Leasing in Georgia: Challenges and Ways to Enhance the Sector

Interview with John Batty, Consultant at PMCG, as part of the project “Development of Alternative Financing for MSMEs,” within the Good Governance Fund (GGF) program, funded with UK aid from the UK Government.

How would you summarize the leasing sector in Georgia?

I think a good analogy, to put it in non-leasing terms, is to compare the leasing sector in Georgia to an airplane at the end of the runway, ready to take off.  It’s a modern airplane, well-serviced and maintained; the flight crew knows their jobs, but the plane hasn’t got a lot of fuel in the tanks. It can’t fly very far. It could maybe fly a couple of hundred kilometers but the passengers all want to go a few thousand kilometers. The leasing industry is similar. It’s ready to take off, but right now there are constraints that are preventing it from achieving what it’s been designed to do.

The original premise of the project was to look at the technical infrastructure to identify any fundamental problems that existed in the leasing sector and we didn’t find anything that was basically or fundamentally wrong. The legal framework is very clear. It’s based on the Unidroit international best practice.

The Civil Code in Georgia is also basically fine with respect to leasing. For the tax code, you know there are some little things, small tweaks, which we recommended that could be made just to improve a few things, but really these are just details. The important thing is that the framework and the infrastructure is there. So, it’s all ready to go, ready to take off if it was an airplane, but it doesn’t have the fuel to go very far; if given the fuel it can fly a long way. It could make a big difference to the national economy, but there are some factors which are still holding it back. It doesn’t have a lot of fuel at the moment.

So, what are the key factors hindering the growth of the sector? We know that you have had active consultations with local players. How do they assess the situation?

I think there are two things really to be said, and the first is perhaps not specifically a leasing issue. I think there was a perception that leasing is a primary driver of economic growth, or economic development. I don’t believe it is. I don’t see it that way myself. Leasing is an enabler, so if other conditions are right, primary conditions, then leasing as a secondary driver really can make a huge difference. But leasing itself does not create the primary conditions for economic investment and economic growth. Let me give you an example which we have observed: I think it was 2017 in Georgia when the Government decided it was going to invest in infrastructure projects. And at that time, there was a sharp increase in demand for construction equipment in order to take advantage of these projects that the Government was driving, and leasing then showed big growth in financing and the leasing of construction equipment. And that’s kind of the model. Whether it’s the public sector or the private sector is another discussion, but if the primary demand, driven by fundamental macro-economic factors, is there, then leasing is really ready to take advantage and support that primary demand by providing financing.

The cost of leasing, and especially the interest rates, is one major factor, of course. I think I would also say that the market is not as aware of the advantages of leasing as it could be. I think that this is an issue of financial literacy that is a general issue in an economy like Georgia, which is still at a relatively early stage of development compared to economies like those of the EU or the U.S. I just don’t think people are aware of the benefits that leasing can bring. And there is perhaps a psychological factor, which I understand; I know that a lot of people still prefer to own the equipment that they use, rather than lease it, where the leasing company is the owner. People want to be the owner themselves, they want to know that they are the legal owner of the equipment. People have to accept that there are advantages of not actually being the legal owner of the equipment though.

Another limiting factor is that there is a very limited secondary market in equipment, in Georgia. And that’s a really big problem for the leasing industry. Because, even though leasing companies are the legal owners of the equipment during the life of the lease transaction, after which the leasing companies have to dispose of the equipment. They have to sell it because they don’t have any further use for it. In most cases, they are not able to find another customer to lease it. They have to sell it, and there is a very limited demand in Georgia for this at the moment. We did talk to the main player in the secondary market and they told us that very often they have to find buyers for equipment outside of the country. They have to go to Turkey or they have to go to Azerbaijan, to look for external markets, because the internal, domestic demand from Georgian companies is very limited and that’s a big problem for the leasing companies. This factor is important, particularly if the leasing transaction ends early because the lessee is not able to fulfill the lease payments. And, in such a case, the leasing company takes back the equipment and to recover its original investment, it has to be able to resell it. And that’s a real challenge at the moment.

We can also say that the lack of a central registry for equipment being leased is a problem.  I know the Ministry of Justice is working on a project, which will cover banks and leasing companies. So, financing of fixed assets is going to be recorded in a central register, where anyone, any bank or leasing company, which is considering leasing some equipment can check with that registry to make sure that it has not already been financed. Currently, the registry is not effective so leasing industry players should agree to support the development of the registry to make the system workable.

Another thing that is missing is the inability of the leasing companies to speak with one voice to the authorities.  You know, in other countries, let’s use the UK as an example because I’m in the UK, albeit it’s generally true for many countries, the leasing companies work through a central association that represents their voices to the authorities, to the central bank, and to the relevant ministries. We don’t have an effective leasing association like that in Georgia. There is an association, but it’s not really active at the moment and I think it would be a big step forward if the leasing companies organized themselves in such a way that they could have one voice, and were united when talking to the authorities. So, really, there are lots of things which individually perhaps are not so fundamental but, taken together, if we could solve all of these individual problems, it would make a big difference.

How can an effectively planned and implemented leasing strategy contribute to overall economic development? Are there cases from other countries to bear in mind?

A good example is Estonia, which is not perhaps identical to Georgia but was still part of the old Soviet Union and it left the Soviet Union around about the same time that Georgia did. So, there are some similarities, and the Estonian economy has really taken off in the last 20-30 years. It’s grown very fast, and there are reasons for that. The leasing sector has been able to play its part. The logic there is that leasing is able to provide financing, which the banking sector may not be able to provide. How is that possible? Leasing uses the equipment itself as a form of security. The banks, when they take security, typically like to have fixed collateral, such as buildings, let’s say factories, that kind of thing. Here, the leasing company will say “OK, I know this equipment, this excavator, I know that over time it will retain its value and I can think of that as security for the lease that I’m going to write.” This is because if the client cannot make lease payments, the leasing company thinks “I own the equipment, it’s mine, so I take it back and I resell it and I get my money back.” That’s one area where leasing has an advantage over banking, and particularly for micro, small and medium enterprises (MSMEs) and that type of customers who perhaps do not have the factory or the premises or the land to give to the banks as security. That’s where leasing can really help.

Leasing can also look at the cash flow that the asset is going to generate. Let’s use the excavator as an example again and assume that there is a construction project where the entrepreneur knows that his equipment can be used to fulfill a contract. It’s a profitable contract and that gives comfort to the leasing company, specifically that the user of the equipment will continue to make all payments, because it is productive equipment that generates a cash flow and, as always, if you are generating a cash flow by using an asset, you want to have that asset and you want to be able to continue to use it. So, you will continue to make your leasing payments. Leasing companies can underwrite the financing with their expert equipment knowledge. So, in that sense, leasing is able to take risks, which the banking sector is not able to do. And, particularly, as I say, with the MSME sector of the economy, that kind of risk does exist. You know, the MSME type clients very often cannot get financing from the bank, but leasing should be able to provide that financing. So that’s the concept, and it’s been seen to work in other countries.

Based on international best practices, what would be the necessary steps to take to raise awareness about leasing as a tool for access to finance for MSMEs?

It needs some kind of PR campaign to explain to the business communities and the MSME communities the benefits of leasing. One way in which this could be led would be through the leasing association. One of the primary purposes of a strong leasing association in other markets, to go out into the business community and explain exactly how leasing works, what the advantages are, what the processes are, and to generally get the word out. But I think it’s also bigger than that because we’re talking now about the benefits to the national economy as a whole, not just for the leasing sector. We are trying to help the country’s economic growth and development. So, personally, I think that the government authorities have a role to play here as well. The Ministry of Finance perhaps could lead some kind of information campaign, in addition to the leasing association.

I also think that the banks have a role to play. As we all know, the main leasing companies in Georgia are owned by major banks. These banks have, as customers, the majority of MSME companies in Georgia, and they could also play a part in this by explaining to their customers that leasing is an alternative to borrowing and has some advantages. There are lots of things to be done, and it requires coordination and leadership, and within this industry, the leadership is not really there at the moment, because there is no single voice, as I said before.

It’s all about getting the message out to the market that there is a product here, leasing, which can really help individual MSME-type clients and together can really make a big positive difference to the growth of the economy, and that’s really what the authorities want to achieve, and that’s really why this project was started. We want to see the benefits that leasing can bring, not to the shareholders of the leasing companies, but to the country, to the people and to the Government as well. It’s important that the Government gets behind the necessary steps that have to be taken to get the message out. Leasing is a very helpful and useful financial tool to help grow individual businesses and, together, to grow the country’s economy.

But the biggest single problem facing leasing in Georgia is the limited availability of GEL funding at competitive rates.  All transactions valued at GEL 200,000 or less must be funded in local currency but the leasing companies do not have access to funding at the same rates as the banks and microfinance institutions, which makes leasing significantly more expensive than borrowing and hence renders it unattractive to potential clients.  The project team has made a number of recommendations that would improve the situation for leasing companies, so we hope to see some positive change in this area. After all, to continue the analogy from earlier, competitive funding for lessors is the fuel that the plane requires; at the present time, leasing companies do not have enough fuel to fly as far as their customers want. It is very much in the national interest to make the changes which the team has recommended and we hope to see the industry really flying high in the near future.

There are lots of things really that could be done here, and if all of these things could somehow be put into place, the plane at the end of that runway would have a full tank of fuel and could fly a very long way indeed.