Defence

A new lunatic express: OBOR projects worldwide are stacking the deck for Chinese enterprises and banks

Kenya Railways Corporation has a standard gauge railway (SGR) project that’s part of Kenya’s Vision 2030 document.

Jun 3, 2017
By Bibek Debroy 
 
Kenya Railways Corporation has a standard gauge railway (SGR) project that’s part of Kenya’s Vision 2030 document. At the moment, work is happening on the first of three phases, from Mombasa to Nairobi, one that will be commercially functional from January 2018. In second and third phases, the line will extend to Uganda, Rwanda and South Sudan. This is part of a master plan to build infrastructure in East Africa. More specifically, there is an East African Railway Master Plan, straddling Tanzania, Kenya, Uganda, Rwanda, Burundi, South Sudan and Ethiopia. It is a great idea to build infrastructure.
 
Infrastructure yields what economists call multiplier benefits. But benefits are typically external to the project, while costs are mostly internal. That’s the reason, barring odd exceptions, infrastructure projects rarely pay their way. That’s also the reason they are mostly funded through debt, rather than bonds, or equity.
 
In this part of the world (Kenya/Uganda), the British built railway infrastructure towards the end of the 19th century, though that was more for strategic reasons, not economic. In 1971, Charles Miller wrote a book about this and titled it, ‘The Lunatic Express: An entertainment in imperialism’. The costs, human and financial, were horrendous. Labour came from India, superior skilled ones from Britain. Sleepers and locomotives came from Britain.
 
We have details for first phase of the SGR project. The principal contractor is China Road and Bridge Corporation (CRBC), a subsidiary of China Communications Construction Company (CCCC). Both are state-owned enterprises. When construction is complete, the line will be operated by CCCC. Locomotives (freight and passenger) and rolling stock (coaches and wagons) will be imported from China, manufactured by various subsidiaries of CRRC Corporation Limited, another state-owned enterprise.
 
Even if one forgets strategic considerations, or China’s objective of garnering resources for infrastructure, this makes obvious sense for Chinese state-owned enterprises and state-owned banks. With endogenous sources of growth drying out within China, this is a softer option than reforming either enterprises or banks.
 
How will the first phase be financed? Since infrastructure projects rarely pay their way, as at the end of the 19th century, they have to be publicly funded. In this particular case, Kenya government funds 10% of the expenditure. The remaining 90% is a loan from Exim Bank of China.
 
Decades ago, there used to be debates around, and arguments against, tied aid. Tied aid means foreign aid in the form of a loan or a grant. But that money must be spent on goods or services produced in the country that provides aid. For obvious reasons, untied aid is more efficient than tied aid. The SGR project, at least the first phase, represents tied aid.
 
Partly because China wants to project these as overseas investments and not loans, terms are rarely in the public domain. Since this is Exim Bank, it won’t be a grant, or an interest free loan, but a loan on concessional terms. In all probability, terms will be something like the following. An interest rate of 2-3%, a maturity of 20 years and a grace period of 2-5 years. A soft loan.
 
On the flip side, a Chinese company must be the principal contractor; for equipment, materials, technology and services, there will be purchase preference for Chinese firms and 50% of total procurement will be from China. Certainly, there is no compulsion to accept these terms. There is choice and soft loans on similar terms are also available from multilateral institutions.
 
However, multilateral institutions will insist on structural reforms, which the Chinese don’t. Hence, the present Kenyan government takes a Chinese loan for an infrastructure project that’s unlikely to yield even that 2-3% and a future Kenyan government and Kenya’s citizens face the consequences.
 
Is this likely? One doesn’t necessarily know about future Kenyan default, though one must mention that debt/GDP ratios are high in Kenya. But since Cambodia and Sri Lanka have already faced that Chinese-loan-driven excess-capacity-infrastructure problem, it is reasonable to expect other countries will also do so. In a perverse way, a domestic Chinese problem is being exported.
 
One Belt, One Road (OBOR) is like a hold-all, in the sense that it has several independent, but linked, infrastructure projects. There is Silk Road Economic Belt, Maritime Silk Road, New Eurasian Land Bridge, China Pakistan Economic Corridor (CPEC) (which India can’t possibly endorse) and corridors through Mongolia, Russia, Central Asia, West Asia, Indo-China, Bangladesh, India and Myanmar. For CPEC, Pakistan has got loans on extremely attractive terms (a few limited bits are even interest free). But on an average, it is still a positive rate of interest of more than 1.5%.
 
It is a wonderful idea to invest in infrastructure. One doesn’t have to cite studies done by economists, linking infrastructure creation to welfare and GDP growth. The Romans knew it, they built roads and bridges everywhere. Sher Shah Suri knew it, and Kautilya before him.
 
But these welfare and GDP calculations factor in multiplier benefits, known as positive externalities. The social rate of return on a specific infrastructure project may be high. The private rate of return is not necessarily high and may not cover costs of borrowing. Cross-country empirical studies show higher social returns for medium income countries, not low income ones, and many in OBOR are the latter. There is a lunatic express element.
 
Times of India, June 3, 2017

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