*This article appears in an extended form in the Rwandan Banker Magazine August 2018 edition*
Supply chain finance (BeneFactors Ltd.’s key product) is a fundamental piece needed to achieve economic growth in the Rwandan context. This is because supply chain finance is a form of working capital, or liquidity, which, when not readily available as is the case in Rwanda, limits the extent to which other resources are utilised, hindering overall growth. This article sets out a number of strategies that companies may use to acquire working capital, analyses their viability for the average Rwandan firm and suggests ways to deploy them to boost growth.
The government’s new National Strategy for Prosperity (NST) seeks to promote competitive value chains. Promoting access to finance is naturally a central piece of this work, most of which is centred around making capital available for investments. However, another potentially very effective way to support the emergence of competitive value chains is to increase liquidity and the availability of customised working capital products. Access to working capital is arguably even more important than investment capital in order to maximise returns on investment and to trigger economic growth.
Comparing different types of working capital products, non-debt supply chain finance (SCF) products – such as factoring and contract finance – appear to hold the biggest immediate potential for the Rwandan economy. The government should therefore seek to promote the emergence of this kind of finance, which may be done relatively easily by providing regulatory space for innovation and strengthening the enforceability of supply chain finance contracts. Such facilitation could increase overall capacity utilisation drastically and by extension reap enormous benefits in terms of faster economic growth, higher employment and increased exports.
Economists consider capacity utilisation an indicator of economic efficiency and productivity. It measures how much companies produce as a share of what they could produce if they were running at maximum effort. Since companies usually have economies of scale, they become more efficient the higher their rate of capacity utilisation. As higher efficiency translates to better competitiveness and therefore faster growth, policy makers tend to see an increase in capacity utilisation as a valuable economic objective.
Imagine a soap manufacturer with a plant that can produce 2 metric tons (MT) of soap per week, but is currently only producing 1MT per week. The company is running at 50% capacity and could produce more without buying any new equipment or building a new factory. If they were to increase production to 2MT they would increase turnover, demand for employment and most likely their profits. This would be good for the economy as output increases and jobs are created – even if investment does not increase.
Capacity utilisation hardly ever reaches 100% due to a number of constraints. Companies tend to keep some extra capacity to be able to respond to demand seasonality or unusual demand peaks; machinery needs repairs from time to time; and capital is indivisible, meaning that our soap manufacturer might not have been able to buy machinery at 1MT weekly capacity – maybe the smallest machine available produces 2MT. Capacity utilisation therefore tends to be peak around 80-90%, even in the most efficient economies and companies.
In low income countries, however, capacity utilisation can be as low as 20%. The reason for this is that in addition to the above universal constraints, developing countries tend to face additional supply-side constraints, such as poor infrastructure, inefficient markets for raw materials, forex shortages that restrict importation of inputs, political instability, high transaction costs and lack of access to financial liquidity, i.e. working capital.
If our soap manufacturer has to deal with frequent power cuts, cannot source her inputs reliably or has to worry about theft and riots, then her equipment and team will not be working full-time. Likewise, if her clients take three months to clear their invoices and the bank then take a week to process payments and she does not have enough working capital to keep machines running in the meantime, the factory will be lying idle while she waits for payments
Supply-side-induced low capacity utilisation tends to hurt small companies more than large ones, since the latter are better able to cope by buying their own generator in case of power cuts and have more resources for working capital etc. Supply-side constraints therefore also give rise to a peculiar pattern found across Sub-Saharan Africa, whereby small companies tend to grow slower than large ones – mathematically, this should not be the case since a small entity should grow at a higher rate than a large one, because they are starting from a lower base.
Getting data on capacity utilisation in Rwanda is tricky, but we do know that:
· In 2011, 38% of industrial firms operated below 50% capacity
· In 2013, average capacity utilisation in manufacturing was estimated at 50% weighted by turnover, but going as low as 12% for certain sub-sectors
· In 2017, labour utilisation stood at 42%
The above surveys all found that access to working capital is the main driver of low capacity utilisation in Rwanda, followed by inefficient markets for inputs. The example above of the soap manufacturer having to wait for payments to be able to prepare the next order is the reality of the vast majority of Rwandan companies. This means that a huge growth potential is not being realised, because machinery and people are sitting idle – and growth could be increased without needing any further investment.
Rwandan firms struggle to access all types of finance from formal financial institutions. However, accessing working capital is particularly challenging, with 47% of firms struggling to do so. There are broadly seven strategies that firms can utilise to access working capital – four of which are already commonly available on the Rwandan market, while three are not. Considering each in turn briefly, we can observe that one of the strategies not commonly available currently has particularly high potential to improve capacity utilisation.
Cash and retained earnings
Most companies start out with some cash and use it to cover their working capital needs to some success. However, a fast-growing company will quickly reach the limits of this. Many founders are unlikely to have enough funds to cover working capital as well as capital expenditures in the early days of their company, and cash from earnings will only grow at the rate of profitability, which will rarely be sufficient. Further, in lines of business where demand is seasonal or fluctuates, keeping cash idle during downtimes is managerially difficult and comes with high opportunity costs. The value of cash also erodes with inflation, making companies keen to quickly turn to other sources of cash.
Advances from buyers and payment on credit to suppliers
With this strategy, a company can delay the point in time they have to pay for their inputs, while bringing forward the time they themselves get paid. While globally very common, it is a strategy which may only be available in certain sectors and depends on the relationships a company has with their buyers and suppliers. Not all buyers are willing to help their suppliers out this way, and not all buyers are able to delay payments to their suppliers. For example, agricultural aggregators and processors are rarely able to deploy this strategy, since they buy from smallholder farmers and cooperatives who cannot wait for payments while supplying supermarkets, hotels and export markets which typically only pay after 30, 60 or even 90 days. Further, Rwandan business culture is not one where payment terms are strictly adhered to – rather suppliers tend to be at the mercy of their buyers’ goodwill and cash flow positions. The biggest buyer is of course the government itself, whose payment behaviour directly affect contracts worth as much as 12% of GDP – more in key sectors such as construction and ICT.
Short-term lending instruments
Bank-intermediated short-term lending instruments include overdrafts, working capital loans, invoice discounting and company credit cards, which are structured as a liability to the firm itself. Commercial banks in Rwanda are both liquid and profitable, meaning they should be able to channel additional funds towards working capital products to meet the demand. However, debt instruments are subject to banks’ lending requirements, most notably the need for fixed asset collateral as well as good historical records – and the banks’ private sector assets are almost entirely debt instruments. This automatically disqualifies the majority of Rwandan firms who do not own collateral, are only just starting up or are not able to produce verifiable company records. Furthermore, the modus operandi of Rwandan commercial banks is not conducive for meeting working capital needs: cash flow constraints tend to be short-term, highly time-sensitive and requiring flexibility to suit a company’s business cycle. Commercial banks in Rwanda typically take weeks or even months to process an application, have either fixed repayment terms that are unlikely to be renegotiated or only offer a maximum of 90 days’ settlement time when non-fixed. Thus, combined with the general inability to access debt instruments in the first place, commercial banks are not currently meeting the working capital needs of most firms. This may of course be improved, both through BNR policy and implementation, but will require a fundamental cultural shift in the commercial banking sector towards expediency, flexibility and a higher risk appetite. Microfinance institutions (MFIs), while easier to access for firms and more flexible, typically limit their credit lines to a few million francs which is insufficient for all but the smallest firms.
Faced with limited options, many Rwandan companies thus turn to the ever-present informal moneylenders, the Banque Lamberts, for a quick and flexible, yet expensive, alternative. Despite their illegality and often extortionate practises, they are very common in the economy and their very existence is a clear indication that there is an un-serviced demand for quick and flexible financial services that is not met by deploying the three strategies above. Interestingly, moneylenders also tend to have high collateral requirements – a car, land etc. – meaning that those seeking their services theoretically should have access to bank-intermediated debt products but clearly find that those products do not service their needs. It is particularly the slow processing time of banks that make companies turn to moneylenders – working capital needs can arise with extreme urgency when an essential piece of machinery needs repairs, a new opportunity presents itself or a buyer unexpectedly delays payment.
Corporate debt papers
Financial instruments such as commercial papers, promissory notes and corporate bonds are essentially documents denoting indebtedness by the company to whomever holds the paper and can in theory be traded freely amongst investors. They are typically unsecured or secured only with movable or intangible assets. Realistically, debt papers are only an option for companies able to demonstrate high creditworthiness to institutional or private investors through processes similar to those required to list on a public stock exchange, and even then, only in markets where there is a critical mass of investors interested in buying such papers. While any company may theoretically issue a corporate debt paper, the ability to sell one would be highly limited in Rwanda, both due to unfamiliarity and lack of interested investors – except perhaps to the informal moneylenders.
The fintech revolution transforming finance everywhere promises enormous potential for companies with working capital needs. Crowdfunding or peer-to-peer (P2P) lending platforms, merchant cash lending (i.e. advances against POS machine earnings), and loans based on company metrics derived from tax data are all examples of new innovations that companies can tap into in market where such service providers have emerged. For the Rwandan market to reap the benefits of the fintech revolution, however, it will be necessary to first reach near zero transaction costs on money transfers, implement innovation-friendly financial regulation and, perhaps most importantly, for the banks to wake up to the advantage that fintech collaboration offers them as a way to gain market share – all features that have been necessary conditions in markets where fintech is blooming. While Rwanda is making good progress on all these fronts, there is still a significant gap to be filled before Rwandan companies can rely on new innovations as a major source of their working capital.
Supply chain finance (SCF)
Compared to the strategies discussed above, SCF products have the most potential to immediately increase capacity utilisation in Rwanda. SCF is akin to partnering with a moneyed family relative and splitting profits according to efforts. When formalised, SCF is often provided by non-bank financial institutions, most notably factoring firms and professional contract financiers. Rather than lending money to companies, these institutions actually partake in the supply chain, providing cash against future payments from reputable buyers, allowing companies to access finance through leveraging the creditworthiness of their supply chain partners and installed capacity, i.e. the investments they have already made. Globally, SCF is an enormous sector, totalling €2.4tr in 2015, or about 3% of global GDP. SCF is yet to take hold on the African continent outside South Africa, which accounts for more than 90% of the African market of about €24bn, with Nigeria and Kenya accounting for most of the rest. The fintech revolution has of course also transformed this product and extended its available to previously excluded companies, yet unlike most fintech products, SCF is centuries old and may be deployed with little to no ICT technology.
SCF is fundamentally different from commercial banking in that repayments come from realised cash flows as opposed to fixed repayment schedules. SCF providers are therefore able to offer a highly customised and flexible source of finance and SCF is found to have a causal effect on trade, whereby a 10% increase in SCF may increase trade by between 0.5% and 1%. SCF is operationally somewhat more complex than corporate lending in that the financier has to consider the stability and creditworthiness of the entire value chain, rather than just the company seeking finance. Structurally it does not require collateral nor specific infrastructure apart from the ability to transfer money smoothly – reaching near zero transaction costs for money transfers will thus greatly facilitate SCF. Regulation-wise, SCF is facilitated by a legal environment that enforces contracts and property rights as well as a legal precedent and business culture that enables the assignment of payments to third parties. The latter is not currently common in Rwanda, yet the Government’ position as the economy’s largest buyer may be leveraged to generate common acceptance of assigning payments and supporting suppliers to access finance. The benefit of doing so is clear since SCF is especially well-suited for SMEs and companies without collateral but participating in formal value chains. This is because all SCF requires are formal, enforceable supply contracts and evidence of supply chain history.
The Rwandan market is only just becoming conducive to the emergence of SCF, facilitated by the widespread adoption of corporate bank accounts, which can provide the necessary paper trail on which a SCF provider may gauge the stability of a value chain. Investments in installed capacity and the increased occurrence of credit sales have also created demand for SCF services to smoothen cash flows and maximise returns on investments made. Thus, as the country continues to attract investment and generate more installed capacity, the demand for SCF to utilise this capacity to its fullest is also likely to increase – as is the national imperative to ensure the country generates the highest return possible on its investments.
The Rwandan economy has increased its installed capacity significantly in recent years. However, the economy continues to run on half steam, due to low utilisation of that capacity, especially due to lack of access to working capital. The widespread existence of informal moneylenders illustrates the existence of unmet demand and inefficiencies in the financial sector. While there are many types of working capital products that may be introduced in Rwanda, the most promising is non-debt supply chain finance (SCF) products such as factoring and contract financing.
Promoting SCF in Rwanda will first and foremost require that BNR provides the regulatory space for new market entrants to operate and innovate. Luckily, BNR has indicated its willingness to do exactly that, partnering with service providers and technical experts to provide such ‘sandboxing’ space. Continued investment in the rule of law and contract enforcement mechanisms is also needed, as SCF agreements tends to be written as complex business contracts and may need additional legal backing to hold in courts. Many countries have specific SCF or factoring laws to achieve this, and the Rwandan regulators will need to assess whether possible gaps in current regulations exists and need to be filled. Continued investment in payment infrastructure to reduce transaction costs will further facilitate the emergence of a vibrant SCF sector, while at the same time laying the ground work for reaping the benefits of the fintech revolution. Such policy actions have the potential to significantly move the needle on overall capacity utilisation and ultimately economic growth.
 Dagdeviren and Mahran, 2010, A tale of industrial stagnation from Africa, International Review of Applied Economics, 24 (4), p495-510. http://uhra.herts.ac.uk/bitstream/handle/2299/6526/903024.pdf?sequence=2
 MINICOM, 2011, Industrial Survey
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 BNR, 2017, 2015-16 Annual Financial Stability Report.
 BCR Publishing, World Factoring Yearbook 2016.
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