Peeking behind "China's Debt Trap Diplomacy"
What links Kenya, Pakistan and Sri Lanka? China, predatory practises and developing economies.
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Filtered Kapi Newsletter #8
In the previous newsletter, we looked at the security framework underpinning BRI projects in Central Asia and Djibouti.
This time we examine whether the projects were feasible, what is the purpose of the investment and where do they stand now.
Let’s look at Kenya, Pakistan and Sri Lanka.
Kenya
A trans national railway in Africa was a flagship project of the BRI.
It would connect Kenya to Democratic Republic of Congo, Rwanda, South Sudan, and Uganda.
Once built the landlocked countries would have a direct connection to the port in Mombasa (Kenya). Reliable access to a port would be a boon to exports as well as travel to and from the region.
Picture courtesy: Bloomberg features
The first phase of the project was a railway line connecting Mombasa to Nairobi (Kenya’s capital). It was completed at a cost of $3.2 billion, secured primarily from Chinese lenders.
Funding required to extend the line from Nairobi to Uganda was not forthcoming. Kenya’s worsening debt to GDP ratio increased questions about the profitability of the project. Allegations of debt trap diplomacy being practised in Africa harmed China’s reputation in the international community.
Did the railway line make financial sense?
Due to a lack of infrastructure, there is limited trade within the landlocked nations. Connecting major cities via railways would reduce transportation time and costs boosting intra trade and exports via Mombasa port. But,
At $5.6 million per kilometre for the track alone, Kenya's line cost close to three times the international standard and four times the original estimate. To service the loans taken for construction the fares charged for goods and people were exorbitant.
The lower demand for freight resulted in revenue of $126 million in 2019 as against the operating cost estimated to be $170 million. Hidden operating costs, high interest rates and a closed bidding process reduced the profitability of the project.
A 2013 World Bank study predicted that freight traffic on the entire East Africa Community rail network would grow to approximately 14.4 million tonnes per year by 2030.
The same study found that investment in a standard gauge railway appeared "only to be justified if the new infrastructure could attract additional rail freight in the order of 20-55 million tonnes per year".
By that measure, the railway would need to win all of the freight currently trucked to and from Mombasa - and more.
To keep up with the facade of prosperity the government forced all importers/ exporters to move goods via the rail instead of trucks.
What if Kenya fails to pay the loan?
If Kenya fails to repay loans advanced by Chinese lenders then it risks losing the lucrative Mombasa port. Terms of the loan specify that the port’s assets are collateral, and they are not protected by Kenya’s sovereign immunity due to a waiver in the contract.
World Bank modelling suggests that the debt burdens associated with BRI will outweigh the growth effects for certain developing countries. Ratings agency Moody’s has warned
Countries rich in natural resources, like Angola, Zambia, and Republic of the Congo, or with strategically important infrastructure, like ports or railways such as Kenya, are most vulnerable to the risk of losing control over important assets in negotiations with Chinese creditors.
Implications of the railway line
The railway line is the country's biggest infrastructure investment since its independence in 1963, attracting massive interest at home.
Since its opening in 2017 the railway line has been mired in controversy ranging from ticketing fraud, bribery accusations and land grabs with one estimate approximating a loss of $10,000 day.
Furthermore, the Chinese have not enabled knowledge transfer to Kenyans. The investment which was to meant to empower Kenyans has fuelled racism and discrimination. Kenyans are treated as second class citizens in their own country.
On May 12, the IMF raised Kenya’s risk of debt distress from moderate to high due to the impact of the coronavirus crisis.
Kenya owes $6.5 billion to China, 21.9% of its total external debt. It is already using a third of its revenue to service that borrowing. To ensure stability Kenya needs to restructure its debt with China.
Pakistan
To decode the web of Chinese investment in Pakistan we have to look at Gwadar; a remote scratch of land on Pakistan’s southwest coast. The city of 140,000 is closer to the Iranian border than to Karachi, a 10-hour drive away.
The idea is to connect Western China to the Arabian Sea via highways, railroads, ports, and airports. The Port serves as a land-based route for oil and gas coming in from Middle East and Africa. This saves time and reduces China’s dependence on the Malacca Strait.
Plans for Gwadar called for roads, railways, pipelines, dozens of factories and the largest airport in Pakistan.
To enable this construction, Pakistan needed power generation capabilities leading to the China–Pakistan Economic Corridor (CPEC) including those as well. Estimated costs for the projects ballooned to $62 billion.
But only half of the announced $62 billion-worth of projects in Pakistan are under way as Islamabad scales back its financial commitments while it implements a $6bn IMF bailout package.
For the CPEC to succeed Pakistan needs basic infrastructure in the form of roads, highways, and power generation capabilities to boost local trade and increase economic independence.
But, corruption, security issues and fears of a debt- trap have hindered progress.
Corruption in the bureaucracy has led to public distrust in projects. A committee set up to examine the high cost of electricity found glaring overpayments made to Chinese owners.
Dire Economic Situation
Pakistan faces structural problems- systematic corruption hinders development. Its balance of payment crises in 2018 is a result of poor governance which enables corruption.
In 2019, Pakistan received a bailout from the International Monetary Fund, and its economy mostly appeared to be moving in reverse: growth slowed to 3.3 percent, inflation hit a five-year high, and deficits soared.
The CPEC is not responsible for all of Pakistan’s troubles, but it has exacerbated long-standing challenges. Gargantuan projects were funded to make the CPEC a success without concern for financial stability.
Pakistan is expected to pay $40 billion in debt repayments and dividends to China over the next two decades. These payments are being made at the expense of the Pakistani taxpayer.
COVID-19 has added fuel to a raging fire. Pakistan has sought an extension of a debt repayment period on $30 billion in loans. China agreeing could save Pakistan around $500 million in annual cash flow.
Sri Lanka
Politicians often put debt-trap diplomacy, China and Hambantota together.
To untangle China’s plan, we have to look at Sri Lanka’s debt load and the port separately.
China has been the largest supplier of arms to Sri Lanka since the 1950’s. Under guidance from Sri Lankan President Rajapaksa, defence and security cooperation between the two countries intensified during the Sri Lankan civil war. During this period, he relied on China for economic and military support.
President Rajapaksa is credited with ending the civil war in 2009 albeit with a devastating record of human right abuses. With a firm control on power the President and his family controlled ~80% of all government spending.
Picture courtesy: South China Morning Post
The port built in the President’s home district is viewed as a vanity project. With space to expand the thriving port in Colombo there was no demand to construct another port. Lenders such as India refused to fund the project questioning the need for a port.
Along with the port came an international airport and a cricket stadium with Chinese funding and contractors.
Construction of the port was rushed to mark the occasion of the Presidents 65th birthday. The Hambantota port opened in an elaborate celebration on Nov. 18, 2010.
In 2012 the port only drew 34 ships. Construction costs soared as port expansions continued, only to fulfil Mr Rajapaksa’s dream.
Mr Rajapaksa utilized the free flowing tap of Chinese money to fuel his re-election campaign.
Corruption along with wasteful projects resulted in Sri Lanka’s debt increasing threefold within 10 years.
Unable to service its debt obligations, the Sri Lankan government handed over the port and 15,000 acres of land around it for 99 years for $1.12 billion.
Was the port a debt trap from the start?
An equity stake in the port was sold in 2017. Sri Lanka was in dire economic stress leading up to 2017.
The largest portion of Sri Lanka’s foreign debt was international sovereign bonds, which amounted to 39% of the total foreign debt as of 2017. These are commercial borrowings obtained from international capital markets since 2007, and such bonds have resulted in soaring external debt servicing due to the nature of the debt.
Data from Ministry of Finance, Sri Lanka as on end of 2017- The Diplomat
Furthermore,
This balance of payment crises is a reflection of the external economic crisis Sri Lanka faces which is more alarming than the “debt trap” of the port.
Fast Forward to 2020
Sri Lanka must make $4.8 billion in debt repayments in 2020.
Sri Lanka’s debt to China amounts to only 6% of GDP. Rather, Sri Lanka has a general debt problem, owing about 27% of GDP to international financial markets and multilateral lenders like the World Bank.
The coronavirus pandemic has dwindled Sri Lanka's foreign reserves to $7.2 billion as of April 2020.
Even though it faces constraints with servicing its loans, cabinet ministers approved a decision to borrow $80 million to improve 105 km of roads.
The country seeks to renegotiate its debts with international investors to avoid another BOP crisis. Unless it changes its practises, another crisis is inevitable.
Maritime Significance
Control over the port in Hambantota gives China a strategic foothold in vital commercial and military waterways in the Indian Ocean. The presence of naval ships in Sri Lanka are a threat to India.
Investment in Hambantota and Gwadar highlight growing Chinese presence in the India Ocean. This change of status quo has India and the United States squirming in their seats.
What links Kenya, Pakistan and Sri Lanka? China, predatory practises and corruption in developing economies. China’s overarching ambition is to extend its national interests beyond its boundaries, thereby threatening American dominance.
The American system left certain developing countries behind will China’s system do better?
I would love your feedback on this newsletter by leaving a comment or replying to this email.
Peeking behind "China's Debt Trap Diplomacy"
Very interesting article
An excellent article once again Aditi. I knew about SL but had no idea about Gwadar and Kenya. Also since I am working on the East Africa region I know that trucking is their primary mode of transport. Port access is limited to Mombasa as you mentioned and Beira, Maputo, Dar es Salaam after which the land route is the only option left.
And trucking is a very important business owing to these geographical circumstances.
Loved the Infographics specially the one showing projects in Pakistan. If something is not done soon enough they will lose lot more than just a port to China. Plus Pakistan is also experiencing some inhouse conflicts with their own military.
Would love to read about your views on alliances in the event of a major war(military or trade).