The Costs of Undermining the Construction Industry

The aftermath of the on-going reform that Abiy Ahmed (PhD) embarked on will be an assortment of opportunities and downturns as far as the local construction industry is concerned. While the Prime Minister’s anti-corruption moves, including his intolerance towards sub-standard infrastructure development works is highly appreciated, it appears that the costs of underestimating the effect of the fiscal policy on construction projects might ultimately outweigh the anticipated benefits of his administration’s position.

The reason is that the economic impact of the construction industry in Ethiopia goes far beyond its statistical representation. According to the National Bank of Ethiopia (NBE) annual report, construction is a ETB287 billion industry that accounted for 71Pct and 18Pct of the industrial output and gross domestic product (GDP) respectively in 2017/2018.

Since the infrastructure development services procured by the government represent the largest share of the construction markets in Ethiopia, the decision to freeze the financing of both new and on-going projects will have a detrimental effect on the national economy at large.

The fiscal policy was introduced while most businesses including the local contractors were still struggling to recover from the declining economic activity of the past three years. Factors such as political uncertainty, regional turmoil, foreign exchange shortages and depreciation of the local currency was best reflected in the three percent downward annual growth of the 2018 GDP as ascertained by the International Monetary Fund (IMF) report.

Since construction is among the first industries to be hit by financial and economic crises, the cumulative effect of such macro-environmental factors will continue to negatively impact the operations and performances of most contractors that are currently facing challenges to meet their growing commitments.

The weekly newspaper Capital recently reported that 90Pct of prominent grade one local contractors are currently unable to pay two months’ employees’ salaries on average. This is only the tip of the iceberg of the looming challenges to be posed in the industry.

Taking into account the research proceedings that concluded that in Ethiopia only 8.3Pct of the construction projects are completed within their original schedules, leaves 91.7Pct to sustain delays of up to 352Pct of their contractual timelines. Unless the government reappraises its financing policies, the chances of on-time implementation of any of the projects currently under local contractors’ contracts is minimal.
Literally translated, the planned service delivery of any of the road, airport, university, hospital, industrial facilities, stadiums and other public projects, and the lives of the millions of ordinary citizens that are directly or indirectly related to these projects, is at stake due to the frozen construction operations. What makes the situation worse is that construction is reportedly ranked as the second highest Ethiopian source of employment, only next to the agricultural sector.

Also, the construction business is widely known as one of the highly risky industries whose operation has always been challenging and unpredictable too. During such a turbulent environment, exposing contractors to high operating risks, failure to secure new project contracts, or even difficulty in collecting their pending payments, shall further exacerbate the financial distress they are facing.

In fact, currently several Ethiopian contractors who are also borrowers have not been able to generate sufficient cash flows to streamline their operations and sustain their debt burden as instances of invoking liquidated damage or early contract termination of projects by some frustrated clients are likely on the rise.

Importantly, the same contractors that are suffering from the monetary policy that the NBE introduced in November 2017 to lower the value of the Birr by 15Pct, are becoming victims of the recent financial policy measure. According to a research sponsored jointly by the-then Ethiopian Class One Contractors Association and the Ethiopian Water Works Contractors Association, the price escalation due to the currency devaluation is anticipated to cause an average 32Pct cost overrun on the building projects under contract.

The implication of the financial measures is so detrimental that, unlike the manufacturing and retail industries which can fix their selling price, contractors usually engage in contracts that last for a couple of years with little or no chance for adjustment due to cost escalation and inflation.

Most importantly, unlike the monetary measure that the NBE took in November 2018 to lift principal payments on arrears of outstanding loans, which is beneficial both to the banks and borrowers, the magnitude of the multi-faceted challenges that contractors are facing might not be resolved through restructuring and rescheduling the repayment of their debts.

As financial distress arises when contractors face difficulty in meeting recurrent obligations, the government should instead benchmark reliable and drastic policy measures, as supporting infrastructure development in times of financial trouble helps the construction industry contribute to enhanced delivery of public services such as education, transport or healthcare, improve businesses’ productivity and ultimately the country’s standard of living.

The successful efforts made by developed nations to curb the unpleasant effects of the 2008 – 2011 global financial crises might worth replicating to address the issue. Specifically, the sum of USD54.7 billion that USA earmarked for construction projects, the Chinese government’s four trillion Yuan stimulus and the 10.1 billion Australian dollars that Australia injected, among other were instrumental to escape the recession.

Besides introducing similar financial stimulus, Belgium and Italy were also among the countries that backed up their declining contractors through tax cut and monetary policies that take various forms. Rather than placing additional burdens, the UK’s support takes the form of both a financial injection that includes a 75Pct government guarantee of bank lending, working capital guarantee and capital for enterprise funds, as well as non-financial support whose various schemes such as late payment or delayed tax return and extended loss carry back also known to help recover the economy.

Adopting what Singapore, Hong Kong and Japan injected into their construction industry as early as the 1989 – 1999 financial crisis and the recent measures that Nigeria took to improve access to finance for contractors including funding a plan to build two million housing units by 2020 might help with learning invaluable lessons had the government of Ethiopia in fact strives to accelerate the growth of the country.

8th Year • May.16 – Jun.15 2019 • No. 74