INDEPENDENT PRIVATE CONSULTING COMPANY

BULECOPROJECT Ltd. INDEPENDENT PRIVATE CONSULTING COMPANY 86, Vitosha Blv., Sofia 1040, Bulgaria; Tel/Fax: +359 2/ 952 01 68; 952 59 54; 952 60 02; E-mail: buleco@sf.icn.bg EXTERNAL ASSISTANCE TO SMALL AND MEDIUM-SIZE ENTERPRISES (SME) DEVELOPMENT IN BULGARIA commissioned by the World Bank Sofia, July 2001

ACKNOWLEDGMENTS BULECOPROJECT Ltd., Sofia thanks all donors, international financial institutions, Bulgarian SME Supporting institutions (ministries, agencies and other governmental bodies), national business and municipal associations, scientific research organizations, NGOs and commercial banks for their support in the preparation of this study and report. The authors would like to express their sincere gratitude to the representatives of the UNDP and the World Bank Offices in Sofia for their valuable contributions. Copyright of the Publisher BULECOPROJECT Ltd., Sofia AUTHORS MEMBERS OF THE TEAM OF CONSULTANTS UNDER THIS WORLD BANK PROJECT TEAM LEADER AND CHIEF EDITOR Ass. Prof. Marin TODOROV, Ph.D. INTRODUCTION & METHODOLOGY - Ass. Prof. Marin TODOROV, Ph.D. PART ONE, par. 1.1. Antonina STOYANOVSKA and Vladimir PAVLOV PART ONE, par. 1.2. Antonina STOYANOVSKA, Vladimir PAVLOV and Todor STAYKOV PART TWO, par. 2.1. - Ass. Prof. Marin TODOROV, Ph.D. PART TWO, par. 2.2. - Todor STAYKOV PART TWO, par. 2.3. - Ass. Prof. Ivan STOICHEV, Ph.D. PART TWO, par. 2.4. - Ass. Prof. Marin TODOROV, Ph.D. PART TWO, par. 2.5. Emily PALAKARTCHEVA PART TWO, par. 2.6. - Ass. Prof. Marin TODOROV, Ph.D. PART THREE, par. 3.1. - Todor STAYKOV and Gueorgui SHIVAROV PART THREE, par. 3.2. - Ivan STOICHEV, Ph.D. and Gueorgui SHIVAROV PART THREE, par. 3.3. - Marin TODOROV, Ph.D. and Gueorgui SHIVAROV PART THREE, par. 3.4. - Emily PALAKARTCHEVA and Gueorgui SHIVAROV This report was commissioned by the World Bank. The findings, views, interpretations, and conclusions do not necessarily represent those of the Bank or its Board of Executive Directors. The Bank does not guarantee the accuracy of the data and analyses presented, and accepts no responsibility for any consequence of their use. 2

TABLE OF CONTENTS INTRODUCTION. 7 EXECUTIVE SUMMARY.10 METHODOLOGY..18 PART ONE ANALYSIS OF THE SME SECTOR AND OF THE STATE POLICY IN SUPPORT TO SME DEVELOPMENT IN BULGARIA..20 1.1. ANALYSIS OF SME S PLACE AND ROLE IN BULGARIAN ECONOMY.20 1.1.1. Structural Analysis of the SME sector in Bulgaria 20 1.1.2. Share of SME sector in Bulgarian Economy Development 23 1.1.3. Main Constraints to SME Development in Bulgaria..33 1.2. STATE POLICY PRIORITIES IN RESPECT TO SME DEVELOPMENT..35 PART TWO ANALYSIS OF EXTERNAL ASSISTANCE FOR SME DEVELOPMENT IN BULGARIA (1998-2000) AND OF PROSPECTS FOR ITS FUTURE ENLARGEMENT...38 2.1. SURVEY OF EXTERNAL ASSISTANCE FOR SME DEVELOPMENT IN BULGARIA (1998-2000)..38 2.1.1. Volume and trends in external assistance for SME development in Bulgaria. 38 2.1.2. Analysis by sources of financing (by Donors and Donor institutions)...39 2.1.2.1. Multilateral Donors.39 2.1.2.2. Bilateral Donors.41 2.1.3. Analysis of external assistance to SME development by terms of assistance 42 2.1.4. Analysis of external assistance to SME development by types of assistance 43 2.1.5. Analysis of external assistance to SME development in Bulgaria by sectors and subsectors of SME support..44 2.2. ANALYSIS OF THE EXTERNAL ASSISTANCE PROJECTS FOR THE ESTABLISHMENT OF LEGAL FRAMEWORK AND STATE POLICY IN SUPPORT TO SME DEVELOPMENT.46 2.2.1. Assistance for development of legal framework and state policy in support to SME development..48 2.2.1.1. Assistance to national authorities.48 3

2.2.1.2. Support to local authorities.52 2.2.2. Assistance for development of tax and other fiscal incentives in support to SME.53 2.2.3. Assistance for adaptation of SME legal and business environment to EU legal requirements and practices, including to the Acquis Communautaire in the process of accession of the Republic of Bulgaria with the European Union 55 2.3. ANALYSIS OF THE EXTERNAL ASSISTANCE PROJECTS FOR THE ESTABLISHMENT AND STRENGTHENING OF A SYSTEM OF SUPPORT SERVICES TO SME DEVELOPMENT..57 2.3.1. Assistance to SME human resources development, in particular to training of SME managers and to vocational training 58 2.3.2. Assistance for introduction of modern managerial technologies in SME practices through consultancy and advisory services 61 2.3.3. Assistance for technological innovation of SMEs and for support of high-tech SMEs..64 2.3.4. Assistance for introduction and certification of ISO quality standards and for improving the quality of SME s products....67 2.3.5. Assistance for establishment and strengthening of Entrepreneurial Organizations and Branch Associations..68 2.3.6. Assistance for development of Regional development agencies, business centers and incubators.70 2.4. ANALYSIS OF THE EXTERNAL ASSISTANCE PROJECTS FOR FACILITATING SME FINANCING AND BORROWING 73 2.4.1. Assistance for capacity building of Bulgarian banks in order to meet the specific SME needs for credits 74 2.4.2. Assistance by providing special credit lines for SME development, serviced by Bulgarian banks..75 2.4.3. Assistance by establishment of investment funds and investment banks from external donors and development financial institutions in order to improve lending to SME..76 2.4.4. Assistance by establishment and strengthening of a national promotion bank Encouragement Bank AD for crediting the investment and export activities of SMEs..79 2.4.5. Assistance by establishing venture capital funds for financing SMEs through equity investment 80 2.4.6. Assistance through support to specialized leasing companies for financing the acquisition of machines and equipment by SMEs 81 2.4.7. Assistance by providing support for the elaboration of Business Plans and Feasibility Studies of SMEs, needed mainly for borrowing from commercial banks...82 2.4.8. Assistance by establishing a national Guarantee Fund to support the crediting of the SME activities.83 2.4.9. Assistance through micro-financing of start-up SMEs 84 4

2.5. ANALYSIS OF THE EXTERNAL ASSISTANCE PROJECTS FOR IMPROVING THE SME EXPORT COMPETITIVENESS AND FOR INTERNATIONALIZATION OF THEIR ACTIVITIES..85 2.5.1. Assistance by providing information and consultancy on international markets and promoting business contacts with foreign partners.86 2.5.2. Assistance by providing access for SMEs in subcontracts and subdeliveries with foreign partners 89 2.5.3. Assistance in promoting investment cooperation and establishing joint ventures of SMEs with foreign partners.90 2.5.4. Assistance for improving the SME competitiveness..91 2.6. PRIORITIES AND EFFICIENCY OF EXTERNAL ASSISTANCE TO SME DEVELOPMENT IN BULGARIA IDENTIFIED ON THE BASIS OF ANALYSIS OF AFFIRMATIVE RESPONSES TO QUESTIONNAIRES UNDER THIS STUDY 94 2.6.1. Major priorities of the donors in external assistance to SME development in Bulgaria in 1998-2000...94 2.6.2. Future external assistance priorities for SME development in Bulgaria.....97 2.6.2.1. Priorities for future external assistance by sectors of support..97 2.6.2.2. Priorities for future external assistance by types of assistance.99 2.6.2.3. Priorities for future external assistance by economic branches..100 2.6.2.4. Priorities for future external assistance by regional levels 100 2.6.3. Assessment on programmes and projects effectiveness in support to SME development in Bulgaria in 1998-2000...101 2.6.4. Assessment on external assistance impact on development of SME sector in Bulgaria in 1998-2000..103 PART THREE MAIN CONCLUSIONS AND RECOMMENDATIONS OF THE ANALYSIS OF EXTERNAL ASSISTANCE PROVIDED TO SME DEVELOPMENT AND PROSPECTS FOR ITS INCREASE..104 3.1. Establishment of the legal framework and government policy supporting SME development.104 3.2. System of SME support services.106 3.3. Facilitating SME financing and borrowing.110 3.4. SME export competitiveness and internationalization of their activities...114 LIST OF TABLES 119 TABLES A - SUMMARY AND DISTRIBUTION OF EXTERNAL ASSISTANCE FOR SME DEVELOPMENT IN BULGARIA (1998-2000)..120 Table A.1. Summary of external assistance for SME development in Bulgaria by sectors and subsectors (1998-2000)..120 Table A.2. Summary of external assistance for SME development in Bulgaria by terms of assistance (1998-2000) 121 5

Table A.3. Summary of external assistance for SME development in Bulgaria by types of assistance (1998-2000) 122 Table A.4. Summary of external assistance for SME development in Bulgaria by donors (1998-2000)...123 Table A.5. Inventory of external assistance projects for SME development in Bulgaria ongoing projects by sectors and subsectors, 1998-2000.124 TABLES B PRIORITIES, EFFICIENCY AND IMPACT OF EXTERNAL ASSISTANCE FOR SME DEVELOPMENT IN BULGARIA (1998-2000), IDENTIFIED IN THE ANALYSIS OF RESPONSES TO QUESTIONNAIRES IN THE FRAME OF THE STUDY..142 Table B.1. Priority sectors for SME development covered by external assistance in Bulgaria (1998-2000) and estimated by donors.142 Table B.2. Priority sectors for future external assistance to SME development in Bulgaria.144 Table B.3. Priority types, branches and levels for future external assistance to SME development in Bulgaria 145 Table B.4. Achievement of objectives of external assistance programmes and projects for SME development in Bulgaria (1998-2000)...146 Table B.5. Assessment of external assistance impact on SME development in Bulgaria (1998-2000)..147 LIST OF ANNEXES 148 Annex 1 Definitions of major terms of Official Development Assistance...149 Annex 2 Types of External Assistance.150 Annex 3 List of Donors, National SME supporting institutions and Beneficiaries respondents to the Questionnaires under this study..151 Annex 4 Questionnaire for description of overall support activities of donor institutions on official external assistance to SME development in Bulgaria 154 Annex 5 Questionnaire for National SME supporting institutions on official external assistance to SME development in Bulgaria...157 Annex 6 Questionnaire for Beneficiaries on official external assistance to SME development in Bulgaria..161 Annex 7 Classification of the external assistance for SME development by sectors and subsectors of SME support 166 Annex 8 Acronyms and Abbreviations.167 6

INTRODUCTION The acceleration of the restructuring and privatization processes in Bulgaria led to the emergence in the second half of the nineties of a wide range of private firms, the majority of which are small and medium enterprises (SMEs). The success in achieving the economic growth objectives is linked to the need to strengthen the SME sector as a critical part of the emerging private economy in Bulgaria. SME development and sustainability was seriously affected by the slowdown of the reform process and the macroeconomic and financial instability of 1996/97. SME development is further hampered by the immaturity of the institutional framework for private businesses and SMEs in particular. Strengthening of the SME sector is crucial for the acceleration of economic growth and the further restructuring of Bulgaria s economy. With the financial stabilization achieved after 1997, there has been an increasing need for investments in Bulgarian SMEs. However, the fragility of the economic stabilization, requiring strict financial discipline by financial institutions and riskexcluding policy, makes the access to financial resources the major problem confronting the SMEs in Bulgaria. Other important issues are connected to the insufficiency of services related to export promotion, technological upgrading, management and marketing, quality management systems, standardization, etc. The Bulgarian Government has stated as its priority the development of SMEs as a mean to achieve desirable economic restructuring and to address unemployment and associated social problems. The support to the development of SME is an important element in a number of official development assistance programmes promoted by the donor community in Bulgaria. In recent years there have been many projects initiated, in which SME development is either directly focused on or is envisaged as one of the results. The main objectives of this study commissioned by World Bank, are: (1) to conduct a survey of the donor assistance to SMEs provided to date in terms of volume, type of assistance and areas of focus; (2) to gather feedback on the effectiveness of the various SME related programs; and (3) to identify the major challenges for the improvement of external development assistance to Bulgaria s SME sector and possible areas of future donor involvement. It is, however, beyond the purpose of this review to prescribe solutions or provide definitive guidelines for future work. Rather, the users of the information contained herein are encouraged to use it as a basis for discussion of future programmess and activities. In Part One, an analysis of the SME s place and role in the Bulgarian economy is presented. Special attention is paid to the main priorities of the state policy in support to SME and to the results of its implementation so far. In Part Two, the external assistance for SME development during 1998 2000 and of the prospects for its future enlargement are under review. For this purpose, the analysis of the volume and trends in external assistance for SME is detailed by sources of financing, by types and terms of external assistance, and mostly by the four main sectors of support to SME. 7

In Part Three, the main conclusions and recommendations from the analysis of the external assistance to SME development and the prospects for its increase are formulated. In this respect some trends can be observed and are taken into account. During the period 1998-2000, multilateral donors and donor countries tend to refocus their priority from institutional building in support of SME development (such as capacity development of Government Agencies, assisting the national and branch business organizations, etc.) to direct assistance to Bulgarian SMEs (direct technical assistance, support to financial institutions working in the SME sector, assistance in the implementation of quality management systems and standardization of products, etc.). Consequently, the main part of the analysis in this study is concentrated in the sectors of direct assistance to SMEs, namely the establishment of a functioning system of SME support services; facilitation of the financing of SMEs and internationalization of SME activities. This shift of focus on the part of donor programmes is an expression of the increasing confidence, both of the donor community and of the Government of Bulgaria, in the SME sector s capacity to actively participate in solving the problems related with increasing SME competitiveness. Because of that, significant attention in this study is paid to the development cooperation projects aimed to strengthen SMEs viability by improving company organization and management; operational market behavior; own capacity for raising capital and attracting foreign partners and investors. In principle, this is an expression of the need for gradual evolution of the Government policy in support to SMEs from strictly purpose-oriented interventions in branches, regions and activities to the establishment of a comprehensive and favorable national legal, institutional and business environment for SME development. This can enhance the needed accelerated mobilization of internal and external resources in Bulgarian micro, small and medium sized enterprises in order to meet the requirements for increasing their competitiveness not only within the national economy, but also at the regional and European level. A key question for improving the external support to SMEs in Bulgaria is the better coordination of donors assistance to SME development. Efficient external assistance coordination involves reliable, effective and well-aimed integration of donors support in the national development plans and programmes. It includes the identification and prioritization of areas in need of external assistance for SME development and the channeling of donors support in these areas. The good coordination of donors assistance reduces the likelihood of overlap and duplication, and fosters partnerships among donors, government and non-government institutions. The coordination among donors in Bulgaria in the period 1998-2000 and nowadays continues to take place in the context of regular meetings, traditionally chaired by the World Bank. These meetings enable the donors to discuss informally major economic and social developments and to exchange information on initiatives, needs and difficulties encountered in the process of implementation of external assistance. The practice of holding topical meetings by sectors has been well received and in many cases found to yield good results. For instance, the meetings on SME development are jointly chaired by the Delegation of the European Commission and the USAID. A fundamental principle advocated by the OECD Development Assistance Committee is 8

that the co-ordination of external assistance should be primarily the responsibility of the government. The different ways to increase government involvement in the process require a much broader analysis and remain beyond the scope of this study. In this study special attention is paid to the review of external donors intentions and plans for development and implementation of future programs and projects in support to SMEs in order to describe steady trends, priorities and commitments within the long-term donors efforts to provide efficient external assistance to SME development in the Republic of Bulgaria. This report represents a first attempt to summarize the direct results, the efficiency and the follow up activities of the projects for official development assistance to Bulgaria, containing strong component of SME support. The authors do not claim to have provided all the answers and acknowledge there is further room for research in the SME development area. Rather, it is hoped that this study will serve as a basis for future discussion and analysis of external assistance to the SME sector. 9

EXECUTIVE SUMMARY 1. Support to SME development is an important element in a number of official development assistance programmes for the Republic of Bulgaria, promoted by the donor community. Many projects have been developed over the last few years, in which SME development has been addressed either directly or indirectly. The main objective of this project is to clarify the major challenges to cooperation in support to SME development by reviewing and analyzing the official development assistance to Bulgaria - in order to allow for the adoption of better economic restructuring and real sector support programmes and projects. 2. The analysis of SMEs role in the Bulgarian economy based on official statistical data for 1998-2000 and study of the sector within this review has shown that the share of micro- and small companies is about 98% of the total number of operating businesses. More than half of them are involved in trade. Tourism and services follow as other major areas of activities. Most of them are start-up enterprises based on the proprietors' previous work experience or because of the low level of initial investments required for a certain activity. The share of microand small-enterprises is the largest in the tourist sector, training and business services. Medium and large companies have the largest share in mining, electric power generation, gas and water supply. The greatest number of SMEs registered is concentrated in four Bulgarian cities - Sofia, Plovdiv, Varna and Bourgas. 3. The share of SMEs in total Gross Value Added gradually increased in 1998-2000 and is now over 30%. SMEs are very sensitive and more rapidly react to the changes in the macroeconomic environment in comparison to bigger companies. In the period 1998-1999, the share of operating profit in Gross Value Added decreased in all companies - irrespective of the size and sector. Only micro- and medium-sized enterprises managed to maintain positive results in this period. The share of the operating profit is highest in the group of the micro- and small enterprises, while the share of this group in labour costs is smallest. Most of micro- and small enterprises are family businesses and they generate employment for the owner and members of his/her family. 4. Under the conditions of high unemployment newly emerged private companies, mainly SMEs, to some extent balance the massive drop in employment in the country. Their share in employment constantly grew during the period under review and reached almost 50%. However, the labour productivity in the SME sector is significantly lagging behind the productivity in larger enterprises. SME share in exports is still very modest, about 20 % only. 5. National business associations and a number of donors' studies identify three groups of stumbling blocks facing SME development in Bulgaria in 1998-2000. Despite the financial stability reached, the business climate is not favourable enough for SME development, due to the following major factors: high fiscal burden, stagnating market demand and weak internationalisation of most 10

Bulgarian companies, high level of administrative and bureaucratic constraints and barriers. The second group of stumbling blocks is related to limitations of SMEs to access financing and in particular, requirements for very high collateral on bank loans represent a very serious obstacle. The third group to be mentioned is associated with insufficiently developed system for servicing and facilitating SME and with weak dialogue among the executive authorities and SMEs associations structures at national, regional and municipal levels. 6. State policy priorities for enhancing SME development are established by the SME Act of 1999, the National Strategy for the Development of SMEs and the Action plan for implementation of the Strategy. They are related to the creation of a favourable institutional, legal, administrative and financial environment that promotes the development of SMEs in Bulgaria. The main goals of the Strategy are to simplify the administrative and legal framework for SMEs operations, to improve access to finance, to enhance the competitiveness of SMEs and to achieve internationalisation of SMEs. The secondary goals of the Strategy are: promoting private ownership, open competition, and entrepreneurship; creating new jobs with relatively low capital investment; developing entrepreneurs' managerial skills; increasing the number of SMEs and their export activity; refinement of the system of public procurement procedures; importing modern technology and "know-how" through SMEs; encouraging foreign investment in the SME sector; European and global economic integration of SMEs. National Strategy for the Development of SMEs is implemented through the Agency for Small and Medium-sized Enterprises established in 1998 at the Council of Ministers. 7. Some positive changes were registered in the attitude of legislative and executive authorities vis-à-vis SMEs during the period under review. The immediate results however suggest the need for further substantial improvement of official public policy. The overwhelming majority of entrepreneurs do not yet see any tangible effect of the SME Act implementation. They expect practical incentives for SME development, such as provision of financial support for startups and long-term financing for SME investments, and better public services for small and medium business etc. They also expect that the existing primary and secondary legislation will be brought in conformity with the need to create effective tax, insurance and other incentives at a much higher pace. More consistent and effective future government policy towards the SME development is required, focused in particular on improving the business environment, development and implementation of clear-cut industrial and regional policy, improvement and extension of the national system of SME export promotion and internationalisation, etc. 8. The analysis of external assistance to the SME sector in 1998-2000 has shown that 126 external assistance programmes and projects were either completed or in the process of implementation with total commitments amounting to 580.7 million US dollars. They were of substantial volume, and disbursements under programmes and projects fluctuated year by year. Disbursements under 11

projects in support to SMEs in Bulgaria amounted to 66.6 million US dollars in 1998, 57.1 million US dollars in 1999, and 59.4 million US dollars in 2000. The total disbursements reached 183.2 million US dollars for this three-year period. 9. The external assistance source of financing for SME support in Bulgaria is formed by a group of 24 donors, which includes 15 bilateral and 9 multilateral donors. Leading donors among multilateral donors are the European Union, the European Bank for Reconstruction and Development (EBRD), the International Financial Corporation (IFC) and the International Bank for Reconstruction and Development (IBRD) of the World Bank Group, The European Investment Bank (EIB) and United Nations Development Programme (UNDP). The United States, FR Germany, Switzerland, the United Kingdom, the Netherlands, Japan, and others are among the leading bilateral donors in terms of disbursements. 10. The analysis of external support to SME development in Bulgaria by terms of assistance shows that since 1998 there is some decrease of the share of grants (mostly for technical assistance projects) in favor of loan provisions. The ratio between disbursements under grants and loans was 72.7:27.3 in 1998-2000. External assistance provided to SME development in Bulgaria is concentrated only in two types - technical cooperation and investment project assistance and the ratio between them was 63.4:36.6. 11. External assistance to small and medium businesses in Bulgaria was directed in four main sectors of support to SME development, with proportional distribution during each year. The sector "System of SME support services" was the leading among them with a share of 43.8% of the total disbursements. Sector "Facilitating SME financing and borrowing" came second under this indicator in the period under review with a share of 38.5%. The share of sector "Establishment of legal framework and strengthening state policy in support to SMEs" was with a 13.2 % share and sector "SME export competitiveness and internationalization" - 4.4 %. 12. This structure of disbursement is supported by the data from the study of donors' priorities in 1998-2000. It shows that sectors and subsectors of support play an important role for the donors in developing and implementing external assistance projects in support to SME in Bulgaria. Sector Assistance for establishment and strengthening of the system of SME support services receives the greatest attention among the sectors of support according to the analysis of donors responses to the questions on their current priorities in 1998-2000, taking 34.5 % of the total affirmative answers. Sector Facilitating SME financing and access to borrowing ranks second as a donors priority with 27.5 %, followed by Improvement of SME export competitiveness and internationalization, which takes 23% of donors' total affirmative answers. External assistance to sector Legal framework and state policy development in support to SMEs in Bulgaria is ranked relatively low among the donors priorities, identified in the review. This sector collects 15.2 % of the affirmative answers. 13. The overall assessment of the efficiency of external assistance for SME development is positive. Donors assessment of the achievement of objectives of 12

the programmes and projects supported by them is 8.2 points on a 10-point scale of assessment, national institutions 8.5 points, and beneficiaries 8.6 points. The majority of donors participating in this review consider programmes and projects funded by them in support to SME development in Bulgaria in 1998-2000 as successful. 57.7 % of the donors evaluate the level of achievement of project objectives as excellent. An attempt was made in the framework of this review to identify the external assistance impact on the development of the SME sector in Bulgaria on the basis of responses of representatives of national institutions supporting its development. 74.4% identify the impact as substantial and rank it between 6-10 points on a 10-point scale. The above justifies the conclusion that external assistance played substantial and in some areas crucial role for development and strengthening of SME sector in Bulgaria in the period 1998-2000. 14. The share in the overall external support for the establishment of a legal framework and state policy in support to the development of small and medium sized business in Bulgaria is relatively high. It corresponds to the needs of a dynamic process of legislative activities, establishment of national institutions and capacity building for development and implementation of SME supportive policy. EU Phare, UNDP, United States, FR Germany, United Kingdom, Japan and others are major donors in programmes in this sector of support. 15. A number of technical assistance programmes and projects at the national and municipal level were implemented in 1998-2000, aimed at the approximation of Bulgarian legislation to the legal practice of the EU member-states; institutional development, including the Agency of Small and Medium-sized Enterprises foundation; elimination of administrative barriers to SMEs; improvement of administrative services quality etc. Because of the restrictive fiscal policy of the Bulgarian Government during this period assistance was not provided for the introduction of fiscal and other budgetary related incentives and instruments for SME encouragement in Bulgaria. A shift has been observed in external assistance towards capacity building for policy implementation instead of capacity building for policy development with the advancement of legislation development and strengthening of state institutions formulating SME supportive policy in Bulgaria. 16. It is feasible to continue external support in this sector of SME support in the future by paying special attention to further streamlining of administrative procedures, to strengthening state and municipal administrative capacities in order to encourage SME development etc. External assistance is also required for adapting the experience, legislation and policies of developed countries, and first of all of the EU member-states experience, in application of tax and other fiscal incentives for encouragement of SME development. In adopting the Acquis Communautaire Bulgaria shall develop special legislation and policies in support to innovative, high tech and job creating SMEs, as well as SMEs contributing to the social integration of vulnerable groups. Support to SMEs of that kind is subject to specific EU regulations. 17. The share of external assistance to the system of support services for SME development is the largest of the commitments and disbursements under the 13

reviewed programmes and projects in 1998-2000. Major subsectors of support include provision of consultant services to individual enterprises and SME branch and regional groups, as well as training of SME entrepreneurs, managers and staff. External assistance for SME technological renovation and introduction of quality management systems was provided on a lesser scope. A trend was observed towards strengthening external assistance for the establishment of sustainable institutions in Bulgaria capable to provide support services to SMEs at the branch and regional level like business centers and business incubators, technological parks, branch and regional business associations. Donors commitments to this subsector have been growing. The EU Phare Programme, UNDP, FR Germany, USAID United Kingdom and the Netherlands are leading donors in strengthening the system of SME support services. 18. During 1998-2000 external assistance for the establishment of a sustainable system of SME support services evolved from general purpose programmes providing initial resources required for these activities to more flexible projects corresponding to SME specific needs. An important shift of direction was observed towards providing support that led to improving SME competitiveness on domestic and foreign markets not only to job creation. The need was taking shape for a shift from provision of individual services to comprehensive support to SMEs through a complex of services. The convergence of different type of services to enterprises was also demonstrated by practices of some regional business centers and business incubators, established with donor support. 19. The experience of many donors supporting the modernization of Bulgarian secondary and high education and vocational training institutions has proven that current and future support to human resources development creates a stable basis for sustainable development of the SME sector in Bulgaria. Direct provision of integrated consultancy on strategic and operational issues to SMEs is worth continuing. Attention should be paid in particular to technological upgrading of SME production capacities as well as to the support for introduction and certification of quality management systems Bulgarian SMEs in accordance with ISO 9000 and other quality standardization systems. Development of stronger capacity of national and branch business associations for rendering specialized services to SMEs is also an appropriate area where external assistance may be directed in the nearest future. 20. An extension of Donors programmes and International Financial Institutions activities aimed at facilitation of SME financing and borrowing in Bulgaria was observed in 1998-2000 in two clearly distinguished subsectors banks lending to SME and SME financing by non-banking institutions. Leading donors in this sector are EBRD, IFC, EIB, EU Phare Programme, USAID, FR Germany, Japan and Austria. 21. Technical assistance was provided for the training of Bulgarian banks staff on lending to SMEs activities. Under the condition of local banks acute shortage of long-term financial resources for lending the assistance by donors and international financial institutions through the opening of specialized credit lines for SMEs is highly valuable. This kind of assistance could expand in the future. Further equity participation of leading donors in local commercial banks would 14

assist the urgent introduction of modern forms of lending to SMEs. Their participation contributes to improving the market environment of SME lending in Bulgaria inter alia by encouraging competition among local banks in lending to SMEs. 22. It is feasible to raise external assistance to professional consultancy provision for the development of bankable documentation required for borrowing by SMEs in order to improve their capacity for development of business plans and feasibility studies. EU pre-accession programmes become increasingly important for SME financing, like SAPARD and other future similar programmes providing for grant assistance to SME investments. External assistance in order to increase SME chances to benefit successfully from EU pre-accession programmes by rendering professional consultancy services and providing bridge financing with the assistance of commercial banks will gain importance in the near future. 23. In spite of the positive experience by leading donors in the establishment of specialized venture capital funds and companies for investment in SMEs capital, this form of assistance has still limited application. In this context, external assistance efforts could be increased toward attracting more foreign venture capital funds in Bulgaria for investment in SMEs. The number of donor supported leasing companies that assist SMEs in the purchase of machines and equipment is too limited in Bulgaria. There is a need for widening the scope of leasing activities by external assistance projects. Donor micro-lending programmes also provide some opportunities for SME financing and start-ups in particular. 24. Expanded future external assistance for improved SME access to financing and borrowing is a key direction for the development of the Bulgarian SME sector. This assistance may be provided in three major areas: development of SMEs capacity to meet the requirements of the financial institutions, improvement of regulatory environment in respect to lending activities and provision of growing medium and long-term financial resources needed for SME development. 25. An increase of the number of donor supported projects aimed at improving Bulgarian SME export competitiveness and internationalization is observed. Among them the share is higher of projects in support to improved SME export competitiveness, cooperative arrangements and establishment of joint ventures. Positive experience has been developed by projects promoting SME exports. Leading donors in this sector of support are EU Phare Programme, FR Germany, United States, Switzerland, Italy and Japan. 26. The analysis of the potential for future external assistance provides grounds to conclude that it is feasible to direct some efforts to improving the National System on export promotion. The System shall be modern, highly effective and shall meet European criteria. It shall provide reliable information, consultations, and assistance for establishment of business contacts and participation in specialized exhibitions and fairs etc. Donor s assistance is needed in the Ministry of Economy, the Agency for Small and Medium-sized Enterprises and the Center on Export Promotion for ensuring their effective functioning in support to SME exports. Further external assistance to the Bulgarian Agency for Export Insurance would increase its capacity to insure SME exports. 15

27. The development of mid-term strategies and action plans of national business and branch associations would be feasible in order to improve export oriented SME competitiveness inter alia through attracting foreign partners and external assistance for their implementation. It is also important that leading donors use more efficiently the potential of their state agencies for investment and export promotion to support the development of their company partnerships between their beneficiaries and Bulgarian SMEs for joint investments, cooperative arrangements, and establishment of joint ventures in Bulgaria. The experience of leading donors in providing integrated services to SMEs, mainly through established regional business centers may be actively applied to improving the SME export competitiveness and thus to create a synergic effect. 28. Identification of future external assistance priorities for SME development in Bulgaria was paid significant attention in this review. Priorities for future external assistance to SME development in Bulgaria are defined by sectors of support and differentiated by donors, national institutions and beneficiaries. Donors consider that support to SME export competitiveness and internationalization is of highest priority with 35.8 % of all responses, followed by assistance to strengthening the system of SME support services with 33.3% of donors responses and facilitating SMEs financing and access to borrowing - with 21.4 %. External assistance to the improvement of the legal framework and state policy development has a modest place among donors future priorities and only 9.5 % of the answers indicate feasibility of implementing projects in this sector. According to national institutions in support to SMEs and beneficiaries, the future external assistance for facilitating SME financing and access to borrowing is their highest priority with 35.9%, followed by assistance to strengthening the system of SME support services with 31.3 % share. 29. The analysis of the answers on appropriate types of assistance has shown that the supporting institutions and the beneficiaries, too consider that the future assistance for SME development shall be directed predominantly to the implementation of investment projects assistance instead of free standing technical assistance. 64 % of the answers give preference to the first type of assistance. The answers provided by national institutions supporting SME development and beneficiaries of assistance differ to some extent in respect to economic branches. Tourism was placed first with 20.7% of answers. It is followed by the high-tech sector with 19.9 % and manufacturing industry - with 17.4 %. Less affirmative answers collect such branches as consulting and other business services, agriculture and food processing. Concentration of the future external assistance at appropriate regional levels would allow effective and direct support to SMEs in Bulgaria. Answers by national institutions supporting SMEs and beneficiaries differ significantly in respect to this question. 43.2% of all Bulgarian respondents consider that future assistance projects shall be dominated by support at the municipal level as more directly related to local SMEs. Priority of external assistance at the national level is attached by 37.5% of Bulgarian institutions and assistance to the regional level - by 19.3%. 30. The analysis of trends and prospects for external assistance to SME development in Bulgaria shows that this assistance may play an extremely important role for an accelerated expansion and strengthening of the 16

Bulgarian sector of Small and Medium-sized Enterprises. The increasing number of viable and competitive SMEs in the key branches of restructuring of the Bulgarian economy may lead to a greater SME share not only in employment, but in generating national gross value added and increasing export. The study allows formulating a set of concrete recommendations on attracting future external assistance to SMEs development. These recommendations are addressed to the national authorities and to the donor community as well. The main conclusions and recommendations are presented in Part Three of this report. 17

METHODOLOGY 31. For the purpose of this report, Bulecoproject Ltd. has carried out a study on the official development assistance programmes and projects in Bulgaria that have a strong SME support component. The criteria for classifying the donors projects as external support to small- and medium-sized business, as adopted in co-ordination with the World Bank, is the existence of a component directly linked with SME activities of at least 30% of the commitments under those projects. The information in this report covers only the share for SME development in the official development assistance, provided to the Republic of Bulgaria. This means that only the assistance from official sources, mainly state bilateral and multilateral sources are subject of the study and assistance from private sources is not covered. 32. The main objective of this assistance is to promote economic development and welfare of Bulgaria. The principles, approaches and terminology of the Official Development Assistance established in the United Nations systems are applied in this study and the major terms are used as they are defined in Annex 1. A significant share of the external assistance to the SME sector in Bulgaria is provided as development loans by EBRD, IFC and EIB and other international financial institutions. This form of support is rendered on market or close to market terms and cannot strictly be treated as official development assistance. On the basis of the approach, adopted by the authors the data on operations of the above-mentioned institutions was included on the grounds that such support may not be available to the country from other sources and that it also contributes to the economic development and welfare of Bulgaria. When classifying the external support to SME sector in Bulgaria by its type, it appeared that only free-standing technical cooperation and investment project assistance were implemented. Information on other types of assistance is provided in Annex 2. 33. The data presented in this report was collected from September to December 2000 using questionnaires, which were sent to over 30 donor embassies accredited to Bulgaria, as well as to multilateral donor institutions. The vast majority of Bulgaria s donors responded to the questionnaires and were visited at their offices. In some cases, contacts were made with relevant institutions in the donor countries. In addition, a wide range of final or mid-term project reports on SME development was studied, which were provided to the team of experts with the kind assistance of almost all donors. Meetings and interviews have been carried out with donors and executing institutions in order to identify their assessment on the effectiveness of the projects, to study the major constraints encountered, conclusions and plans for follow-up activities, aimed at SME development in Bulgaria. Another purpose of those meetings was to collect additional information on the projects under implementation or in the process of concept development and co-ordination. The UNDP assistance for collecting preliminary data has been extremely useful by providing information contained in the annual UNDP Development Co-operation Report Bulgaria for years 1996 2000. 18

34. The data on external assistance volume in this report is presented in US $ and is based on actual disbursements for 1998, 1999 and 2000 as reported by the donors. Since some donors provided data in their national currencies its conversion in US $ was made by applying the United Nations monthly weighted average exchange rate for each year. A few donors did not provide all the requested information and some of the data was approximate. While every effort was made by the team of exports to be as accurate as possible, in some cases a certain degree of approximation had to be allowed for. 35. For the purpose of this study Bulecoproject Ltd. developed in co-ordination with the World Bank three main sets of questionnaires for collecting quantitative and qualitative information on external assistance to SME development. Two questionnaires were elaborated in order to clarify the donors assessment of the SME support projects implemented so far and their future intentions in this area. The first of them, presented as Annex 4 is related to each donor s assessment on its overall assistance to SME development in Bulgaria, as well as to identification of stumbling blocks encountered and the future plans for supporting programmes and projects in the area of the SME development. The second one concerns quantitative data on concrete programmes and projects and the assessment of their results. 36. A questionnaire was also developed in co-operation with the World Bank, contained in Annex 5, and presented to national SME support authorities Ministries, Agencies and other institutions in order to collect information on their policy for attracting and utilizing external support to SME development, their assessment on the effectiveness of the support and their future priorities in respect to external support to SME development. A specific questionnaire was prepared for Regional Governors in order to summarize their opinion on the results of the external assistance projects in support to the SME development and on the future needs to attract such support in concrete districts and regions of the country. A special questionnaire, contained in Annex 6, was elaborated for the executing agencies and institutions - beneficiaries of the projects in support to SMEs in order to clarify their assessment on the projects results, the existing constraints as well as their future needs for support to the SME development. 37. The major conclusions and recommendations of this report are based, first of all, on the opinions, assessments and recommendations of the donors, the national SME supporting institutions in Bulgaria and the beneficiaries - as stated in their responses to the above mentioned questionnaires, and further clarified during the meetings and interviews conducted by the authors. A list of donors that answered the questionnaires is presented in Annex 3. A classification of programmes and projects was developed by sectors and subsectors of support, specific to external assistance to Bulgaria and it is provided in Annex 7. 38. For the purpose of this study, an Analysis of the SME role and place in the Bulgarian economy based on statistical data for the period January 1996 December 2000, has been prepared and included in the first part of this Report. This is an attempt of the team of experts to describe the actual aspects and trends in the SME development for this period and especially those in 2000. 19

PART ONE ANALYSIS OF THE SME SECTOR AND OF THE STATE POLICY IN SUPPORT TO SME DEVELOPMENT IN BULGARIA 1.1. ANALYSIS OF SME S PLACE AND ROLE IN BULGARIAN ECONOMY 1.1.1. Structural analysis of the SME sector in Bulgaria 1.1. The analysis in this chapter is based on data from annual balance sheets and profit loss statements of 189 367 enterprises for 1997, 204 501 enterprises for 1998 and 209296 enterprises for 1999. These samples of firms do not include enterprises from the financial sector and budgetary financed enterprises from the education, healthcare and public administration. The sole traders and co-operatives mainly from the agriculture and services sectors are also underrepresented to some degree. Nevertheless, these samples are representative for the so-called real sector (nonfinancial enterprises, which are not financed by the state budget). According to the Bulgarian legislation micro enterprises are those with employment less than 10 people; small enterprises with employment between 11 and 50 people; medium enterprises with employment between 51 and 100 people; and large enterprises with employment above 100. Table 1.1. Structure of enterprises(1) by their size class (in percent - %) 1997 1998 1999 All enterprises 100.0 100.0 100.0 Micro enterprises 92,5 92.4 92.5 Small enterprises 5,2 5.4 5.5 Medium enterprises 1,1 1.1 1.0 Enterprises with 101-250 employees 0,8 0.8 0.7 Large enterprises 0,4 0.4 0.4 Source: NSI, own calculations 1 According to the Bulgarian legislation micro enterprises are those with employment less than 10 people; small enterprises with employment between 11 and 50 people; medium enterprises with employment between 51 and 100 people; and large enterprises with employment above 100. 20