68881 THE WORLD BANK GROUP Report No. X._SL Sierra Leone Investment Climate Policy Note Africa Finance and Private Sector Group (AFTFP) June 2009 This Investment Climate Policy Note (ICPN) for Sierra Leone evaluates the country‘s business environment by: (i) analyzing barriers to private sector investment and growth and how they vary among different types of firms, (ii) benchmarking Sierra Leone‘s investment climate and firm performance to that of other countries and (iii) provide recommendations to promote and strengthen the private sector. The ICPN is supported by the statistical analysis of a 2009 survey of firms based in two of Sierra Leone‘s major urban centers, as well as data from other sources. CURRENCY EQUIVALENTS (Exchange Rate as of April 1st 2009) Currency Unit: Sierra Leone Leone (SLL) US$1.00=Le 3200 Abbreviations and Acronyms DTIS Diagnostic Trade Integration Study EITI Extractive Industries Transparency Initiative FDI Foreign Direct Investment FIAS Foreign Investment Advisory Services GDP Gross Domestic Product GoSL Government of Sierra Leone GST Goods and Services Tax IDA International Development Association ICPN Investment Climate Policy Note LLC Limited Liability Corporation LPI Logistics Performance Index PPIAF Public-Private Infrastructure Advisory Facility PPP Purchasing Power Parity PPP Public Private Partnerships PRSP Poverty Reduction Strategy Paper SLAM Sierra Leonean Association of Manufacturers SLIBA Sierra Leone Indigenous Business Association SMEs Small and Medium Enterprises SSA Sub-Saharan Africa TFP Total Factor Productivity WAPP West African Power Pool Vice President: Obiageli Katryn Ezekwesili Country Director Ishac Diwan Sector Director Marilou Jane Uy Sector Manager Iradj Alikhani Task Team Leader Rekha Reddy ii ACKNOWLEDGEMENTS This report was prepared by Rekha Reddy under the overall guidance of Iradj Alikhani and Alvaro Gonzalez. George Clarke and John Speakman served as peer reviewers for this work and provided many helpful suggestions and comments. Alvaro Gonzalez provided crucial methodological advice, comments and input to many drafts of this report. Christopher Juan Costain provided extensive comments and input to many drafts of the report. His input particularly strengthened the recommendations for policy actions. Douglas Addison and Peter Mousley provided useful input and feedback as quality assurance team members. Sebastian James and Mohua Mukherjee provided important input into the sections and policy recommendations on taxation and electricity issues respectively. Niti Bhutani and Suhail Kassim also gave helpful feedback during the peer review process. The Africa Finance and Private Sector Development team would like to express their gratitude to the Sierra Leone authorities, and especially to the managers and staff of the 150 firms surveyed in 2008 and 2009. iii TABLE OF CONTENTS EXECUTIVE SUMMARY ........................................................................................................................ vii POLICY OPTIONS TO THE IMPROVE INVESTMENT CLIMATE .................................................. xi INTRODUCTION .................................................................................................................................... 1 CHAPTER 1: COUNTRY CONTEXT .................................................................................................... 5 MACROECONOMIC PERFORMANCE ........................................................................................... 5 ECONOMIC STRUCTURE ................................................................................................................ 7 POLITICAL ECONOMY-GOVERNANCE, POLITICAL STABILITY AND REFORM ................ 8 CHAPTER 2: FIRM PERFORMANCE ................................................................................................. 11 SALES AND EMPLOYMENT GROWTH ....................................................................................... 11 LABOR PRODUCTIVITY ................................................................................................................ 12 LABOR COSTS ................................................................................................................................. 13 SKILLS, TRAINING AND TECHNOLOGY ................................................................................... 15 CHAPTER 3. INVESTMENT CLIMATE CONSTRAINTS ................................................................ 20 INDIRECT COSTS ............................................................................................................................ 20 PERCEIVED CONSTRAINTS ......................................................................................................... 21 ELECTRICITY .................................................................................................................................. 23 TAXES ............................................................................................................................................... 26 INFORMALITY ................................................................................................................................ 29 CORRUPTION .................................................................................................................................. 30 ACCESS TO LAND .......................................................................................................................... 31 CHAPTER 4. ACCESS TO FINANCE IN SIERRA LEONE .................................................................. 33 THE FINANCIAL SECTOR IN SIERRA LEONE ........................................................................... 33 USE OF FINANCIAL SERVICES .................................................................................................... 34 SOURCES OF FINANCE ................................................................................................................. 35 REASONS FOR LOAN APPLICATIONS AND REJECTIONS ..................................................... 37 PERCEPTIONS ................................................................................................................................. 39 CHAPTER 5: EXPORTS AND INTERNATIONALIZATION ................................................................ 43 EXPORT STRUCTURE .................................................................................................................... 43 CHARACTERISTICS OF EXPORTING AND NON-EXPORTING FIRMS .................................. 44 BUSINESS ENVIRONMENT AND EXPORTS .............................................................................. 45 TRANSPORT .................................................................................................................................... 47 CHAPTER 6: CONCLUSIONS AND POLICY RECOMMENDATIONS ............................................... 50 REFERENCES ........................................................................................................................................... 56 iv LIST OF TABLES Page Table 0.1: Sample Frame-Sierra Leone Indicator Survey 2 Table 1.1: Selected Macroeconomic Indicators for Sierra Leone and Comparator Countries 5 Table 1.2: Doing Business Ranking for Sierra Leone 10 Table 2.1: Employment and Sales Growth by Firm Type (2006-2009) 11 Table 2.2. Median Productivity, by Firm Characteristics 13 Table 2.3. Use of Internet Technology 17 Table 2.4: Top and Bottom Performers and Characteristics 18 Table 3.1: Perceptions of Constraints to Conducting Business, By Firm Type 22 Table 3.2: International Comparison of Power Outages 24 Table 3.3: Accessing Services: International Comparison 25 Table 3.4: Marginal Effective Tax Rates 27 Table 3.5: Tax Administration in Sierra Leone and Comparator Countries 27 Table 3.6: Informality 29 Table 3.7: Percentage of Firms Expected to Give Informal Payments or Gifts 30 Table 3.8: International Comparison of Procedures and Costs of Registering Property 32 Table 4.1. Use of Financial Services by Firm Category 35 Table 4.2: Variations in Sources of Working Capital Finance 36 Table 4.3. Reasons for Not Applying for a Loan 37 Table 4.4: Margins on Lending-International Comparison 39 Table 4.5: Econometric Determinants of Access to Finance in Sierra Leone 41 Table 5.1: Logistics Performance Index: International Comparison 46 Table 5.2: Current State of the Road Network 48 LIST OF FIGURES Figure 1.1: Changes in Sector Composition 7 Figure 1.2: Rankings of Sierra Leone‘s Performance in Governance 8 Figure 1.3: International Comparison of Sierra Leone‘s Performance in Governance 9 Figure 2.1: Labor Productivity of Manufacturers: International Comparison 12 Figure 2.2: Labor Costs and Unit Labor Costs 14 Figure 2.3: Rigidity of Employment Index 15 Figure 2.4: Firing Costs (weeks of salary) 15 Figure 2.5: Firms Offering Formal Training 15 Figure 2.6: Education Level of Firm Managers 15 Figure 2.7: Years of Manager Experience 16 Figure 2.8: Age of Firm (years) 16 Figure 3.1: Indirect Costs as a Percentage of Sales: International Comparison 20 Figure 3.2: Perceptions of Major Constraints to Conducting Business 22 Figure 3.3: Biggest Obstacles to Conducting Business in Sierra Leone 23 Figure 3.4: Firms with Generators 24 Figure 3.5: Firms Perceiving Electricity as a Constraint 24 Figure 3.6: Losses from Power Outages, by Firm Size 25 Figure 3.7: Firms Citing Tax Issues as a Major Problem 26 Figure 4.1: Private Sector Credit to GDP 34 Figure 4.2: Bank Credit to Bank Deposits 34 Figure 4.3 Firms Utilizing Checking or Savings Accounts 34 v Figure 4.4 Firms Utilizing Loans or Lines of Credit 34 Figure 4.5: Financing of Working Capital (%) 35 Figure 4.6: Financing of New Investment (%): International Comparison 35 Figure 4.7: Financing of Working Capital (%) International Comparison 36 Figure 4.8: Financing of New Investment (%) 36 Figure 4.9: Loan Application Activity by Firms in the Last Year 37 Figure 4.10: Loans Requiring Collateral 38 Figure 4.11: Value of Collateral (% of Loan) 38 Figure 4.12: Comparison of Firms Who Perceive Access to Finance as an Obstacle 39 Figure 5.1: Sierra Leone Trade Growth 43 Figure 5.2: Export Composition (fob, 2007) 43 Figure 5.3: Percentage of Firms That Export 44 Figure 5.4: Firms which Feel Customs and Trade Regulations are a Major Constraint 45 Figure 5.5: Time for Import and Exports 46 Figure 5.6: Documents for Imports and Exports 46 Figure 5.7: Comparative Cost of Imports and Exports (per container) 47 Figure 5.8: Firms Perceiving Transport as a Major Constraint 49 vi EXECUTIVE SUMMARY This Investment Climate Policy Note (ICPN) for Sierra Leone evaluates the country‘s business environment by: (i) analyzing barriers to private sector investment and growth and how they vary among different types of firms, (ii) benchmarking Sierra Leone‘s investment climate and firm performance to that of other countries and (iii) providing recommendations to promote and strengthen the private sector. The ICPN is supported by the statistical analysis of a 2009 enterprise survey of 150 formal, manufacturing and service firms with five or more employees based in Western Area/Freetown and Kenema, two of Sierra Leone‘s major urban centers. It does not cover rural firms, informal firms or firms with less than five employees, which make up the majority of the country‘s enterprises. Data from other enterprise surveys facilitate international comparisons with Mano River Union members Guinea, Liberia and Cote d‘Ivoire, and two larger post-conflict economies: the Republic of Congo (DRC) and Rwanda. Key findings are summarized below with priority recommendations based on these findings following the summary. The ICPN is organized as follows. Chapter 1 provides context for Sierra Leone‘s business environment. Chapter 2 discusses the performance of Sierra Leone firms, with a focus on labor productivity. Chapter 3 examines how investment climate constraints cost businesses money and time, discusses main bottlenecks to conducting business as identified by managers of Sierra Leone firms, and reviews obstacles related to electricity supply, tax rates, informality, corruption and access to land. Chapter 4 analyzes data on how firms access and use finance, and chapter 5 discusses exports and internationalization in Sierra Leone. Chapter 6 concludes and provides policy options to improve the investment climate. Country Context: The Slowing of Post-Conflict Growth Following the end of its 11 year civil conflict in 2002, Sierra Leone has had one of the highest growth rates in Africa, with an average of 7 percent growth between 2002 and 2007. However, Sierra Leone‘s post-conflict growth spurt has declined as the global downturn reduces the demand for Sierra Leone‘s mineral exports. Agriculture, including fishing, remains the dominant sector, and the manufacturing sector is limited. In 2007, the country ranked last among all countries in the Human Development Index. Falling commodity prices and FDI make the identification and remedy of investment climate problems essential as they increase the ability of the economy to adapt to economic shocks more easily. With respect to governance, the rankings for key indicators for Sierra Leone suggest a strong increase in performance in almost all categories, and it is considered more stable politically than other near country comparators. Firm Performance: Low Labor Productivity and Relatively High Labor Costs Sierra Leone represents a paradox: strong firm level growth despite low productivity. Most firms in Sierra Leone reported significant growth in both their sales and labor force over the last three years, with growth highest for small firms and manufacturing firms. However, labor productivity for firms in Sierra Leone‘s small manufacturing sector appears to be relatively low by international standards. Value-added per worker was approximately US$1,000 for the median manufacturing firm, similar to Guinea and Liberia, but far lower than many other countries in Sub-Saharan Africa. The median labor cost per worker in all Sierra Leone manufacturing and vii services firms surveyed was US$575, similar to that of other countries in the region. Unit labor costs (labor costs as a percentage of value added) of 34 percent were relatively high, which is associated with greater difficulties in competing internationally. Addressing these fundamental productivity issues is critical—without doing so developing countries become unable to sustain high growth rates. What explains this low productivity? The median firm in Sierra Leone is smaller than in certain other comparator countries, so lack of economies of scale might be one factor. Skills level and technology use might also contribute. While the experience level of managers is similar to that of other Sub-Saharan Africa countries, few firms offer formal training to their workers relative to firms in other countries in the region and managerial education levels are low. Firms in Sierra Leone make relatively little use of Internet technology. Labor market rigidity might be another explanation, as firing costs are among the highest in Africa. This is likely to affect decisions of formal firms to restructure and provide incentives for increased productivity. Econometric analysis show the relationship between productivity and firm characteristics: manufacturing firms have low performance relative to non-manufacturing firms, while foreign-owned firms and exporters have higher performance than their non-exporting, domestically owned counterparts. Difficulties in the Business Environment Impose Significant Costs It is estimated that firms in Sierra Leone have to bear additional indirect costs of 14 percent of sales due to difficulties in the business environment. According to the data reported by firm managers in the enterprise survey, losses due to power outages amount to nearly 7 percent of sales and losses due to theft, vandalism and arson and the cost of hiring security cost an additional 3 percent of sales, with bribes in the course of business another 4 percent. As substantial as these losses are, they are lower than in Liberia, Guinea and Cote d‘Ivoire. Managers Perceive Electricity Supply and Tax Rates as Major Problems Electricity and tax rates were the most commonly named by firm managers as the major constraints to business operations, by 53 percent and 42 percent respectively of firm managers surveyed respectively. Access to land, corruption and access to finance were also identified as major concerns by more than 30 percent of firm managers. When asked to identify a single biggest obstacle to doing business, firm managers named tax rates, access to finance and electricity most often. Firms located in Freetown and manufacturers perceived more constraints in operating their businesses overall relative to other firms. Insufficient and Unreliable Electricity a Drag on Firm Performance Access to electricity is clearly one of the most severe constraints in Sierra Leone‘s investment climate. The survey data show that most firms in Sierra Leone (86 percent) have experienced power outages. The average firm in Sierra Leone experiences 16 power outages in a month with an average duration of 10 hours—almost 7 days in total—again, higher than the average in Sub- Saharan Africa. Faced with an unreliable (and in recent years virtually non-existent) public power supply, 82 percent of firms purchased generators, double the average for Sub-Saharan Africa. The data suggest that large firms and manufacturers are more severely affected by power outages, although outages affect firms of all sizes. viii The long awaited Bumbuna plant is due to come online later in 2009 and will increase generating capacity, but will primary provide power to Freetown, which currently uses more than 80 percent of the country‘s electrical power. Most areas in the interior, except for Bo and Kenema, are largely without public power supplies. Electricity generation is still far from sufficient, but as it increases, the urgency of improving the country‘s limited transmission and distribution network increases. Taxation Linked to High Level of Informality According to survey data of firm managers, tax rates were second in the rankings of major constraints to conducting business. Large firms and foreign owned firms, who spend more hours dealing with tax issues than other firms were particularly concerned about this issue. This is not unusual: tax rates have ranked among the top three obstacles in over two-thirds of countries in Sub-Saharan Africa. However, marginal tax rates (the effective tax rate on incremental investment by a business), suggests that the tax burden is largely in line with those of other countries in the region. Taxation is believed to be a key driver of informality, and studies suggest that the majority of firms in Sierra Leone are informal. The enterprise survey data on which this study is based does not cover informal firms, and further research on this topic is needed. A majority of the Sierra Leone firms in the sample feel that the ―typical‖ firm in their country evades taxes. Tax administration is not considered to be a particularly important issue by firms, and collection of tax revenues in Sierra Leone is low relative to other countries in the region. Although collection efforts are improving, in this context, if a lower tax rate were desired, then compensating measures would be needed to broaden the tax base so that the revenue effort is not undermined. Corruption Pervasive in Certain Transactions Thirty-six percent of firm managers and 60 percent of manufacturing firm managers feel corruption is a serious problem in Sierra Leone. According to enterprise survey data, corruption imposes a cost of about 4 percent of a firm‘s annual sales. This cost, while significant, is less than in most comparator countries. Other data on governance suggests that Sierra Leone performance on corruption has steadily deteriorated since 2000. A significant proportion of firms have been asked for gifts or informal payments in the course of business operations, including 20 percent of firms who have paid money to public officials to ―get things done.‖ In particular, 43 percent of firms reported being asked for gifts of informal payments to gain a construction permit and 34 percent of firms report giving bribes to secure a government contract. Access to Land Remains a Complex Problem Access to land represents a major constraint to conducting business for 37 percent of firms, the third highest ranked constraint cited by firms. The issue of clear title to land is of huge importance in Sierra Leone for private sector investment. Transfering property in Sierra Leone involves significant time and cost, as it historically has had a dual land tenure system. As such, access to land is a greater concern in Sierra Leone than in any of the comparator countries used in this survey and is of particular concern for firms located in Freetown. Reforms to improve access to land are underway, yet transferring property remains difficult, and land reforms are costly and controversial. ix Access to Finance Limited among Many Segments Although financial service provision in Sierra Leone is growing, both in terms of outreach and depth, survey data and other indicators suggest that finance imposes important constraints on business expansion. Use of financial services by firms remains low. Of the firms surveyed, 68 percent had a checking or savings account and 17 percent of firms surveyed had a loan or line of credit, which is average relative to neighboring countries, but well below the average for Sub- Saharan Africa. Forty-two percent of firms were using overdraft facilities. Firms rely heavily on internal funds and retained earnings for working capital and investments, with 84 percent of working capital needs and 87 percent of new investments financed by internal funds and retained earnings. Certain types of firms are less likely to have credit, particularly those which are small, manufacturers, domestically owned or located outside Freetown. Bank finance makes up a small fraction of working capital (9 percent) and new investment (4 percent). Supplier credit is very limited in Sierra Leone. International comparisons show that this reliance on internal funding is common in countries near Sierra Leone. What explains the level of usage of credit among firms? From the demand side, of the surveyed firms, 25 percent had applied for a loan or lines of credit. For those who did not apply, nearly one-third of firms cited no need for credit. One-quarter of firms cited complex application procedures and high interest rates. Less than 10 percent of firms cited collateral requirements as an impediment, and collateral requirements as reported in the survey data are not high relative to other countries in the region: 83 percent of loans in Sierra Leone required collateral, with an average value of 63 percent of the loan. Few firms have audited financial statements, which are an important element in firm‘s ability to access credit. From the supply side, Sierra Leone‘s net lending margins are high relative to other near-country comparators, and lending rates average 20 percent, often attributed to a lack of competition and low efficiency in the banking sector. Small Number of Exporting Firms Despite being a small, natural resource-rich country with a coastline, survey data show that just three percent of Sierra Leone firms export, lower than in all other comparator countries except for Liberia. Although conclusions about the characteristics of exporting firms are limited by the small number of exporting firms in the sample, nearly all the exporting firms were located in Freetown and show higher labor productivity than non-exporting firms. With respect to the business environment for exports, nearly a third of firms identify customs and trade regulations as a major constraint to business operations. The infrastructure for transportation—roads, river and sea transport and airports—was damaged during the conflict, and is being rehabilitated. Transportation has been mentioned by one-third of firms as a major constraint. Overall logistics efficiency in Sierra Leone is low relative to other countries, and data suggest that it could improve the timeliness and cost efficiency of its imports and exports. While diamonds have historically been Sierra Leone‘s principal export, export diversification is occurring. Mineral exports are likely to diminish in the context of the global economic slowdown. Agricultural exports offer the most important potential for a broad-based increase in incomes, and developing standards and infrastructure to promote their growth is necessary. x POLICY OPTIONS TO THE IMPROVE INVESTMENT CLIMATE Main Findings Target Intervention Short-term Medium Term FIRM LEVEL PERFORMANCE AND LABOR FORCE DEVELOPMENT Labor productivity is low �Address probable causes �Consider using �Address regional relative to other countries of low labor productivity instruments such as disparities by encouraging in Africa, particularly for such as labor market matching grants to support skills building initiatives manufacturing firms and weaknesses, lack of training programs by firms for areas outside of those located outside of training and low levels of Freetown education Freetown �Sustain efforts to expand access to education while striving for improvements in quality INFRASTRUCTURE High prices, insufficient �Improve access to and �Make Bumbuna � Continue efforts to availability and low stability of electricity Hydroelectric Project expand electricity reliability of electricity supply operational generation capacity �Increase the percentage �Strengthen and expand imposes significant costs of billed revenue collected transmission and on firms. distribution network to accommodate power in corridors where increased generation capacity is envisaged �Bring Sierra Leone into the West Africa Power Pool BUSINESS TAXATION AND REGULATION Tax rates perceived as �Broaden tax base to � Execute new law �Rationalize fees and major constraint to enable a reduction in providing for a new licenses for business operating a business. corporate tax levels Goods and Services tax registration to limit implicit taxation Lack of security over title �Reduce time and cost of �Continue efforts to to property a major transferring property reduce time and cost of �Update existing research constraint to private sector transferring land on deterrents to investment formalization of firms GOVERNANCE AND CORRUPTION A significant proportion of �Reduce graft costs for �Focus on reducing firms have been asked for firms corruption in procedures gifts or informal payments to acquire construction in the course of permits and secure conducting business. government contracts xi POLICY OPTIONS TO IMPROVE THE INVESTMENT CLIMATE Main Findings Target Intervention Short-term Medium Term ACCESS TO FINANCE A small percentage of �Reduce information �Continue improvements �Develop a partial credit firms access credit, asymmetries to increase to credit information guarantee scheme to particularly small firms and ease of evaluating infrastructure, for example encourage lending in rural manufacturers. creditworthiness of firms the proposed credit and underserved areas and the flow of bankable reference bureau system �Promote the use of projects �Increase percentage of lending technologies that firms with audited increase the spectrum of �Encourage projects to financial statements by acceptable collateral, such increase the spectrum of providing matching grants as leasing acceptable collateral for accounting services �Establish training programs to improve capacity of SMEs to solicit and manage credit and assist banks in developing their capacity to lend to SMEs Interest rates and margins �Reduce interest rates for � Support initiatives to �Improve creditor rights are higher than in certain firms improve enforcement of by strengthening property comparator countries. contracts titling systems, and creating secured interest in movable property EXPORTS AND INTERNATIONALIZATION Few Sierra Leone firms �Improve timeliness and �Support development of �Improve local export. cost efficiency of imports standards and storage transportation, the port and exports facilities necessary for system, and terminal international exports handling xii INTRODUCTION 1. This Investment Climate Policy Note (ICPN) for Sierra Leone evaluates the country’s business environment. This evaluation is conducted by (i) analyzing barriers to private sector investment and growth and how they vary among different types of firms, (ii) benchmarking Sierra Leone‘s investment climate and firm performance to that of other countries and (iii) provide recommendations to promote and strengthen the private sector. The ICPN is supported by the statistical analysis of a newly completed World Bank enterprise survey—the first for the country—of urban manufacturing and service firms with five or more employees based in two of Sierra Leone‘s major urban centers, Western Area/Freetown and Kenema. It also complements the survey with information from other World Bank sources such as the existing Diagnostic Trade Integration Study (DTIS), the Doing Business Report and the Logistics Performance Index. 2. The ICPN is a new analytical product that differs from the traditional Investment Climate Assessment (ICA) in a number of ways. First, the ICPN emphasizes cross- country comparisons and benchmarks the investment climate across many firm characteristics (ex: size of firms, sector of activity). Both the ICA and the ICPN draw on enterprise surveys and rely on data obtained through interviewing businesses (albeit not exclusively). However, because of the relatively small samples of firms taken from the formal manufacturing sector in countries such as Sierra Leone, an ICPN does not include estimates and analysis of firm-level total factor productivity. Finally, the ICPN is a more targeted report focusing on a smaller set of indicators of firm performance and concentrating on certain dimensions of the investment climate. 3. In the broadest sense, the investment climate includes fixed factors such as a country’s climate, endowment of natural resources, and location. For operational purposes, however, the ICPN focuses on factors that are directly affected by government policies. These include macroeconomic stability, the state of the country‘s infrastructure, contracts and market rules, access to finance and the rule of law and governance. Policies in these areas affect the expected return to investment and innovation and the associated uncertainty and risk associated with different economic activities. 4. The costs of conducting business, or transactions costs, are also important factors in the quality of the investment climate. To provide goods and services, businesses engage in thousands of transactions, if each of these transactions is costly, businesses are burdened by disadvantages that others, in other economies, might not have. The Doing Business report and the indicators tracked by enterprise surveys are important tools in measuring the transaction costs of an economy. 5. The goals of the ICPN are five-fold: (i) provide analytical support to the ongoing policy dialogue between the Government of Sierra Leone (GoSL), the World Bank, other donors and private sector actors working on investment climate issues, (ii) provide data-driven recommendations to reduce challenges faced by different types of firms, (iii) identify promising sources of growth to support the formulation of policies that promote greater economic diversification and broader pro-poor growth in Sierra Leone and provide the 1 analytical foundation for future Bank projects in Sierra Leone, and (iv) identify areas where there is a need for more analytical work. Survey Data 6. The Investment Climate Policy Note focuses on survey data that were collected in Sierra Leone. The first enterprise survey for Sierra Leone, categorized as an indicator survey, was conducted from September 2008 to February 2009 as part of a larger initiative of the World Bank Group enterprise survey unit.1 These surveys collect information on the investment climate—including topics such as corruption, competition from the informal sector, macroeconomic instability, and worker education and skills. Indicator survey questionnaires have a standard format to promote comparability across countries, and are designed to utilize smaller samples and have more a limited scope than larger enterprise surveys. The survey was designed before plans for this policy note were developed. 7. The objective of the surveys is to obtain feedback from enterprises in client countries on the state of the private sector as well as to build a panel of enterprise data that will make it possible to track changes in the business environment over time and allow, for example, impact assessments of reforms.2 Through interviews with firms in the manufacturing and services sectors, the Indicator Survey data provides information on the constraints to private sector growth and is used to create statistically significant business environment indicators that are comparable across countries. 8. The Sierra Leone sample is smaller than for some of the other countries. As an indicator survey, 150 formal firms were surveyed and that the range of questions is more limited than in a full enterprise survey. The sampling frame is stratified over two urban regions (Freetown and Kenema), the manufacturing and service sectors, and by firm size: small, (5- 19 full time employees), medium (20-99 FTE) and large (100+ FTE). Table 0.1: Sample Frame-Sierra Leone Indicator Survey Region Employees Sector Total Manufacturing Services Kenema 5-19 21 22 43 20-99 2 6 8 100+ Kenema Total 23 28 51 Western 5-19 25 16 41 Area/Freetown 20-99 23 16 39 100+ 4 15 19 Western 52 47 99 Area/Freetown Total Total 75 75 150 Source: World Bank. ―Sierra Leone Indicator Survey Dataset,‖ 2009 1 For more information and to access any of the enterprise survey data used in this study, please visit www.enterprisesurveys.org 2 World Bank. (2007). ―World Bank Enterprise Survey: How to Implement the Survey.‖ February. 2 9. The 2005 Census of Business Establishments provided the sample frame. The Census identified 10,840 business establishments in the urban areas of the 14 administrative districts of Sierra Leone. (The rural areas were not surveyed.) Forty-three percent of firms were located in Western Area/Freetown, with the Eastern area containing 22 percent of firms and the Northern and Southern areas hosting 18 percent of firms each. 10. A variety of manufacturing and services firms were surveyed. Manufacturing refers to the mechanical or chemical transformation of materials or substances into new products. Manufacturing operations are generally conducted in facilities described as plants, factories, or mills, and characteristically use power-driven machines and materials-handling equipment. In addition, the assembly of components of manufactured products is considered manufacturing, as in the blending of materials. The retail and wholesale industries are the two service industries targeted by the surveys. Retail services refer to the selling of goods and/or services directly to the consumer while wholesale refers to the sale of goods or services to someone other than final consumers.3 11. Firms represented a diversity of ages and activities. The 2005 Census of Business Establishments showed that 82 percent of firms initiated operations in the post-war period (post 2002) with 12 percent of firms initiating operations during the 11 year civil war period.4 However, the 2009 enterprise survey sample represented different concentrations in ages. Slightly under 10 percent of firms surveyed were established before 1980. 25 percent of firms began between 1980-1990. 43 percent of firms were established during the conflict period between 1990 and 2002, and just 23 percent of surveyed firms were established since conflict ended in 2002. The enterprise survey sample includes foreign firms (14 percent), exporters (3 percent), and firms owned (partially or wholly) by women (6 percent). 12. Most firms are very small. During the 2005 Census of Business Establishments, 77 percent of firms identified themselves as petty traders with 1-4 employees. These firms are not covered by the World Bank enterprise survey data for Sierra Leone around which this study is centered. Sixteen percent of firms identified themselves as small establishments, defined as those with 5-19 employees. Medium and large scale enterprises, with 20-40 and 50+ employees respectively, each represented 1 percent of the census population.5 Limitations and Sampling Issues 13. While the sample provides a useful basis for analysis, it is important to consider its limitations. First, an estimated 40-80 percent of firms operate informally,6 and this survey only includes formal enterprises. Second, only firms with five or more employees are included, excluding ―petty enterprises‖ with four employees or less which make up a majority (77 percent according to a 2006 study)7 of Sierra Leone firms. Third, the data 3 World Bank Enterprise Survey Unit. (2009) ―Sierra Leone Indicator Survey Dataset.‖ Available at www.enterprisesurveys.org 4 Statistics Sierra Leone (2006). ―Report of the Census of Business Establishments.‖ April. 5 Statistics Sierra Leone (2006). ―Report of the Census of Business Establishments.‖ April. 6 FIAS. (2006) ―Sources of Informal Economic Activity in Sierra Leone.‖ June. 7 Statistics Sierra Leone (2006). ―Report of the Census of Business Establishments.‖ April. This Census focused on all urban settlements in the 14 Administrative Districts of the country. 3 surveys a sample of urban firms, and 66 percent of the population lives in rural areas. 8 Fourth, the survey includes only the manufacturing and service sectors, which employ 2 and 20 percent of the population, respectively. Fifth, no mining firms were included in the sample—these firms represent a significant part of Sierra Leone‘s GDP. Sixth, this sample includes only currently operating businesses, that is, those which are surviving in the Sierra Leone business environment, introducing a ―surviving firms‖ bias. Lastly, with a sample size of 150 firms, some of the sub-samples are fairly small, minimizing the variation present in the sub-group, and thus, the conclusions one is able to draw in statistical analysis. 14. Sampling difficulties were present. The frame acquired for Sierra Leone was the database for the Census of Business Establishments 2005 provided by Statistics Sierra Leone. 9 Acquiring an adequate sample of medium and large firms (especially of manufacturing) proved challenging due to the limited number of establishments present in the universe. This contributed to the small number of large firms present in the overall sample as second and third choice firms were not present if the first choice firm was unavailable. The number of contacted establishments per realized interview was 1.25: which includes explicit refusals to participate in the survey and the quality of the sample frame as represented by the presence of firms ineligible for the survey. 10 15. Accuracy of responses and non-response were an issue for certain questions. The surveying agency reported a high response rate and positive attitude from respondents due to a feeling of collaboration towards research efforts supporting reconstruction after a period of civil strife. However, the sensitive issue of financial information proved challenging challenge with the survey consultant identifying most respondents seemingly giving reports of about 80 percent accuracy. Financial records given by respondents are self-reported and unchecked against published audited accounts. Furthermore, certain questions, such as those concerning informal payments were sensitive and had a relatively high rate of non-response.11 Comparator Countries 16. The World Bank has conducted similar enterprise surveys in about 100 countries throughout the world. Because the sampling and survey methodology and the questionnaire are the same across the world, it is possible to compare results and benchmark firm performance and the investment climate across countries. 17. In this study, firms are benchmarked to comparator countries in Africa: (i) near country comparators and members of the Mano River Union, Guinea, Liberia and Cote d‘Ivoire,12 (ii) two larger post-conflict economies: the Republic of Congo (DRC) and Rwanda (iii) an aggregate comparator for the Sub-Saharan Africa region. Differentials across firm size, sector, ownership category and location are explored. 8 Staffs of the IDA and IMF. (2005) ―Republic of Sierra Leone Joint IDA-IMF Staff Advisory Note on the Poverty Reduction Strategy Paper.‖ April 13. 9 The local agency team for the survey was managed by private consultant Musa Gbogboto. 10 World Bank Enterprise Survey Unit. (2009) ―Sierra Leone Indicator Survey Dataset.‖ Available at www.enterprisesurveys.org 11 World Bank Enterprise Survey Unit. (2009) ―Sierra Leone Indicator Survey Dataset.‖ Available at www.enterprisesurveys.org 12 The Mano River Union is an international organization composed of Sierra Leone, Guinea, Liberia and Cote d‘Ivoire with the purpose of promoting sub-regional economic integration. 4 CHAPTER 1: COUNTRY CONTEXT A favorable economic environment is essential for promoting economic growth. This chapter discusses Sierra Leone’s macroeconomic environment following the end of civil conflict in 2002 and its effect on the investment climate. It examines economic growth trends and macroeconomic performance as compared to other comparator countries and trends in inflation and interest rates because they directly affect firm-level incentives to invest. This chapter also includes a discussion of the political economy of Sierra Leone, reviewing governance and political stability. MACROECONOMIC PERFORMANCE 18. Sierra Leone had been experiencing a robust post-war recovery. In the aftermath of an 11 year civil war (1992-2001) which destroyed its physical and social infrastructure, it has sustained one of the highest GDP growth rates (an average of 7 percent) in Africa since 2002. Reconstruction, a substantial increase in aid flows and improved structural and macroeconomic policies contributed to this rapid growth,13 and its GDP increased to more than US$ 2 billion annually. Its GDP per capita, although low at $US 284, is higher than that its neighbors Liberia. Large mineral deposits enabled strong export growth. Sierra Leone‘s strong recovery continued into 2008 when real Gross Domestic Product (GDP) grew by an estimated 5.5 percent despite rising food and fuel prices. Table 1.1: Selected Macroeconomic Indicators for Sierra Leone and Comparator Countries (Averages, 2002-2007) CPI GDP per Private Gross Inflation capita (% Capital Formation FDI inflows (%) growth) (% of GDP) (% of GDP) Congo, Republic of 3.1 1.4 15.8 18.9 Cote d‘Ivoire 2.7 -1.3 6.9 1.8 Gambia 1.5 1.7 13.6 11.8 Guinea Conakry 0.7 0.8 8.7 1.9 Liberia - -3.0 3.9 26.0 Rwanda 8.1 3.5 12.7 0.6 Sierra Leone 8.6 6.9 8.8 4.1 Sub-Saharan Africa 12.8 2.6 13.7 2.6 Source: World Development Indicators, Development Data Platform Database 13 IMF. 2008 Article IV Consultation. IMF Country Report No. 09/2 January 2009. 5 19. However, economic recovery has slowed along with the global economic downturn. In 2009, the IMF forecasts that real GDP growth is expected to drop to 4.5 percent as global recession reduces the demand for Sierra Leone‘s mineral exports and the rate of post-war recovery declines. Given the breadth of the current economic crisis, and the potentially damaging effect of falling commodity prices and FDI, identifying and remedying investment climate problems is particularly essential. Investment climate reforms would increase the ability of the economy to adapt to economic shocks more easily. 20. Consumer price inflation had been pushed higher by high food and oil prices. Steady increases in oil prices in 2007 and 2008, combined with the spike in rice prices 2008 contributed to double digit inflation rates in 2007 and 2008, an increase from 8.3 percent in 2006 to 13.8 percent 2008.14 High demand for a limited supply of goods, most of which are imported and then transported over long distances, is expected to add significantly to national inflationary pressures.15 The Government limited some of these price increases in 2008 by reducing import tariffs on rice, flour, and petroleum products. 21. Inflation declined to single digits in February 2009 in line with declines in international commodity prices. Falling inflation may prompt a modest decline in interest rates, although they remain high relative to other comparator countries (see chapter 4 for additional discussion). 22. The exchange rate remained stable through 2008 at just under 3,000 Leones per US dollar. It has since depreciated to 3,100 Le/US$ in the first quarter of 2009 due to falling export receipts, although the real exchange rate is appreciating markedly. Moreover, depressed international diamond prices will reduce foreign exchange earnings, putting more downward pressure on the currency. Because much of the food consumed in Sierra Leone is imported, exchange rate movements and inflation abroad are likely to significantly affect domestic prices.16 23. Fiscal performance has generally been improving since 2002, but fiscal policy will likely be expansionary to alleviate the effects of the financial and food crises. The overall fiscal balance (after grants) had consistently moved over the last 7 years from -16.5 percent of GDP in 2002 to -6.8 percent of GDP in 2007. The primary fiscal balance improved to -1.9 percent of GDP in 2007 from -3.1 percent of GDP in 2006.17 This trend was not continued into 2008. Due to faster growth in recurrent spending, a temporary subsidy to the power sector as well as higher international food and fuel prices. This led to a deficit of 3.4 percent of GDP. Although improvements to the tax collection system and efforts to broaden the tax base should increase revenues, public finances will be affected by slowing domestic revenue as Sierra Leone suffers the impact of the global economic downturn. 24. Significant developmental challenges remain. Sierra‘s population of 4.5 million continued to rank last among all countries in the 2008 Human Development Index (based upon social 14 World Bank. (2009). Sierra Leone Country Brief. March. 15 Economist Intelligence Unit (2009). ―Country Report, Sierra Leone‖ June. 16 IMF. ―Sierra Leone: Selected Issues and Statistical Appendix.‖ January 2009. IMF Country Report No. 09/12 17 IMF. ―Sierra Leone: Selected Issues and Statistical Appendix.‖ January 2009. IMF Country Report No. 09/12 6 indicators data from 2006). Its rate of growth, while still well above SSA averages, is starting to slow (see Table 1). Growth in 2009 is projected to fall below the 6 to 9 percent18 estimated to be required for achieving the Millennium Development Goal of halving the proportion of people living on less than a $1/day in 1990 by 2015.19 ECONOMIC STRUCTURE 25. The goal of sustaining rapid and inclusive growth is made more challenging because so much of Sierra Leone’s growth has been dependent on the exploitation of natural resources, such as diamonds, rutile and bauxite. Yet most mining is capital intensive, and although it contributes more than 19 percent of GDP, it employs less than 3 percent of the formal sector population (although closer to 7 percent of the total population)20. In contrast, the agriculture sector (including fisheries) employs more than 60 percent of the population while providing 44 percent of GDP, with both the share of employment and GDP declining every year (as shown in Figure 1.1 below). The manufacturing sector has been weak, due to supply side constraints and competition from cheaper imports. The drop in demand for mineral exports may force Sierra Leone to diversify as employment and production in certain mines declines. Figure 1.1: Changes in Sector Composition Value Added (% of GDP) 70 60 50 Agriculture, 44 40 Services, 32 30 Industry, 24 20 10 0 2000 2001 2002 2003 2004 2005 2006 2007 Source: World Development Indicators (2007) 26. Economic diversification and more inclusive growth patterns will be critical to sustain high growth. A recently completed private sector development diagnostic report noted the critical need to develop a culture of entrepreneurship, as Sierra Leone is weaker than many of its West African peers in the rate of new business entry. It also identified fisheries, segments of agriculture and tourism as potentially strong sources of private sector growth that are 18 Economist Intelligence Unit. (2008) ―Country Report. Sierra Leone.‖ December. 19 Nathan Associates Inc. (2008) DFID Sierra Leone: Private Sector Development Strategy Programme. ―Diagnostic Report.‖ August. 20 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 7 currently not attracting investment. 21 The Government and the World Bank have the opportunity to assure that policy efforts build growth linkages across sectors. POLITICAL ECONOMY-GOVERNANCE, POLITICAL STABILITY AND REFORM 27. This chapter examines recent trends and conditions related to governance, political stability and reforms related to the investment climate. Given Sierra Leone‘s status as a post-conflict country, and the critical need for investment these are key critical themes. 28. The rankings for key governance indicators for Sierra Leone suggest a strong increase in performance in almost all categories. As measured by Kaufmann and Kraay (shown in Figure 1.2), voice and accountability, government effectiveness, regulatory quality, rule of law and particularly political stability, which was minimal in 2000, have all improved. Only control of corruption shows any deterioration in performance. Governance affects incentives to save, invest and innovate and through those mechanisms significantly determines economic growth in the long-run. 29. Sierra Leone is considered more stable politically than other post-conflict, near country comparators such as Cote d’Ivoire, Guinea and Liberia. As shown in Figure 1.3, only Rwanda is considered more stable of the group considered. Similarly, with respect to government effectiveness, Rwanda is considered the best performer, with Sierra Leone performing similarly to other countries in the group. Figure 1.2: Rankings of Sierra Leone’s Performance in Governance Voice and Accountability Political Stability Government Effectiveness 2007 Regulatory Quality 2005 Rule of Law 2000 Control of Corruption 0 10 20 30 40 Country's Percentile Rank (0-100) Source: Kaufmann, Daniel, Aart Kraay, and Massimo Mastruzzi (2008) 30. Enterprise survey data contains information on Sierra Leone firm manager’s perception of political stability as an obstacle to firm-level growth and management of the firm. While subjective data have limitations, managers‘ views about the macroeconomic environment are likely to affect the levels and types of investments they make. In the recent 21 Nathan Associates Inc. (2008) DFID Sierra Leone: Private Sector Development Strategy Programme. ―Diagnostic Report.‖ August. 8 Sierra Leone indicator survey, 19 percent of firms deemed that political instability was a major constraint. This perception varied strongly with the size of the firm, with 15 percent of small firms feeling it was a major constraint compared with 66 percent of large firms. Figure 1.3: International Comparison of Performance in Governance 50 45 40 35 30 25 20 15 10 5 0 Political Stability Government Effectiveness Country's Percentile Rank (0-100) Cote d'Ivoire Guinea Liberia Rep. Congo Rwanda Sierra Leone Source: Kaufmann, Daniel, Aart Kraay, and Massimo Mastruzzi (2008) 31. The 2009 World Bank enterprise survey for Sierra Leone provides information on a number of governance aspects, in particular, whether bribes are usually requested to speed- up procedures related to customs, tax, licensing or other regulations and the amounts typically paid in bribes (as a percentage of sales). Chapter 3 draws on this information to analyze the constraints posed by governance shortcomings, in particular the lack of control of corruption and rule of law. This policy note also discusses whether firms with different characteristics are affected in different ways by governance problems. 32. With the exception of the natural resource based industries, Sierra Leone has a poor investment climate relative to many other economies that limits its competitiveness. It ranks 156 out of 181 countries evaluated in the 2009 Doing Business index (see Table 1.2). Administrative barriers include difficulties in registering property, a tax regime that deters small businesses from registering, difficulty in enforcing contracts, and particularly in employing workers. This has caused a high proportion of economic activity to remain informal, far higher than the West African or low income country average. An improvement in the investment climate is needed to sustain high GDP growth rates, grow businesses, and promote exports. 33. However, Sierra Leone has shown promise is certain areas of reform and relative to its neighbors. Its Doing Business rank of 156 of 181 countries represents an improvement over its 2008 rank of 163, and is higher than any of the other Mano River Union members (as shown in Table 1.2). For both the starting a business‖ and ―protecting investors‖ components Sierra Leone‘s rank of 53 of 181 countries is far better than neighbor Liberia, which is ranked 88 of 178 and 142 of 178 respectively for these components. A rank of 53 for Sierra Leone means that it takes 7 steps, 17 days and a fee that amounts to approximately 56 percent 9 of GNI per capita to open a business, while in Liberia it takes 8 steps, 27 days and a fee of approximately 100 percent of GNI per capita. Table 1.2: Doing Business Ranking for Sierra Leone and Neighboring Countries 2009 2008 Cote Rank Rank Guinea Liberia d’Ivoire Doing Business 156 163 171 157 161 Starting a Business 53 94 177 88 167 Dealing with Construction Permits 169 171 171 157 161 Employing Workers 173 173 114 105 112 Registering Property 163 175 157 172 139 Getting Credit 145 141 163 131 145 Protecting Investors 53 49 170 142 150 Paying Taxes 160 154 168 59 148 Trading Across Borders 132 133 110 115 155 Enforcing Contracts 141 139 131 165 124 Closing a Business 145 144 109 146 68 Source: World Bank, 2009 Doing Business Report 34. Overall, Sierra Leone ranks ahead of its neighbors in the Mano River Basin according to Doing Business. Liberia (157), Guinea (171), and Cote D‘Ivoire (161) lag further behind in the rankings. On starting a business, one of the 10 indicators of the Doing Business index, Sierra Leone is the top performer in West Africa. The report identifies Sierra Leone making reforms in four key areas: starting a business; dealing with construction permits; registering property (discussed in greater detail in Chapter 3); and trading across borders (discussed in greater detail in Chapter 5). 10 CHAPTER 2: FIRM PERFORMANCE How competitive are Sierra Leone firms? The 2009 indicator survey captures information on various measures of firm performance that allow for the calculation of indicators such as sales and employment growth, labor productivity and labor cost per worker.22 This chapter begins by presenting sales and employment growth between 2006 and 2009 by firm type. It then discusses measures of labor productivity as compared to other countries in Africa and across firm characteristics including size, sector and other relevant aspects, including a discussion of what firm characteristics are associated with greater or lower labor productivity. It concludes with a discussion of skills, training and practices of workers in Sierra Leone firms. SALES AND EMPLOYMENT GROWTH 35. On average, all categories of firms reported growth in both sales and labor force over the last three years. From the data provided by the Enterprise Surveys, two measures of growth; three-year growth in sales and three-year growth in the labor force can be calculated. The median Sierra Leone firm reported that their sales grew by 66 percent and their labor force by 14 percent since 2006. As shown in the table below, reported median growth has been higher for smaller firms than larger ones and in manufacturing firms rather than non- manufacturing firms. However, these results should be interpreted with caution because they are based on recall data; the survey respondents are asked to recall their sales and labor force from three years ago.23 Furthermore, variation in the sales data is quite large. Table 2.1: Employment and Sales Growth by Firm Type (2006-2009) Percentage change Median Employment Growth Median Sales Growth All 14% 66% Small 17% 70% Size Medium 14% 61% Large 14% 21% Manufacturer 20% 74% Sector Non-Manufacturer 6% 58% Domestic 14% 67% Ownership Foreign 20% 48% Freetown 14% 53% Location Kenema 20% 80% Source: World Bank Sierra Leone enterprise survey, 2009 22 In this report, total factor productivity (TFP) is not computed because of a lack of information on the capital stock. 23 Deaton, A. 1997. The Analysis of Household Surveys: A Microeconometric Approach to Development Policy. Baltimore: Johns Hopkins University Press. The accuracy of recall data are often questioned and is a source of debate. Furthermore, this is a question introduces bias, as firms which failed in the past three years would not be a part of the sample. 11 LABOR PRODUCTIVITY 36. Labor productivity for manufacturing firms in Sierra Leone is relatively low. The concept of value added per worker is used to measure labor productivity, i.e. the amount of output per worker. To ensure that results are comparable across countries, the evidence analyzed exclusively covers firms in that sector. As shown in Figure 2.1, value-added per worker for the median manufacturing firm is calculated to be around $1,000, which is lower than the values obtained in most low-income countries in the region with the exception of Liberia. For example, value-added per worker was over $2,000 in Cote d‘Ivoire and closer to $4,000 in Rwanda. Figure 2.1: Labor Productivity of Manufacturers: International Comparison $10,000 $9,000 $8,000 $7,000 $6,000 $5,000 $4,000 $3,000 $2,000 $1,000 $- Source: World Bank Enterprise Surveys Note: Comparisons only include manufacturing enterprises. This chart reports value added per worker in 2005 US$. Value added is calculated by subtracting intermediate inputs and energy costs from manufacturing sales. Workers include both temporary and permanent workers. Local currency values were converted to USD using the average exchange rate for the year from WDI. 37. Sierra Leone has limited activity in the manufacturing sector. Manufacturing contributes less than 5 percent of GDP, with mining and agriculture playing far more active roles in overall growth. Members of the Sierra Leonean Association of Manufacturers (SLAM) cited three major reasons for the limited level of entrepreneurship and investment in the manufacturing sector: the high cost of power, high cost of shipping and port charges which increase the cost of importing raw materials and difficulties in port clearance due to corrupt practices.24 38. One factor that might reduce productivity is the relatively small size of Sierra Leone manufacturers. Labor productivity tends to be lower in small firms—although small firms 24 Nathan Associates Inc. (2008) DFID Sierra Leone: Private Sector Development Strategy Programme. ―Diagnostic Report.‖ August. 12 also tend to be less capital and skills intensive. The median manufacturing firm has only about 9 employees in Sierra Leone, which is similar to Liberia but far lower than Rwanda which has a median of 21 employees. 39. For all firms in Sierra Leone, there are significant differences in labor productivity between firms in different sectors and in different locations. As shown in Table 2.2, of the 150 firms surveyed, manufacturing firms tend to be less productive than non- manufacturing firms, smaller firms are less productive than larger firms, and the few foreign owned firms in the sample were more productive than the domestically owned firms. Multivariable regression analysis at the close of the chapter confirms this finding, as manufacturers are prevalent among the bottom performing quintile of firms. One problem with labor productivity is that it is generally lower in firms that are labor intensive (i.e., firms that use little capital per worker). Since firms in some particularly labor intensive industries, such as garment production, are prevalent in Sierra Leone, productivity might appear to be artificially low. Table 2.2: Median Productivity, by Firm Characteristics % of surveyed firms Value Added Labor cost per Unit Labor per worker worker Cost (%) (US$) (US$) All 1673 576 34 Small 1313 686 52 Size Medium 3549 1039 29 Large 3938 1215 31 Sector Manufacturer 996 635 64 Non- 2966 924 31 Manufacturer Ownership Domestic 1456 729 50 Foreign 5102 1299 25 Location Freetown 3341 962 29 Kenema 1494 466 31 Source: World Bank Sierra Leone enterprise survey 2009 Note: Values are medians for all enterprises with available data. Value added is calculated by subtracting intermediate inputs and energy costs from sales. Workers include both permanent and temporary workers. Labor cost is the total cost of wages salaries. Allowances bonuses and other benefits for both production and non- production workers. Unit labor costs are labor costs divided by value-added. LABOR COSTS 40. The cost of labor is similar to that of other near-country comparators. For the median Sierra Leone firm across all sectors, labor costs are close to $580 per worker annually. The cost per worker of manufacturing firms is far lower than for non-manufacturers. Smaller firms have lower labor costs per worker, as do firms located in Kenema. The cost per worker of manufacturing firms is far lower than for non-manufacturers. Foreign owned firms have higher labor costs per worker than domestically owned firms. 13 41. Sierra Leone’s unit labor costs are relatively high. In some countries, low productivity firms are accompanied by low wage workers. This does not appear to be the case in Sierra Leone. Unit labor costs (labor costs as a percent of value-added) take differences in productivity into account when assessing labor costs. In Sierra Leone, unit labor costs are 34 percent, higher than other comparators, including neighbors Liberia and Guinea (as shown in Figure 2.2). When unit labor costs are higher (i.e., when labor costs are higher compared to productivity), all else equal, firms find it more difficult to compete internationally. Figure 2.2: Labor Costs and Unit Labor Costs Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 42. Labor markets tend to be somewhat rigid. Labor markets in the country tend to be somewhat rigid as illustrated by the 2009 Doing Business Report indicators depicted in Figure 2.3 and 2.4 with potential implications for productivity. The Doing Business Report overall rigidity of employment index, which attempts to capture the difficulties in hiring and firing workers as well as the rigidity of hours of work, is higher in the country than any other comparator with the exception of the Republic of Congo. Firing costs (189 weeks of salary) are among the highest in Africa. This is likely to affect decisions of formal firms to restructure and restricts the ability of firms to provide incentives for increased productivity. The adoption of steps to simplify procedures to fire workers could contribute to increase efficiency in the labor market by reducing transaction costs. 14 Figure 2.3: Employment Rigidity Index Figure 2.4: Firing Costs (weeks of salary) Sierra Leone Sierra Leone Côte d'Ivoire Côte d'Ivoire Guinea Guinea Liberia Liberia Rep. Congo Rep. Congo Rwanda Rwanda SSA SSA 0 10 20 30 40 50 60 70 80 0 50 100 150 200 Source: World Bank, Doing Business Report 2009 SKILLS, TRAINING AND TECHNOLOGY 43. Few Sierra Leone firms offer formal training. Barely one in five Sierra Leone firms offer formal training (see Figure 2.5), lower than all other country comparators and the Sub-Sahara Africa region, except for Cote d‘Ivoire. Larger firms were more likely to offer training than smaller firms, as were firms located in Freetown rather than Kenema. The econometric analysis at the conclusion of the chapter contains more detail on this topic. Figure 2.5: Firms Offering Formal Training Figure 2.6: Education Level of Firm Managers University, None, 8% Sierra Leone 19% 17% Côte d'Ivoire 19% Guinea 21% Primary, 23% Liberia 29% Vocational, Rep. Congo 38% 16% Rwanda 28% SSA 31% Secondary, 0% 10% 20% 30% 40% 50% 36% Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 44. Education levels of Sierra Leone firm managers are fairly low. As shown in Figure 2.6, managers who have completed secondary school or partial university education make up the largest category. Managers who have completed university training are nearly all located in Freetown rather than Kenema. The size of the firm and level of education of the manager were inversely related. Large firms have managers with university training, while nearly all of those with no education or a primary school education managed small firms. 15 45. Larger firms have more experienced managers. The average firm manager in the Sierra Leone firms surveyed has 13 years of experience. The most striking difference is between managers of large firms, who had an average of 21 years of experience, and managers of small firms who had an average of 12 years of experience. Firms in Kenema had managers with 2 more years of experience on average than in Freetown. Understandably, the experience of the firm manager is correlated with the age of the firm. As shown in Figures 2.7 and 2.8 below, the average Sierra Leone manager has similar years of experience to country comparators in Africa, and the average Sierra Leone firm is older than in other country comparators. Given the 2005 Census of Business Establishments findings discussed in the Introduction in which the majority of firms were found to have been established after the war, Sierra Leone‘s average firm of 16 suggest that the sample is biased towards more mature firms. Figure 2.7: Years of Manager Experience Figure 2.8: Age of Firm (years) Sierra Leone 13 Sierra Leone 16 Côte d'Ivoire 7 Côte d'Ivoire 7 Guinea 11 Guinea 9 Liberia 14 Liberia 11 Rep. Congo 13 Rep. Congo 15 Rwanda 10 Rwanda 10 SSA 12 SSA 13 0 2 4 6 8 10 12 14 16 0 5 10 15 20 Source: World Bank Sierra Leone enterprise survey, 2009 46. Firms in Sierra Leone make relatively little use of internet technology. As shown in Table 2.3, few surveyed firms had their own websites, the lowest of any country comparators and half of the Sub-Saharan Africa average. Similarly, only 15 percent of firms used e-mail, again significantly less than any of the country comparators. This low level of usage corresponds to World Bank data which show 0.2 Internet users per 100 people in the general population. This low level of usage can be explained by the high cost of Internet access, approximately US$10.60/month25 in a country where annual per capita income is US$280 ($US23/month). The low level of usage can also be explained by Sierra Leone‘s limited basic infrastructure, which will be discussed in greater detail in Chapter 3. 25 World Bank. (2007) ―ICT at a Glance.‖ 16 Table 2.3: Use of Internet Technology Sierra Congo, Côte Guinea Liberia Rwanda SSA Leone Rep. d'Ivoire (2006) (2009) (2006) (2009) (2009) (2009) % of Firms Using 8.2 28.6 10.7 8.4 10.1 18.1 17.2 Own Website % of Firms using 15.5 57.0 22.2 20.0 36.2 38.9 42.0 E-mail Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 17 ECONOMETRIC ANNEX Firm Performance In this section, econometric analysis of firm performance indicators is conducted to strengthen the univariate analysis of enterprise survey data discussed earlier. The univariate analysis with respect to labor productivity identifies extremes in performance. However, there may be firms (or at least representative firms) populating the area around the mean of distribution for firm performance. To explore the characteristics of successful and unsuccessful firms, the same productivity data is divided into sub-samples of top and bottom performers. A probit calculation, a specification of generalized linear models, is used to model the relationship between a discrete dependent variable (representing a category from a mutually exclusive set of categories) and independent variables. Table 2.4: Top and Bottom Performers and Characteristics Dependent Variable Explanatory Highest Lowest Provides Variables Performing Performing Training (3) Quintile (1) Quintile (2) Small Firm 0.04 -0.03 -0.20* (5-19 employees) (0.11) (0.05) (0.12) Located in Western 0.10 -0.01 0.21* Area/Freetown (0.10) (0.02) (0.10) Manufacturer -0.25*** 0.37*** -0.13 (0.08) (0.08) (0.09) Age of Firm -0.00 0.00*** 0.00 (0.00) (0.00) (0.00) Foreign Owned 0.10 -0.05** 0.03 (partially or wholly) (0.18) (0.01) (0.11) Exporter (exports some 0.39 - 0.02 percentage of sales) (0.24)* (0.18) Manager has at least a 0.05 0.04 0.03 secondary education (0.11) 0.02 (0.12) Uses loan or line of 0.29*** -0.04 0.1 credit (0.08) (0.03) (0.09) LLC (Limited Liability -0.07 0.04 -0.09 Corporation) structure (0.11) (0.08) (0.08) No. Observ. 150 144 150 Pseudo R2 0.20 0.31 0.13 Source: Sierra Leone enterprise survey (2009) and author’s calculations based upon the survey * significant at 10%; ** significant at 5%; *** significant at 1%. Standard errors are provided in parentheses. Notes: The coefficients represent the marginal effects for the probit model, probability weighted with median weights. Omitted categories are: medium and large firms, Kenema region, non-manufacturing firms, non-exporting firms, managers with less than a secondary school education, firms not using loans or line of credit and firms with registrations other than limited liability corporation (such as sole proprietorships.) 18 Manufacturing firms continue to be associated with low labor productivity, while foreign firms and exporting firms have higher productivity, all things being equal. Access to credit is strongly associated with high performance, although it is unclear whether banks are successfully identifying and providing credit to higher productivity firms or whether firms are more productive because they have access to capital. Table 2.4 (column 3) also explores the characteristics of firms that do and do not provide training to their workers. Larger firms and firm located in Freetown are most likely to provide training. 19 CHAPTER 3. INVESTMENT CLIMATE CONSTRAINTS The Enterprise Survey collects information on the investment climate—including 17 topics such as access to infrastructure, taxation, access to finance, competition from the informal sector, and corruption. The first part of this chapter measures how investment climate constraints cost businesses money and time. The second part of the chapter discusses main bottlenecks to conducting business as identified by managers of Sierra Leone firms. The final section of this chapter reviews key investment climate issues that are considered critical: specifically, the provision of electricity, tax rates, informality and corruption. INDIRECT COSTS 47. It is estimated that firms in Sierra Leone have to bear additional indirect costs of 14 percent of sales due to difficulties in the business environment. As shown in Figure 3.1, the surveyed firms reported losses due to power outages amounting to nearly 7 percent of sales. Losses due to theft, vandalism and arson and the cost of hiring security add 3 percent of sales, with bribes in the course of business another 4 percent. These losses are substantial, but lower than near country comparators Liberia, Guinea and Cote d‘Ivoire. Figure 3.1: Indirect Costs as a Percentage of Sales: International Comparison 25% 22% 20% 20% 18% 15% 15% 14% 14% 10% 5% 0% Sierra Leone Côte d'Ivoire Guinea Liberia Rep. Congo Rwanda 2009 2009 2006 2009 2009 2006 Theft Security Costs Electricity Bribes Source: World Bank Enterprise Surveys 48. Indirect costs affect certain categories of firms more severely. Larger firms report a higher proportion of their sales lost through power outages (14 percent vs. 6 percent) than smaller firms. They also have more losses from theft and other crime than smaller firms (9 percent vs. 3 percent), and correspondingly higher expenses for security costs than smaller 20 firms (14 percent vs. 3 percent). Foreign owned firms and manufacturing firms also reported higher losses from theft and power outages, although sample sizes for these firms were very small. PERCEIVED CONSTRAINTS 49. What investment climate problems do firms perceive as their biggest obstacle? Electricity and tax rates were identified most often by firm managers as major constraints to business operations.2627 As shown in Figure 3.2, 53 percent of firms identified electricity and 42 percent mentioned high tax rates as constraints to their operations. Access to land, corruption and access to finance were also identified as major concerns by more than 30 percent of firm managers. Figure 3.2: Perceptions of Major Constraints to Conducting Business Source: Sierra Leone World Bank enterprise survey, 2009 50. The perception of obstacles to doing business varies across firms. Across firm sizes, electricity and tax rates were the top two concerns. Concern about tax rates and tax administration increases with the size of the firm (see Table 3.1). For the medium and large sized firms surveyed, corruption and labor regulations were also key issues. Larger firms were more concerned with political instability, customs and trade regulations than smaller firms. 26 The Enterprise Survey asks firm managers to rate the magnitude of obstacles in each of 17 areas of the investment climate is to the current operations of their business. They respond by rating each on a five-point scale between ‗no obstacle‘ and a ‗very severe obstacle‘. Figure 3.2 shows the percent of each type of firm that rated each area as a ‗major‘ or ‗very severe obstacle.‘ 27 Perception-based data has drawbacks related to its subjective nature. Still, enterprise managers have a better view of the obstacles they face than anyone else. 21 51. Firms located in Freetown and manufacturers perceived more constraints overall. Manufacturers cited electricity, corruption, tax rate and access to land most frequently as major obstacles. Over 20 percent more manufacturers perceive access to finance and corruption as constraints than non-manufacturers. Interestingly, access to finance was a much greater concern in Freetown, which houses most of the country‘s banking infrastructure than in Kenema. Table 3.1: Perceptions of Constraints to Conducting Business, By Firm Type % of Firms SIZE LOCATION SECTOR Identifying Small Medium Large Freetown Kenema Manuf. Non- Obstacle Manuf. Electricity 53 48 93 62 42 64 51 Tax Rates 40 58 74 57 24 54 40 Access to 36 21 46 47 19 54 30 Finance Corruption 36 42 53 52 17 60 31 Access to Land 36 42 31 55 13 42 36 Transportation 29 30 61 35 22 33 30 Customs/ 24 42 49 41 9 20 29 Trade Regul. Political 15 34 67 30 4 18 19 Instability Courts 16 12 11 27 0 33 11 Unskilled 15 23 7 27 1 41 9 Workforce License/Permit 14 42 53 28 0 22 17 Informal 14 18 20 23 3 16 14 Sector Practices Crime & Theft 13 18 42 24 2 18 13 Labor 10 12 42 20 0 14 10 Regulations Tax Admin. 11 9 40 20 1 20 9 Source: World Bank Sierra Leone enterprise survey, 2009 52. Tax rates, access to finance and electricity were cited as the single most important constraints to business operations. Firms were asked to identify the biggest constraint to doing business in Sierra Leone (Figure 3.3). Responses and ranking of constraints varied from the earlier survey questions asking whether certain investment climate issues were major constraints (Figure 3.2) and letting firm managers choose multiple responses, with access to finance and informal sector practices perceived as greater concerns critical. As shown in Figure 3.3, tax rates are perceived as a bigger constraint in Sierra Leone than in Sub-Saharan Africa, as is corruption and access to land. Access to finance and electricity are perceived as lesser concerns in Sierra Leone than in Sub-Saharan Africa as a whole. 22 Figure 3.3: Biggest Obstacles to Conducting Business in Sierra Leone Source: World Bank Sierra Leone enterprise survey, 2009 ELECTRICITY 53. Despite improvements in the years following the war, limited infrastructure remains a major impediment to social and economic development, particularly in rural areas.28 In particular, lack of regular electricity supply is a major deterrent to investment in Sierra Leone. Half of all Sierra Leone firms surveyed cited electricity as a major constraint to business operations, and Sierra Leone has one of the highest rates of firms with electricity generators in the Sub- Saharan Africa region. 54. The level of electricity generated in Sierra Leone is increasing but still insufficient. From September 2006 to December 2007, little public power was delivered by the National Power Authority. In 2007, national energy generation capacity was about the lowest in SSA: a mere 6 KWh per capita against a Sub-Saharan African average of 541. In 2008 138.78 gw/hr were produced, up from 30.68 gw/hr in 2007, due to the introduction of two independent power producers, as well has other enhancing activities.29 The long awaited Bumbuna plant is due to come online later in 2009,30 but will primarily provide power to Freetown, which uses more than 80 percent of the country‘s public electrical power. Although the situation has significantly improved, Freetown still faces problems with load shedding, as the available electricity generation capacity is still insufficient. Most areas in the interior, except for Bo and Kenema, are largely without public power supplies.31 Revenue collection for electricity supply has been challenging, discouraging private investment. 28 World Bank. (2006). ―Sierra Leone: Adding Value through Trade: A Diagnostic Trade Integration Study.‖ October 27. 29 Bank of Sierra Leone (2008) Annual Report. 30 IMF. Article IV report. (2009) January. 31 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ 23 55. Power outages impose important costs on firms. According to the 2009 World Bank enterprise survey data, the vast majority of the 150 firms surveyed (86 percent) in both Freetown and Kenema have experienced power outages. The average firm in Sierra Leone reported having 16 power outages in a month with an average duration of 10 hours, that is, almost 7 days a month. This is far higher than the average 4 days of outages per month estimate for Sub-Saharan Africa and the 1 day of outages reported by Cote d‘Ivoire and Liberia firms surveyed. As discussed earlier in this chapter, firms reporting losses from power outages described them as equivalent to nearly 7 percent of annual sales. Table 3.2: International Comparison of Power Outages Sierra Congo, Côte Guinea Liberia Rwanda SSA Leone Rep. d'Ivoire (2006) (2009) (2006) (2009) (2009) (2009) Number of Power 15.9 27.4 4.5 33.9 5.3 4.5 12.7 Outages in a Typical Month Average Duration 10.2 32.5 4.6 6.8 3.8 4.6 7.2 of Power Outages (hours) Value Lost Due to 6.6 15.7 5.0 14.0 3.7 5.0 6.0 Power Outages (% of Sales) Source: World Bank enterprise surveys 56. Sierra Leone has one of the highest rates of firms using generators in Africa. Faced with an unreliable power supply, 82 percent of firms have acquired generators, double the average for Sub-Saharan Africa. This high acquisition of generators is likely a result of the extreme failure of public power provision in the country, These diesel generators provide a major source of power, but are costly to purchase and maintain (although some emergency rental programs have been financed by donors). Interestingly, despite the widespread usage of generators relative to other countries, the perception of electricity as a major constraint to business operations is average in Sierra Leone relative to other countries. Figure 3.4: Firms with Generators Figure 3.5: Firms Perceiving Electricity as a Problem Sierra Leone 82% Sierra Leone 53 Rwanda 7% Rwanda 40 Liberia 60% Liberia 84 Guinea 69% Guinea 64 Côte d'Ivoire 82% Côte d'Ivoire 71 Congo, Rep. 58% Congo, Rep. 55 SSA 41% SSA 51 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 0 10 20 30 40 50 60 70 80 90 Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 24 57. Larger firms suffer greater losses from power outages. The small firms surveyed have power outages for an average of 7 days a month, lower than the larger firms which lose power for nearly 9 days per month. The value lost due to power outages is higher for large firms (see Figure 3.6), all of which are located in Freetown. These firms are more likely to be making high value products, and less able to function with electricity substitutes such as candles and flashlights. All of the surveyed large firms reported owning a generator. Although the sample size of large firms and for these questions is small, the data suggest that manufacturers are more adversely affected by power outages than non-manufacturers. Figure 3.6: Losses from Power Outages, by Firm Size Source: Sierra Leone World Bank Enterprise Survey, 2009 58. Connection times to access electricity, water and mainline telephone connections are similar to other countries in the region. For those who requested these connections in Sierra Leone in the last two years, it took an average 15 days for electricity and water to be installed, and 21 days for a landline telephone, which was similar or in some cases better than the country comparators. However, given that only 17 of the 150 Sierra Leone firms surveyed had electricity connections installed in the last two years, 12 firms had water connections installed and 7 firms had telephone connections installed, conclusions from this data are necessarily limited. Table 3.3: Accessing Services: International Comparison All countries Delay in Obtaining an Delay in Obtaining Delay in Obtaining a Electrical Connection a Water Mainline Telephone (days) Connections (days) Connection (days) Sierra Leone (2009) 15 15 21 Côte d'Ivoire (2009) 21 15 6 Guinea (2006) 16 21 59 Liberia (2009) - 9 - Republic of Congo (2009) 8 7 20 Rwanda (2006) 18 - 62 25 Sub-Saharan Africa 34 38 40 Source: World Bank enterprise surveys TAXES 59. Tax rates are a greater concern in Sierra Leone than in neighboring countries. As shown in Figure 3.7, 43 percent of all firm managers cite tax rates as a major concern. This is slightly higher than the average in Sub-Saharan Africa and higher than any comparator country except for Rwanda. As discussed earlier in this chapter, tax rates are cited most frequently as the most important constraint to conducting business by Sierra Leone firm managers. This is not an uncommon finding: in the World Bank Enterprise Surveys conducted in fiscal year 2007, 17 of 40 find the tax rate to be among the top 3 obstacles (a 2004 World Bank study found tax rates to be among the top three obstacles in over two- thirds of countries in Sub-Saharan Africa) and 33 of 40 find it to be a bigger obstacle than tax administration.32 Figure 3.7: Firms Citing Tax Issues as a Major Problem Tax Rates Tax Administration Sierra Leone 43% Sierra Leone 11% Côte d'Ivoire 31% Côte d'Ivoire 27% Guinea 39% Guinea 31% Liberia 28% Liberia 19% Rep. Congo 40% Rep. Congo 50% Rwanda 45% Rwanda 22% SSA 41% SSA 28% 0% 10% 20% 30% 40% 50% 0% 10% 20% 30% 40% 50% 60% Source: World Bank enterprise surveys, all data are from 2009 except for Guinea and Rwanda which are from 2006. 60. Marginal effective tax rates are comparable to other countries in the region. This is the effective tax on an incremental investment by a business, summarizing the impact of the tax system on the decision of an investor to infuse capital into his or her business. A 2006 study of marginal effective tax rates in Sierra Leone showed that these tax rates were high for the manufacturing sector relative to other countries for whom comparable data was available (see Table 3.4), but that these rates were relatively low for the tourism sector. 33 An alternative calculation of total tax rates as measured in the Doing Business survey shows taxes in Sierra Leone to be higher than in other comparator countries, but this calculation is projected to decline due to the implementation of a new Goods and Services Tax, which replaces a number of existing taxes (including the sales tax).34 32 Independent Evaluation Group/The World Bank. (2008). ―Doing Business: An Independent Evaluation.‖ 33 Source: FIAS. ―Sierra Leone: Tax and the Investment Climate,‖ November 2006 34 As measured by the 2009 Doing Business survey, the total tax rate calculated for firms is 234 percent of total profit, orders of magnitude higher than other comparator countries and the Sub-Sahara Africa average. The Doing Business study calculates total tax rates based as a profit levels for a representative firm. In the case of a country like 26 Table 3.4: Marginal Effective Tax Rates Country Agriculture Manufacturing Tourism Financial Services Sierra 12% 27% 7% 28% Leone Lesotho 18% 11% 43% 51% Rwanda 7% 7% 13% 28% South Africa 6% 21% 14% 30% Notes: Assumes take up of standard incentive packages offered through the respective investment promotion agencies, which apply to most medium and large scale investments. Includes tax holidays. Source: FIAS. ―Sierra Leone: Tax and the Investment Climate,‖ November 2006. 61. Most of the surveyed firms were inspected in the last year. With 86 percent of firms visited, small firms make up all but one of the firms who were not visited. In the last year, the average firm was inspected or required to meet with officials an average of 2.5 times, lower than for any comparator country. Approximately 9 percent of firms stated that they were expected to give gifts during meetings with officials, far lower than the Sub-Saharan Africa average of 20 percent, and lower than any comparator country except for Rwanda. Initiatives are currently underway by World Bank/DFID to improve tax collection. Table 3.5: Tax Administration in Sierra Leone and Comparator Countries Visits or % of Firms % of Firms Who Annual Time required Expected to Believe Typical tax completing meetings Give Gifts In Firms Report Less payments forms with tax Meetings With than 100% of (number) (hours) officials Tax Officials Income for Tax Purposes Sierra Leone 3 9 82 28 399 Cote d‘Ivoire 7 14 68 66 270 Guinea 4 57 95 56 416 Liberia 7 50 90 32 158 Republic of Congo 3 37 87 61 606 Rwanda 4 5 23 34 160 SSA 4 20 58 38 312 Source: First three columns: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. Last two columns: Doing Business 2009 Sierra Leone where profit levels are low, any taxation appears high as a percentage of profit. The bulk of this 234 percent comes from a 15 percent sales tax which was been replaced by Parliament with a Goods and Services Tax (GST) in June 2009. This is a cascading tax, in that the tax burden is multiplied up the value chain and is ultimately born either by the consumer (in a non-competitive market) or the firm (in a competitive market). Without this sales tax, the total tax rate as calculated by the Doing Business project is expected to decline dramatically. Additional explanation and evaluation of the Doing Business tax methodology is provided at http://www.doingbusiness.org/features/taxes2009.aspx and the 2008 World Bank Independent Evaluation Group (IEG) Report: Doing Business: An Independent Evaluation. 27 62. Tax administration is a relatively minor concern to most firms. A smaller proportion of firms in Sierra Leone cited tax administration as a problem than any comparator country, as shown in Figure 3.7. This is consistent with the ranking discussed earlier in which tax administration was the lowest concern of any of the 17 investment climate indicators. This might be attributable to the fact that revenue collection in Sierra Leone is low by regional standards.35 This may change as the government increases efforts to broaden the tax base, improve tax collection and eliminate ad-hoc tax exemptions (which have been common in recent years) for firms.36 63. Large firms and foreign owned firms are particularly concerned about tax issues. This is understandable given their more prominent role in the economy, which makes them more likely to have pay taxes. 77 percent of these firms identify tax rates as a major constraint. Larger firms have a higher number of required meetings with tax officials than small firms (3.2 vs. 2.3) and spend a higher number of senior management hours on tax issues than small firms (14 hours vs. 6 hours). Foreign firms had a similar pattern relative to domestically owned firms. Foreign firms were also less likely to believe that firms report less of their income for tax purposes. 64. The vast majority of firms believe that the typical firm evades taxes. To avoid the problem of asking firm managers if they illegally evade taxes, firm managers are asked whether they believe a typical firm would report less than 100 percent of their income for tax purposes. More than three-quarters of all firms believe underreporting occurs, with smaller firms believing this is more common than larger firms. As high as this figure may appear, this is lower than other Mano River Basin country comparators, although much higher than in Sub-Saharan Africa overall. However, in a 2009 survey of SMEs conducted by the Sierra Leone Indigenous Business Association (SLIBA), 98 percent of SMEs reported that they pay their taxes, with the most common forms of taxes paid being city council registration (paid by 87 percent of surveyed SMEs) fees and income tax (paid by 67 percent of surveyed SMEs).37 65. Sierra Leone is making efforts towards simplifying and improving the administration of its tax regime. In addition to the planned Goods and Services tax mentioned earlier, the World Bank has supported a Sierra Leone tax simplification rollout. The project supports the efforts of the Sierra Leone National Revenue Authority and Ministry of Finance to simplify tax policy, reduce compliance costs, spread the tax burden, facilitate formalization and job creation, and reduce avenues for corruption. Improvements to the tax collection system are underway to boost what is estimated to be a huge amount of uncollected revenue. Authorities are working to modernize the National Revenue Authority and broaden the tax base through enforcement of the existing tax legislation and the previously mentioned introduction of a law to implement the Goods and Services Tax (GST). 35 IMF. ―IMF Executive Board Completes Fourth Review.‖ Release No. 9/235. June 24, 2009 36 IMF. ―Sierra Leone Memorandum of Understanding.‖ June 4, 2009. 37 Jalloh, S. and A. Turay. (2009) ―Survey of Business Establishments in Sierra Leone.‖ Commissioned by the Sierra Leone Indigenous Business Association. Unpublished draft. 28 INFORMALITY 66. Formal activity in Sierra Leone is confined primarily to large scale mining, construction, retail and financial services, tourism, and government employment. In Sierra Leone, an estimated 40-80 percent of firms operate informally. 38 67. The high tax burden has been a main driver of informality. Research generally suggests that formal firms tend to be more productive than informal ones and also that firms choose to remain informal because of high costs associated with regulation and taxes. This is supported by a 2006 World Bank/IFC FIAS (Foreign Investment Advisory Services) study of informal enterprises in Sierra Leone: 75 percent of interviewed businesses saw the tax burden and administration as a main driver of informality. 39 Even though some of Sierra Leone‘s tax policies, such as imputed taxes based on revenues and profits imposed on unregistered businesses, were designed to broaden the tax base and bring informal enterprises into the formal economy, the way in which these taxes are assessed may have the opposite effect, and prevent small businesses from moving to the formal economy. Firing costs (previously discussed in Chapter 2) also act as a deterrent—at 187 weeks of salary, they are among the highest in Africa. 68. Most firms feel competition from informal or unregistered firms, but few feel it is a major constraint to conducting business. According to data from the 2009 World Bank Sierra Leone enterprise survey, 80 percent of services firms feel competition from informal firms, higher than in any of the other comparison countries, such as Liberia and Guinea where only 62 percent of firms felt this way. Understandably, a higher proportion of small firms feel competition from unregistered or informal firms (Table 3.6). In contrast, 14 percent of firms feel informal firms pose a major constraint, lower than the Sub-Saharan Africa average of 82 percent. Table 3.6: Informality Sierra FIRM SIZE Leone Small Medium Large % of Services Firms Competing 80.34 83.87 60.81 36.99 Against Unregistered or Informal Firms % of Firms Formally Registered 89.22 88.68 91.18 100 when Started Operations in the Country Number of years firms operated 0.86 0.93 0.51 0 without formal registration % of Firms Identifying Practices 14.21 13.57 18.41 19.91 of Competitors in the Informal Sector as a Major Constraint Source: World Bank Enterprise Survey 2009 38 FIAS. (2006) ―Sources of Informal Economic Activity in Sierra Leone.‖ June. 39 FIAS. (2006) ―Sources of Informal Economic Activity in Sierra Leone.‖ June. 29 69. Most firms reported formally registering upon starting operations. Close to 90 percent of surveyed firms report formally registering upon starting operations, higher than the Liberia, Cote d‘Ivoire and the Sub-Sahara Africa average. As this survey did not cover informal sector firms, data on their operations and constraints are not available. Given the high percentage of informal firms in the country, informality is clearly a critical area for further study. CORRUPTION 70. As discussed in Chapter 2, Sierra Leone‘s performance in government effectiveness and regulatory quality has been trending upwards. However, despite this improvement, corruption still imposes significant costs on firms, particularly for certain procedures such as getting a construction permit or securing a government contract. 71. About one-third of firm managers and 60 percent of manufacturing firm managers said that corruption was a serious problem in Sierra Leone. Although this is relatively high, it does not place corruption among the very top concerns of Sierra Leone firms. The objective data suggest that corruption is a serious problem but no more so than in many of the comparator countries. Bribes impose an indirect cost of nearly 4 percent of sales which is a significant amount but lower than in Cote d‘Ivoire and Guinea. 72. A significant proportion of firms have been asked for gifts or informal payments in the course of conducting business. Table 3.7 shows the percentage of firms that have been asked for payments when making business related requests. One-fifth of firms reports that bribe payments are needed ―to get things done‖ in Sierra Leone. Forty-three percent of firms reported having to give gifts to get a construction permit, and 34 percent of firms report giving bribes to secure a government contract. Table 3.7: Percentage of Firms Expected to Give Informal Payments or Gifts Sierra Côte Guinea Liberia Rep. Rwanda SSA Country Leone d'Ivoire 2006 2009 Congo 2006 2009 2009 2009 To public officials 19 31 85 53 48 20 41 to “get things done� For an operating 9 32 52 45 n.a. 5 19 license For an import 3 28 34 23 16 6 18 license For a construction 43 12 66 56 13 18 27 permit For an electrical 7 16 57 44 16 0 20 connection For a phone 15 5 47 n.a. 11 3 17 connection 3 39 41 18 .. 19 For a water 2 30 connection In meetings with 9 14 57 50 37 5 20 tax officials To secure a 34 32 75 48 73 14 44 government contract Transparency 158 151 173 138 158 192 - International rank (of 180 countries) Source: World Bank Enterprise Surveys (2006 and 2009). Last row is from Transparency International Corruption Perceptions Index (2008) 73. In most cases, the incidence or bribery in Sierra Leone is lower than that of comparator countries. The proportion of firms bribing public officials ―to get things done‖ in Sierra Leone are half the Sub-Saharan Africa average. The exception is with respect to bribes to acquire a construction permit, which occurs at more than 15 percent higher than the Sub- Saharan Africa average. Other sources confirm that although corruption may be a drain on the Sierra Leone economy, it is not much worse than many comparator countries. Transparency International‘s corruption perceptions index (CPI) which quantifies the degree of corruption as perceived by business people and country analysts rates Sierra Leone as better than Rwanda and Guinea although worse than Cote d‘Ivoire and Liberia. 74. Confidence in the judicial system appears low. Thirty percent of firms believed that the court system was fair and uncorrupted, which is lower than all comparator countries except for Guinea. However, relatively fewer firm managers perceived it as a major constraint. ACCESS TO LAND 75. Thirty seven percent of firms view access to land as a major constraint to conducting business. In fact, access to land is a greater concern in Sierra Leone than in any of the comparator countries used in this survey and the Sub-Saharan Africa regional comparator. Land is a key factor of production, and the issue of clear title to land is of huge importance in Sierra Leone for the private sector. A lack of security over title to property increases the risk of investing and makes it more difficult to use property as collateral for raising finance. Establishing rights over land and creating land markets are important to the development of manufacturing and services sectors in urban centers, as well as to the growth and commercialization of agriculture in rural areas. 76. Regional disparities exists in perception of access to land as a constraint. As shown in Figure 3.1, 55 percent of firms in Freetown cited access to land as a major obstacle, relative to the 14 percent of firms in Kenema who view it as an obstacle. Although more manufacturers view access to land as a constraint than non-manufacturers, it was still among the top three constraints cited by Sierra Leone services firms. Access to land was also a particularly large concern for medium sized firms, perhaps because they are more likely to be considering expansion. 31 77. Transfering property in Sierra Leone involves significant time and cost. Historically, Sierra Leone has had a dual land tenure system wherein Freetown and surrounding areas are governed under a system of freehold while the provincial areas are considered common property distributed under the purview of traditional leaders.40 It is estimated that over 60 percent of litigation in the country is concerned with disputes over title to land.41 Data shown in Table 3.8 shows the number of procedures, days and cost as a percentage of property value to register property as measured in the 2009 Doing Business Report, with Sierra Leone performing in line with country comparators. Table 3.8: International Comparison of Procedures and Costs of Registering Property Number of Number Cost (% of Procedures of Days Property Value) Sierra Leone 7 86 12.9 Cote d‘Ivoire 6 62 13.9 Guinea 6 104 13.9 Liberia 13 50 14.7 Republic of Congo 8 57 9.2 Rwanda 4 315 0.6 Sub-Saharan Africa 7 96 10.5 Source: World Bank Doing Business Report 2009 78. Reforms to improve access to land are underway. Land management has concentrated on ensuring clear ownership and use of land through the development of land management systems. A large program to reduce the time for property transfers and building permits and to increase confidence in lands records is underway. The program includes computerizing land records, cadastral index mapping, and piloting a computer mapping database. The Minister of Lands has agreed to sign permits within 2 weeks.42 79. Yet transferring property remains difficult. For example, a 2008 procedure simplification was recently reversed. According to the laws of Sierra Leone, survey plans must be submitted to the Lands Ministry by a licensed surveyor on behalf of the buyer, to be counter signed by the Director of Surveys and Lands. In April 2008, Sierra Leone lifted the moratorium on the signature of the Director. However, in December 2008, this moratorium was re-instituted, making it harder to transfer property.43 It remains difficult to use land as collateral for credit—although not impossible as discussed in greater detail in Chapter 4 on Access to Finance. 40 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 41 Sierra Leone Private Sector Development Strategy Inception Report, EME for DFID, 2007. 42 World Bank. (2009) ―Sierra Leone: 2008/2009 Reforms.‖ April 24. 43 World Bank. (2009) ―Sierra Leone: 2008/2009 Reforms.‖ April 24. 32 CHAPTER 4. ACCESS TO FINANCE IN SIERRA LEONE Although financial service provision in Sierra Leone is growing, Investment Climate Survey data and other indicators suggest that finance imposes important constraints on business expansion. This chapter provides an overview of the financial sector in Sierra Leone, and reviews access to and use of financial services across different types of firms within Sierra Leone and among comparator countries. THE FINANCIAL SECTOR IN SIERRA LEONE 80. The financial system in Sierra Leone is growing from a small base. At the end of 2008, Sierra Leone had 13 commercial banks, up from 10 in 2007. In addition, 2 discount houses, 6 community banks (providing basic credit and deposit services in rural areas), 5 microfinance institutions and 71 registered foreign exchange bureau were also operating. 44 81. Coverage and outreach has increased in recent years. The number of commercial bank branches increased from 31 in 2005 to 57 in 2008, and community bank branches increased from 2 to 6. Although 60 percent of branches are in Freetown, new branches have recently opened in areas such as Makeni Town and Bo. Still, national coverage remains limited with an average of 1 branch per 100,000 inhabitants in this country of 6.6 million. At the close of 2008, there were 83,712 current accounts and 206,565 savings accounts. 45 82. Private sector credit in Sierra Leone has been growing rapidly, but remains relatively low. Net domestic credit to the private sector was only 5 percent of GDP (Le 74.57 bn) in 200746, amongst the lowest in the world when compared to an average of 17 percent in Sub- Saharan Africa (see Figure 4.1) and 65 percent in OECD countries.47 However, credit to the private sector grew 57 percent in 2008, an increase over the 39 percent increase in 2007. Commercial banks credit to the private sector accounted for 97 percent of the increase. The main sectors to benefit from this increase were services (29 percent), commerce and finance (21 percent) and construction (18 percent) sectors.48 An increase in this ratio has been a causal factor in sustaining rapid growth and the incomes of the poor.49 Credit constrained firms will have limited growth and experience difficulty in managing their cash flow. 83. Financial intermediation remains lower than in many comparator countries. With the exception of the Republic of Congo, Sierra Leone‘s ratio of bank credit to bank deposits of 35 percent is lower than any of its comparator countries. Near-country comparators Liberia and Cote d‘Ivoire have a much higher proportion of deposits converted into loan assets (see Figure 4.2). Commercial banks have a high liquidity and excess reserves position and have 44 Bank of Sierra Leone (2008) Annual Report 45 Bank of Sierra Leone (2008) Annual Report 46 World Development Indicators, 2007 47 IMF. ―Second Review under the PRGF‖ IMF Country Report No. 08/249 July 25, 2008. 48 Bank of Sierra Leone (2008) Annual Report 49 Levine, R., N. Loayza and T. Beck (2000), ―Financial Intermediation and Growth: Causality and Causes,‖ Journal of Monetary Economics, 46, 31-77. 33 built up a sizeable stock of government paper, which offers very attractive rates of return with little risk and is thus more attractive than lending to the private sector.50 A recent IMF report cites anecdotal evidence that the pass-through between Treasury bill rates and other interest rates (lending and deposit rates) are minimal because those rates are rigid due to the oligopolistic nature of the banking sector. 51 However, as competition increases in the financial sector, this should improve over time. Figure 4.1: Private Sector Credit to GDP Figure 4.2: Bank Credit to Bank Deposits Sierra Leone 5% Sierra Leone 35% Côte d'Ivoire 14% Côte d'Ivoire 86% Guinea 5% Guinea 40% Liberia 8% Liberia 50% Rep. Congo 2% Rep. Congo 21% Rwanda 11% SSA 17% Rwanda 77% 0% 5% 10% 15% 20% 0% 20% 40% 60% 80% 100% Source: World Development Indicators, 2007 (2005 Data for Guinea and Rwanda) USE OF FINANCIAL SERVICES 84. Use of financial services by firms is low relative to the average for Sub-Saharan Africa. Of the firms surveyed, 68 percent had a checking or savings account (see Figure 4.3), well below the average for SSA, although similar to neighboring countries Cote d‘Ivoire and Liberia. Seventeen percent of firms surveyed had a loan or line of credit, which is average relative to its neighbors, but well below both the SSA average and the global average of 31 percent of firms with credit. Interestingly, 42 percent of firms were using overdraft facilities, flexible accounts that allow firms to draw upon in the event that their account balance becomes negative. This is high relative to comparator countries such as Cote d‘Ivoire, where only 17 percent of firms use such facilities. Figures 4.3 and 4.4: Firms Utilizing Financial Services With Checking or Savings Accounts With Loans or Lines of Credit Sierra Leone 68% Sierra Leone 17% Côte d'Ivoire 67% Côte d'Ivoire 11% Guinea 54% Guinea 6% Liberia 66% Liberia 21% Rep. Congo 85% Rep. Congo 12% Rwanda 83% Rwanda 38% SSA 83% SSA 22% 0% 20% 40% 60% 80% 100% 0% 10% 20% 30% 40% Source: World Bank enterprise surveys (2006-2009) 50 IMF. ―Sierra Leone: Selected Issues and Statistical Appendix.‖ January 2009. IMF Country Report No. 09/12 51 IMF. ―Sierra Leone: Selected Issues and Statistical Appendix.‖ January 2009. IMF Country Report No. 09/12 34 85. Certain types of firms are much less likely to use credit. As shown in Table 4.1, small firms, manufacturing firms, domestic firms, and firms located outside of Freetown are more likely to lack access to financial services. As one would expect, use of savings accounts, loans or lines of credit and overdrafts increase with firm size. Within industries, manufacturers are less likely to have loans or lines of credit, however these firms appear to make heavy use of overdraft facilities to compensate. Foreign firms use loans and lines of credit four times more than domestic firms, although from the data it is not clear whether they have more of a demand for these facilities or are approved more often. Table 4.1. Use of Financial Services by Firm Category % of surveyed firms With With Loans or With Checking or Lines of Credit Overdraft Savings Account Total 68 17 42 Small 64 14 38 Size Medium 92 34 62 Large 100 49 77 Sector Manufacturer 60 6 28 Non- 71 20 46 Manufacturer Ownership Domestic 66 15 41 Foreign 100 60 81 Location Freetown 71 18 50 Kenema 63 16 31 Source: Sierra Leone World Bank Enterprise Survey, 2009 SOURCES OF FINANCE 86. Firms rely heavily on retained earnings for working capital needs and investments. As shown in Figure 4.7 and 4.8, 84 percent of working capital needs and 87 percent of new investment in Sierra Leone are financed by internal funds and retained earnings. Bank financing makes up a relatively small fraction of working capital (9 percent) and new investment (4 percent). Supplier credit is very limited in Sierra Leone. Figure 4.5: Financing of Working Capital Figure 4.6: Financing of New Investment Supplier Other Supplier Other Credit/ (moneylend Credit/ (moneylen Borrowed Customer er, friends), Customer der, from Non- Advances, 2% Borrowed Advances, from Non- friends), 4% Banks, 1% 4% 1% Banks, 4% Borrowed Borrowed from Banks, from 9% Banks, 5% Internal Internal Funds/ Funds/ Retained Retained Earnings, Earnings, 84% 87% 35 Source: Sierra Leone World Bank Enterprise Survey, 2009 87. International comparisons show that this heavy reliance on internal funding is common in countries near Sierra Leone. Although Sierra Leone makes heavy use of retained earnings, Cote d‘Ivoire and the Republic of Congo are even more dependent. Guinea however, makes heavy use of supplier credit for working capital, and in the Sub-Saharan region as a whole, bank financing is more common. Owner‘s funds and new equity (registered under the ―other‖ category) make up a much higher proportion of funding for new investment in Sierra Leone (5 percent) than any other comparator country or in the SSA region. Figure 4.7: Financing of Working Capital (%) Figure 4.8: Financing of New Investment Sierra Leone Sierra Leone Côte d'Ivoire Côte d'Ivoire Guinea Guinea Liberia Liberia Rep. Congo Rep. Congo Rwanda Rwanda SSA SSA 0 20 40 60 80 100 120 0 20 40 60 80 100 120 Internal Funds Bank Supplier Credit/Advances Other Internal Funds Bank Supplier Credit/Advances Other Source: World Bank enterprise surveys 88. Access to finance among certain segments of firms, such as manufacturers and small firms, appears particularly limited. A much higher percentage of large firms than small ones borrowed from banks. Manufacturers are heavily dependent on their own internal funds for working capital, which coincides with their perceptions of access to credit being a major constraint in conducting business, and possibly affected to the lower productivity of these firms. Firms located outside of the capital city in Kenema were particularly dependent on their own funds to finance working capital. Table 4.2: Variations in Sources of Working Capital Finance SIZE SECTOR LOCATION Small Medium Large Manuf. Non- Freetown Kenema Manuf. Internal 87% 68% 62% 92% 82% 77% 93% Funds/Retained Earnings Borrowing from 5% 26% 38% 4% 10% 13% 4% Banks Borrowing from 1% 4% 0% 1% 1% 2% 0% Non-Banks Supplier Credit/ 4% 2% 0% 2% 4% 7% 0% Advances 36 Other Sources 2% 1% 0% 1% 2% 1% 4% (Family, etc.) Source: Sierra Leone World Bank Enterprise Survey, 2009 REASONS FOR LOAN APPLICATIONS AND REJECTIONS 89. What explains the level of usage of credit among firms? Firms were asked whether they had applied for a loan in the fiscal year before the survey. If they did, they are asked whether their application was rejected. If they did not apply, they are asked why not. 90. The majority of firms did not attempt to access credit. Of the surveyed firms, 25 percent had applied for a loan or lines of credit, of that amount 4 percent were rejected. The remaining 75 percent of firms did not apply for credit, with application procedures, collateral requirements and high interest rates the most commonly cited deterrents (see Figure 4.9). Figure 4.9: Loan Application Activity by Firms in the Last Year Source: World Bank Sierra Leone Enterprise Survey, 2009 91. The data suggest that manufacturers have particular difficulty accessing credit. As shown in Table 4.3, manufacturers were least likely to report ―no need for credit.‖ Of the manufacturing firms that did not apply for credit, the largest percentage refrained from doing so because application procedures are too complex or because they did not have appropriate collateral. For businesses of all sizes (including large firms), complex application procedures for loans and lines of credit were a key impediment to soliciting credit. This difficulty accessing credit might reflect the relatively low labor productivity and high unit labor costs of manufacturing firms that were discussed in Chapter 2. Table 4.3. Reasons for Not Applying for a Loan % of surveyed firms No Application Interest Collateral Inadequate Other Need Procedures Too Size/ Complex High Maturity Total 31 24 23 8 5 8 Small 31 23 24 7 6 9 Size Medium 34 37 8 18 2 1 37 Large 73 27 - - - - Manufacturer 21 41 5 24 1 Sector Non- 35 19 28 3 7 Manufacturer Location Freetown 27 27 0 14 6 7 Kenema 31 24 23 8 5 3 Source: World Bank Sierra Leone Enterprise Survey, 2009 92. Collateral is required for the vast majority of loans. 83 percent of loans in Sierra Leone require collateral (see Figure 4.10 and 4.11) with land, buildings and equipment serving as the most common forms. Personal assets and loan accounts are sometimes utilized as well. For those firms in the sample who were denied credit, unacceptable collateral or cosigners were the most common reason for rejection. Still, the value of collateral as a percentage of the loan is similar to other near-country comparators and far below the average of the Sub- Sahara Africa region. Figure 4.10: Loans Requiring Collateral Figure 4.11: Value of Collateral (% of Loan) Sierra Leone 83% Sierra Leone 63% Côte d'Ivoire 43% Côte d'Ivoire 56% Guinea 56% Liberia 53% Liberia 73% Rep. Congo 53% Rep. Congo 69% Rwanda 160% Rwanda 97% SSA 81% SSA 120% 0% 50% 100% 150% 0% 50% 100% 150% 200% Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 93. Sierra Leone’s net lending margins are higher than in other countries. In 2007, Sierra Leone had higher lending rates and a wider spread between deposit and lending rates than any of the other comparator countries for which this data is available (see Table 4.4), with high overhead costs accounting for much of the spread. Bank of Sierra Leone data from 2008 showed that spreads have remained high: the interest paid on savings deposits ranged from 5.5 to 9 percent while loans and advances were made at as high as 22 to 39 percent.52 This lending rate is roughly consistent with data from the enterprise survey, in which the average interest rate on loans or lines of credit for firms in the survey was 20 percent although values ranged from 5 percent to 35 percent. Interestingly, average interest rates varied little with the size of the firm. An important factor to consider when examining Table 4.4 is the currency utilized in each country. Sierra Leone uses the leone as its currency (SLL), while Liberia uses dollars and the Republic of Congo and Rwanda each use their own franc. 52 Bank of Sierra Leone. (2008). Financial Information Sheet. September 19. 38 Table 4.4: Margins on Lending-International Comparison Lending Deposit Interest Rate Interest Rate Interest Rate Spread Sierra Leone 25.0 15.0 10.0 Liberia 15.1 11.1 3.8 Republic of Congo 15.0 10.8 4.3 Rwanda 15.8 9.1 6.8 Source: World Development Indicators, 2007 94. A small proportion of firms used auditors. Firms were asked if their financial statements were checked and certified by an external auditor in last fiscal year. Twenty percent of these firms were checked—nearly all located in Freetown. This varies greatly by size of firm: fifteen percent of small firms had their financial statements audited, while 51 percent of medium and 93 percent of large firms did. As banks cite the inability to acquire accurate financial information as a critical reason for not financing small and medium enterprises, this could explain the low level of bank financing among these firms, as we will see later in the econometric analysis at the end of the chapter. PERCEPTIONS 95. Firms perceive access to finance to be the second most important constraint to conducting business, with significant variation among types of firms. 35 percent of firms surveyed identify access to finance as a major constraint. Manufacturing firms complain about access to finance more than non-manufacturing firms (54 percent vs. 30 percent). Small firms perceive access to finance as a greater problem than medium sized firms (36 percent vs. 21 percent), and domestically owned firms perceive access to finance to be a greater problem than foreign owned firms (35 percent vs. 28 percent). Firms in Kenema find access to finance to be a greater constraint than those located in Freetown, which could be explained by the presence of 5 commercial bank branches in Kenema relative to 34 branches in Freetown. Figure 4.12: Comparison of Firms Who Perceive Access to Finance as an Obstacle Sierra Leone 35% Côte d'Ivoire 67% Guinea 58% Liberia 35% Rep. Congo 43% Rwanda 36% SSA 47% 0% 10% 20% 30% 40% 50% 60% 70% Source: World Bank Enterprise Surveys, All data are from 2009 except for Rwanda and Guinea which are from 2006. 39 96. Access to finance is less of a concern in Sierra Leone than in certain comparator countries. As shown in Figure 4.12, firms surveyed in nearby countries such as Guinea and Cote d‘Ivoire and in Sub-Saharan Africa on average cite access to finance as a greater constraint to conducting business than in Sierra Leone. Perceptions of access to finance in Sierra Leone are similar to that of its neighbor Liberia. 97. Sierra Leone ranks 145 out of 181 economies on the getting credit measure. In comparison, Liberia ranks 131 and Cote d‘Ivoire ties Sierra Leone for 145th place. On the index of legal rights, Sierra Leone scores a 4 of 10, losing points, losing points because creditors do not have absolute priority to their collateral and because security rights as prescribed by law are limited. Sierra Leone compares less favorably with respect to credit bureau coverage, scoring a 0 on this index, due to the absence of any credit information infrastructure. More details are available on the Doing Business website (www.doingbusiness.org). 40 ECONOMETRIC ANNEX OF DETERMINANTS OF ACCESS TO FINANCE Access Indicators In this section, the econometric analysis of access indicators checks the univariate results discussed earlier in the chapter by controlling for key factors simultaneously. Many firm characteristics are correlated, and thus one characteristic could proxy for the effect of another characteristic in univariate analysis. For example, foreign-owned firms are larger and managers located in Freetown have higher education levels than those in Kenema. Table 4.5 reports probits with six different dependent variables used as indicators of access. Two of the dependent variables are subjective indicators: one in which the firm claims access is a major constraint to operations and another in which the firm states ―no need for loans‖ as a reason for lack of loan application. Four are objective indicators: whether the firm has a savings or checking account, a line of credit, loan or overdraft, or has applied for a loan. A probit calculation is a specification of a generalized linear model, used to model the relationship between a discrete dependent variable (representing a category from a mutually exclusive set of categories) and independent variables. Table 4.5: Econometric Determinants of Access to Finance in Sierra Leone Dependent Variables Explanatory Rate access Has a Has line of Has an Applied for Has no Variables to finance as savings or credit or overdraft a loan (5) need for a major checking loan (3) (4) loan (6) constraint(1) account (2) Small Firm -0.20 -0.11 -0.30 -0.21 -.34 .16 (0.15) (0.16) (.13)*** (0.15) (.13)*** (.07)** Western 0.45 -0.07 -0.02 0.08 0.17 -0.30 Area/Freetown (0.10)*** (0.12) (0.06) (0.15) (0.10)* (0.12)*** Manufacturer 0.11 -0.03 -0.10 -0.25 -0.20 0.07 (0.10) (0.12) (.04)* (0.13)* (0.07)*** (0.10) Age -0.00 0.02 0.01 0.00 0.00 0.00 (0.00) (0.01)*** (.00)* (0.01) (0.00) (0.00) Foreign- -0.24 - 0.22 0.22 0.20 .04 owned (partial (0.08)** (0.17)* (0.19) (0.17) (0.17) or wholly) Exporter -0.19 - 0.49 0.33 0.26 -0.13 (exports a % (0.11) (0.27)** (0.20) (0.26) (0.07) of sales) Manager with -0.25 0.33 -0.14 .18 -0.39 0.25 secondary (0.14)* (0.14)** 0.09** (0.14) (0.13)*** (0.08)*** educ. or more Limited -0.08 0.22 0.02 .27 0.00 0.06 Liability Corp. (0.12) (0.10)* (0.09) (0.15)* (0.11) (0.12) Has audited -0.39 0.20 0.12 .31 0.07 0.44 financial. (0.07)*** (0.14) (0.10) (0.15)* (0.12) (0.12)*** statements 41 No. Observ. 150 128 150 150 150 150 Pseudo R2 0.25 0.18 0.46 0.16 0.23 0.23 Notes: * significant at 10%; ** significant at 5%; *** significant at 1%. Standard errors are provided in parentheses. The coefficients represent the marginal effects for the probit model, probability weighted with median weights. Omitted categories are: Medium and large firms, Kenema region, non-manufacturing firms, non-exporting firms, managers with less than a secondary school education, and firms without audited financial statements. From the subjective indicators, we see that firms located in Kenema are less likely to feel credit constrained, as are firms who have managers with higher education or firms who have audited financial statements. Being located in Freetown was associated with a greater perception of access to finance being a constraint to operations and a lesser likelihood of ―having no need‖ for a loan. Those firms with managers that had a secondary school education were less likely to feel credit constrained and to say they had ―no need‖ for a loan rather than being unable to access a loan than firms with managers with lower educational attainment. Foreign firms did not feel credit constrained as often as their domestic counterparts. Firms with audited financial statements were associated with not perceiving access to finance as a major obstacle. However, the causality is not clear, as firms with banks might require statements as a condition for a loan. There are more significant differences on objective indicators – specifically the use of credit products. Small firms and manufacturing firms have less usage of credit products and less likely to have applied for loans. Being a firm in Freetown is associated with a higher likelihood of applying for a loan than being a firm in Kenema. Unsurprisingly, firms that export and firms that are at least partly foreign report greater usage of credit products. The age of the firm is strongly associated with use of a checking or savings account, and to a lesser extent whether the firm has credit or not. As with the subjective indicators, the education level of the firm manager is important to the firm‘s access to finance, although tests showed joint significance with other variables. 42 CHAPTER 5: EXPORTS AND INTERNATIONALIZATION The chapter provides an overview of the Sierra Leone export market and presents characteristics of firms that participate in the export. It explores what factors in the business environment may be hindering exporting behavior by firm. Data from the Enterprise Survey are complemented with information from the Doing Business database and the Logistics Performance Index. 98. Information on export behavior provides a sense of how well firms in Sierra Leone are integrated into regional and global markets. For a small, mineral-rich economy such as Sierra Leone, maintaining the level of exports is critical to sustaining this growth during this period of global economic decline. EXPORT STRUCTURE 99. While diamonds have historically been Sierra Leone’s principal export, export diversification is occurring. Sierra Leone is a well-known for its production of gem-quality diamonds, and as recently as 2005, diamonds made up nearly 95 percent of total exports. However, just two years later (see figure 5.2) in 2007, the year for which most recent trade data is available, rutile (a titanium ore) and bauxite made up 30 percent of export volume. In 2007, diamonds provided $US 170 million in exports, with smuggled diamonds make up additional volume of unrecorded exports, although the Government of Sierra Leone has taken a number of steps to incentivize legal exports in recent years. Imports rather than exports dominate international trade in Sierra Leone. Figure 5.1: Sierra Leone Trade Growth Figure 5.2: Export Composition (fob, 2007) 1400000 Cocoa Others 5% 5% 1200000 1000000 million Leones 800000 Rutile Total Exports (fob) 16% 600000 Imports (cif) 400000 Diamonds Bauxite 200000 14% 60% 0 Source: Bank of Sierra Leone 100. Exports are likely to diminish in the context of the global economic slowdown. With the economic slowdown in the European Union and United States, the main destinations of exports from Sierra Leone, export growth is expected to slow and key commodity prices have already fallen. The mining sector is expected to contract, as international diamond prices have fallen sharply. Furthermore, the 2008 collapse of part of a major rutile mine and the suspension of production in other mining sites will slow down any anticipated increase in mineral exports. 43 101. Agricultural exports offer the most important potential for a major increase in incomes. Agriculture benefits rural areas, where the majority of the poor reside. Mining does not provide large numbers of jobs directly and has limited linkages with the rest of the economy to enable jobs to be created in other sectors. Currently, only cocoa is the only significant non-mineral exports (and even that, only 5 percent of the total) Diversifying into other agricultural commodities such as coffee (which made up 1 percent of 2007 exports), palm oil, rice and fish would help Sierra Leone achieve a more inclusive growth pattern and reduce the dangers of a natural resource curse.53 CHARACTERISTICS OF EXPORTING AND NON-EXPORTING FIRMS 102. Survey data suggest that a small percentage of Sierra Leone firms export relative to other comparator countries. Just three percent of surveyed firms export, either directly or indirectly. Although firms in the country tend to export more than firms in Liberia, the percentage of exporting firms in Sierra Leone is much smaller than other African comparator countries such as Cote d‘Ivoire and Guinea. The Sub-Saharan Africa average is 12 percent. Figure 5.3: Percentage of Firms That Export 16% 15% 14% 12% 12% 12% 10% 10% 8% 6% 4% 3% 3% 2% 1% 0% Liberia Sierra Côte Rep. Rwanda SSA Guinea Leone d'Ivoire Congo Source: World Bank Enterprise Surveys 103. Conclusions about the characteristics of exporting firms are limited by data availability. As only six of the surveyed firms export, this analysis considers a very small number of observations which impairs standard statistical analysis. All but one of the exporting firms was located in Freetown, and three of the four firms had some percentage of foreign ownership. The few exporting firms were spread across different industries, including transport, chemicals, and the other services category. 104. Firms which export have higher labor productivity than non-exporting firms. Exporting firms have more than double the value added per worker than non-exporting firms. 53 World Bank. (2006). ―Sierra Leone: Adding Value through Trade: A Diagnostic Trade Integration Study.‖ World Bank: Washington DC. October 27. 44 The relatively low export participation of firms in Sierra Leone is another indicator of the relative low performance of firms in terms of productivity indicators. In general, firms that are not competitive will find it hard to compete in international markets. Self-reported data captured in the enterprise survey suggested that between 2003 and 2006 the median exporting firm grew by 32 percent in sales and by 19 percent in labor force. However, again, due to the small sample size, it is difficult to draw conclusions. BUSINESS ENVIRONMENT AND EXPORTS 105. Nearly a third of firms identify customs and trade regulations as a major constraint to business operations. This is higher than most country comparators, with the exception of the Republic of Congo. Larger firms were more likely to identify these regulations as a major constraint than smaller firms. Figure 5.4: Firms which Feel Customs and Trade Regulations are a Major Constraint Source: World Bank enterprise surveys, 2006 and 2009 106. Overall logistics efficiency in Sierra Leone is low relative to other countries. The Logistics Performance Index (LPI) is the simple average of the country scores on the seven key dimensions (shown in the table below). According to this index, Sierra Leone has lower performance than its Mano River Basin neighbors Liberia and Guinea. Although Sierra Leone ranks stronger than most of its peers in terms of customs efficiency and effectiveness and ease and affordability of arranging international shipments, domestic logistics costs (e.g., local transportation, terminal handling, warehousing) receives a poorer score, likely reflecting the lack of basic infrastructure in Sierra Leone. Sierra Leone also does not score well in timeliness of shipments reaching destinations. 45 Table 5.1: Logistics Performance Index: International Comparison Country LPI Customs Infrastructure International Logistics Tracking Domestic Timeliness Shipments Competence & Logistics Tracing Costs Guinea 2.71 2.50 2.33 2.50 2.67 2.83 3.20 3.50 Cote 2.36 2.22 2.22 2.13 2.38 2.00 3.00 3.25 d‘Ivoire Liberia 2.31 2.40 2.14 2.83 2.00 2.00 3.20 2.43 Guinea 2.28 2.14 2.25 2.22 2.00 2.22 3.14 2.86 Bissau Sierra 1.95 1.58 1.83 1.82 1.91 2.00 3.00 2.64 Leone Rwanda 1.77 1.80 1.53 1.67 1.67 1.60 3.07 2.38 Source: World Bank, 2009 107. Data suggest that Sierra Leone could improve the timeliness of its imports and exports. World Bank/IFC Doing Business data show that despite the fact that it typically takes longer to export or import in other African countries than in Sierra Leone, it takes 17 days less to import and 9 days less to export in neighboring Liberia. Recent empirical research suggests that delays in trade-related procedures may have important economic effects. Djankov, Freund and Pham (2006) find that time delays affect international trade and each additional day that a product is delayed prior to being shipped reduces trade by more than one percent.54 They also find that delays have an even greater impact on exports of time- sensitive goods, such as perishable agricultural products. Sierra Leone fares well in terms of paperwork required, relative to other comparator countries. Successful implementation of plans for a computerized system for inspections and assessments would increase efficiency further. Figure 5.5: Time for Import and Exports Figure 5.6: Documents for Imports and Exports Sierra Leone 34 Sierra Leone 7 29 7 Côte d'Ivoire 43 Côte d'Ivoire 10 23 9 Guinea 32 Guinea 7 33 9 Documents for Liberia 17 Time for Imports Liberia 10 Exports 20 9 Rep. Congo 62 Time for Exports Rep. Congo 11 Documents for 50 12 Imports Rwanda 42 Rwanda 9 42 10 SSA 41 SSA 8 35 9 0 20 40 60 80 0 5 10 15 Source: World Bank/IFC Doing Business Database 2009 108. Costs to import and export are higher in Sierra Leone than for other Mano River basin countries. The World Bank/IFC Doing Business data below coincides with the data from the Logistic Performance Index which states that domestic logistics costs are high. 54 Djankov, Freund and Pham. (2006). ―Trading on Time.‖ World Bank Policy Research Paper No. 3909 April. 46 Costs to export in Sierra Leone are double than in Guinea and nearly 20 percent higher than in Liberia. Still, the cost per container of US$1,450 is well-below the Sub-Saharan Africa average of US$1,879. Figure 5.7: Comparative Cost of Imports and Exports (per container) Sierra Leone $1,535 $1,450 Côte d'Ivoire $2,437 $1,904 Guinea $1,191 $720 Liberia $1,212 Cost to Import $1,232 Rep. Congo $2,959 Cost to Export $2,490 Rwanda $5,070 $3,275 SSA $2,279 $1,879 $- $1,000 $2,000 $3,000 $4,000 $5,000 $6,000 Source: World Bank/IFC Doing Business Database 2009 TRANSPORT 109. Much of Sierra Leone’s transportation infrastructure is in poor condition. 2002 data collected through the World Development Indicators project indicated that 8 percent of roads in Sierra Leone were paved following the end of conflict, far lower than the 21 percent that was average in Sub-Saharan Africa. Even today, data provided by the Sierra Leone Roads Authority (shown in Table 5.2) show that even in Class A roads connecting provincial capitals, unpaved roads outnumber paved roads 2:1. In Class B secondary roads that connect the district centers, unpaved roads outnumber paved roads 80:1. Class F are feeder roads made of gravel or earth which provide basic means of communication serving several villages or small towns or connecting minor centers of population to a higher class road.55 The lack of adequate rural and feeder roads connecting villages and farm areas to market centers and the lack of regular transport services poses serious challenges in the country.56 55 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 56 World Bank. (2006). ―Sierra Leone: Adding Value through Trade: A Diagnostic Trade Integration Study.‖ World Bank: Washington DC. October 27. 47 Table 5.2: Current State of the Road Network Road Network/Class Total Length Current Status (Km) Excellent Good Fair Poor Class-A Bituminous 756 294 152 135 175 Unpaved 1,384 - 411 206 767 Subtotal Class - A 2,140 294 563 341 942 Class – B Bituminous 24 - - 10 14 Unpaved 1,880 - 620 580 680 Subtotal Class – B 1,904 - 620 590 694 Class – F ( Feeder 4,152 - 1,420 762 1,070 Roads) Subtotal Class – F 4,152 - 1,420 762 1,970 Urban Roads 3,104 140 24 1,126 1,814 Subtotal Urban Roads 3,104 140 24 1,126 1,814 Percentages % 100% 4% 23% 25% 48% Source: Sierra Leone Roads Authority 110. Air, river and sea transport are limited and require further development. International air transport in Sierra Leone is dominated by foreign and other regional airlines and there are no organized internal flights. Rehabilitation and upgrading of existing airport infrastructure and improvement of airport safety standards is required, although it is not urgent unless visitor numbers and cargo traffic increase substantially. 57 River transportation has the potential to capturing greater market share of goods and services transported in Sierra Leone; however the sector is constrained by high transportation costs, inadequate boat construction and safety problems.58 111. Port infrastructure is inadequate. The main seaport in Sierra Leone is the Port of Freetown, and discharge operations are often slow due to inadequate equipment. The cost of shipment to Freetown much higher than other countries in the region, especially Guinea. For the country to become the regional entrepot, Freetown needs to become the premier port in the Mano River Union.59 112. A weak transportation infrastructure can substantially increase the costs that firms face when paying for inputs. It can also have a negative impact on competitiveness as it reduces the scope for price reductions when delivering goods to clients. Improvements in transport would help Sierra Leone‘s exports to become more competitive by improving quality and reducing the wedge of domestic transactions costs, resulting in an increased price paid to producers. 57 Sierra Leone Private Sector Development Strategy Inception Report, EME for DFID, 2007. 58 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 59 Sierra Leone Private Sector Development Strategy Inception Report, EME for DFID, 2007. 48 Figure 5.8: Firms Perceiving Transport as a Major Constraint Sierra Leone 30 Côte d'Ivoire 38 Guinea 51 Liberia 41 Congo, Rep. 50 Rwanda 27 Sub-Saharan Africa 27 0 10 20 30 40 50 60 Source: World Bank Sierra Leone enterprise survey 2009 113. About one-third of firms perceive transportation as a major constraint. As shown in Figure 5.8, 30 percent of firms see transportation as a major problem, but still, fewer firms perceive transportation as a constraint than in Mano River comparators Liberia and Guinea. As shown in Chapter 3, Table 3.1, larger firms, manufacturing firms and firms located in Freetown are much more likely to perceive transportation as a major constraint. 49 CHAPTER 6: CONCLUSIONS AND POLICY RECOMMENDATIONS 114. The preceding chapters have highlighted shortcomings in terms of labor markets and training, infrastructure, business taxation and regulation, governance and corruption, access to finance and exports that have negative impacts on private investment and private sector growth. This chapter briefly discusses policy options in a number of priority areas to foster private sector development in the country based on the analysis previously undertaken in the report. FIRM LEVEL PERFORMANCE AND LABOR FORCE DEVELOPMENT 115. The findings of strong firm-level economic growth and low labor productivity in manufacturing suggest that private sector growth is likely to come from other sectors. The 2009 enterprise survey data suggest that labor productivity for manufacturing firms is low in Sierra Leone--even relative to Mano River Union members Guinea and Cote d‘Ivoire. This suggests that private sector growth might be best pursued through other sectors, such as agriculture and agroprocessing which employ the vast majority of the population. Recall data from Sierra Leone firms show strong firm level growth across all sectors. Whether this can be attributed to a peace dividend from the end of conflict, natural resource rents, or some other combination of factors is a subject for further research. Regardless of the cause, few countries have been able to maintain strong growth without addressing fundamental productivity issues. 116. Labor productivity is likely hindered by the low level of education of workers in the country. Survey results show that firm manager educational levels are fairly low. The provision of basic education has been a high priority of donors60 and the primary school completion rate has risen 13 percent between 2003/2004 and 2006/2007, to about 70 percent of the school age population.61 While this is a promising development for the country‘s large youth workforce, the government (with support from donors and other development partners) needs to sustain efforts to expand access to education and maintain adequate inputs at the school level while striving for improvements in quality. 117. Lack of formal training opportunities for firm staff and the low use of technology also limit productivity. Training opportunities at the firm level remain limited as shown in the enterprise survey data. The low provision of training by firms might be explained by a number of market failures such as externalities and free rider problems associated with the inability to ensure that once workers are trained by a firm they are not ―poached‖ by competitors, but also because of low returns to training. As such, if funding could be identified, matching grants to support training programs by firms or the establishment of private-sector led industry specific training centers could provide an important complement 60 World Bank. (2005). The Republic of Sierra Leone Joint IDA-IMF Staff Paper on the Poverty Reduction Strategy Paper. April 13. 61 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 50 to efforts to increase basic education. The use of Internet technology will likely increase as the availability of basic services, such as electricity and roads improve. 118. Regional disparities exist and merit attention. The survey data show that education levels and training opportunities are lower in the Kenema region. Government has enacted key legislation to support the decentralization process and important responsibilities have been devolved to district councils, with local councils now playing a greater role in basic education. These local councils could also play a role in encouraging necessary skills building initiatives for areas outside of Freetown. INFRASTRUCTURE 119. The lack of basic electricity services is a binding constraint to growth. National generating capacity remains among the lowest in Sub-Saharan Africa, and the analysis in Chapter 3 demonstrates that infrastructure deficits, in particular the lack of reliable electricity supply impose significant costs on firms in Sierra Leone. Although these costs are lower than for other Mano River Union members, they are still significant, with 7 days of power outage per month, costing an estimated 7 percent of annual firm sales. 120. The generation of electricity is increasing. Hydroelectric power supply is the main available source of commercial energy, and the Bumbuna Hydroelectric Project should become operational in 2009 after years of delays, significantly expanding generation capacity in Western/Area Freetown. Government has expressed interest in a second phase of the project that would expand generating and transmission capacity, which would fulfill a critical need. 121. The capacity of the transmission and distribution network will be a critical issue. Capacity will be particularly strained in corridors where an increased supply of electricity is envisaged such as Bumbuna to Freetown, Makeni-Magburaka, and Lunsar-Port Loko. Regional initiatives have the potential to play a critical role in improving capacity. For example, the West African Power Pool (WAPP) project would allow Sierra Leone to get access to cheaper hydroelectricity through an interconnected regional grid. Sierra Leone seeks to become a fully active member of the WAPP task force led by the ECOWAS Secretariat. This will provide access to regional inter-connector transmission facilities as well as access to funding for developing regional supply initiatives.62 122. Incentives to counter underinvestment in energy should be supported. Public private partnerships (PPPs) are a promising option to attract finance, technology and managerial skills, and examples have been developed in Sierra Leone. However, revenue collection for public electricity services remains a challenge, contributing to underinvestment in the development of the power sector. The National Power Authority has historically shown weak financial performance, but plans to encourage revenue collection through the 62 The Republic of Sierra Leone. (2008). ―Poverty Reduction Strategy 2008-2012.‖ November. 51 installation of pre-paid meters are under development for the Freetown area and should be implemented. TAXATION AND BUSINESS REGULATION 123. Nearly half of all firms perceive tax rates as major constraint to operating a business. In a number of other enterprise surveys, high tax rates are a common problem while tax administration is typically a minor concern. This is the case in Sierra Leone. At the same time, marginal effective tax rates are largely in line with country comparators for whom data is available in the SSA region. 124. Broadening the tax base is necessary before considering a reduction in corporate tax levels. The need to reduce business tax levels must be balanced with the need to maintain fiscal sustainability. A new Goods and Services tax was passed in June 2009 by the Sierra Leone Parliament and should increase the tax base. This tax replaces a number of existing taxes and introduces a Self Assessment for Income Tax, a Taxpayer Identification Number, and reforms in the customs law and administration. Effective implementation of this tax is the next challenge for Sierra Leone as it continues its efforts to improve revenue collection. 125. Rationalize fees and licenses for business registration to limit implicit taxation. Local fees are a source of variation in business fees, and as an important source of implicit taxation, should be made transparent. The April 2009 establishment of a one-stop shop for company registration and fee payment is a step towards standardization and the improvement of information flow. Incorporation fees for businesses have also been standardized and published. 126. More research is needed on informal sector firms. As noted in Chapter 1, the 2009 World Bank enterprise survey around which this report is based does not capture data from informal firms and firms with less than five employees, which make up a majority of businesses in Sierra Leone. A 2006 study suggests that businesses decide to operate informally in Sierra Leone due to licensing, tax issues, and lack of information.63 Additional work is needed to further explore the deterrents to and benefits of formalization in Sierra Leone in the context of recent tax changes and further reconstruction of the country since 2006. 127. Reforms to improve access to land are critical. Until the land tenure and registration system is improved, it will remain difficult to use land as collateral, and the lack of clear title will remain a deterrent to private sector investment. Efforts to improve land information systems and reduce the time and cost of transferring land should be continued, recognizing that many of these reforms are costly and often controversial. GOVERNANCE AND CORRUPTION 128. A significant proportion of firms have been asked for gifts or informal payments in the course of conducting business. Enterprise survey data suggest that graft costs impose 63 FIAS. (2006) ―Sources of Informal Economic Activity in Sierra Leone.‖ June. 52 costs on firms equal to an estimated 4 percent of annual sales, which while significant, is lower than in other Sub-Saharan Africa country comparators. However, unlike other indicators of governance which have been improving, Sierra Leone‘s performance related to corruption has been measured to be steadily deteriorating since 2000.64 129. The Government should focus on reducing corruption in procedures where it is most pervasive. According to the survey data, firms were most often asked for bribes or informal payments in the context of acquiring construction permits and securing government contracts. The Government of Sierra Leone should seek information on effective practices from other countries to effectively fight corruption. ACCESS TO FINANCE 130. Use of financial services is relatively limited. Despite recent advancements in the financial sector system, use of financial services by firms is low relative to the average for Sub-Saharan Africa. This is due both to reasons of lack of supply of and demand for financial services. 131. Initiatives to reduce information asymmetries between financial institutions and firms should be encouraged. As in other African countries, credit information is poor which exacerbates market failures linked to asymmetric information that are inherent to financial markets. Authorities could attempt to mitigate this by encouraging the establishment of private credit information bureaus, possibly in partnership with neighboring countries in order to reap economies of scale in their operations. Alternatively, a simple credit reporting system, such as the one using a basic spreadsheet to track borrowers in neighboring Liberia, could be developed in Sierra Leone. 132. Weak accounting practices might be hampering firms’ access to finance. The survey data showed that the percentage of firms with audited financial statements is low and that the possession of financial statements is a key factor related to having credit. The inability of banks to get reliable information about company accounts exacerbates asymmetric information and increases risks from the perspective of lenders, thus reducing the availability of credit. As such, the Government of Sierra Leone might consider ways to increase percentage of firms with audited financial statements, such as providing matching grants for accounting services. 133. SMEs should be targeted by any programs to improve access to credit. According to the 2009 enterprise survey data, small and medium enterprises (SMEs) in Sierra Leone are particularly credit constrained. Recent literature has shown that SMEs not only report higher financing obstacles than large firms, but that the effect of these financing constraints is stronger for SMEs than for large firms.65 Efforts to increase access to finance should address 64 Kaufmann, Daniel, A. Kraay, and M. Mastruzzi (2008), Governance Matters VII: Aggregate and Individual Governance Indicators, 1996-2007. June 24. 65 Beck and Demirguc-Kunt (2005). ―SMEs, Growth and Poverty.‖ NBER Working Paper. 11224, National Bureau of Economic Research. 53 both the supply and demand for credit. Training programs to improve the capacity of SMEs to solicit and manage credit are important, given that nearly one-third of such firms do not apply because they find application procedures too complex. At the same time banks may require assistance to develop their capacity to lend to SMEs. In-depth training of loan officers (to cover any changes in loan structuring, collateral valuation and registration, problem loan management and cash flow analysis) is a key area. Analysis of existing SME loan applications and establishment of an appropriate SME department may also be needed to address this distinct market. 134. Financial products that increase the spectrum of acceptable collateral should be encouraged. Although collateral was not cited in the survey as a major deterrent to accessing credit in other countries, the small percentage of firms accessing bank financing suggest the need to increase the entry points to formal finance in Sierra Leone. In other countries, lending technologies such as leasing have been important in helping smaller firms seeking access to credit. 135. A partial credit guarantee scheme to encourage lending in rural and underserved areas may be useful. A risk sharing Partial Credit Guarantee program is aimed at encouraging the commercial banks to lend to the SME sector, by partially back-stopping potential losses resulting from the non-repayment of the outstanding principal amount of the loans made by lending banks to SMEs. Such as credit guarantee scheme could be targeted at encouraging agricultural lending and credit in rural areas, given the limited presence of banks there. 136. Long-term efforts to reduce interest rates paid by firms should be supported. According to the 2009 enterprise survey data, nearly a quarter of firms did not apply for credit because they considered interest rates too high. While high interest rates are a complaint common across countries, net lending margins in Sierra Leone are higher than in other comparator countries for whom data is available. The increasing competition that is occurring as the financial sector develops should reduce interest rates. However, broader initiatives to support the enforcement of contracts and improve creditor rights are important. For example, new High Court Rules for 2007/2008 impose strict deadlines and shorten the duration of cases and introduce the discovery method for commercial cases allowing parties to exchange documents before the matter is heard.66 Strengthening property titling systems, and creating secured interest in movable property are longer term efforts that would also improve the environment for lower interest rates. EXPORTS AND INTERNATIONALIZATION 137. Few firms export, inhibited by the lack of international standards and storage facilities. The 2009 survey data show that few Sierra Leone firms export. Agricultural exports offer the most important potential for a broad-based increase in incomes but remain limited. The adoption of appropriate standards and the development of storage infrastructure are needed to access export markets. For example, due to the lack of phytosanitary standards, Sierra Leone is unable to export fish to the European Union—slowing the 66 World Bank. (2009) ―Sierra Leone: 2008/2009 Reforms.‖ April 24. 54 development of the promising fisheries industry. Warehouse facilities, and in particular cold storage facilities that would support agricultural exports, are currently limited. 138. Improvements to local transportation, the port system, and terminal handling will improve the timeliness and cost efficiency of exports. With donor support, extensive construction and rehabilitation of the roads network, particularly feeder roads will be attempted in the next five years. Plans to implement a landlord port system, in which the National Ports Authority assumes landlord status and leases existing port assets should also create incentives for greater investment. Fishing ports could be developed to boost that promising sector, possibly under a private public partnership.67 River transportation will benefit from an overall reduction in transportation costs, improved boat construction, safety mechanisms and navigational lights for night travel. Developing efficient cargo handling facilities will also improve the timeliness of exports in all transportation systems. 67 Sierra Leone Private Sector Development Strategy Inception Report, EME for DFID, 2007. 55 REFERENCES Bank of Sierra Leone. (2007) ―Annual Report and Statement of Accounts for year ended December 31 2007‖ Bank of Sierra Leone. (2008) Financial Information Sheet. September 19. Beck and Demirguc-Kunt (2005). ―SMEs, Growth and Poverty.‖ NBER Working Paper. 11224, National Bureau of Economic Research. Deaton, A. 1997. The Analysis of Household Surveys: A Microeconometric Approach to Development Policy. Baltimore: Johns Hopkins University Press. 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