MICROCAPITAL STORY: Uganda’s Construction Sector Suffers from Soaring Interest Rates, Microfinance Institutions (MFIs) May Hold the Key

African Alliance, a group which provides investment banking services across the African continent, recently released a report on Uganda’s construction sector which found that, despite unprecedented growth, the industry is being threatened by financial risk. To mitigate the likelihood of default, most financial institutions charge construction firms high interest rates coupled with short repayment periods. However, the increasing number of players, particularly microfinance institutions (MFIs), is expected to help drive down interest rates.

African Alliance has been in Uganda since 1997, but Africa Alliance Uganda was formally established in 2002 after the passing of the Collective Investment Scheme Regulations. It currently offers asset management, corporate advisory and securities services to clients which include major corporations, the Ugandan government, NGOs and individuals.

In the past five years, the construction sector has experienced an average growth rate of 12.8 percent, more than double the national average for the same period. However, due to various problems in the sector, credit institutions view financing construction projects as risky. According to Renaissance Capital, Ltd., a local stock brokerage firm, Uganda’s construction sector is faced with significant barriers to entry due to high capital requirements. Consequently, most construction companies which are established suffer from low liquidity because the high capital investment demands leave them with little money for working capital purposes.

Locally-owned construction companies are also affected by high levels of inefficiency – often caused by antiquated equipment – and scarcity of resources, which leads to low output, decreased profit and reduced growth. Political uncertainty and lack of strong industry regulations also contribute to instability and poor quality. Incidents of collapsed buildings and the sale of substandard construction materials are common in the sector.

Compounding these difficulties is the fact that financing construction is a particularly complicated exercise for investors. As a result, construction companies and manufacturers of building materials are facing problems raising funds for their operations. This in turn restricts expansion of capacity, slows down projects and leads to low output of finished work.

According to Edith Tusuubira, country manager of Oikocredit, competition will help to bring down high interest rates among formal finance institutions just as it has among MFIs. Development finance institutions typically charge 14 percent interest for construction projects, while banks charge 19 percent. Average interest rates among MFIs, while still high, have fallen from 36 percent in 2005 to approximately 25 to 30 percent today.

Oikocredit is a development finance institution and one of the largest financiers of microfinance worldwide. As of December 2006, it had 11 regional and 18 country offices worldwide, and EUR 320 million (USD 472 million) in total assets.

Additional Resources:

NationMedia.com: “Financiers shy away from construction’s high risks.”

African Alliance

African Alliance: Uganda

Renaissance Capital, Ltd.

Oikocredit

Oikocredit: Facts and Figures

Bloomberg.com: Currency Calculator

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