Sri Lanka – An Emerging Economy and an Emerging Leasing Industry (Part 1 of 3)

Sri Lanka (formerly called Ceylon) is a vibrant and booming country which is truly starting to see the growth benefits after the 30 year war ended two years ago with the Tamil Tigers.

A major impact of the war was on the country’s infrastructure as well as it’s economic growth. Without forgetting the impact on the people of Sri Lanka through division, personal tragedies and poverty. (the average per capita income in 2010 was US$5,100)

But now that the war is over the capital city of Colombo and the surrounding countryside is changing rapidly. Gone are the cement roadside barricades being replaced with trees and shrubs and enter construction in the ports, roads, hotels, commercial office blocks and residential buildings.

Such growth also brings it’s own problems such as the recently completed power plant (from China) failing 5 times in the last three months. Colombo, as we speak, are suffering 2 hours enforced electricity blackouts every day until the problem is resolved.

In addition to the operational problems of growth comes the financial problems. Where will all the funds come from to bring Sri Lanka more into the global economy ?

The wealth of the country is without doubt growing with the most recent loan from the International Monetary Fund (IMF) being declined by the Sri Lankan government as it was not required.

Foreign investments in infrastructure projects are increasing (a substantial amount from China) but as yet foreign banks have not seen the market as attractive enough for investment in equipment leasing.

Equipment Leasing – Historically

I first visited Colombo last year and met with 6 banks and finance companies to establish their leasing products, market and future plans. Previous market research had given me a great deal of this information but breaking into a new region demands face to face discussions.

The result was a step back in time to other emerging markets in which I have worked. All of the funders I met with could finance cars for private users. That was the bottom line!

We were surrounded by cranes, ships, power plants (although broken) manufacturing equipment, Technology – it was an equipment junkies paradise but all we finance is cars!

Vehicles, as an asset to finance, provides safe residual risk and a safe second hand market in which to sell the asset in the event of repossession. This is the starting point for most markets that are becoming familiar with equipment leasing.

The Market Today

  • Finance Leases and Hire Purchase
  • 95% of leasing is based on vehicles
  • At the end of 2010 there were 70 registered leasing companies.
  • Growth will come from demand (as in Australia and India)
  • Product development will come from international vendors of equipment and international banks such as Macquarie Bank, ANZ and HSBC to a lesser extent. (neither of the first two banks are yet in Sri Lanka for equipment finance as the market is viewed as too small)
  • Domestic banks and finance companies have an opportunity to be ahead of the international banks

Market Education

This had to take place from a funders point of view as well as the users point of view, which is not dissimilar to other Asian countries in which we work such as Malaysia, China, Korea and Indonesia. (all to different degrees). Further ahead in their legislation than a lot of their neighbors, Sri Lanka has the accounting standards in place to manage operating leases as well as finance leases in the form of LKAS17

Cross border transactions were not possible due to attracting withholding tax and therefore the domestic banks needed to be onside. We provided Rental documents tailored to the Sri Lankan market which had to be passed by their boards and their legal departments before we could look at sourcing business.

From the clients view point, we needed to make them aware of Rentals / Operating leases that could assist in preservation of their capex budgets and spread the costs of ownership over the useful life of the equipment.

Market Changes

The rapid growth in the economy has seen the government step in and try to curb inflation by increasing the cost of funds. Last year the interest rate for equipment leasing in Sri Lanka was around 13%, today it is anywhere between 18% and 23% (effective).

This in itself would have an adverse effect on the leasing industry and it did. But the government then increased the import taxes on vehicles – in some cases 200% !! So the only market that the banks and finance companies lease equipment has suddenly dried up.

Growth of any industry is impacted by numerous forces such as  economic shifts, be they domestic or international, inspired by technology changes or government enforced changes.

Other markets developing for equipment finance such as China (albeit now the second largest leasing country in the world with US$83.3 billion in 2011) are seeing an unprecedented change with foreign banks actually reducing their lending exposures. This is due to pressure from their home markets such as Europe and USA along with balance sheet weakness and political pressure. RBS and ING have pulled back from Asia whilst French and German banks are under pressure to meet Basel III regulations.

At the same time the local banks such as CIMB (based in Malaysia), DBS (from Singapore), United Overseas Bank (UOB from Singapore) and OCBC have all been quick to take the place of the shrinking foreign investments from overseas banks.

This is a unique position that is occurring in China but Sri Lanka finds it’s market development some time behind that of China where the foreign banks have not started to take a dominating foothold, certainly for equipment finance. This is where the opportunity lies for the local Sri Lankan banks to establish their own beachhead before this occurs.

We will present two more articles on Leasing in Sri Lanka over the following months.

 

By Paul Errington

CEO

Connaught Finance Investments

Hong Kong

Equipment Leasing in China and Hong Kong (SAR)

Now, the fourth largest country in the world for equipment finance how has the “emerging” market of China and the Special Administrative Region of Hong Kong managed this growth in the last year?

This article looks at where this growth has come from, where it is likely to come from in the future and some of the road bumps and road blocks that have faced equipment leasing in the region.

One issue in reviewing any emerging market for equipment leasing is the available statistics and their quality. China is no exception and in fact is probably at the extreme of the scale.

Information gathered for this article has come from the Deloitte Top 500 IT Company Survey, the White Clark Group, IDC, MOFCOM (Ministry of Commerce) and most importantly raw data gathered from operating in the China and Hong Kong leasing markets.

Over the past 10 years, equipment leasing in China has been hampered by too many regulations in some areas and not enough in others. Lack of reliable financial information for due diligence assessments and no registration of equipment have been two major challenges as well as lack of protection for lessors in the event of repossession of goods. Flaunting these problems, equipment leasing in 2010 increased by 87%, (to US$46 billion) making China the fourth largest country in the world for equipment leasing, behind only USA, Germany and Japan. (White Clark Group)

The increase demand in China is a direct result of the market becoming more aware of leasing as a product and not from the proactive marketing of the 170 licensed lessors in the country. These lessors are a combination of traditional banks, finance companies, foreign banks and vendor captives.

Although we are seeing new foreign banks move into the country most of these such as Bank of America are there to support their vendor relationships and not for new business.(still on the verge of moving into China) Who is supporting who is the question? As operating leases are becoming more in demand lessors look to the vendors for remarketing agreements and guarantees to support the credit risk that the banks are accepting. But still, this is educating the market and the market is growing.

This rush of new lending to meet the market demand has resulted in the existing regulations being stretched to their limits, tested and in many cases failing. With many apparent “good” credit risks financing none existent equipment, financing the equipment two or three times and in some cases defaulting with little recourse left to the lessors through the courts.

This road bump is not encouraging for new lessors but it does emphasise the necessity for stronger regulations to protect lessors as well as better due diligence by the lessors themselves.

So what of the future for China and equipment leasing? The past growth has been focused on larger ticket items such as aircraft, mining equipment and construction equipment.

This has resulted in a market penetration for equipment leasing of only 3% in comparison to America with 17% and other mature leasing countries between 10% and 30% penetration. China therefore remains a very attractive growth market.

The future expansion of equipment leasing will be, as I have said before, through foreign banks and vendor captive finance companies. This is not forgetting the local banks of which recently the top 4 posted higher net profits than the top 4 American banks. But still equipment leasing is a very small part of their portfolio and it is imported foreign experience that will cater for growing demand.

The size of transactions will change from the big ticket items to mid range items and industries will also change into technology and communications equipment.

2011 has already been witness to this shift with multi-national corporations and SME’s financing their technology investments through leasing. Technology itself does not just cover data centre’s and IT departments but also highly advanced and technology based manufacturing equipment.

What will also drive the leasing demand for IT equipment is the ever shifting dynamic nature of IT itself and the development of new products.

We recently attended a Hitachi Data Systems seminar in Hong Kong entitled “The Rise of the Information Centre” which was also attended by 250 CIO’s and IT managers. The focus of the seminar was the shift from “Data Centres” to “Information Centres” based on the growth of Cloud computing.

“IT is becoming a strategic partner to business and not just a business function. Technology is now being harnessed by companies to create a competitive edge in the market” (IDC guest speaker reported)

This shift to Information Centres will have a substantial impact on equipment leasing in China as the intent is very much on the lowering of cost and the increase in efficiency. Cloud, will in fact deliver greater flexibility to scale up infrastructures and share costs thus allowing a larger IT investment by corporations.

This demand for increased equipment leasing will be catered for by captive vendor finance companies such as CISCO, IBM, HP and Hitachi Data Systems. Foreign banks are also in the Chinese market to various degrees of pro activeness and success from Australia and New Zealand Bank (ANZ) who meet neither of these two descriptions to the more assertive and professional services being offered by Societe Generale and Macquarie Equipment Finance.

All rapidly growing markets, in any industry, have teething problems and China is no exception with equipment finance. The market is too large to be ignored and categorised as too difficult in which to operate equipment finance companies. Therefore the solution is more appropriate regulations (this does not mean ‘tighter’ as this would be counter productive) and greater recourse granted to lessors to pursue any defaulting lessees. Hopefully an increase in the former will result in a decrease in the latter working along the lines of prevention is better than a cure.

Equipment leasing in China is too important to the global equipment leasing industry not to find these solutions.

Paul Errington

Connaught Finance Investments

Captives in China are big winners

China Leasing Summit

Over one hundred delegates attended the 2010 China Leasing Summit held in Beijing on the 8th and 9th July. It was satisfying to see so many equipment suppliers and manufacturers in the audience.

During the “getting to know you” session, where everyone attending introduced themselves and gave their reasons for being at the conference, it was clear that many manufacturers are actively seeking trading partners and relationships with local lessors.

Attending in order to learn from others was the main reason for being there; not something that we dare to admit to in the West – our reasons are usually to tell others how to do it – how to increase margins, how to be less aggressive in sales, etc.!

Active big-ticket deals

In spite of the very clear need for the leasing market to arrive at a level of maturity sooner rather than later; which would give comfort to a Western perception of ‘safe investment’, there is still some way to go. There is nevertheless a very active market in the bigger-ticket transactions such as aircraft, shipping, mining equipment and power plants.

Local estimates are that the overall level of leasing penetration into the China market is now up between 6% and 7%, which is substantially greater than the 3% two years ago. The increase appears to be highly dependent on the big ticket market continuing.

Future development will be in the small to medium-sized business market as the local banks start up their leasing operations and are able to use their superior data bases in order to make credit judgements.

Investment into Europe leasing

The main question for Europeans looking at the China leasing market is “When are the Chinese going to start investing in the European leasing market?” The time must surely be right in view of the lack of liquidity in both Europe and the US. There are some signs that this may start happening sooner rather than later.

Reflecting on the West’s entry into the Chinese leasing market over the past ten or so years it is clear that the real winners have been the manufacturer captives and those specialist lessors supporting the vendor market. The generalists are struggling to find a stable customer base and progress is slow.

The potential is vast however, but tapping into a market with significant cultural differences requires a degree of patience, which many of our Western companies just can’t afford.

The content of the summit was a mixture of presentations intended to impart knowledge of various leasing processes such as risk management, asset management and structural issues, many of which were presented by representatives of Western leasing companies.

The local content concentrated on systems, taxation, pricing and regulation. This mixture works well in what is still an emerging market, albeit growing at a considerable rate.

To confront the opportunities that the market offers requires great patience and personal commitment from senior management in the investor business. It would be gratifying to see more European leasing companies looking for ways to expand their business into what will inevitably be the World’s dominant market in the next decade.

Written by Derek Soper

Courtesy of Asset Finance Europe Now Asset Finance International

Asset Finance Logo

Mongolia – Yaks and Gurts and now Equipment Leasing!

Better know for exports in Yak wool than equipment leasing, Mongolia has an established leasing industry (although with problems of development) and a substantial growth potential.

Not to be confused with Inner Mongolia (which is still part of China) we are looking at Outer Mongolia, which has been independent since 1921.

The first question should be “is there really equipment leasing in Mongolia and is it significant enough to write an article about?” Well with a population of 3 million, this is a very good question but some financial analysts are predicting that in the next 5 years it will be the – yes THE, fastest growing economy in the world. I now hear the skeptics amongst you saying “well, it’s easy to grow from nothing”! Point taken but Mongolia already has substantial equipment finance and is already one the fastest emerging countries for equipment leasing in Asia.

Let’s look at the economy, where the investment is coming from, what are the challenges to growth and how do companies finance equipment.

Geographically, Mongolia is bigger than France, Germany and Italy put together. It shares boarders with China to the south and Russia to the north. Ulaanbaatar, the capital holds the record as being the coldest capital in the world when temperatures dropped to -57c. But in the summer months, drought and sand storms are accompanied with +30c temperatures.

With a GDP of only US$10.8 billion, the country can defiantly be identified as ‘emerging’ with its growth and development

GDP Per Capita

The wealth of the county lies in its natural resources, Copper, gold, silver, coal and uranium and this is where the growth and demand is for equipment financing.

Political unrest and concerns about corruption have delayed this growth but now with a recently signed mining lease being granted to Ivanhoe Mines to develop the Oyu Tolgoi copper project a surge in foreign investment has started over the last few years. Ivanhoe will be investing US$5 billion in this mine (which will represent about 34% of countries GDP by then) Other mining companies include South Gobi Resources, Mongolian Mining Corporation (formerly Energy Resources) Entrée Gold and Khan Resources to name but a few.

Mining companies and mining contractors have been moving gradually into the country with their biggest challenge being lack of infrastructure to extract the minerals. Only 3.2% of the countries roads are paved and the railroads are under-developed, the main one being the trans-Siberian link through Russia to Europe.

Leighton (an Australian mining contractor) has a concession to operate the Ukhaa Khudag coal mine in the South Gobi region, near the border with China. State-owned Mongolian Mining LLC, which granted the concession to them, has awarded Leighton a contract for the design, construction and initial operation of a 225km freight railway. The railway will transport coking coal from the Ukhaa Khudag coal mine to China. (70% of Mongolia’s exports are to China)

With growth, especially capital equipment intensive industries such as mining, comes the need for equipment finance. Although there has been some macroeconomic stability in recent years the development and sophistication of the finance industry has been strongly challenged by the new demands of foreign investment. In fact confusion still remains between the local accounting standards and those of the International Accounting Standards. One aspect which is on the side of financial development and equipment leasing is the very lack of legislation that deals with it! In China we see over legislation which hinders equipment leasing but in Mongolia the government is open to creating legislation to assist growth of their economy.

The leasing industry of Mongolia consists of Mongolian banks (about 48); non bank financial institutions (NBFI), 15 suppliers of equipment and transport vehicles, 16 manufacturers of other types of products and foreign banks are starting to have local representation but actual licenses to be lessors are very few. Again, as we saw in the expansion of leasing in Indonesia it is the vendors who pioneer finance and the financial institutions who follow very very slowly behind them.

Although equipment leasing does exist – mostly vehicles, mining equipment, medical, consumer items and agricultural equipment- there are still major factors that have to be addressed. Domestically, these factors are not so relevant but when you consider the larger transactions for foreign companies such as Leighton and Redpath (Mining contractors) then there are substantial hurdles to overcome such as VAT 10%, withholding tax 20%, lack of consistency in tax legislation and customs tariffs on imported goods of 5%.

Ivanhoe Mines have just announced a budget of US$758 million in 2010 for their construction and engineering in Oyu Tolgoi mine. This is just one aspect of the development of one mine (although it is the jewel in the crown for the Mongolian government).

But the inconsistency of legislation is the main issue for large ticket mining equipment leases. There is no registration system for leased assets in the country, the Corporate Income Tax laws (CIT) contradicts the International Accounting Standards (IAS) as to whether a leased asset is even recorded on the company accounts of a lessee! At the same time the lessor and lessee can mutually agree who will show the asset on their books to claim depreciation.

Repossession of goods for a defaulting on lease payments is also rather unclear which does not provide potential lessors with very much comfort in their security if they cannot have access to it or even insist on collecting it from the lessee.

Equipment suppliers benefit most from the current legislative framework. They enjoy VAT exemption for the interest portion of the lease payment. Their customers / lessees also benefit from reduction of taxable income by the amount of interest paid. Bank customers do not benefit from this provision

In summary, growth for equipment leasing will be driven by the growth of the economy which comes from the mines and the infrastructure to manage the mines. Vendors will then lead the development for equipment finance followed by the more entrepreneurial non bank finance companies and then the banks themselves.

Any concerns that we have in the more developed leasing markets around the world of the new IAS regulations on operating leases being on or off balance sheet will have a zero impact in Mongolia as they have not advanced that far. They will on the other hand impact the foreign mining companies who have their balance sheets exposed in their own country of origin.

Equipment Leasing in Indonesia – What does the Future Hold ?

We need to know a little about Indonesia before we can look at equipment leasing and what drives the market, about its current players and where it will go in the future.

There are 17,500 islands that make up the archipelago of Indonesia with the main islands being Java, Borneo, Sumatra, Sulawesi and New Guinea. These 5 islands contain most of the 240 million population with some of the islands having no habitants at all.

Religion plays a large part in the future of equipment finance, believe it or not, through Islamic Finance! Indonesia has 86% of its population of the Muslim faith, 5.7% Protestant and 3% Catholic. 62% of the worlds Muslims live in Asia which represents 23% of the entire world population.

Indonesia, has weathered the global financial crisis relatively smoothly because of its heavy reliance on domestic consumption as the driver of economic growth. Although the economy slowed significantly from the 6%-plus growth rate recorded in 2007 and 2008, expanding at 4% in the first half of 2009, Indonesia outperformed its regional neighbors and joined China and India as the only G20 members posting growth during the crisis. But how long can domestic consumption be relied upon for future growth?

Indonesia struggles with poverty, natural disasters such as the earthquake and tsunami that devastated Aceh in 2006 and the drilling disaster that has caused 90 million cubic feet of clay and water to gush to the surface creating a 6 square kilometer lake.

In addition to this there is corruption at all levels of government and commerce. The annual poll by the Political and Economic Risk consultancy (PERC) shows that Indonesia remains the most corrupt country in Southeast Asia (Worst being 10 and least corrupt being 1) Indonesia scored 9.27. Cambodia was second at 9.10, Singapore was the least corrupt with 1.42 and then Australia with 2.28 and Hong Kong with 2.67 (for comparative purposes USA was 3.42)
As in any emerging market, skill sets and experience can be domestically grown but the importation of foreign knowledge is by far the fastest way to grow an economy or specific industry. So, facing foreign investors, be they banks or mining companies, are the natural disasters, currency fluctuations, historical political unrest (although this is getting better since the collapse of the Suharto regime and the election of Bambang Yudhoyono) and last but not least the high levels of corruption.

There are currently (as at February 2010) 124 commercial banks in Indonesia; of which 10 are majority foreign owned and 28 are foreign joint ventures.
Equipment leasing plays a large part in the country’s economy (US$5 billion or EUR 3.8 billion) which has been driven by the expansion of the mining industry and the plantation industries (Tin, Gold, coal, copper and bauxite are mined and plantations cover palm oil, timber and rubber) All users of heavy equipment which has greatly stimulated the leasing industry.

The leasing industry is dominated by several companies, mainly joint venture companies, whose shareholders are equipment vendors, distributors and company groups.

Some of the more prominent market lease suppliers are:

  • Dipo Star Finance PT (a joint venture with Mitsubishi Corporation of Japan)
  • Orix Indonesia Finance PT
  • Caterpillar finance
  • BNP Lippo Utama Leasing
  • Buana Finance PT
  • UFJ BRI Finance PT
  • Chandra Sakti Utama Leasing (CSUL)
  • OCBC
  • ANZ Panin Bank

(this is not an exhaustive list but covers the major companies)

Some of the traditional products are offered by these companies for leasing of equipment but factoring is very much favored without cultural stigma along with vehicle finance being a strong contender.

In addition are Finance Leases and Operating leases as we all know them traditionally. The latter having either very small residual positions and not offered by many companies unless vendor owned and then ‘blind discounting’ becomes apparent. The majority of operating leases therefore tend to be fully amortised over the term (a.k.a. Australian market in the 1990’s) with an inflated discount rate to achieve the necessary guidelines for off balance sheet finance under the International Accounting Standards.

But what about the future of leasing? As mentioned in my last article on Equipment Leasing in Asia, this will be driven by vendors and joint ventures that bring into the country their international experience. Certainly this is already emerging in Indonesia and they are well ahead of other countries in Asia such as Greater China, Korea, Thailand and even Singapore.

What else is on the horizon for our industry with regards to new products? I have spent 23 years in equipment finance in the UK, Australia and Asia and I have seen two recessions (early 1990’s and 2009) I have seen developed countries (Australia) grasp the equipment finance products with both hands and drive it to catch up to the European and USA markets.
One of the largest changes our industry now faces and this is not to say it is for the worse, we just have to know what to do with it, is Islamic Finance.

The fundamental aspect of Islamic Finance is that money can never attract interest charges under the Islamic Law (Sharia ) The basic principle of Islamic banking is the sharing of profit and loss and the prohibition of usury. Common terms used in Islamic banking include profit sharing, safekeeping , joint venture, cost plus and leasing .

Developing economies in Asia will expand 9.2 percent in 2010 compared with 2.6 percent for advanced countries, the International Monetary Fund said on July 7 2010.

As 62% of the worlds 1.6 billion Muslims live in Asia the development and growth of Islamic Finance will have a significant effect on regional finance which will undoubtedly impact aspects of equipment financing.