Private Sector Development in Low-Income Countries - Development in Practice (WB, 1996, 188 p.): Chapter 2-Establishing an attractive business environment agile firms, agile institutions: The private sector's assessment of the business environment

Private Sector Development in Low-Income Countries - Development in Practice (WB, 1996, 188 p.)

Chapter 2-Establishing an attractive business environment agile firms, agile institutions

		(introduction...)
		The private sector's assessment of the business environment
		Foundations of a dynamic private sector
		Secure, flexible transactions
		Competition-and simplified regulation
		Enterprise development
		Efficient infrastructure
		The agenda for developing an attractive yet competitive business environment

The private sector's assessment of the business environment

Several countries, often with help from the World Bank Group, have conducted surveys about how domestic and foreign private firms feel about the business environment (box 2. 1). These surveys have produced a wealth of data about the costs enterprises face in starting, operating, and expanding their businesses and about how entrepreneurs rank various impediments to doing business:

· In Cameroon, firms have identified access to finance, lack of demand, and taxes and tax administration as the three most important constraints.
· Entrepreneurs in Cote d'Ivoire note the same constraints, adding political and policy uncertainty near the top of their list.
· In Kenya, entrepreneurs are concerned about macroeconomic stability, infrastructure, regulations, and access to finance.
· In Egypt, tax administration weighs almost as heavily on firms as taxes themselves. A business may not know its actual tax liability for ten years after submitting its declaration.
· In India, firms are burdened by excessive regulations that prevent them from responding to an increasingly competitive environment.
· In Sri Lanka, firms have identified the cost of finance, the level of taxes, poor infrastructure, labor regulations, and policy uncertainty as key constraints.

To compete successfully requires agile firms connected to world markets. But firms in mast low-income countries have been held back by a difficult business environment that has increased risks and transaction costs.

Private sector assessments and firm surveys suggest that these constraints can increase the cost of doing business by as much as 30 percent over costs in other countries. The surveys also suggest that when economic and political conditions are secure, when the risks of policy reversals are low, and when the business environment is inviting, domestic entrepreneurs are forthcoming in their investments, and foreign investors come in willingly.

Institutional Investor publishes biannual country credit ratings that reflect the international financial community's perception of the economic, financial, and political health of countries (table 2.1). In most low-income countries (except China and India), country risk is still perceived as high. Some countries, such as Bangladesh, Bolivia, Sri Lanka, Uganda, and Zambia, have improved their country credit ratings considerably.

BOX 2.1 PRIVATE SECTOR ASSESSMENTS IN LOW-INCOME COUNTRIES: A PARTICIPATORY APPROACH TO DIAGNOSIS AND IMPLEMENTATION

But most low-income countries need to make much greater efforts to overcome negative perceptions of country risk. In Africa, the harsh business environment has generally resulted in poorer performance of private investment than in other parts of the world. Investments were most successful in countries where the business environment was hospitable. The IFC's operations in the export-oriented oil, gas, and mining sectors have performed well—because they have been structured to be insulated to a large degree from the local economy. But the performance of its investments in the manufacturing and service industries—when measured in financial and economic rates of return, specific loss reserves, and write-off rates—has been significantly below the average of these measures for the rest countries need to make much greater efforts to overcome negative perceptions of country risk.

In collaboration with the governments and the private sector, IDA and IFC have prepared ten private sector assessments in low-income countries and are planning to complete eight more by the end of 1996. The assessments have: Documented the private sector's economic role and its relation to the public sector. Surveyed firms to improve the quality and quantity of data available regarding obstacles to private sector development—including insufficient access to credit and problems with starting, operating, and expanding a business. Clarified issues related to the nature and sequencing of reforms affecting the private sector—such as macroeconomic and political stability and the functioning of financial markets. Highlighted the high cost to business of complex regulations, poor infrastructure, and poor performance by public institutions—particularly institutions of public finance, such as customs and taxation. Reduced mutual suspicion and stimulated constructive, focused dialogue between business and government— leading to the institutionalization of private-public consultative measures. Helped the Bank Group to set priorities, define its agenda, and identify new projects in private sector development. Helped coordinate donors' strategies and support for private sector development. Based on the findings of past private sector assessments, the Bank Group is now focusing on developing standards for measuring the role of the private sector in the economy and defining constraints to private sector development arising from distorted incentives, excessive government regulations, crowding out by government, and weak support systems. Most important, private sector assessments are now being used to establish cooperative arrangements among the private sector, governments, the Bank Group, and the donor community to design reform programs acceptable to all key stakeholders.

In Africa, the harsh business environment has generally resulted in poorer performance of private investment than in other parts of the world. Investments were most successful in countries where the business environment was hospitable. The IFC's operations in the export-oriented oil, gas, and mining sectors have performed well—because they have been structured to be insulated to a large degree from the local economy. But the performance of its investments in the manufacturing and service industries—when measured in financial and economic rates of return, specific loss reserves, and write-off rates—has been significantly below the average of these measures for the rest of the Corporation's portfolio. It is this latter category of investments whose performance is directly tied to the overall economic and business environment in the local economy.

Poor performance was rooted in macroeconomic shortcomings—mainly unrealistic exchange rates and foreign exchange shortages. Further increasing costs were infrastructure inadequacies that required firms to take on functions that private firms in other parts of the world did not have to be concerned with. And weakening the performance of investments were regulatory impediments—from price controls and import restrictions to interference in product mix decisions and labor markets and delays in granting permits.

In the past few years, many African governments have taken macroeconomic measures that are reducing the cost of doing business, and many have started the long process of correcting policy and institutional weaknesses that contribute to high risk and transaction costs. But much more needs to be done to change investors' perceptions.

China and India have demonstrated the value of economic reforms, particularly over the past four years. Their economic reforms have been rewarded by expanded access to international capital markets and foreign direct investment (FDI), which has brought new markets, new technologies, and muchneeded competition. In China, FDI went from negligible amounts at the beginning of the 1980s to nearly $20 billion in 1993. In India, FDI approvals went from $73 million in 1990 to more than $2 billion in 1993, and actual FDI flows increased from $165 million to $600 million. Indian firms have also raised more than $4 billion from international debt and equity markets.

TABLE 2 1 COUNTRY CREDIT RATINGS

Country	1991	1994	1999
Switzerland	92.4	92.4	92.3
Malaysia	62.0	67.6	69.2
Thailand	62.5	62.2	62.8
China	53.1	57.4	58.4
India	38.4	42.2	46.2
Pakistan	27.0	29.7	30.1
Egypt	23.4	30.9	29.5
Sri Lanka	21.9	30.4	31.7
Zimbabwe	28.7	29.0	30.2
Ghana	N/A	27.6	29.2
Kenya	28.3	23.7	24.0
Bangladesh	16 4	23.2	25.0
Bolivia	15.0	21.4	23.2
Nigeria	19.5	18.4	17 6
Cd'lvoire	17.2	17.0	18.2
Tanzania	12.0	15.2	16.1
Zambia	9.8	13.9	14.4
Uganda	5.3	11.6	11.2
Zaire	10.1	8.3	7.5
Sierra Leone	6.9	7.4	5.8

Source: Institutional lnvestor, September 1991 and September 1994.

Regaining the confidence of investors may take time. But once investments start, they create a virtuous cycle—investment flows increase the incentives to maintain stability and continuity, which in turn leads to more investments. The Multilateral Investment Guarantee Agency (MIGA) has been assisting low-income countries in starting this virtuous cycle by providing political risk insurance and technical assistance (box 2.2).