Friday, July 29, 2016

THE CASE FOR GOVERNMENT INTERVENTION IN THE ECONOMY

The future seemed very bright for Samson in 2011 when he borrowed sh100m against the family home to beef up his maize garden in Mityana. He had been growing maize for two years on 20 acres and had ready buyers from South Sudan, ready to pay for his crop while still in the field.

With the money he hoped to double the acreage under maize in the next season and steadily grow his enterprise to cover the entire square mile of land he had access to in five years.

But no sooner had he borrowed the money than interest rates were adjusted upwards. A season down the line war broke out in South Sudan killing his market. Maize prices collapsed. HE shifted out of maize into higher value crops like vegetables but the losses he had sustained in his previous endeavour meant he couldn’t set properly.

Today Samson’s house in on the block with the bank seeking to recover about sh200m, the latest victim of circumstances out of his control and not of his making.

“I am too small to be bailed out."

"The current economic slowdown that has prompted the debate of bailing out distressed local companies has its genesis in Uganda’s three decade long economic recovery, recent world events and an ongoing jostling for power and influence with the highest office in the land...

In a recent days a list has been published of companies allegedly tilting over the edge into financial ruin seeking help from government to pull them back from the brink of disaster.

The list, included companies in steel manufacturing, the hospitality industry, manufacturing, general trade and real estate development. The public outcry was as a result of the perception that many of these companies were connected to the ruling NRM government, fuelling the suspicion that these were payoffs for support during the last election.

But Ashie Mukungu, a former economist at the African Development Bank (AfDB), is concerned that a genuine economic challenge in need of urgent solutions is being politicised and even trivialised. He argues that if the situation is not arrested in time the repercussions can set the economy back many years.

“In 2011 with inflation out of control and lending rates increasing some businessmen started complaining. At the time government thought there was no need for government intervention and that the economic conditions that were causing the stress would play themselves out and everybody would be fine,” said Mukungu, who has been studying the situation for the last five years.

Following the 2011 polls inflation hit a 20-year high peaking at 30 percent in October of that year.

In scrambling to contain the price increases the Bank of Uganda using its Central Bank Rate (CBR) sent a signal to the banks to increase their lending rates. This had the knock on effect of reducing borrowing and loan defaults, as businessmen couldn’t keep up with the higher lending rates for projects that were premised on lower interest rates.

Inflation figures fell back to single digits in 2012 but just as the economy was beginning to gain traction at the end of 2013 civil war broke out in South Sudan, which accounted for an estimated one billion dollars (sh2.5trillion) in trade with us annually. Trade with our northern neighbour has never recovered to the pre-civil war levels falling to as low as $100m or under $10million a month.

“We have forgotten or ignored that this money was being made by Ugandans up and down the value chain. But the bigger players took out loans to finance these endeavours and are suffering under the weight of increasing interest when they don’t have the income,” Mukungu explained.

"But closer to home government is seating on at least sh1.5trillion in unpaid bills to suppliers according to the auditor general’s recent report to parliament. Some people believe this figure is grossly understated as the sums have been rolled over for as long as a decade. Businesses who had taken out three year loans and have not been paid for four years are in pain, Mukungu said...

And as if the inability to pay due to unmet projections wasn’t bad enough lending rates are already high in the market a situation not helped by governments increased borrowing from the public.

In last week’s treasury bill auction the yield on the benchmark 91- day bill stood at 15.64 percent, so banks’ lending rate to their best clients is at about 20 percent and to the rest of the public nearer to or above 30 percent.

Other issues including the depreciating shilling which has shed more than 40 percent in recent years, the shut out of Ugandan manufacturers from supplying the Multi-billion dollar Karuma and Isimba dam projects, the delay in oil production and the lack of long term financing have all conspired to aggravate an already less than ideal situation.

That there is a case for a second look at the plight of our businesses seems to be borne out by the evidence, the question is what would be the nature of the government intervention or bailout.

A lot of the outcry seems to have come from the perception that a bailout for distressed companies would targeted at a few favourites and would involve free money doled out in spadefuls.

Patrick Bitature, chairman of the umbrella body the Private Sector Foundation of Uganda (PSFU) in a recent interview said the intention was far from that.

“My agenda was not necessary to bailout a certain number of businesses. No I wanted a solutions for all businesses operating in Uganda because there was a change in the macroeconomic environment,” he told Business Vision in a recent interview.

"Supporters of the bailout have recommended a battery of short to long term policy shifts, not targeted at specific businesses but to the general economy that would jump start production and demand....

In the short term a clearing of domestic arrears – which prime minster Ruhakana Rugunda has already directed on, the expediting of businessmen who lost property in south Sudan, the capitalisation of Uganda Development Bank (UDB) and buy back of some of government paper would be useful.

In addition an easing of regulations on the classification of bad debt. As it I snow if a debt is not serviced for three to six months to is considered delinquent. This has the carryover effect of lowering banks’ capacity to lend as they would have to provide for the bad debt from their capital and harm the borrower’s future ability to borrow.

In addition a lifting of the cap on restructuring of loans. As it is now regulations only allow that a loan be restructured twice but this should be extended to at three to five times before the loans are declared bad loans.

On Monday it was reported that the central bank said the proposals on reclassification of loans was unacceptable because they were set by international standards and were agreed upon by the region’s central banks.

In the medium term is It has been recommended that an independent agency, the  Asset Recovery & Reconstruction Company is set up to take over non-performing loans and offer the banking sector some relief.

And finally in the long term there has to be a determined effort to boost production all around by support the manufacturing, agriculture and other productive sectors of the economy.

“This term bailout I don’t know where it came from what we are talking about is a stimulus package,” Mukungu said.

Bitature weighed in calling for a strategic intervention from government, “It is imperative that the intervention be done quickly, transparently and with specific focus on businesses in key sectors and which employ a large number of Ugandans,” he said.

"Hinting on the critera that would determine who benefits from the suggested intervention apart from job creation would be tax record, foreign exchange earnings and social corporate responsibility.
Mukungu is adamant that it would be full hardy to let the market correct itself, that is the distressed companies fail and more efficient players take off where they left off...

“One, like them or not these distressed companies are the base on which our nascent middle class stands. It has taken us 30 years to build it you let it go and you will have to start again and it will take more than 30 years to build another crop of capitalists like we have now,” he said.

But he also argued that this situation left to its devices will lead to a larger problem for the financial sector.


“And if that happens you will have to bail out the banks anyway most of which are foreign owned. So would you rather offer some relief to local Ugandans or wait and bail out foreign banks?.”

Tuesday, July 26, 2016

TO BAILOUT OR NOT TO BAILOUT, THAT IS THE QUESTION


It has been a tough eighteen months for the business community and the general economy as a whole.
Recent stress maybe traced back to the Bank of Uganda’s move to raise its policy Central Bank Rate (CBR), which banks look to, to determine their lending rates, in April last year. The central bank anticipating huge depreciation in the shilling against major currencies made the pre-emptive move to reduce money in circulation and head off anticipated inflation.

"While the central bank were largely successful in this, restricting inflation in the last year to single digits, the move has had the knock on effect of raising lending rates, which are only now coming down, putting the brakes on private sector borrowing and, in severe cases, leading to business closures....

It has not helped too that South Sudan has imploded once again. Before the 2013 fighting our businessmen were doing at least $200m of business with our northern neighbour. And that is only the official figure. Who knows how much more was happening through unofficial channels.

The recent fighting that flared up at the beginning of the month could not have come at a worse time. 

The uneasy peace was seeing trade beginning to resume and in a situation where business was struggling here, it was expected that demand from South Sudan woUld carry us over the worst.

In addition the six month electioneering period put a further damper on the economy, as investors stayed away or adopted a wait-and-see posture aggravating the log jam in the economy.

"So it came as no surprise that the issue of bailouts for the distressed business community has been mooted...

Prime Minister Ruhakana Rugunda is leading the effort on the government side and the Private Sector Foundation of Uganda (PSFU) is making presentations on behalf of the business community. A list, which it turns out is fictitious, has been published of possible beneficiaries of this government bailout.

Previous communication was that government was going to, look into the domestic arrears with renewed urgency, press for compensation for businessmen affected by the civil war in South Sudan and looking into the issue of bad loans.

People familiar with the negotiations are clear that any government intervention has to be well thought out, transparent and sustainable and discussions are far from being concluded.
Be that as it may, if a bailout is organised we need not reinvent the wheel.

Former US treasury secretary Hunk Paulson, who was at the center of the massive bailout of US companies during the global financial crisis, was quite clear about which had to be aided.

He went in support financial institutions who by the nature of their operations were not only massively exposed to the bad debts coming out of the real estate sector but had their finger in every sector of the economy by virtue of their nature.

In addition he bailed out the car industry which employed thousands and whose activities supported whole cities.

The idea being that the failure of these companies would have a ripple effect on the economy beyond their individual industries.

At the best of times and even with the best of intentions a government bailout of the private companies will always come under heavy criticism, but Paulson decided that it was better to make a bad decision than not make one at all.

His consolation as he said in his book “On the Brink:  Inside the race to stop the collapse of theglobal financial system,” was that history would vindicate his actions. 

The jury is still out on whether his intervention was good but the US economy is steadily recovering and were it not for a lack of similar momentum in the European Union (EU) growth would have been much more robust in the US.

The point is that no government has the resources to bailout all distressed players, however many political points this will win.

A strategy has to be adopted that allows us the biggest bang for our buck.

"In theory the failure of companies would lead to greater efficiencies in the long run, as more credible companies rise up to take their place. The political fallout from such a strategy however may be too high to stomach for the powers that be...

The move to resolve domestic arrears is a good place to start. A government owes trillions upon trillions of shillings to Ugandan businessmen which has a knock on effect down the chain as suppliers are not paid, jobs are not created or cut all together and the expansion plans are put on hold.

Helping with distressed debt would be a hot potato, as accusations of favouritism are bound to arise. Maybe a way to have a win-win situation is in that in return for government’s help either in helping write off loans or win some relief from the banks the affected companies should be encouraged to list their businesses on the stock exchange.

With one stroke we will have greater external scrutiny of these companies, which may lead to greater revenue collections and even open the doors to more sustainable financing for the companies in the future.

That would be an unpopular trade-off for many businessmen but it will be a way to hit two birds with one stone – rescue ailing companies and two ensure that the improved future fortunes of the companies are shared by a wider pool of people.