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An Ungrounded Accusation
The real story of China's involvement in Sri Lanka's Hambantota Port
By Koh King Kee | NO. 34 AUGUST 23, 2018
The Hambantota Port in Sri Lanka on February 8, 2017 (XINHUA)

"How China got Sri Lanka to cough up a port," was the headline of a widely quoted article published by The New York Times on June 25, 2018.

The paper asserted that Sri Lanka said, "Yes, though feasibility studies said the port wouldn't work. Yes, though other frequent lenders like India had refused. Yes, though Sri Lanka's debt was ballooning rapidly under Mr. Rajapaksa."

But are these allegations true and fair?

Feasibility and vision

The Sri Lankan Government had long wanted to build a seaport at Hambantota, and two feasibility studies were undertaken before it embarked on the ambitious port project.

The first study was completed in 2003 by Canadian engineering firm SNC-Lavalin. However, it was rejected by the ministerial task force on the grounds that it was not bankable and was incomplete since it overlooked the new port's potential impact on the country's main commercial port in Colombo.

Three years later, Ramboll, a Danish consulting firm, undertook a second feasibility study and adopted a more optimistic view for the potential of Hambantota Port. It projected that dry and bulk cargo would constitute the main traffic for the port until 2030. Hambantota Port was expected to handle approximately 20 million 20-foot equivalent units by 2040.

On December 26, 2004, a magnitude 9.1 earthquake, its epicenter off the west coast of Indonesia's Sumatra Island, triggered a series of deadly tsunamis across the Indian Ocean, killing an estimated 230,000 people in 14 countries.

Sri Lanka was the second hardest hit. The powerful waves wiped out entire villages and townships on the south and east coasts of the island nation, causing 30,000 reported deaths, damaging highways and railways, destroying schools and hospitals and leaving 900,000 people homeless.

Hambantota, a bustling southeastern coastal town known for its salt production, was completely devastated.

The town is also home to Mahinda Rajapaksa, the sixth president of Sri Lanka, and is his electoral district. After coming to power in November 2005, he wasted no time in launching several big-ticket infrastructure projects to revitalize the economy of his hometown. Hambantota Port, a project first mooted by his father, was one of them.

In a brief published in April 2018, the Center for Strategic and International Studies, an influential U.S. think tank, affirmed that Hambantota Port was not a China-initiated project. In fact, Hambantota Port was constructed long before the Belt and Road Initiative was launched in 2013.

India was the first country Rajapaksa turned to for financial help to build the Hambantota Port. However, his request was rejected as India deemed the project economically unviable. The multilateral development banks (MDBs), were also unwilling to lend their support to the project.

China saw the potential of Hambantota Port, which sits strategically a mere 10 nautical miles north of the busy Indian Ocean international shipping route. It not only meets the logistical needs of China's burgeoning global trade, but also serves as a transshipment hub and supply base providing bunkering facilities to the large number of vessels plying one of the busiest shipping routes in the world. India's relaxation of its cabotage rules in May greatly enhanced Hambantota's status as the transshipment port for goods destined for the subcontinent.

The Export-Import Bank of China (China Exim Bank) eventually agreed to fund 85 percent of Hambantota Port's Phase One construction costs after extensive negotiation. The 15-year commercial loan of $306 million carried an interest rate of 6.3 percent with a four-year moratorium.

"The Sri Lankan team did try to seek a preferential loan from China, but the quota for China's preferential loans then to Sri Lanka had been used for the Norochcholai Coal Power Plant and other projects," a leading Sri Lankan financial expert explained in a Xinhua News Agency report in 2015.

Sri Lanka was given two options for the interest on the loan: a 6.3 percent fixed rate or a floating rate pegged to the London Interbank Offered Rate, which was over 5 percent then and trending higher. In October 2007, Sri Lanka issued a Fitch BB-rated, 5-year sovereign bond at 8.25 percent, an unsurprising move for a nation that was still mired in a prolonged civil war with Tamil separatists.

China Exim Bank later provided additional loans totaling $900 million to finance Phase Two of the Hambantota Port project at 2-percent interest, a preferential rate enjoyed by 77 percent of Chinese loans to Sri Lanka.

Opening losses

Construction work for Phase One of Hambantota Port, undertaken jointly by the China Harbour Engineering Co. and Sinohydro Corp., commenced in January 2008. The port became operational on November 18, 2010, five months ahead of schedule.

However, Hambantota Port was unable to generate sufficient revenue to meet its loan obligations due to inadequate governance, lack of commercial and industrial activities and its inability to attract passing vessels to dock at the port. By the end of 2016, it suffered a total loss of $304 million.

Amid mounting pressure to meet the International Monetary Fund's bailout terms and loan repayment obligations, the Sri Lankan Government struck a public-private partnership (PPP) deal with China in July 2017, giving majority control of Hambantota Port to China Merchants Port Holdings (CMPH), which is listed on the Hong Kong Stock Exchange (HKSE).

According to the filing made by CMPH to the HKSE, the terms of the concession agreement related to Hambantota Port were as follows: CMPH would make an investment of $1.12 billion in Sri Lanka, out of which $974 million would be used for the acquisition of 85 percent of shares in the Hambantota International Port Group (HIPG), a company which was granted a 99-year term by the Sri Lankan Government to develop, manage and operate Hambantota Port valued at $1.4 billion.

HIPG would acquire 58 percent of Hambantota International Port Services (HIPS), which had been given the exclusive rights to develop, manage and operate the Common User Facility of Hambantota Port.

The Sri Lanka Port Authority (SLPA) would hold 15 percent and 42 percent equity interest in HIPG and HIPS, respectively.

The remaining $146 million would be deposited in CMPH's Sri Lanka bank account for the purpose of future development of the port and marine-related activities.

Within 10 years from the effective date of the concession agreement, SLPA has the right to buy back 20 percent shares of HIPG on mutually agreed upon terms.

After 70 years, SLPA could acquire CMPH's entire shareholdings in HIPG at a fair value to be determined by the valuers appointed by both parties.

On expiry of 80 years, SLPA could buy up CMPH's shareholdings in HIPG for $1, leaving CMPH with 40 percent shareholdings in HIPH.

After 99 years, CMPH would transfer all its shareholdings in HIPG and HIPS to the Sri Lankan Government and SLPA at the token price of $1 upon termination of the agreement.

The concession agreement went into effect on December 9, 2017.

To increase industrial and commercial activities at the port, China further undertook to develop a 50 square km economic zone and build a liquefied natural gas plant as well as a tourist dockyard. China will also invest between $400 million to $600 million to develop Phase Three of Hambantota Port which is expected to be completed by 2021.

The PPP thus represents not a debt-equity swap but fresh investment by CMPH amounting to $1.12 billion. The loan taken by SLPA for the construction of Hambantota Port was transferred to Sri Lanka's treasury. CMPH's investment in HIPG will be disbursed in three tranches of $292 million, $97 million and $584 million, with the balance of $146 million to be deposited in CMPH's Sri Lanka bank account for future use.

A lesson learned

Sri Lanka had a dream, its government had a vision: to turn strategically located Hambantota into one of the busiest ports in the world.

When its neighbor turned its back, when the MDBs were cold to the project, China provided the funding and built Hambantota Port with good intentions.

However, as the dream turned sour, China got the blame. The storyline was twisted. Hambantota became the oft-cited case of a "debt trap" under the Belt and Road Initiative. China was accused of twisting Sri Lanka's arm "to cough up a port."

In Hambantota there is a lesson that China must learn: Belt and Road projects must be transparent. The perception of the world is just as important as the original intention.

According to a recent report by the Financial Times, "China's development banks—the biggest lenders in the sector worldwide—are ramping up cooperation with overseas financial institutions after problems with international investment projects."

China's Development Bank is now "considering combining its lending efforts with Western financial institutions that require adherence to 'international standards'—including open, competitive tenders for project contracts as well as public studies on environmental and social impacts," the paper highlighted.

The author is the Director of China Belt and Road Desk, Baker Tilly MH Advisory Sdn Bhd, Malaysia. The story was first published on Cnfocus.com

Copyedited by Laurence Coulton

Comments to yulintao@bjreview.com

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