Grant Assistance Report

JFPR: INO 39195 November 2005

Proposed Grant Assistance Indonesia: Assistance for Restoration of Microenterprise and Microfinance in Aceh (Financed by the Japan Fund for Poverty Reduction)

CURRENCY EQUIVALENTS

(as of 17 November 2005)

Currency Unit − rupiah (Rp) Rp1.00 = $0.000100

$1.00 Rp10,000

ABBREVIATIONS ADB – Asian Development Bank ARMMA – Assistance for Restoration of Microenterprise and Microfinance in Aceh BPD Aceh – Bank Pembangunan Daerah Aceh (provincial bank) BPR bank perkreditan rakyat (village bank) BPS – Badan Pusat Statistik (Central Agency for Statistics) BRI – Bank Rakyat Indonesia ETESP – Earthquake and Tsunami Emergency Support Project GTZ – Deutsche Gesellschaft für Technische Zusammenarbeit GmbH

(German Technical Cooperation) JFPR – Japan Fund for Poverty Reduction MSE – micro and small enterprise NGO – nongovernment organization PAR – portfolio at risk PFI – participating financial institution PMU – project management unit SRC – staff review committee TA – technical assistance USAID – United States Agency for International Development

NOTES

(i) The fiscal year of the Government of Indonesia ends on 31 December. (ii) In this report, “$” refers to US dollars.

Vice President J. Eichenberger, Vice President (Operations 2) Director General S. Akhtar, Director General, Southeast Asia Department Director A. Konishi, Director, Governance, Finance, and Trade Division,

Southeast Asia Department Team Leader R. Moyes, Credit Specialist, Southeast Asia Department

JAPAN FUND FOR POVERTY REDUCTION (JFPR)

JFPR Grant Proposal

I. Basic Data Name of Proposed Activity Assistance for Restoration of Microenterprise and

Microfinance in Aceh (ARMMA) Country Indonesia Grant Amount Requested $2,000,000 Project Duration 2 years Regional Grant Yes / No Grant Type Project / Capacity building II. Grant Development Objective(s) and Expected Key Performance Indicators Grant Development Objectives (GDO): The objective of ARMMA is to (i) expand the outreach of microfinance in Aceh by developing microcredit pilot programs that reach down-market to households and microenterprises affected by the tsunami, and that have traditionally found access to formal financial institutions difficult; and (ii) evaluate potential new livelihood activities through applied subsector research. Expected Key Performance Indicators:

1. Four microfinance pilot projects operating within no less than three participating financial institutions (PFIs) within 12 months of project inception, at least two of which follow Syariah principles of Islamic banking

2. Seed capital of $800,000 disbursed to microenterprises through pilot microcredit projects within 24 months, to no less than 1,500 borrowers, with an average loan size of no more than Rp5 million

3. Portfolio at risk (PAR) of no greater than 10% at the close of the project 4. At least two of four pilot schemes at PFIs (i) expand microcredit by more than 100%, with

additional funding sources other than the JFPR grant; and (ii) demonstrate the capacity to continue beyond the close of the project

5. At least four potential new livelihood activities are identified by the project and receive funding under ADB’s Earthquake and Tsunami Emergency Support Project (ETESP)

III. Grant Categories of Expenditure, Amounts, and Percentage of Expenditures

Category Amount of Grant Allocated in $

Percentage of Expenditures

Equipment and Supplies 106,400 5Training, Workshops, Seminars, Audit 129,000 6Consulting Services 410,000 21Seed Capital for Pilot Lending Programs 800,000 40Grant Management 418,000 21Contingencies 136,600 7TOTAL 2,000,000 100

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JAPAN FUND FOR POVERTY REDUCTION JFPR Grant Proposal

Background Information

A. Other Data Date of Application Submission May 2005 Project Officer Tom Moyes, Credit Specialist Project Officer’s Division, E-mail, Phone

Governance, Finance, and Trade Division (SEGF) rmoyes@adb.org 632 5436

Other Staff Who Will Need Access to Edit/Review the Report

Ayumi Konishi, Director, SEGF Hermie Bustamante, Project Analyst, SEGF Agnes Canillas, Administrative Assistant, SEGF

Sector Finance Theme Microfinance Targeting Classification Targeted Intervention Was JFPR Seed Money used to prepare this grant proposal? Yes No

Have SRC comments been reflected in the proposal? Yes No

Name of Associated ADB Financed Operation(s)

Earthquake and Tsunami Emergency Support Project (ETESP)

Executing Agency

Bank Pembangunan Daerah Aceh (BPD Aceh) Aminullah Usman, Managing Director Jln. Tgk. H. Mohd. Daud Beureu-eh No. 24 Banda Aceh Phone: +62 0651 22966; Fax: +62 0651 33784

Grant Implementing Agencies

Syiah Kuala University, Faculty of Economics Dr. Said Muhammad, Dean Fakultas Ekonomi Universitas Syiah Kuala Darussalam, Banda Aceh 23111 Phone/Fax: +62 0651 741 0352 E-mail: saidmuha@yahoo.com Mercy Corps Sasha Muench, Mikcrofinance Programs Jl. Sultan Mansursyah No. 7 Peunit, Kampung Ateuk, Banda Aceh Phone/Fax: +62 651 21757 Cell: +62 0813 100 80797 E-mail: smuench@id.mercycorps.org BPD Aceh Syariah Branch Same contact number as above Bank Danamon Syariah Branch Trisiladi Supriyanto, Senior Vice President Syariah Business Directorate Graha Surya Internusa Building, 3rd Floor Jl. HR. Rasuna Said Kav. X – O Kuningan, Jakarta 12950 Phone: +62 21 2551 7198; Fax: +62 21 252 4443 E-mail: trisiladi.supriyanto@danamon.co.id

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Village Banks (bank perkreditan rakyats) To be determined

B. Details of the Proposed Grant 1. Description of the Components, Monitorable Deliverables/Outcomes, and

Implementation Timetable Component A Component Name Microfinance and Livelihood Surveys Cost ($) 261,243 Component Description This component will provide two related services to the project:

Microfinance Surveys. Social or poverty studies carried out within the past 5 years will be quickly reviewed for relevance; baseline social surveys of communities will be prepared; and pilot activities, particularly from the customer’s perspective, will be periodically carried out. These studies and baseline and result surveys will be discussed in a series of project seminars to disseminate results and solicit wide stakeholder input into developing microfinance experiments. The project will monitor other microfinance projects or activities and prepare periodic reports on total microfinance activity in Aceh and North Sumatra. Livelihood Surveys. The United States Agency for International Development (USAID) and ADB have done work in Aceh on prospects for new agricultural activities, and these reports will likely contain useful and relevant technical analyses. These will be reviewed, and additional or thoroughly updated subsector profiles or market studies will be prepared to shed light on potentially profitable livelihoods that could be developed economically through well-designed interventions or investments. Under the ETESP, significant resources will be available to build on the subsector work in order to develop livelihood projects (e.g., enhanced organization of marketing efforts for Aceh coffee, production of high-quality chili for export). Subsector surveys will inform the evolving loan product design and credit underwriting processes at work concurrently within the pilot schemes so that micro-bankers can be made aware of the risks inherent in unfamiliar subsectors. In addition, the project will monitor and evaluate livelihood work carried out by other donor or government agencies and nongovernment organizations (NGOs), and maintain a list of livelihood activities under way in Aceh and North Sumatra.

Monitorable Deliverables/Outputs • Comprehensive review and collation of social survey data • Baseline poverty data • Economic impact evaluation of microfinance pilot schemes • Microfinance pilot scheme customer satisfaction surveys • Seminars to analyze, discuss, and publicize results of pilot

microcredit programs • Comprehensive microfinance support activity donor matrix • Comprehensive review and collation of economic subsector data• Analysis of at least eight discrete subsectors that present

opportunities for livelihood development

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• At least four of these subsector analyses developed into market plans that can be elaborated and promoted under the ETESP

• Comprehensive matrix of livelihood support activities by donors/agency.

Implementation of Major Activities: Number of months for grant activities

24 months, from November 2005 through November 2007

Component B Component Name Microfinance Pilot Schemes Cost ($) 1,257,915 Component Description

Preliminary Phase (November 2005 through January 2006). Project specialists will work with implementing agencies to design pilot microcredit schemes. This work entails determining the target market, evaluating customer activities and needs, converting these needs into loan product features, and projecting administrative support and labor requirements. The latter activity will be integrated into the business plans of each pilot microcredit lending scheme. Staff of implementing agencies will be formally trained in microfinance lending techniques. Before the roll-out begins, key policies and procedures for the pilot schemes will be documented by each implementing agency. Roll-out Phase (January 2006 through November 2007). Lending pilot schemes commence, with additional coaching and training provided as needed, along with continuous product improvement and refinement, and financial and operational monitoring of pilot activity.

Monitorable Deliverables/Outputs • Preparation of business plans for each of four pilot microcredit programs

• Training for at least 25 staff members (combined) of implementing agencies in microfinance

• Disbursement of $800,000 through four pilot micro-lending schemes, with not less than 1,500 borrowers being served at the end of the schemes (number of borrowers with outstanding loans as of June 2007) and an average loan size of not more than Rp5 million, and a PAR of not more than 10% measured at 1 November 2007

• At least two out of four PFIs supplement pilot funding with sources of funds other than this JFPR grant, to expand pilot efforts by not less than 100% by the end of the project

Implementation of Major Activities: Number of months for grant activities

24 months: from November 2005 through November 2007

Component C Component Name Grant Management Cost ($) 480,842 Component Description Strong grant management is required and will be provided by a

project management unit (PMU) headed by the team leader–senior microfinance specialist, who will divide his or her time between activities directly related to managing the project, and consulting on

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technical issues related to the pilot microcredit schemes. The PMU will manage procurement and arrange for periodic financial audits of the project. This component will provide overall project administration, including technical and other support services provided under components A and B. The PMU must be properly outfitted and equipped to manage the project, which may take place over a wide area. In order for the PMU to assist the pilot schemes and to carry out research and surveys efficiently, as well as to facilitate on-site verification and auditing, two vehicles will be necessary, as well as computers and other office equipment. The vehicles and equipment will remain with BPD Aceh at the close of the project. Corruption is always a concern in Indonesia, and is the primary rationale for the strong focus on Grant Administration. Specific anticorruption measures are detailed in the section "Risks Affecting Grant Administration" below. ARMMA activities, including subsector work and microcredit pilots, will take place in a limited number of communities affected by the tsunami and earthquakes. These communities, to be selected during project implementation, will be located within the province of Aceh, and potentially, on Nias island, which is part of North Sumatra.

Monitorable Deliverables/Outputs • Quarterly progress reports • Annual project review report • Monthly financial report • Annual audited financial reports • Evaluation report including baseline survey data • Final project completion report

Implementation of Major Activities: Number of months for grant activities

24 months, from November 2005 through November 2007.

2. Financing Plan for Proposed Grant to be Supported by JFPR Financier Amount ($) JFPR 2,000,000 Other Sources (Please identify) 0 Total 2,000,000

3. Genesis

The unprecedented natural disaster in Aceh and North Sumatra of 26 December 2004 wreaked tremendous economic damage, most acutely felt by micro and small enterprises (MSEs). Before the tsunami, Aceh’s ecomony was dominated by family-owned firms, many of them small and most operating outside the formal economy. Households relied on either agriculture or fishing as their main source of income. There were few large firms. According to the Central Agency for Statistics (BPS), only 65 medium-sized or large establishments were operating in Aceh in 2002. An enterprise survey carried out by BPS in 2002 revealed that Aceh had, in contrast, 187,996 MSEs, employing an average of 1.8 people each. Post-tsunami

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estimates put the number of businesses lost at 80,000; the tsunami may have caused 140,000 jobs to be lost. These figures are simply estimates but point to the magnitude of the economic damage.

A quick review of the financial sector in Aceh shows that few institutions enjoyed substantial scale in commercial lending before the tsunami, with the provincial development bank, BPD Aceh and Bank Rakyat Indonesia (BRI), combining to dominate the local market for loans. Even though economic activity was mainly carried out by MSEs, these firms were largely unserved, at least on the lending side, by formal financial providers. BPD Aceh and BRI accounted for 73% of the approximately $339 million of lending in Aceh (Bank Indonesia figures as of 30 September 2004). BRI loans were mainly to small and medium-sized businesses and were asset-based. BPD Aceh’s main lending activity consisted of loans to civil servants, secured by their salaries and classified as consumer lending. Only the village banks (BPRs), licensed to operate within a single subprovincial (kabupaten) area, provide what could be considered micro-loans to MSEs. Total lending by BPRs in Aceh was $4.1 million in September 2004, or less than 1.2% of provincial credit outstanding. Closer inspection of BPR operations reveals that, similar to BRI, their lending is asset-based—i.e., based on collateral cover. They do not analyze borrower cash flow. Their underwriting standards and traditional, highly risk-adverse approach to banking renders the vast majority of firms unbankable.

Microfinance, specifically, microcredit, is not available to most MSEs in Aceh and was not before the tsunami. Now most banks (BPD Aceh being the significant exception) are not lending in Aceh because many borrowers have died and a substantial percentage of their loan portfolios are impaired. BPRs, which are micro-lenders, are in a particularly difficult situation, suffering disastrous loan losses combined with steady deposit withdrawals by cash-strapped customers. Surviving MSEs may suffer a more acute lack of access to capital than before the crisis, as their income-generating assets may have been lost. A way must be found to purchase new equipment and/or inventory to get their businesses back up and running. It is more important than ever before to develop commercial microfinance in Aceh and for financial institutions to find ways to expand service outreach to MSEs. Trying to start greenfield financial institutions or growing an NGO microfinance operation to commercial scale requires a long gestation and involves high operational risk. The most sensible approach is to design and carry out a number of controlled experiments with microfinance as a potential new line of business for capable and interested existing financial institutions, and to then scale up successful pilot operations. 4. Innovation

The tsunami has led to huge financial losses for individuals and financial institutions, and to survivors’ understandable aversion to risk. For MSEs, the idea of investing in a new business having just lost everything is not particularly attractive; the memory of loss is still acute, and the fear of losing all again is a powerful disincentive to investment. Syariah “lending” in such an environment may be the best method of overcoming this fear because the business risks are shared between the financial institution and the entrepreneur. Syariah or Islamic banking principles do not allow lending in the formal sense of the word; “investing” is a better way to describe Syariah finance. Money extended by the financial institution is repaid based upon a projection of the firm’s profit (revenue sharing is another formula that can be employed, though profit sharing is more popular in Indonesia). In practice, the volume of profits is projected in advance (this determines the amount of money that the business can access), the rate of profit sharing is agreed on beforehand (e.g., 40% for the financial institution), and the amount extended to the business by the financial institution and the schedule of repayments are

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structured based on anticipated profits. Formally registered companies and informal, individual entrepreneurs can participate in Syariah financing. Collateral is not required.

The project aims to be innovative in adapting Islamic banking principles to smaller,

microfinance products. The Syariah-type lending schemes that have been evaluated for this project appear to be geared toward larger businesses. Projecting profits is easy for larger, established businesses with more formal accounting systems. It will likely be a more challenging, time-consuming, and administratively costly proposition for MSEs. Still, it should be possible to project profits for even very small MSEs; many good microcredit schemes project household cash flow efficiently and accurately. Interestingly, much of the Syariah lending taking place in Aceh and the rest of Indonesia supports vehicle and equipment purchases; conventional leasing requires a firm to be a nonbank financial institution licensed by the Ministry of Finance, which has not issued many licenses recently. Under the Indonesian variant of Islamic banking, Syariah banks can structure contracts that closely resemble leases, obviating the need for a leasing license. There is no reason why lease contracts cannot be downsized to micro levels. Micro-leasing has worked in many other places. With good prospects for success, then, the project will undertake two Syariah microfinance pilot projects. The project will promote systematic exploration of alternative livelihood opportunities through research activities carried out through the main local university of Syiah Kuala. This effort represents a commitment to innovation and to developing local skills in subsector analysis. Some people in Aceh need to learn how to do something other than what they did before the tsunami to earn a living, e.g., fishermen whose fishing grounds have been destroyed. Many households have lost their breadwinners and/or seen their villages wiped out, which has broken down traditional economic support systems. Applied research will uncover new or improved products or processes that can provide livelihoods for some people who cannot return to their livelihood before the tsunami. This research will also benefit those who can return to what they did before but who could benefit from new opportunities. Some alternative crops such as patchouli are promising, but this grass must be gathered and processed carefully to ensure the quality of the oil it produces (used as a base for perfume), which involves new organizational and marketing approaches. Existing studies highlight some of these opportunities, which is why the project will review all subsector work done on Aceh in recent years as a first priority. 5. Sustainability

The objective of the project is to develop microfinance pilot projects that will grow into sustainable lines of business for PFIs. These pilot projects should become sustainable before the project closes: it is the whole point of the undertaking. If a bank or financial institution can demonstrate that it can make a market rate of return on microlending equal to or greater than the return it makes on other kinds of business after considering all risk factors, it should continue in that line of business.

The project will develop a strategy to use the $800,000 in grant seed capital after the

project. The first proposal is to place the funds into an endowment or trust arrangement, e.g., for the education and health of children affected by the tsunami. The endowment would assume ownership of the funds and might allow them to continue to revolve, to the extent that the FIs are using them wisely, safeguarding their value, and producing a reasonable return. Such an arrangement is being contemplated for the ultimate disposal of grant seed capital funds that will be made available to financial institutions in Aceh under the ETESP. This approach will likely be attractive to other potential cofinancing partners. Another alternative would be to finance or

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partially finance the construction of facilities (e.g., branches of a microcredit-providing financial institution) to support the development of commercial microfinance. The PMU, working with ADB staff and the government, in consultation with the Japanese embassy, to devise a useful and creative strategy for the continued good use of the seed capital funds.

The microfinance and livelihood survey activities present certain challenges for development into commercially sustainable operations. The livelihood research initiative could develop into a kind of business development services provider. With creative management and under the right set of circumstances, this initiative could be converted into a commercially sustainable business, along the lines of a consulting firm or technical service provider. These prospects cannot be fully evaluated in advance; the provision of business development services is an area where few donor agencies can boast of real commercial success. The Project will certainly be committed to exploring all avenues leading to a sustainable business model for the project’s livelihood research activities. 6. Participatory Approach

A participatory approach will be ensured by involving the management of PFIs in all decision making on the design and development of their pilot microcredit schemes. Their participation and complete buy-in to project objectives will be essential to the project’s success. Local participation in the microfinance and livelihood survey activities is part of component design; these activities will be carried out by local experts for the benefit of local people. Significantly, local NGOs in Aceh have severe capacity constraints, and most have no experience in economic development, i.e., microfinance or livelihood support. The project will, however, fully engage with and support outreach activities of the economics faculty of Syiah Kuala University, a state university.

Primary beneficiaries and other affected

groups and relevant description Other key stakeholders and brief description

Primary beneficiaries include MSEs, which are likely to include a substantial percentage of women owner/operators (40–50%). MSEs are mainly household enterprises, and so the impact in terms of numbers of borrowers is magnified by household numbers. In addition, access has been shown to lead to small, but not insignificant, increases in employment, as many firms with access to capital are more likely to add employees than firms without access.

The project will benefit the PFIs, which will be assisted to expand their businesses profitably. The project is expected to have a significant demonstration effect for financial institutions operating in Aceh and North Sumatra.

7. Coordination

The project has been developed in microfinance, an area where Japanese aid agencies will not be active. Significant and continuous consultation with the World Bank, USAID, GTZ, and other donors has taken place, and the activities contemplated under this grant do not duplicate assistance efforts being contemplated by other development partners. GTZ is likely to become active in microfinance in Aceh, and is keenly interested in the outcome of the proposed pilot schemes. There is broad scope for cooperation between ADB and GTZ going forward in microfinance. USAID is providing a limited amount of financial support (estimated at $5 million) through a partial credit guarantee program that targets assisting small and medium enterprises. The World Bank’s primary vehicle for assistance in Aceh will be its Kecamatan Development Project, which may provide some limited credit to communities for development projects. This

9

project’s operations are not anticipated to have an impact on the development of microfinance pilot schemes. The microfinance and livelihood survey, to the extent that it provides a central point for gathering and disseminating information on the activities of all development partners in these thematic areas, may provide a service to all donor agencies. 8. Detailed Cost Table

Please refer to Appendix 1 for the detailed cost estimates. C. Linkage to ADB Strategy and ADB-Financed Operations 1. Linkage to ADB Emergency Assistance Plan The proposal complements the livelihood and microfinance support activities contemplated under the recently approved $290-million ETESP. Under the ETESP, ADB has set aside approximately $21 million to support livelihoods and build commercial microfinance institutions. This proposed JFPR project, ARMMA, is integral to the ETESP, as ARMMA activities will pioneer approaches that can be scaled up under the ETESP, with its greater resources and longer time frame. JFPR provides sufficient resources to undertake critical initial microfinance support operations in Aceh, resources that are fitted approximately to the absorptive capacity of local financial institutions. ETESP resources will supplement ARMMA’s efforts to test and refine poverty lending techniques and identify new, profitable livelihood activities. 2. Linkage to Specific ADB-Financed Operation Project Name Earthquake and Tsunami Emergency Support Project (ETESP) Project Number 0002 Date of Board Approval 7 April 2005 Grant Amount ($ million) 290

3. Development Objective of the Associated ADB-Financed Operation The ETESP’s development objective is to finance viable MSEs and to help create sustainable livelihood opportunities for people suffering the effects of earthquakes and the tsunami. 4. List the main components of the Associated ADB-Financed Operation

Livelihood and microfinance support component, as noted above. 5. Rationale for Grant Funding versus ADB Lending Grant funding is preferred modality given severity of the disaster.

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D. Implementation of the Proposed Grant 1. Provide the Name of the Implementing Agency

• Mercy Corps • BPD Aceh (government owned) • Bank Danamon (Syariah Department) • Syiah Kuala University, Faculty of Economics

(state university) • BPRs to be determined (many government

owned) Mercy Corps is a United States (US)-based NGO with substantial operating experience

in Indonesia, and a distinguished track record in developing microfinance institutions, most notably Xac Bank of Mongolia. Mercy Corps provides disaster and emergency assistance in Aceh and has ongoing microfinance operations in Java. It was one of the first relief organizations to respond to the disaster and was brought in by USAID under a cooperative agreement. Along with some other well-known international NGOs, Mercy Corps has been operating cash-for-work programs in Banda Aceh and other communities severely affected by the tsunami. They are keen to move beyond these short-term relief operations in the province and to develop long-term commercial microfinance solutions. Mercy Corps has substantial funds that it has raised on its own from charitable contributions, mostly in the US, and could supplement the JFPR seed capital funds should the pilot schemes prove successful. Mercy Corps can provide personnel—local staff and international experts—to carry out pilot lending activities in concert with PFIs. It undergoes annual external audits and is considered a transparent, well-managed, and properly governed nonprofit institution.

Bank Danamon is Indonesia’s second largest privately owned commercial bank, with

Rp53 trillion in total assets (as of 31 December 2003, according to Bank Indonesia). It enjoys a reputation for business dynamism as well as for clean operations. Fifty-one percent of Bank Danamon’s shares are held between Temasek Holdings, the national investment holding company of Singapore, and Deutsche Bank. Danamon’s Syariah operations began during 2004, and the Syariah Department has only $50 million in assets. They are looking to increase their operations dramatically and are interested in working in partnership with ADB in Aceh.

Syiah Kuala University has more than 1,300 faculty members and 18,000 students. Its

Faculty of Economics regularly graduates Aceh’s business and government leaders. The faculty has more than 10 US-trained professors with master’s and doctor’s degrees, who are expected to deliver specific subsector studies and other surveys as needed under a task-based contractual arrangement. 2. Risks Affecting Grant Implementation

Type of Risk Brief Description Measure to Mitigate the Risk Market Pollution As so many agencies have so much

money at their disposal, the temptation will be to provide funds that will be on-lent to MSEs at subsidized rates, which would pollute the commercial loan market and undermine commercial microfinance operations.

ADB supports Government efforts to provide grants (instead of subsidized loans) to people who have suffered from the disaster. ADB rigorously monitors the actions of others, and carries out continuous dialogue with other development partners and the Government.

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Type of Risk Brief Description Measure to Mitigate the Risk Corruption PFIs and others engage in corrupt

practices, which are made possible by poor governance and lack of transparency.

The Project will adopt the following measures: (i) loan disbursements, and any cash or in-kind assistance under the Project will be checked against suitable identification and verification. All records, receipts, certificates, and other documents related to loans, cash, and/or in-kind assistance will be properly maintained and made available to ADB at any time; (ii) particular measures will include random performance audits to ensure funds have been used properly, spot audits conducted periodically during the project implementation period, and completion and post completion audits to address governance, financial accountability, and trans-parency; (iii) disclosure of information to the public will be provided by posting project inputs on community bulletin boards; and (iv) the Project will use ETESP’s grievance review and resolution mechanisms. One example would be tracking of funds, procurement, and training activities through the web site of e-Aceh.org.

Institutional Resistance

Banks prefer to lend larger amounts because of administrative cost structures (pressure not to reduce loan size and to reach a poor clientele), and to have good collateral coverage (pressure to continue old ways of doing business).

TA under the grant, supplemented with Mercy Corps resources, will demonstrate the commercial possibilities of micro-lending operations that use best practices.

Credit Risk Borrowers do not repay loans. This risk may be intensified by market pollution. Overall, credit risk will be mitigated by good borrower selection, proper underwriting, and strong operational execution—capacities that will be strengthened through project TA.

Safety Operations are limited because the conflict continues.

Risk cannot be controlled or mitigated by project measures.

3. Incremental ADB Costs No incremental funding requested.

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4. Monitoring and Evaluation

Key Performance Indicator Reporting Mechanism Plan and Timetable for M&E Outcome Indicators

Microfinance pilot schemes become part of mainstream operations of PFIs and enhance profitability

Outreach to MSEs by PFIs increases substantially after the pilot scheme phase closes. (MSEs accessing credit are at least triple the number served under pilot schemes, measured on the third anniversary of the closing date of the project)

PFIs offer deposit and other services to MSEs

Livelihood opportunities identified under the project provide jobs and income for many

PFI financial reports Provincial subsector economic data (BPS) Grant review missions

Project must provide reporting indicators and formats to PFIs May require additional resources to study and measure

Output Indicators Four microfinance pilot projects operating within no less than three PFIs within 12 months of project inception, at least two of which follow principles of Islamic banking

Project quarterly reports, annual report PFI quarterly pilot reports

Reports will be prepared by the project monthly, quarterly, and annually; PFIs will report at least quarterly

$800,000 seed capital disbursed to microenterprises through pilot microcredit projects within 24 months, to no less than 1,500 borrowers, with an average loan size of no more than Rp5 million

Project quarterly, annual, and final reports PFI periodic reports

Key indicators (cumulative lending, number of borrowers, average loan size) to be built into reporting formats from inception

Portfolio at risk of no greater than 10% at the close of the project

Project final reports Indicators of portfolio quality incorporated into periodic report formats from inception

At least two of four pilot schemes at PFIs (i) expand microcredit by more than 100% with additional funding sources coming from outside the JFPR grant, and (ii) these pilot schemes demonstrate the capacity to continue beyond the close of the project

Project final report Grant review missions PFI financial reports

Continuous pilot scheme and market monitoring, and ongoing dialogue with PFIs

At least four potential new livelihood activities identified by project, and receive funding under the ETESP

Project periodic reports Specific subsector studies

Project determines work plan of Syiah Kuala research

5. Estimated Disbursement Schedule

Fiscal Year Amount ($) 2005 50,000 2006 1,200,000 2007 750,000 Total Disbursements 2,000,000

Appendix 1 13

Total (Input) Percentage

1 Equipment and Supplies 106,400 5

2 Training, Workshops, Seminars, and Audita 129,000 6

3 Consulting Services 828,000 41

4 Seed Capital 800,000 40

5 Contingencies 136,600 7

Subtotal JFPR Grant Financed 2,000,000 100

0 0

0 0

0 0

Total Estimated Cost

a Audit for Component C only.Source: Asian Develoment Bank.

Government Contribution

Other Donor(s) Contributions

Community's Contributions

JFPR = Japan Fund for Poverty Reduction

0

0

00

0

0

0

17,843

261,243

0

0

85,915

1,257,915

0

30,000

0

32,842

418,000

480,842

0

50,000

Component C Grant ManagementInputs/Expenditure Category

322,000

800,000

Component B Microfinance Pilots

Component A Microfinance and

Livelihood Surveys

106,400

49,000

88,000

0

Table A1.1: Summary Cost Table

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Appendix 1

AmountMethod of

Procurement243,400 243,400

1.1 Equipment and Supplies 106,400 106,400 DP1.1.1 Computers per unit 3 1,500 4,500 4,500 DP1.1.2 Printers per unit 3 500 1,500 1,500 DP1.1.3 Telephones/Communication per unit 24 400 9,600 9,600 DP1.1.4 Office Supplies monthly amount 24 500 12,000 12,000 DP1.1.5 Vehicle per unit 2 25,000 50,000 50,000 DP1.1.6 Fuel monthly amount 24 1,200 28,800 28,800 DP

1.2 Training, Workshops, & Seminars 49,000 49,0001.2.1 Subsector Surveys per survey 8 3,000 24,000 24,000 DP1.2.2 Microfinance Pilot Results Surveys per survey 4 2,500 10,000 10,000 DP1.2.3 Microfinance Pilot Review Seminars per seminar 4 3,750 15,000 15,000 DP

1.3 Consulting Services 88,000 88,000Domestic Consultant

1.3.1 Social Survey Specialist per person month 8 5,500 44,000 44,0001.3.2 Subsector Specialist per person month 8 5,500 44,000 44,000

1,172,000 1,172,0002.1 Training, Workshops, & Seminars 50,000 50,000

2.1.1 Microfinance Training Workshops per workshop 4 6,250 25,000 25,0002.1.2 Microfinance Pilot Review Seminars per workshop 4 6,250 25,000 25,000

2.2 Consulting Services 322,000 322,000International Consultants

2.2.1 Grant Manager/Senior Microfinance Specialist

per person month 6 37,667 226,000 226,000

Domestic Consultant2.2.2 Grant Coordinator/Microfinance Expert per person month 12 5,333 64,000 64,0002.2.3 Administrator/Training Specialist per person month 6 5,333 32,000 32,000

2.3 Seed Capital 800,000 800,0002.3.1 Pilot 1 - Syariah Microcredit seed capital 1 200,000 200,000 200,0002.3.2 Pilot 2 - Syariah Microcredit seed capital 1 200,000 200,000 200,0002.3.3 Pilot 1 - Conventional Microcredit seed capital 1 200,000 200,000 200,0002.3.4 Pilot 2 - Conventional Microcredit seed capital 1 200,000 200,000 200,000

Component B: Microfinance Pilots

Component A: Microfinance and Livelihood Surveys

Govern-ment

Other Donors

Commu-nities

Costs

Supplies and Services RenderedCode

Contributions

UnitQuantity

UnitsCost Per

UnitTotal

$

JFPR

Table A1.2: Detailed Cost Estimates

Appendix 1 15

AmountMethod of

Procurement448,000 448,000

3.1 Audits 30,000 30,0003.1.1 Pilot Audit per audit 4 3,750 15,000 15,0003.1.2 Project Audit per audit 2 7,500 15,000 15,000

3.2 Consulting Services 418,000 418,000International Consultants

3.2.1 Grant Manager/Senior Microfinance Specialist

6 37,500 225,000 225,000

3.2.2 Islamic Banking Specialist 2 42,500 85,000 85,000Domestic Consultant

3.2.3 Grant Coordinator/Microfinance Expert 12 5,333 64,000 64,0003.2.4 Adminitrator/Training Specialist 6 5,333 32,000 32,0003.2.5 Syariah Banking Specialist 2 6,000 12,000 12,000

Components A to C Subtotal 1,863,400 1,863,400

Contingency 136,600 136,600

Total Grant Costs 2,000,000 2,000,000

DP = direct purchase; JFPR = Japan Fund for Poverty ReductionSource: ADB estimates.

Contributions

(Maximum of 10% of total JFPR Contribution)

Commu-nitiesCode Supplies and Services Rendered

Costs

UnitQuantity

UnitsCost Per

UnitTotal

$Component C: Grant Management

JFPRGovern-

mentOther

Donors

Table A1.2: Detailed Cost Estimates (Cont.)

16 Appendix 2

FUND-FLOW ARRANGEMENTS 1. Fund-flow arrangements will be simple and direct. Detailed procedures for managing grant fund flow into Aceh are under discussion between the Asian Development Bank (ADB), other donor partners, and the Government, which has set up a special-purpose agency to manage all rehabilitation and reconstruction projects. As the Executing Agency will be BPD Aceh, a licensed bank, the most expeditious way to manage fund flow will be through a special-purpose account established at the bank and controlled by the project management unit (PMU). Because of BPD Aceh’s limitations in handling foreign exchange, however, the imprest account will be established at Bank Indonesia. The requirements related to imprest accounts will be clarified before project implementation after consultation with the Office of the General Counsel and Controllers. 2. In any event, Bank Pembangunan Daerah Aceh (BPD Aceh) alone will have access to the imprest account, and the PMU alone will have access to accounts set up for the project at BPD Aceh. The implementing agencies will be given access to special project accounts set up for them at BPD Aceh. Neither the Faculty of Economics of Syiah Kuala University nor Mercy Corps, despite being project implementing agencies, are expected to require access to a bank account. Only the participating financial institutions will need to use such a fund-flow arrangement. The ceiling amount to be deposited into the Japan Fund for Poverty Reduction (JFPR) imprest account will be based on estimated expenditures for the first 6 months but not exceeding the equivalent of $100,000. The statement of expenditure procedure will be used to liquidate or replenish the imprest account. Initially, the limit of $100,000 will be maintained but, based upon requirements for microcredit pilot schemes and other anticipated project activities, this amount may need to be increased. The use of the JFPR account, imprest account, and procedures will be audited annually by independent external auditors acceptable to ADB. A separate audit opinion on the use of the JFPR account, imprest account, and procedures should be included in the annual audit reports. Subject to arrangements being worked out with the Ministry of Finance for all tsunami-related assistance, the arrangements proposed here may be revised before project implementation.

Appendix 3 17

Figure A3: Implementation Arrangements

Syiah Kuala

Mercy

Bank Danamon Syariah

Bank BPD Aceh

Syariah BPR #1 BPR #2

Syariah microcredit pilots Standard microcredit pilots

ADB

Bank BPD Aceh: Executing Agency

Grant Management/ Project Management Unit

Implementing Agencies

Micro and small enterprises

Technical support, pilot management,

staff training

Baseline survey, microfinance surveys,

subsector analysis

18 Appendix 3

IMPLEMENTATION ARRANGEMENTS

1. The Executing Agency for the grant project will be Bank Pembangunan Daerah Aceh (BPD Aceh), a financial institution majority-owned by the provincial government, with minor ownership interests held by the smaller local government units, the kabupaten. BPD Aceh is a financially sound institution and is regularly audited by Bank Indonesia. It has offered the use of its premises to the project for free, will provide logistical support to the project, and can make staff members available from time to time to assist the project management unit (PMU). It is considered desirable that a licensed, government-owned (but 100% Acehnese) financial institution serve an executive role in the project, as it will allow for maximum efficiency in managing and moving funds and create an easily audited financial trail for all project expenditures. A detailed implementation diagram is attached as Figure A3. 2. The PMU will be established at BPD Aceh and be responsible for the day-to-day management of project activities, including management of all the financial affairs of the project, ongoing financial control, and arranging annual external audits. In addition, the PMU will enter into contractual agreements with the implementing agencies, which will outline specific areas of cooperation under the project, provide detailed expectations of performance, and strictly define the nature of all financial dealings. On a technical level, the PMU will also be the source of technical assistance (TA) for the design of microcredit lending schemes and provide ongoing advice and counsel to the implementing agencies. 3. There will be up to six implementing agencies under the project, including three or four participating financial institutions, which will implement the pilot microfinance schemes. The Economics Faculty of Syiah Kuala University will implement the project’s research and surveys. Mercy Corps will provide TA to the pilot programs and, in some cases, may provide the personnel to directly run the pilot programs. Mercy Corps is interested in developing commercial microfinance and sees a linkage or partnership with the Asian Development Bank (ADB) to be advantageous. From the perspective of ADB and this project, the partnership with Mercy Corps provides access to world-class expertise in microfinance as well as, potentially, substantial additional resources to scale up successful pilot operations. 4. Given the urgent need to reestablish normal economic activity and promote the growth and development of livelihoods and financial services in the areas affected by the earthquakes and tsunami, goods and services will be procured expeditiously. Simplified procedures are described in ADB’s Streamlined Consultant Recruitment and Procurement for Tsunami Emergency Assistance (Appendix 3 of ADB’s Board paper on ADB Assistance for Tsunami-Affected DMCs [February 2005]). Local procedures will be followed. Procurement will be carried out using direct purchase. All procurement will be undertaken in accordance with ADB’s Guidelines for Procurement. 5. Consultants will be hired in accordance with ADB’s Guidelines on the Use of Consultants (January 2005) and other arrangements satisfactory to ADB on the engagement of domestic consultants. ADB will engage 14 person-months of international consultants, including a grant manager–senior microfinance specialist (12 person-months) and an Islamic banking expert (2 person-months). A total of 54 person-months of domestic consulting services will be procured, including a grant coordinator–microfinance expert (24 person-months), a financial accounting–audit specialist (12 person-months), a social survey specialist (8 person-months), a subsector specialist (8 person-months), and a Syariah banking specialist (2 person-months).

Appendix 3 19

6. It is advisable that the international consultants be engaged as individuals, using the direct selection method allowed under these circumstances. The local consultants will be engaged through a consulting firm, and the project will follow the short-listing requirements outlined in the recent tsunami-related Board documents. The biodata technical proposal format will be used. The Indonesia Resident Mission may be tasked with managing the selection of the local firm. 7. It is anticipated that Syiah Kuala University faculty members will be engaged under a series of contracts that will contain specific terms of reference related to a single activity such as a subsector study or a microfinance survey. The university will not be specifically named in the contract. These studies and surveys will require the formation of teams, the composition of which will vary for each study in accordance with technical requirements. An overall budget has been prepared for these activities, which the PMU will manage. The grant manager will develop the work plan and the terms of reference for each study in conjunction with Syiah Kuala faculty members.