Will Lease Financing

Will Lease Financing Boost Productive Capacity of MSEs?

Leasing – an agreement by which one party conveys an asset to another for a specific amount of time in exchange for periodic payments – may help small manufacturing enterprises better access machineries and other goods. In order to finance leasing contracts, many micro and small enterprises (MSEs) have turned to newly formed companies that provide funding options to these institutions. According to the International Finance Corporation (IFC), lease financing benefits not only MSEs, but can strengthen the overall economy as well. EBR’s Ashenafi Endale spoke with key individuals in the financial and manufacturing sector to learn more about the issue and its promises in boosting productivity.

Debab Biru, a 29-year-old mother of one, was busy at a garment production centre located in the Kolfe Keranyo District in Addis Ababa on Wednesday February 24, 2016, designing, cutting, sewing and packing garments, which is the routine of the more than 60 people who work in the hall.
The facility where she works is located on the second floor of a three-storey building that houses over 700 people organised as micro and small enterprises (MSEs). The centre is one of the initiatives taken by the government to house MSEs in clusters to boost the lingering manufacturing sector.
Now the government is working on another measure to help bolster the fledgling sector. Six months ago, after the National Bank of Ethiopia (NBE) issued a directive that enabled microfinance institutions (MFIs) to start capital goods lease financing, Debab was able to obtain a modern sewing machine from the Addis Capital Goods Finance, which was formed by the government right after the directive.
When she first started working, Debab says she was using an old machine she received from her family. Obtaining a new machine has proven fruitful: “Since [acquiring a new machine], my production has increased in quality and quantity,” she says. “Now I can produce up to 15 shirts a day, which was three times lower six months ago.” This increased productivity bodes well for the textile sub-sector, a crucial element in Ethiopia’s manufacturing sector.
The World Bank bolsters Debab’s claims. In a study of textile factories in Kenya and the Philippines, they report that productivity increased by 40Pct in most firms due largely to improved technologies. This came as a result of economic policies that spurred “international competitiveness through increased technological and organi[s]ational competence and changes.”
Debab is one of 400 workers at the garment production centre who received a new machine from Addis Capital Goods Finance. She paid 15Pct of the machine’s total cost upfront and is paying ETB300 every month – the price set by the leasing company – which she hopes to pay off within three years.
She says the leasing agreement is serendipitous for wageworkers. “The price of the machine in the market is a little more than ETB10,000, which I could not have afforded,” she told EBR. “But based on the new system anyone can get the necessary machineries for their operation.”
By definition, a lease is a form of financing in which the owner of an asset (the lessor) temporarily transfers the right to use – and sometimes other ownership rights and obligations – to another party (the lessee). The lessor typically makes the lease for a specified time in return for a lump sum or periodic rental payments from the lessee.
The main advantage to leasing is that it provides an alternative to ownership. The party that leases also benefits from not having its resources invested in equipment. However, there are also numerous logistical motivations behind leasing. A company that leases a machine, for example, avoids the risk of investing its resources in an asset that may soon become technologically obsolete. That company may also benefit from having access to the machine for only a short time – to complete a big project, for example – without having to invest larger sums in the equipment and dispose of it soon after.
Additionally, lessees benefit from a number of tax advantages. A firm that leases machineries, for example, will be able to deduct its lease payments from its taxable income immediately rather than deducting the cost of purchasing equipment as depreciation over time.
According to the International Finance Corporation (IFC), leasing development is especially important in emerging economies. “Lease financing bridges a significant gap in the [MSEs] access to the finance arena.” The IFC says this helps [MSEs] gain better access to financing and develop their overall production capacity. The relationship also benefits the leasing company because they “develop better capabilities than commercial banks in physical asset management, repossession, evaluation and remarketing.”
These benefits, according to the report, spread to the rest of the economy: “Developing the leasing industry also creates a broader impact on the capital markets in a developing country. Leasing companies book medium term assets that provide banks, pension funds and insurance companies with a diversification of investment opportunities.”
Addis Capital Goods Finance, which was established with ETB200 million in paid-up capital, is one of five similar companies formed six months ago to finance the supply of machineries for enterprises in the manufacturing sector. It plans to supply machineries worth ETB400 million by the end of the current fiscal year.
Other companies formed around the same time – in the Amhara, Oromia, Southern and Tigray states – were established by MFIs in their respective regions. These entities have the responsibility of leasing capital goods for MSEs operating within their boundaries.
For instance, Addis Capital Goods Finance reports that it has supplied 1,300 machineries – worth ETB31 million – to 710 individuals organised under 598 MSEs in Addis Ababa since they began operations six months ago. Even though it supplies machineries for enterprises engaged in the leather, metal, plastic, woodworks, bakery and other manufacturing activities, the textile and garment sub-sector took 90Pct of the machineries it’s supplied so far, according to Mekonnen Leta, Machineries Lease Expert at the company.
Based on the demand and capacity of the enterprises, Addis Capital Goods Finance studies their proposals, according to the company’s specifications, and supplies the machineries, which the company buys after floating international tender, according to Mekonnen. “The enterprises must be beginners with [a maximum of] ETB1.5 million in paid-up capital,” he says.
The winners of the tenders then transport, install and conduct test production. Until the supplier fulfils such responsibilities, 2.5Pct of the payment will be held at the Addis Capital Goods Finance. Addis Capital Goods Finance also gives a four-month grace period to start monthly payment.
“Knowledge and need are the only things asked from the enterprises to receive machineries,” attests Aschalew Worku, Machineries Lease Officer at the company. “Most MSEs are happy to leave their old machines and able to produce more efficiently. Some are even paying the cost of the machineries in short time and taking more than two additional machines.”
However, Aschalew says not all MSEs benefit from this system. “There are so many enterprises in Addis Ababa that are not aware about the capital goods lease finance scheme we started,” he argues. “When they learn about it, however, it will be beyond our capacity. It is just a matter of time.”
Seyoum Teshome, an expert at the Federal Micro and Small Enterprises Agency, however, says the new scheme has the potential to address one of the major bottlenecks of the manufacturing sector: lack of machineries.
“Initially, the plan was that the technical, vocational and educational training schools would fill the skill gap while MFIs avail loans to strengthen MSEs financially to develop manufacturers from the ground up,” explains Seyoum. “But later, the lack of machineries became a major problem and starting capital goods lease finance, for weak enterprises, became [necessary]. It is the best solution to solve their problems and boost the manufacturing sector as well as create major sources of employment and income generation for a wider segment of the society.”
Information obtained from the NBE reveals that during the first five-year Growth and Transformation Plan, the government created 2.8 million jobs through MSEs and a total of 271,519 new enterprises were established in 2014/15. At the same time, MSEs received more than ETB6.5 billion in loans last year, which was 29.2Pct higher than a year prior.
In terms of the regional distribution of newly established MSEs, 51.9Pct were in Oromia, followed by the Amhara (24.1Pct), Tigray (12.4Pct), Southern (7.2Pct) regions and Addis Ababa (2.7Pct).
Hailu Misganaw, Head of Business Promotion at the Development Bank of Ethiopia (DBE), says that since MSEs are increasing year after year, new ways of addressing the problems should be created.
“Although the government continues to strengthen its support of MSEs engaged in the manufacturing sector and is persisting to address their rapidly increasing needs in various areas, financial service is becoming critical challenge to MSEs,” argues Hailu. “Moreover, as most MSEs gradually grow, their financial need to purchase machineries becomes beyond their capacity.”
Currently the DBE is in the final stage of availing money for a capital goods lease-financing scheme for MSEs engaged in the manufacturing sector. It plans to allocate ETB41.5 billion within the next five years.
“Now we are on the last verse to finance MSEs engaged in the government’s priority areas like agro-processing, manufacturing, construction industries and mining that operate with more than six employees and have a total capital between ETB500,000 and ETB7.5 million,” says Hailu.
According to its plan, DBE will purchase the capital goods in its name and the ownership of the machineries will automatically be transferred to the lessee upon the last lease payment. The amount of lease includes expenses such as cost of capital goods, pre-production interest, insurance, bank charge, transport, loading and unloading and installation cost, according to Hailu.
The DBE is looking to expand its reach to spread in capital goods lease financing. “It also has plans to open 117 new branches all over the country so as to avail credit to MSEs in the form of lease financing as partial cost of fixed investment,” said Hailu.
Even though the Capital Goods Leasing Business Proclamation was issued in 2013, the NBE initially issued a directive that only allows MFIs to engage in capital goods leasing, setting their start-up capital at ETB200 million.
However, it’s shaping a policy framework for local and international banks to start lease financing, according to Getahun Nana, Vice Governor of the NBE. He says local and international financial institutions can join the lease financing scheme now.
Indeed, lack of regulation has halted not only the DBE, but also private banks. “It has been a long time since we planned to start lease financing; however, the lack of regulation to govern the scheme was the major problem that has been hindering us, in addition to liquidity problems most private banks in the country are facing,” said Tsehav Shiferaw, President of Awash International Bank.
Ephrem Mekuria, Communications Manager for the Commercial Bank of Ethiopia (CBE), echoes these sentiments, suggesting that the future of lease financing seems promising. “It has been years since we finalised feasibility studies to start lease financing, but it could not be realised because of lack of policy framework,” he says. “We will start the scheme in the near future.” To that end, CBE has also given a loan amounting to ETB2 billion for the establishment of the five capital goods finance companies formed last year and unions, according to Ephrem. EBR


4th Year • March 16 2016 – April 15 2016 • No. 37

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