Monday, May 2, 2016

BAILOUTS? GOVERNMENT IS DAMNED IF IT DOES, DAMNED IF IT DOESN’T

Last week Standard Chartered Bank got a court order to put Steel Rolling Mills under receivership for their failure to honour their debt obligations.

The Jinja based industry became only the latest casualty in a hostile environment that has been buffeted by rising lending rates, shilling depreciation and an underachieving economy.

The steel manufacturer is facing closure following refusal of the commercial court to issue an injunction temporarily stopping the bank from shutting it down pending the main suit. In the main suit the company is challenging StandardChartered’s bid to put it under receivership.

In 2014 Steel Rolling Mills borrowed two loans of sh18b and $10m (sh35b) to purchase a sponge iron plant, which turns iron ore into steel. However, last year the bank recalled the loan in its entirety but the company argued that the loan was for 96 months and that the 45 days’ notice to repay was unreasonable.

Company officials argue that unforeseen developments in the economy have made it difficult to service the loan properly but point out they have already paid about sh26.5b of the loan.

“A combination of things – a drop in demand form the construction industry, falling steel prices, rising interest rates, currency depreciation and increased cost of production, all unforeseen at the time of taking out the loan have made it difficult,” Steel Rolling Mills’ Sami Alam told Business Vision.

Economic growth is expected to come in at five percent, down from the projected 5.8 percent. The shilling has stabilised in recent months but last year peaked at a historic high of sh3,700 to the dollar from below sh3000 at the beginning of the year. The shilling has since clawed back some value and is now trading in the ranges of sh3,300 to the dollar on the open market.

Lending rates also jumped following the central bank’s raising of its key Central Bank Rate, which serves as a benchmark for commercial lenders. The CBR peaked at 17 percent in February this year from 11 percent twelve months prior, this had the knock on effect of raising lending rates to as high as 25 percent for prime borrowers.

The Bank of Uganda felt it necessary to raise the CBR to head off potential inflationary pressures.
The enterprise under threat is the only one in Uganda which converts iron ore from a company owned mine in Kabale and from artisan miners into steel at their Jinja plant.

The company, which also trucks 250 tons of iron ore daily from Kabale and produces 4000 tonnes of steel a month, also employs about 4,000 people directly and indirectly.

Industry leader Roofings Ltd produces about 350,000 tons of steel products a year from imported semi processed steel.

But the multi-million dollar investment is not the only one creaking under the weight of hard economic terms.

"According to a senior businessman small businessmen who owe sh40b and are failing to pay are in danger of losing up to sh120b in assets pledged as collateral for the loans...

Everest Kayondo the boss of the Kampala City Traders Association (KACITA) could not confirm the figure but said the pain was real.

 “The high interest rates in a situation where business is declining means many of our members have seen their businesses going into receivership,” Kayondo said.

“It is particularly painful when as we predicted the banks are showing healthy profits, but at the same time they are treading on dead businesses.”

Banks, which have released their results recently, have shown that they are bringing their bad loans under control, provisioning less for them last year than the previous year, while profits have mostly come in higher in 2015 than in 2014.

A closure of these businesses would put thousands out of work and compromise the ability of local businessmen to create more jobs.

Already big names like supermarket chain Uchumi have been placed under receivership and WBS TV has been taken over by URA. Meanwhile the classified pages are inundated with properties being auctioned to redeem bad loans as numerous small operators have sunk quietly out of sight in recent months.

Inevitably when such economy wide distress arises calls for government intervention are not far behind.

“This is not a normal situation,” agroprocessor Andrew Rugasira told Business Vision.  “When you are in a situation of recession pressures government has an important role to play in assessing distressed loan portfolios to reduce the stress either by having the financial sector restructure these loans or by injecting liquidity into the economy.”

He argues that the cost to the economy in terms of jobs lost, loss of business to support companies and a general lowering of demand make the case for government intervention important.

Politics will always be a factor in how government intervenes in the economy, benefiting some who may not be deserving of government help to the detriment of those who are but who might be at odds with the establishment or not have the correct connections.

“There will always be politics. There is no perfect scenario. But the discussion must be had and systematic, orderly way for government to lend hand come out,” Rugasira said.

Opponents of government intervention are hard to find.

"The classical argument is that companies should be allowed to fail, that to intervene is to distort the market’s ability to allocate resources efficiently and only serves to perpetuate the inefficiencies that led to the collapse in the first place...

Governments around the world are having to rethink this orthodoxy.

During the global financial crisis that started in 2007, the US, European and Japanese governments pumped money into their respective economies and partially nationalised some of their biggest financial institutions as a way to climb out of the crisis.

Only last week The Financial Times reported that the UK government was going to re-nationalise up to a quarter of distressed Tata Steel and lend them hundreds of millions of pounds to the firm which had threatened to close down after suffering substantial losses  for years.


The UK government cited the 40,000 jobs under threat and the strategic importance of the steel industry to the economy as the reasons for interventions.

2 comments:

  1. Paul interesting piece, I am one of the opponents of government direct cash handouts which are one-off and 'picky' better governments work on the taxation (like they could have taxed more on semi & processed steel products) and infrastructure (power) basically lowering factors of production

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