China rail loan terms behind Kenya ban on road freight, deal shows
- Agreement required Kenya’s port authority to guarantee cargo traffic on Standard Gauge Railway from Mombasa to Nairobi
- The order was made under the previous Kenyan government and rescinded by President William Ruto when he took office
The agreement required Kenya Ports Authority, which owns the port of Mombasa, to guarantee a certain amount of cargo traffic to the SGR, funded and built by China.
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Failure to do so would require payment of the difference from its revenues, according to the payment arrangement agreement – also known as take-or-pay (TOPA) – for the Mombasa-Nairobi SGR project, seen by the South China Morning Post.
The railway runs from Mombasa to the capital Nairobi with an extension to Naivasha, a town in central Rift Valley, where it ends abruptly after China dropped its earlier promise to fund construction to Malaba on the border with Uganda.
The project was funded with a US$5 billion loan from China Eximbank, agreed by former president Uhuru Kenyatta just over a year after winning his first term as the country’s fourth president.
Part of China’s transcontinental Belt and Road Initiative, the railway was built by China Road and Bridge Corporation, a subsidiary of China Communications Construction Company, which also won a 10-year contract to run the trains, both passenger and freight.
To forestall any possibility of Kenya defaulting on the loans, China Eximbank crafted an extensive financing plan, which included an agreement that Kenya’s treasury would allocate annual funds for the repayments.
“Kenya is expected to allocate a sufficient amount of funds from its annual budget to pay China Eximbank all amounts due and payable under the loan agreements,” it said.
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The agreement notes that any of the clauses in the contract shall remain in force until the loan is fully repaid in 2035.
Kenya was also required to take an export credit insurance policy from Sinosure, the Chinese export credit insurance company, for the Eximbank commercial loan, at a one-time cost of US$113 million.
Besides annual budget allocations, China Eximbank asked Kenya to set up a long-term service agreement – the TOPA – between Kenya Railways Corporation and Kenya Ports Authority.
Revenues were to be deposited in an escrow account set up by Kenya Railways, the treasury and China Eximbank, from which loan repayments would be made. Kenya Ports Authority is responsible for collecting freight and service charges on behalf of the rail company and depositing them in the escrow account.
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For this to work, the Kenyan government issued policy directives to ensure freight shifted from road to rail transport. In 2019, importers were ordered to use the railway for goods headed to Nairobi and Western Kenya, including cargo meant for neighbouring Uganda and Rwanda.
The TOPA became controversial in December 2018 when Kenya’s auditor-general raised concerns that the terms could surrender control of Mombasa port if Kenya defaulted on the railway loans.
However, experts said there was nothing unusual, since an offtake agreement is a common feature in Chinese deals involving mega infrastructure contracts.
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For Kenya’s auditor, the SGR payment arrangement agreement represented a “significant risk” that the ports authority had not disclosed in its financial report.
“[The agreement] substantively means the authority’s revenue would be used to pay the government of Kenya’s debt to China Eximbank if the minimum volumes required for consignment are not met,” the auditor-general warned in a 2018 letter to Kenya Ports Authority.
“The KPA assets are exposed since the authority signed the agreement where it has been referred to as a borrower.”
Critics picked up the issue, describing it as an example of Chinese debt trap diplomacy – accusing China of burdening African countries with unsustainable debt which cannot be repaid, with the aim of seizing ports and other assets.
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China’s foreign ministry said in December 2018 it had “checked with the relevant Chinese financial institution and found that the allegation the Kenyan side used the Mombasa port as collateral in its payment agreement … is not true”.
The claim was debunked in April this year by scholars from Johns Hopkins University’s China Africa Research Initiative, who said Kenya has not used Mombasa port assets as security, but rather used its profitability, dynamism and overall financial capacity to support the SGR project.
The study was led by Deborah Brautigam, a professor of international political economy at Johns Hopkins University, and founding director of the China Africa Research Initiative.
It found the take-or-pay agreement mechanism allowed the Kenyan government to create a bankable project while the main project owner Kenya Railway Corporation operated at a loss.
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“The SGR project was carefully and creatively constructed to reduce the risks of a sovereign default and enhance the bankability of a project with significant benefits to Kenyans, now and in the future,” the study said.
“Instead of serving as collateral or security for the loans, the profitable Mombasa port was linked to the SGR project as its major customer. The port’s only role was to help Kenya Port Authority, its owner, ensure that a set level of cargo would be transported between Mombasa and Kenya’s inland capital of Nairobi.
While the study found that Kenya Ports Authority had agreed to draw on its revenues to make up the difference if cargo levels dropped below that level, “KPA faces a risk to its cash flows – not its ports”, it said.
But the port authority may not meet its target, because of President William Ruto’s fulfilment of an election promise to redirect cargo imports to Mombasa for unloading, instead of Nairobi or Naivasha.
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Kenya’s treasury has assured the bank that the railway development levy – a 2 per cent charge on all imports – “will act as insurance in case revenues under the take-or-pay arrangement fall short of the amount required to service the loan”.
Kenya has given an “irrevocable agreement” that funds deposited or transferred into the escrow account by its railway corporation will be paid to China Eximbank. The account is supposed to maintain a minimum balance of US$250 million.
Parties in the deal agreed that any dispute that cannot be settled by mutual agreement will be referred to the China International Economic and Trade Arbitration Commission for arbitration in Beijing.
