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