GROW Project. The Case for Longer-Term Loans in Uganda's High-Interest Market.
August 29, 2024
In a country like Uganda, where we are accustomed to high interest rates—borrowing from commercial banks at rates as high as 18%, 19%, and even above 20%, particularly for unsecured loans—it is noteworthy when projects emerge offering more favorable interest rates. GROW Projects rates are capped at 10.5%, even on a reducing balance from some banks and it’s a commendable but that’s one side of the coin. When you consider other lending sources such as microfinance institutions and loan sharks, where rates can soar to 30% per annum, the introduction of such projects is seen as a significant benefit. They provide a much-needed respite from the exorbitant loans available to the people especially this one targeting women.
One crucial aspect of loan terms is the repayment period. A short-term loan can create immense pressure on cash flows. For a business borrowing, let's say, 100 million Ugandan shillings, it is always advisable to negotiate for a longer-term loan rather than a short-term one. A longer repayment period, perhaps with a grace period of three months before repayments begin, can be far more manageable than immediate repayments but what the GROW project has done to cap loan periods to a maximum of 24 months is counterproductive to the very service they are trying to solve.
The efforts by initiatives like GLOW Project to lower interest rates for women-led businesses are commendable. However, favorable terms should not be limited to interest rates alone; they should also extend to the duration of the loan. Considering that World Bank-sponsored projects can have funding periods of 30-40 years, it begs the question: Why can't the loan terms be extended accordingly? A longer repayment period, although it may result in paying more to the bank over time, is preferable to the strain of repaying a loan within 24 or 12 months. Such short-term loans can place undue stress on a business's cash flows, with the majority of revenue being funneled back into loan repayments.
Consider a business that borrows 100 million shillings with only 12 to 24 months for repayment. There is a 70% likelihood that after the 24 months, they will need to borrow again. The chances of effectively utilizing the loan within that period are slim, and the constant repayment demands can stifle the business. In contrast, a longer repayment period reduces the monthly payment burden, allowing businesses to retain cash flow for reinvestment and growth.
Now, let's look at the repayment schedules for different loan terms:
From the table above, it's clear that extending the loan term from 18 to 36 months nearly halves the monthly repayment amount. If a business generates a revenue of 8 million shillings and only needs to pay 3.7 million shillings monthly, it retains 5 million shillings to reinvest and grow while servicing the loan. This is a stark contrast to a scenario where nearly 80% of revenue goes towards loan repayment.
Very few businesses in Kampala can inject 100 million shillings of working capital and see their revenue streams double within three months. It takes time for such growth to manifest. Therefore, offering businesses a longer repayment period allows them to stabilize their cash flows and grow sustainably. A 24-month term might require a monthly repayment of 4.6 million shillings, but doubling the term to 48 months reduces the monthly burden by 1.7 million shillings. Extending the term to 72 months means only paying 2.3 million shillings per month.
Globally, we observe that long-term business loans of six to ten years are offered to give companies the breathing room to expand their revenue base while managing loan repayments at a sustainable level. If a 10-year loan is an option, it is wise to choose it over a five-year loan. The longer term limits the strain on cash flows, allowing for smaller monthly payments. Even in months when revenue is lower, businesses can still meet their loan obligations without the intense pressure of a short-term, high-repayment loan that could potentially cripple the business. Spreading out cash flows over a longer period is often a more prudent approach to business financing.
Alex Kakande
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