Sri Lankan government sells majority stakes in state-owned transport and logistics infrastructure

In an effort to address the rising levels of public debt, the government moved to sell a majority stake in the recently constructed deepwater port in Hambantota to the state-owned China Merchants Port Holdings (CMPH) in July 2017. The deal will help shore up state reserves to allow for higher spending on priority infrastructure. It also demonstrates that there are opportunities for foreign investment in Sri Lanka, with the port holding the potential to become a major global roll-on/roll-off (ro-ro) trans-shipment hub.

However, the sale has been widely criticised, with some stakeholders arguing that the port’s selling price was too low given its high construction costs, strategic geographic position and long-term growth prospects. Although Sri Lanka will benefit from increased fiscal space and new foreign investment in the port’s surrounding infrastructure, the persisting concerns about national sovereignty and the economic losses of privatising Hambantota’s large-scale infrastructure developments continue to challenge developers.

With concerns over Chinese influence mounting, the government is now expected to leverage competing international interests by selling a majority stake in the Mattala Rajapaksa International Airport (MRIA) in Hambantota to the government of India.

Debt Trap 

By mid-2017 Sri Lanka’s debt had reached $64bn, with an estimated 95% of the state’s total revenues channelled into servicing its loans. It has been estimated that more than one-tenth of the government’s debt is owed to Chinese state-owned firms, with some local media reports stating that Chinese firms account for as much as $8bn of Sri Lanka’s total debt. Most of the debt can be attributed to a spate of recent infrastructure projects launched in the Southern Province’s district of Hambantota, roughly 250 km south-east of Colombo, under plans to transform the district into a new economic, commercial and shipping hub.

Under the previous administration of Mahinda Rajapaksa, Chinese companies were contracted to build the Magampura Mahinda Rajapaksa Port (MMRP), MRIA, which is located some 20 km outside of Hambantota, and a new international cricket stadium. In addition, there were plans to connect all of these facilities via a series of multi-lane expressways.

The port and airport projects have added significant pressure to the state’s balance sheet, though exact contract details are unclear and budget estimates vary considerably between sources. In November 2011, for example, the BBC placed the total cost of the MMRP at $1.4bn, while Ship Technology reported that China’s Import-Export Bank covered 85% of phase one’s construction costs, which were estimated at $361m.

Daily Mirror wrote that the second phase amounted to $808m, while the Financial Times put the project’s total cost at $1.3bn. Accounts of how involved Chinese firms are vary as well, with Forbes asserting that China provided $247m of MRIA’s $272m budget, while in December 2017 The Interpreter estimated that the combined value of the port and airport deals was somewhere closer to $1.5bn, with the majority sourced through “relatively high-interest loans” from China.

Strategic Location 

The logic behind building up Hambantota seemed solid, as the port is located along one of the world’s busiest maritime shipping lanes, making it a natural hub for trans-shipment and logistics. Any facilities built in the region would be well positioned to capitalise on the increasing Indian Ocean trade volumes. Critically, Hambantota also offers a deepwater draught, and India does not have a deepwater port, giving MMRP a major competitive advantage over India’s ports. The first phase of MMRP’s construction, which commenced in January 2008 and finished in April 2010, comprised the building of new ship-building, bunkering, crew-changing and ship-repair facilities, as well as two breakwaters. Dredging works involved a 210-metre entrance channel and 600-metre turning circle.

A joint venture between Sinohydro Corporation and China Harbour Engineering Company (CHEC) was contracted for the first phase, which also covered the excavation of a 17-metre-deep basin area, 600-metre general purpose berth, 610-metre oil quay, 105-metre service berth, and associated roads and buildings. Once complete, the first phase offered capacity for 2500 ships and 100,000 deadweight tonnes annually.

The second phase involved deepening the entrance channel by 1 metre, adding 2.4 km of new quay length through the creation of a 450-metre-wide, 840-metre-long harbour basin, construction of a 40-ha industrial area with container handling and ro-ro facilities, and a new shipyard facility in the south-west corner. This second phase was completed by the end of 2015. The planned third phase will see the port’s capacity reach 20m twenty-foot equivalent units on completion.

Lagging Assets 

MMRP’s proximity to larger, busier and more well-equipped facilities in Colombo have seen it underperform since it began operations. According to a local media report published in July 2017, just 44 ships had been handled at Hambantota since 2015, while the SLPA recorded the port handling a total of 350 ships between 2010 and March 2018. Reportedly, the port earned LKR132m ($862,000) in 2012, falling short of the initial revenue target of between LKR500m ($3.3m) and LKR600m ($3.9m). However, annual revenues have risen since then, totalling LKR585.2m ($3.8m) in 2013 and LKR5.4bn ($35.3m) in 2014, when bunkering operations commenced. Nonetheless, by April 2017 the port had registered losses of $300m since opening.

MRIA, meanwhile, has been labelled one of the world’s emptiest airports. Built over an area of 12,000 ha, the first phase of construction began in 2009. This initial phase – which included a 12,000-sq-metre terminal building, 12 check-in counters, two gates and a 3500-metre runway capable of handling large commercial jets – came on-line in March 2013. The government awarded the contract for the second phase of construction to CHEC that same year.

Although MRIA has the capacity to handle 1m passengers annually, the airport has fallen short of its targets since 2013. According to the Central Bank of Sri Lanka, MRIA handled 2740 passengers in 2015 and 4770 in 2016. Only one airline – the low-cost carrier flydubai – offers flights to MRIA, with carriers Air Arabia and SriLankan Airlines cancelling flights to the airport in May 2013 and January 2015, respectively.

Fire Sale 

As a result of fragile revenues and rising recurrent expenditure, the budget deficit appears set to exceed 5% of GDP over 2018-20 (see Economy chapter). The difficult economic situation makes budget rationalisation and the creation of new fiscal space important priorities for the government. This has been evidenced by recent developments at MMRP and MRIA, where Sri Lanka is moving to carefully balance competing geopolitical interests, while also shoring up its revenue base.

In July 2017 CMPH agreed to buy an 85% stake in MMRP for $1.1bn under a 99-year lease agreement. This deal proved highly unpopular and was later negotiated to a 70% stake, with the stipulation that the port not be used for military purposes. The deal is expected to see approximately $6bn of the country’s debt to China converted into equity, while the remaining $1.1bn is to be used for debt repayment. The CMPH made a payment for $292.2m, or 30% of the $974m total, as a first instalment for its stake in the port, as well as $146m of direct investment into Sri Lanka in December 2017.

In preparation to take over operations at the port, the CMPH created two new companies: the Hambantota International Port Group, which is wholly owned by the CMPH and responsible for managing the port and its terminals; and Hambantota International Port Group Services, which is in charge of maintaining security at the port. The SLPA has a 50.7% stake in the latter firm, with CMPH holding the remaining 49.3%.

Despite widespread criticism of the sale, there are a number of potential benefits for Sri Lanka. For instance, a planned special economic zone (SEZ) to be located adjacent to MMRP stands to receive some $5bn of Chinese investment, which would create 100,000 jobs. The deal could also kick-start a slew of new opportunities for private investment in infrastructure developments, with the government already moving to increase the utilisation of public-private partnership frameworks in the sector (see Economy chapter).

Controversy 

The port deal has also faced criticism, mainly due to the perception that the low sale price did not adequately pay for the high-value project. Although shipping activities at MMRP have been lower than expected in recent years, ro-ro traffic has already risen sharply, which is partly due to the large amount of land available at the site, India’s resurgent automotive manufacturing industry and the port’s deepwater capabilities. Indeed, the SLPA recorded ro-ro traffic growth of 311.8% year-on-year over the first nine months of 2014, handling more than 126,000 motor vessels. In addition, MMRP is well positioned to challenge Singapore for regional ro-ro supremacy.

As such, the $1.1bn sale has been criticised as too low a price for a 99-year majority stake. By comparison, a consortium led by Chinese firm CITIC Group has recently moved to acquire an 85% stake at the planned Kyaukphyu deepsea port in western Myanmar at a cost of $7.2bn. Furthermore, the Kyaukphyu port and its associated SEZ span an area of 1600 ha, while MMRP’s SEZ will cover 15,000 ha when complete.

In December 2017 Constantino Xavier, an academic on foreign policy at US think tank Carnegie, echoed widespread criticism when he told the Financial Times that the deal is viewed by many as modern colonialism. “Beijing typically finds a local partner, makes that local partner accept investment plans that are detrimental to their country in the long term, and then uses the debts to either acquire the project altogether or to acquire political leverage in that country,” Xavier said. This mounting sentiment likely contributed to the minister of transport and civil aviation approving a deal with the government of India and sending it to Cabinet for review. This deal would hand over a 70% stake of MRIA for 40 years at a cost of $205m. Some industry analysts have said that this agreement is more focused on assuaging concerns over China’s influence, rather than bolstering investment and passenger numbers at MRIA.