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Trade finance key to President Magufuli’s industrialisation agenda for Tanzania

2016-11-29 13:00:34

By Paul Kibuuka

"Trade finance instruments like Letters of Credit (LCs) are crucial to unlock the entrepreneurial potential amongst Tanzanians and to “smooth” Tanzania’s path to industrialisation", Paul Kibuuka, Managing Partner at Isidora & Company Advocates.

Dar es Salaam. In what came to be widely described as a powerful speech for the inauguration of the 11th Parliament in Dodoma on 20th November last year, President Dr. John Magufuli gave a new impetus to the case for industrialisation in Tanzania, profusely stating industrialisation will form a fundamental linchpin to his plans for the country’s economic transformation, and hoped that the industrial sector would generate 40 per cent of all new jobs by 2020.

Augmenting the President’s plans, five months later, in April this year, while presenting the second Five-Year Development Plan (FYDP II) spanning fiscal years 2016/17 to 2020/21, the minister for Finance and Economic Planning, Dr. Philip Mpango, also told Parliament that the government of Tanzania will execute a Tshs107trn comprehensive package of development projects, including the establishment of an industrial economy.

The government started implementing the ambitious FYDP II, together with the Tshs29.5trn National Budget for 2016/17, on July 1.

Many will agree that President Dr. Magufuli’s industrialisation agenda for Tanzania is unmistakeably in line with the UN’s 2030 Sustainable Development Goal 9 (“Build resilient infrastructure, promote inclusive and sustainable industrialisation and foster innovation”).

However, for Tanzania to smoothly tread its path to industrialisation, the government and the private sector must promote and support effective trade finance, which is pivotal in achieving trade development. This will, in turn, help catalyse industrialization in Tanzania and make the country to attain superior significance in not only African, but also global affairs through the growth of factories and creation of jobs.

But what precisely does trade financing mean? Plus, why should it matter to the industrialisation agenda?

To illustratively answer these germane questions, picture this: You are a processor of mouth-watering cashew nuts in Tanzania’s southern region of Mtwara, and you have just received a $3.0m purchase order for your processed nuts in 2017 from Woodstock Farms, owned by United Natural Foods (UNFI), the largest wholesale distributor of natural and organic foods in the U.S. That’s assuredly positive news for you.

The challenge, however, is that you will need to procure a large quantity of raw cashews from farmers through the Warehouse Receipts System (WRS) and auction and, perhaps, some more machines from a company based out of Vietnam in order to increase your processing capacity and satisfy that order. Now, this will cost you money as the supplier in Vietnam will require a big sum in advance, and this can hinder your cash-flow.

Nevertheless, you could find help in bank-intermediated trade finance whereby your bank right here in Tanzania pays your supplier in Vietnam, and the bank then collects from your customer, Woodstock Farms. The bank charges you a fee or commission (and may ask for some cover or collateral to mitigate the risks involved) for the service provided and you retain the remainder.

A shortage of such effective trade finance is a reality holding back the competitiveness of Tanzania’s manufacturing sector. This reality and the degree to which the possibility for domestic value addition is left unexploited are glaringly typified by the country’s trade in cashew nuts.

While according to 2012 statistics from the UN’s Food and Agricultural Organisation (FAO) Tanzania ranks as the eighth largest producer of cashew nuts in the world and is Africa’s biggest grower after Nigeria, Cote d’Ivoire and Guinea-Bissau, a recent report by the African Cashew Initiative shows that of the 145,000 MT that Tanzania produced in 2015, raw cashew nut (RCN) exportation, mainly destined for India, was 135,000 MT.

This means that only 7 per cent or 10,000 MT was processed locally, missing a big opportunity to add value domestically, industrialise and create jobs.

Some empirical research studies to come out recently show that developing countries’ manufacturing industries which are intensely assimilated into global production processes attain higher economic growth. In light of this, SMEs – the backbone of the Tanzanian economy – must be assimilated into global production processes if Tanzania is to benefit from such growth opportunity and promote sustainable industrialisation throughout its economy.

This will require the government of Tanzania to promote and support bank-intermediated trade finance activities in Tanzania, which are vital for SME access to working capital and credit insurance against global trade risks e.g. price or currency variations.

Notably, more than 60 per cent of respondents to a Kibuuka Law Chambers survey conducted in Dar es Salaam between May and July this year stated that access to trade finance is one of the biggest hurdles to taking part in production processes. 80 per cent of respondents also recognised a role for the Bank of Tanzania (BOT) in easing access to affordable trade finance solutions.

The survey follows on the heels of a World Bank Group study in 2015 which suggests that over 50 per cent of SMEs lack steady access to bank credit facilities, limiting their successful assimilation into production processes.

Incidentally, a 2016 WTO report “Trade finance and SMEs: Bridging the gaps in provision” indicates that the trade finance gap is especially striking in Africa, where estimates from the African Development Bank (AfDB) put the value of unmet demand for trade finance at between $110bn and $120bn.

Although the government of Tanzania has, over the past couple of years, introduced reforms to help develop the country’s economic and financial system, including strengthening the Small Industries Development Organisation (SIDO), it is still difficult to find cheap trade finance for SMEs.

“Stringent lending conditions and higher interest rates [ranging between 15-25 per cent], pose a momentous problem to assimilating Tanzania’s manufacturing SMEs into the global trading system and to benefiting from export-led industrialisation”, says Mr. Isdore Shirima, an economist and long-serving retired Regional Commissioner, who was once in charge of Tanzania’s cashew growing region of Mtwara.

To continue on its path of industrialisation, Mr. Shirima agrees that tapping into the AfDB’s existing Trade Finance Program (TFP), which guarantees trade finance instruments, such as Letters of Credit (LCs), issued by Tanzanian banks, will help address the market demand for bank-intermediated trade finance in the manufacturing sector.

The government of Tanzania, in particular the BOT, under the auspices of the ministry of Finance and Economic Planning, and the ministry of Industry and Trade have a key role in promoting industrialisation through trade by supporting effective trade finance. The BOT and regional development banks of which Tanzania is a member (e.g. the Eastern and Southern African Trade and Development Bank/PTA Bank) as well as international financial institutions (e.g. the International Finance Corporation/IFC) should unceasingly work together with the WTO to develop and launch new initiatives to help support trade finance in Tanzania and other countries.

Moreover, in order to tackle more effectively the challenges related to trade finance in Tanzania, the government should also strengthen its SME programmes; place bigger emphasis on trade finance for the assimilation of SMEs into production processes; raise awareness about existing trade financing gaps and hold discussions with a broad spectrum of stakeholders, including the Confederation of Tanzania Industries (CTI) membership; encourage and assess efforts by commercial banks in addressing the gaps; and ensure the existence of lending standards and interest rates that serve the needs of the manufacturing sector - an engine of growth and industrialisation in Tanzania. Perhaps, as reported in the media recently, the goodwill proposal by commercial banks in neighouring Kenya to set aside over Ksh2trn or $20bn (approximately, Tsh43.7trn) for financing SMEs at concessionary rates instead of the Central Bank of Kenya setting interest rate caps is an example worth emulating in Tanzania as it treads the path to industrialisation.

Paul Kibuuka is the Managing Partner of Isidora & Company Advocates. Email: paul.kibuuka@isidoralaw.co.tz Twitter: @isidoralaw

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