As we continue to grapple with the public health crisis caused by the Ebola outbreak in the Mano River Union, there is an economic crisis on the horizon that may bring more hardship on the people of Sierra Leone. Iron ore prices have declined steadily over the past 12 months, from just over $135 a ton to about $70 a ton. The sharp drop in prices has created financial difficulties for small mining companies around the world and governments that are highly dependent on revenues from iron ore mining. The two largest iron ore miners in Sierra Leone are now financially distressed, with London Mining in Administration and the shares of African Minerals suspended from the AIM. The states of these two firms will have implications for their employees and their communities, suppliers, the government and the domestic banking system that provides short term capital to facilitate commerce. Aggressive expansion by major iron ore mining companies over the past few years has resulted in a supply glut in the global iron ore market. That increase in supply, combined with slower growth of the Chinese economy, the worlds largest consumer of iron ore, has triggered a slide in the price of the commodity globally. While the major miners who benefit from economies of scale, are able to weather the supply shock, many smaller mining companies are now faced with loss making operations, as market prices fall below their per unit production costs. Communities close to the two main domestic mining companies, that supply labour to the distressed mining firms will be directly impacted as the iron ore miners scale back operations. There will be job losses and reduced economic activity in these communities that have become dependent on income from miners. Also, domestic suppliers who provide goods or services to the mining companies will be badly affected. Most of these companies would have delivered goods or services on credit to the mining companies thereby extending unsecured credit lines to these mining firms. These debts are most likely subordinated to debt owed to international banks, meaning that they will only be paid after debt owed to international banks have been paid. In the immediate term, there will be a sharp drop in revenue the government of Sierra Leone gets directly from the mining companies and indirectly through domestic suppliers. This will have a direct fiscal impact in 2015 and it is likely that the government will be unable to reach revenue targets set for the upcoming fiscal year. The government may have to issue more domestic debt or seek additional external debt financing from one or more multilateral financial institutions. If the government is unable to use debt financing to make up for the revenue shortfall, it would have to make budget cuts as a result of reduced revenues. These budget cuts would have an impact on economic growth. In addition, as mining companies put expansion plans on hold, government revenue from iron ore miners in the following fiscal years may be drastically reduced, posing a risk to the fiscal expansion plans that the government has embarked on over the past few years. The government would either have to rein in spending or sharply increase public debt over the next few years. The implications for the banking sector depends on the direct exposure domestic banks have to the mining sector. Over the past few years, banks have been competing to get a piece of the mining action. Given the combined size of the two main iron ore firms is as large as the rest of the Sierra Leonean private sector, banks may have been heavily exposed to the mining sector. The domestic bank debts accumulated by the mining firms are also most likely subordinated to debts owed to international banks. Domestic banks with huge exposures to the mining companies may have to take large losses. Also, banks may have extended unsecured credit to many domestic suppliers of the iron ore firms, creating a indirect exposure that could be costly if suppliers start defaulting on loans because they are unable to collect debts owed by the iron ore firms. These defaults could mean more losses for our domestic banks. The extent of these second order losses depends on the volume of the unsecured loans that have been extended to suppliers of the mining sector. Authorities should pay close attention to exposure of domestic banks to the mining sector, to avoid a crisis that would happen if depositors lose confidence in the banking system. Otherwise there is a risk that one or more banks could collapse. The possibility of collapse could undermine confidence and trigger bank runs, as customers, knowing that their deposits are uninsured, could rush to withdraw their savings. Bank runs would lead to the collapse of one or more banks, since banks, as intermediaries, are unable to accommodate massive simultaneous withdrawals. A banking crisis would disrupt access to short term funding for traders, importers and exporters. Access to credit could dry up and interest rates may rise. Increased financing costs would reduce competitiveness of exporters and increase costs for traders, who would pass on those costs to consumers, by increasing prices of basic commodities. Without adequate funding, importers may cut down on the volume of imports and prices of basic commodities may rise rapidly because of shortages. Rapid inflation would bring more hardship on the people of Sierra Leone. Hopefully, authorities are prepared to take steps needed to prevent a banking crisis. Banks that are heavily exposed to the iron ore mining sector should make provisions large enough to absorb potential losses. Those that cannot meet capital requirements after making such provisions should be forced to raise additional capital immediately. ©Jiwoh Abdulai
Posted on: Mon, 29 Dec 2014 23:57:44 +0000