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How SGR tax saved Kenya from mortgaging Mombasa port

BUSINESS
By Dominic Omondi | Apr 18th 2022 | 8 min read
By Dominic Omondi | April 18th 2022
BUSINESS
Pacific International Shipping Line (PIL) Kenya assistant manager Siva Kumar (right) and Kenya Railways Business, Commercial and operations expert James Siele (second right) flag off an SGR freight cargo wagon loaded with one hundred and eight containers belonging to PIL Kenya, April 28, 2018.  [File, Standard]

 

A scheme put in place by a Chinese bank for the repayment of the Sh591.8 billion loan for the Standard Gauge Railway (SGR) might be responsible for the increase in the cost of living.

A new working paper by scholars from Johns Hopkins University, while debunking the rumour that the Port of Mombasa was used as collateral for the SGR, shows how the Chinese lender — the Exim Bank of China — crafted an elaborate financing scheme to ensure that Kenya repaid three loans it took.   

Kenya expected to take out an export credit insurance policy from China’s Sinosure for the Exim loan at a one-time cost of $113 million (Sh13.2 billion). This pushed the total financing cost of the SGR to Sh605 billion and ensured that taxpayers were going to painfully underwrite Kenya’s most expensive project.

Consumers would pay a new Railway Development Levy (RDL) on imported goods for home use as importers were forced to use the SGR, even where it was costly.   

Under the Four-Parties-Payment Arrangement, the Kenya Ports Authority (KPA) was required to guarantee minimum traffic for the SGR or pay for the shortfall (even if it meant forcing importers to use the SGR), as the Chinese lender went all out to forestall any possibility of default.

Sovereign default

“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,” reads part of the paper, titled “How Africa Borrows From China: And Why Mombasa Port is Not Collateral for Kenya’s Standard Gauge Railway.”

This payment arrangement between KPA, National Treasury, Kenya Railways Corporation (KRC) and EximBank might also have informed far-reaching re-organisation of State corporations that saw both railways and ports — as well as the pipeline — placed under the oversight of the National Treasury. 

As the borrower, the National Treasury is expected to religiously service the three loans by ensuring that KPA delivers the right freight onto the SGR line.

KPA collects freight charges on behalf of KRC and deposits the money in a special fund from where the repayment of the SGR loans and operational costs are financed.

The two per cent RDL — until 2019 charged at the rate of 1.5 per cent — is collected by Kenya Revenue Authority (KRA) and remitted to a special fund for the repayment of the loans should the money from cargo not be sufficient.

In-bound cargo

The increase in the RDL rate from 1.5 to two per cent as well as a policy directive by KPA to push all inbound cargo from the port of Mombasa to SGR coincided with a period when Kenya was expected to start repaying the SGR loans.

The first repayment for the loan used for the construction of the first phase from Mombasa to Nairobi started on July 21, 2019.

The Sh233.4 billion loan would be paid bi-annually every year until January 2029, according to data from the National Treasury.  

In January 2021, Treasury was to start servicing the $1.5 billion (Sh172.7 billion) loan for the construction of the Nairobi-Naivasha leg of the SGR. The loan, which would be paid in 30 instalments up to July 21, 2035, would see Treasury pay Sh5.75 billion twice a year.  However, the principal payment for this loan was deferred after China gave Kenya a debt repayment holiday in the wake of the Covid-19 pandemic, which disrupted the country’s export earnings.

The authors of the paper have argued that 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 (KPA), its owner, ensure that a set level of cargo would be transported between Mombasa and Kenya’s inland capital of Nairobi.

“If cargo levels dropped below that level, KPA agreed to draw on its own revenues to make up the difference”

According to the paper, repayment of the SGR loan was to largely come from Kenya’s Railway Development Levy (RDL), which was basically a tax on all imports.

Former National Treasury Cabinet Secretary Henry Rotich is said to have told the National Assembly that Treasury expected the SGR to repay the loans through operations revenues to the extent possible.

However, Exim Bank required credit enhancements — some kind of backup or secondary means of revenue to be provided by the borrower.

Consequently, the lender asked the government to set up a Long-term Service Agreement, also known as a “take-or-pay agreement” (TOPA) between KPA and Kenya Railways.

 As a result, KPA agreed to “take” a minimum level of transport services offered by Railways via the SGR, a failure to which it would pay for the shortfall.

The authority was to collect the transport charges due to KRC for travel along the railway to the Nairobi container depot from the customers and then remit the same to a project escrow account.

The account — in which funds are held in trust whilst two or more parties complete a transaction — was set up by Railways, the Treasury and the Exim Bank.

Citing a 2014 report of the National Assembly’s Departmental Committee on Transport, the authors of the paper note that “revenues from the railway operations will be deposited [by KPA]” into the escrow account “from which loan repayments will be made.”

When TOPA commenced in 2020, the ports authority agreed to transfer a minimum tonnage of six million from Mombasa to Nairobi. This was projected to rise to a maximum of 7.58 million tonnes this year.  

Unfortunately, the first six months of the TOPA coming into effect (January through June 2020), coincided with the Covid-19 pandemic. As a result, KPA only shipped 1.98 million tons instead of the pledged three million.

This meant KPA would need to remit to Kenya Railways the value equivalent to 1.02 million tonnes, unless the Technical Committee made up of chief executives from both KPA and KRC, decided that Covid-19 was an act of God which would then free KPA from this obligation.

Back in 2013, the government had come up with the Railways Development Levy (RDL) to “provide funds for the construction and operation of a standard gauge railway network in order to facilitate the transportation of goods”.

The levy, which was initially pegged at 1.5 per cent, was later raised to two per cent in the Finance Act of 2019.  

According to the five authors from Johns Hopkins University, Mr Rotich had said that the funds raised through the RDL would also be used to repay the SGR loans in case of a shortfall from the fees paid by KPA under the long-term-service agreement.

Between Financial Year 2013-2014 and June last year, the taxman had collected at least Sh163.4 billion from the levy. In the current financial year ending June, he is expected to collect Sh31.6 billion from the RDL and the same is expected to rise to Sh35.1 billion in the upcoming financial year.

Initially, the money from RDL was supposed to supplement the loans for the construction of the SGR, especially the acquisition of land.

However, as the study shows, the money has also been used to repay part of the Chinese loan.

Expand railway

In his recent Budget speech, Treasury CS Ukur Yatani proposed yet another Sh18.5 billion for the development of SGR “to expand railway transport to the rest of the country.”

However, the Budget books show that the ‘development of Standard Gauge Railway’ was allocated a total of Sh27.82 billion.

The money was not going to build new SGR for the rest of the country as the CS had told the country.

Instead, Sh9.07 billion was allocated to the Mombasa-Nairobi part of the SGR while another Sh18.5 billion was allocated to the Nairobi-Naivasha segment.

The Working Paper, the authors say, was informed by allegations, which started with a leaked statement from Auditor General’s office, that failure by Kenya to repay the loan would see the country’s port of Mombasa seized.

However, their two-year forensic analysis of the various contracts between the Treasury and Exim Bank showed that KPA faces a risk to its cash flow — not the Mombasa port.

“Kenya has not used Mombasa Port assets as security,” the Paper says. “Rather it used Mombasa Port’s profitability, dynamism and overall financial capacity as a support to the SGR project.”

Allegations that the port was used as collateral, the scholars say, became widely accepted globally as another example of “Chinese debt-trap diplomacy” where Beijing gives expensive loans with the intention of seizing the borrower’s strategic assets in the event of a default.

In Kenya’s case, that was a result of the Auditor-General’s leaked letter which mistakenly indicated KPA as the borrower, whereas the deal was between Treasury and Exim Bank of China.

The authors also faulted the media’s misinterpretation of the take-or-pay agreement and its sovereign immunity waiver clause.

According to the authors, few international banks will offer a loan if there is no legal way to recover their money should the borrower default.

Generally, sovereign States like Kenya are immune from lawsuits under international law.

“Waivers of sovereign immunity are standard clauses in international commercial loan contracts.”

The authors also fault the government for not being transparent on the loan agreement.

However, they also note that worried about debt distress, Kenyan officials have expressed interest in restructuring the SGR loans, following in the footsteps of Ethiopia, which in 2018 was successful in achieving a 20-year extension in repayment for its Chinese-financed railway.

Interest payment

“With a 10-year payment extension, SGR revenues and the RDL could fully cover all principal and interest payments after the peak year of 2022,” reads part of the report.  

“This would effectively ease pressure on Kenya’s foreign exchange reserves and further reduce the already low probability of default on the SGR debt.”

The working paper is an initiative of the SAIS China-Africa Research Initiative based at the Johns Hopkins University School of Advanced International Studies in Washington, United States of America.

It was authored by Deborah Brautigam, Vijay Bhalaki, Laure Deron, and Yinxuan Wang.

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