate IS: Insurance Supervision Department BS: Banking Supervision Department BMERD: Bank Modernization And External Relations Directorate 67 Annex 9: Economicand FinancialAnalysis ETHIOPIA: FinancialSector CapacityBuildingProject NOT APPLICABLE 68 Annex 10: Safeguard Policy Issues ETHIOPIA: FinancialSector Capacity BuildingProject The project does not involve land acquisition, construction, or potential environmental or social impacts and therefore does not trigger an environment safeguard policy. 69 Annex 11:ProjectPreparationand Supervision ETHIOPIA: FinancialSector Capacity BuildingProject Key Institutionsresponsible for preparingthe project: World Bank; NBE;MoFED; Prime Minister's Office. Bank staff and consultants who workedon the projectincluded: Name Title I IJnit - __- I Priya Basu (TTL) LeadFinancial Economist SASFP I Abavomi Alawode I Sr Financia T X T R T C D I Andres Jaime Sr Financial Specialist AFTFS UfukGuven Young Professional AFTFS Olivier Hassler Sr HousingFinance OPD Specialist Jonathan Pavluk Sr Counsel LEGAF Rajat Narula Sr. Finance Officer LOAG2 Jose Antonio Garcia Garcia Financial Specialist OPD Luna (Payments System) Marjorie Mpundu Consultant LEGAF Serap Oguz Gonulal Consultant (Insurance OPD supervision) ErinBryla Consultant (Agricultural ARD RiskInsurance) Jemal Mohammed Omer Sr Economist AFTP2 Paul Moreno Lopez Sr Economist AFTP2 Eshetu Yimer Financial Management AFTFM SDecialist Samuel Haile Selassie Procurement Specialist AFTPC Yeshareg Dagne Program assistant AFTFS Senait Kasa Yifm Program assistant AFTP2 70 Annex 12: Documentsin the Project File ETHIOPIA: FinancialSector CapacityBuildingProject CBE Strategic Restructuring Plan CBB Business Process ReengineeringPlan DBEBusiness Process ReengineeringPlan Ethiopia--Country Assistance Strategy, World Bank (March 24, 2003) Ethiopia--Country Assistance Strategy Progress Report, World Bank (August 24, 2004) Ethiopia- InterimCountry Assistance Strategy (to be presentedto the World Bank's Board on May 25) Ethiopia--SustainableDevelopmentand Poverty ReductionProgram (SDPRP) Ethiopia--Plan for Accelerated and Sustained Development to EndPoverty (May 2006) EIBI--ACompendium on the Ethiopian Lnstitute ofBanking and Insurance (February 2005) EIBI--Draft Curriculum for Banking and Financial Services Department (April 2004) EIBI--Draft Curriculum for the Insurance Department (April 2004) EIBI--Draft Curriculum for the Rural, Micro and SME Finance Department (March 2004) InternationalMonetary FundCountry Report No. 04/65 (March 2004) NBEFive Year strategic Plan(Oct 2004) NBEImplementationPlan(February 2005) NBEannual Report (various years) NBE Quarterly Bulletin(various issues) NBEAnnual Bulletin(various years) Rural Financial Intermediation Program Appraisal Report-IFAD(October 3 1, 2001) RevisedManagement Development Program (April 2004) 71 Annex 13: Statementof Loans and Credits ETHIOPIA: FinancialSector CapacityBuildingProject Difference between expected and actual Original Amount in US$Millions disbursements Project ID FY Purpose IBRD IDA SF GEF Cancel Undisb Ong Frm Rev'd PO78458 2005 ET-ICT Assisted Dev SIM (FY05) 0.00 25.00 0.00 0.00 0.00 23.51 4.91 0.00 PO50272 2005 ET-Priv Sec Dev CB (FY05) 0.00 19.00 0.00 0.00 0.00 21.76 0.33 0.00 PO78692 2005 ET-Post Secondary Education SIL (FY05) 0.00 40.00 0.00 0.00 0.00 36.53 9.83 0.00 PO82998 2005 ET-Road Sec Dev Prgm Ph 2 Sup12 0.00 160.90 0.00 0.00 0.00 155.47 20.82 0.00 (FY05) PO87707 2005 ET-Productive Safety Nets APLl (FY05) 0.00 14.30 0.00 0.00 0.00 74.36 -9.26 0.00 PO74020 2004 ET-Pub Sec Cap Bldg P i (FY04) 0.00 100.00 0.00 0.00 0.00 8 1.05 12.10 0.00 PO76735 2004 ET-Water Sply & Sanitation SIL (FY04) 0.00 75.00 0.00 0.00 0.00 91.79 13.02 0.00 PO446I3 2003 ET-RSDP APLl (FY03) 0.00 0.00 0.00 0.00 0.00 100.94 25.28 0.00 PO49395 2003 ET-Energy Access SIL (FY03) 0.00 132.70 0.00 0.00 0.00 144.07 103.10 0.00 PO81773 2003 ET-Emerg Drought Recovery ERL (FY03) 0.00 0.00 0.00 0.00 0.00 3.04 0.56 0.00 PO50938 2003 ET-Dec Sen, Del CB (FY03) 0.00 26.20 0.00 0.00 0.00 22.86 18.49 0.00 PO75915 2003 ET-Pastoral Community Dev APL (FY03) 0.00 0.00 0.00 0.00 0.00 1I.45 -8.41 0.00 PO57770 2002 ET-Cultural Heritage LIL (FY02) 0.00 5.00 0.00 0.00 0.00 3.64 2.15 0.00 PO50383 2002 ET-Food Security SIL (FY02) 0.00 85.00 0.00 0.00 0.00 71.05 8.79 0.00 PO73196 2001 ET-Demob & Reinteg ERL (FYOI) 0.00 170.60 0.00 0.00 0.00 23.11 16.46 -5.08 PO69886 2001 ET-MAP (FYOI) 0.00 59.70 0.00 0.00 0.00 4.09 -0.40 0.00 PO69083 2001 ET-Global Distance Learning (FYOI) 0.00 4.90 0.00 0.00 3.14 0.57 4.19 0.24 PO67084 2001 ET-ErmergRecov & Rehab ERL(FYOI) 0.00 230.00 0.00 0.00 0.00 32.25 12.67 -10.40 PO52315 2001 ET-Medicinal Plant Conserv LIL (FYOI) 0.00 2.60 0.00 0.00 1.05 0.16 0.87 0.00 PO50342 2001 ET-Women Dev Initiatives LIL(FYOI) 0.00 5.00 0.00 0.00 0.00 0.28 -0.22 -0.26 PO35147 2001 ET-GEF Med PlantsCnsv & Sust Use 0.00 0.00 0.00 1.80 1.oo 0.29 1.80 0.00 (FYOI) PO00756 1999 ET-Health Sec Dev (FY99) 0.00 100.00 0.00 0.00 0.00 1 1.69 9.10 0.00 PO00733 1998 ET-Agr Research & Training SIL (FY98) 0.00 60.00 0.00 0.00 0.00 4.94 3.62 0.00 Total: 0.00 1,315.90 0.00 1.80 5.19 918.90 249.80 - 15.50 72 ETHIOPIA STATEMENT OF IFC's HeldandDisbursedPortfolio InMillions ofU S Dollars Committed Disbursed IFC IFC FY Approval Company Loan Equity Quasi Partic. Loan Equity Quasi Partic. Total portfolio: 0.00 0.00 0.00 0.00 0.00 0.00 0.00 0.00 Approvals Pending Commitment FY Approval Company Loan Equity Quasi Partic. Total pendingcommitment: 0.00 0.00 0.00 0.00 73 Annex 14: Country at a Glance ETHIOPIA: FinancialSector CapacityBuildingProject Sub- POVERTY and SOCIAL Saharan Low- Ethiopia Africa income Development diamond` 2004 Popuiation,mid-year(millions) 70.0 7 8 2,336 GNI percapita (Aflasmethod, US$) 113 600 513 Life expectancy T GNI (Atlas method, US$ billions) 7.6 432 1,184 Average annual growth, 1998-04 Population (%j 2.2 2.2 1.6 Labor force (%j 2.0 1.0 2.1 Gross per GN1 i / ! j y primary Most recent estimate (latest year available, 1998-04) capita enrollment Poverty(%ofpopulation belownatlonalpovertyline) 44 Urban population(%oftotalpopulation) 16 37 31 Lifeexpectancyat birth (yearsj 42 46 56 Infant mortality(per1OOOllve births) 1Q 131 79 Chiid malnutrition(%of childrenunder5) 47 44 Access to improved water source Access to an improvedwater source (%ofpopulaflonj 22 58 75 Literacy(%ofpopulationage a+) 42 65 61 Gross primaryenrollment (%of schooi-agepopulation) 66 95 94 ---Ethiopia Male 76 0 2 131 Low-income group Female 55 66 66 KEY ECONOMIC RATIOS and LONG.TERM TRENDS 1984 1994 2003 2004 Economic ratios. GDP (US$ billions) 5.7 4.9 6.5 6.0 Gross capital formationiGDP 8.3 15.2 21.0 21.2 Exports of goods and services/GDP a.7 13.0 17.6 15.7 Trade Gross domestic savings/GDP 7.5 5.4 2.4 0.3 ~k Gross national savings/GDP 9.7 14.2 6 1 13.4 T Current account balanceiGDP -6.6 -2.3 -6.2 -7.7 Interest payments/GDP 0.6 0.9 0.7 0.5 Domestic Capital formation Total debt/GDP 73.7 205.4 1P.3 savings Total debt service/exports 20.4 8.8 6.3 7.5 Present value of debt/GDP 60.6 11 Present value of debtlexports. .. 330.4 Indebtedness ,1984-94 1994-04 2003 2004 2004-08 (average annualgrolclhj GDP * 1.2 4.6 -3.9 0.1 -.-l_l_ Ethiopia GDP percapita -16 2.1 -5.6 13.9 Low-incomegroup Exports of goods and services -1.3 13.1 18.9 26.4 r STRUCTURE of the ECONOMY 1984 1994 2003 2004 Growth o f capital and GDP (%) (%of GDP) Agriculture 46.8 55.1 43.0 46.9 Industry 14.2 9.8 13.2 9.5 Manufacturing 0.7 Services 37.0 35.1 46.6 43.6 Householdfinal consumption expenditure 76.3 62.2 78.1 82.7 Generalgov'tfinal consumption expenditure 8.2 P.5 8.6 n.l Imports of goods and services 8.5 8.6 36.1 39.6 I -----GCF -GDP 1984-94 1994-04 2003 2004 (average annualgrolclhj Agriculture 2.7 1.6 -Q.6 18.9 Industry -3.5 4.5 4.3 7.1 Manufacturing -4.2 4.0 2.9 6.7 Services 16 7.0 2.4 6.5 ""*" Householdfinal consumptionexpenditure 2.3 2.7 -4.1 8.2 Generalgov'tfinal consumptionexpenditure -3.1 P.2 -6.2 -2.0 Gross capital formation -13 7.1 2.4 22.1 Imports of goods and services -0.1 9.6 0.O 34.8 Note:2004 data are preliminaryestimates. `Thediamonds showfourkeyindicatorsinthecOUntry(inboIdJcomparedwithits income-groupaverage.If dataare missing, thediamondwill be incomplete. 74 Ethiopia PRICES and GOVERNMENT FINANCE I 1984 1994 2003 2004 Domestic prices Inflation (%) (% change) 20 T Consumer prices -0.2 1.2 15.1 8.6 Implicit GDP deflator -3.3 2.6 12.5 9 5 Government finance (% of GDP, includes current grants) Current revenue 20.2 17.0 26.0 24.5 Current budget balance 1.3 1.4 1.8 7.1 Overall surplus/deflcit -6.5 -8.1 -10.7 -5.2 GDP deflator - 0 ' C P l I TRADE 1984 1994 2003 2004 (US$ millions) Export and import levels (US$ mill.) Total exports (fob) 448 280 483 601 3,WO Coffee 285 158 165 224 Pulses and oilseeds 23 12 66 110 2 500 Manufactures 89 52 72 62 2 wo Total imports (ci0 1,026 915 1,940 2,587 1500 Food 126 126 316 269 1000 Fuel and energy 183 222 288 310 500 1 Capital goods 449 257 618 920 0 Export price index (2000=100) 137 110 81 83 98 99 00 O i 02 03 04 Import price index (2000=100) 89 81 104 117 ~xports ILI Imports Terms of trade (2000=100) 153 136 78 71 BALANCE of PAYMENTS 1984 1994 2003 2004 (US$ millions) Current account balance to GDP (%) Exports of goods and services 612 556 1,139 1,499 Imports of goods and services 1,116 1,100 2,431 3,171 Resource balance -504 -545 -1,291 -1,673 Net income -19 -79 -66 -64 Net current transfers 147 512 955 1,116 Current account balance -377 -112 -402 -620 Financing Items (net) 334 327 664 1,024 Changes in net reselves 42 -214 -262 -405 Memo: Reselves including gold (US$ millions) 109 469 931 1,350 Conversion rate (DEC, locaUUS$) 2.1 5.8 8.6 8 6 EXTERNAL DEBT and RESOURCE FLOWS 1984 1994 2003 2004 (US$ millions) i Composltion of 2003 debt (US$ mill.) Total debt outstanding and disbursed 4,220 10,063 7,287 IBRD 44 4 0 IDA 379 1,373 3,179 I F: 72 G: 07 Total debt service 130 112 99 113 IBRD 8 4 0 0 IDA 5 19 26 27 E 2578 B 3,179 Composition of net resourceflows Official grants 205 638 0 Official creditors 509 201 206 242 Privatecreditors 117 -33 -13 Foreigndirect investment (net inflows) 5 17 0 Portfolio equity (net inflows) 0 0 0 World Bank program Commitments 169 75 28 A IBRD E -Bilateral Disbursements 41 150 204 B IDA -- D -Other multilateral F -Private Principal repayments 7 13 9 9 C-IMF G Short-term - Net flows 35 136 196 Interestpayments 6 10 17 18 Net transfers 29 127 179 DevelopmentEconomics 9/12/05 75 Annex 15: Maps ETHIOPIA: EthiopiaFinancialSector CapacityBuildingProject Map number IBRD33405 76 32E 36E 40E 42E 44E ERITREAERITREA To To ETHIOPIA Keren Keren R e REP.REP d OFOF SELECTED CITIES AND TOWNS ETHIOPIA To To AdigratAdigrat S YEMENYEMEN PROVINCE CAPITALS Gedaref Gedaref Humera Humera 14N Tekeze AxumAxum NATIONAL CAPITAL T I G R AY MekeleMekele RIVERS Ras Dashen Ras Dashen Terara (4620 m) rara (4620 m) MAIN ROADS Atbara D e n a k i l e 14N a D RAILROADS Gonder Gonder A M H A R A PROVINCE BOUNDARIES Lake A FA R Dinder INTERNATIONAL BOUNDARIES Tana 12N Debra Debra 12N Tabor abor Weldiya eldiya esert DJIBDJIB DJIBOUTI Bahir Dar Bahir Dar Blue AsayitaAsayita 46E 48E Aba Nile n Dese Dese e G u l f o f A d y SUDANSUDAN BENSHANGULBENSHANGUL AsosaAsosa Hanger Debre Debre Markos Markos Awash E t h i o p i a n 10N 10N Didesa P l a t e a u DIRE DAWA DIRE DA Dire Dawa Dire Dawa To To HarerHarer Hargeysa Hargeysa Gimbi Gimbi Nekemte Nekemte ADDIS ABABA ADDIS ABABA ADDISADDIS HARARHARAR Jijiga Jijiga ABABAABABA Awash Aw SOMALIASOMALIA Nazret Nazret Baro Welkite elkite O R O M I YA Ramis Aware Aw Degeh Bur Degeh Bur GambelaGambela Gore Gore 8N G A M B E L A y Domo Domo 8N Asela Asela e Akobo Jima Jima Hosaina Hosaina l l Shebele Bonga Bonga a Wabe O g a d e n Shashemene Shashemene V S O M A L I SodoSodo Awasa wasa Goba Goba t Dodola Dodola Warder arder Kebri Dehar Kebri Dehar SOUTHERN NATIONS, SOUTHERN NATIONS, Wendo endo f i Imi Imi NATIONALITESNATIONALITES R 6N AND PEOPLES AND PEOPLES Wabe Gestro t Wabe 6N a Shebele 0 50 100 150 200 Kilometers r e Genale Negele Negele 0 50 100 150 Miles G FerferToTo Yavello avello Dawa Mogadishu Mogadishu Dolo Dolo Odo Odo This map was produced by the Map Design Unit of The World Bank. DECEMBER Lake IBRD The boundaries, colors, denominations and any other information 4N MegaMega 4N Turkana shown on this map do not imply, on the part of The World Bank Group, any judgment on the legal status of any territory, or any 33405 endorsement or acceptance of such boundaries. INDIAN 2005 UGANDAUGANDA KENYAKENY Moyale Moyale To To OCEAN To To 32E 34E 36E 38E To To Wajir Wa Marsabit Marsabit 40E 42E Mogadishu Mogadishu 44E 46E 48E R