13 January 2019

Kenya: SGR Pact With China a Risk to Kenyan Sovereignty, Assets

Photo: Daily Nation
The standard gauge railway project.

Kenya's key strategic assets at home and abroad will not be protected by "sovereignty" and risk being seized by the Chinese government should there be a default in repaying the Standard Gauge Railway loan, a copy of the contract seen by the Sunday Nation reveals.

The initial agreement for the Mombasa-Nairobi railway signed on May 11, 2014 also details how the pact will be governed by Chinese laws with all disputes being arbitrated in Beijing.

In addition, the contract, and a subsequent one on the Nairobi-Naivasha phase, also have a confidentiality clause gagging Kenya from making the deal public "without prior written permission of the lender (China)".

This comes more than two weeks after President Uhuru Kenyatta, responding to a question from NTV's Mark Masai during a live television interview on December 28 last year, promised to release the SGR contract to put to rest any "porojo" (rumours) that the Chinese could seize the Port of Mombasa.

This week, State House spokesperson Kanze Dena, in response to our enquiries, said the contract "can be released anytime, even this week".

IMMUNITY

However, the signed SGR deal seen by the Sunday Nation suggests the risks go beyond the port.

"Neither the borrower (Kenya) nor any of its assets is entitled to any right of immunity on the grounds of sovereignty or otherwise from arbitration, suit, execution or any other legal process with respect to its obligations under this Agreement, as the case may be in any jurisdiction," Clause 5.5 of the Preferential Buyer Credit Loan Agreement on the Mombasa-Nairobi SGR reads.

The contract is signed by National Treasury Cabinet Secretary Henry Rotich and Mr Li Riogu, then-Chairman and President of the State-owned Export-Import (Exim) Bank of China.

In the deal, Kenya is also compelled to import goods, technology and services from China.

According to experts interviewed for this article, the blanket reference to "any asset" not only exposes the Kenya Ports Authority (KPA), whose leaked audit report last month raised questions about its vulnerability in case of default, but also allows the Chinese lenders to take over other critical resources -- anything from airports and natural resources to embassies abroad.

CONFIDENTIALITY

When we put the implications of this clause to Mr Rotich, the Treasury Cabinet Secretary gave a terse response: "Where did you get such information? Send me where you got it from. Not aware about such a thing."

The apparent exposure of Kenya's assets gets even more curious given the clause that says the loan agreement would be "governed by and construed in accordance with the laws of China".

The initial SGR loan agreement, signed slightly over one year after the Jubilee administration came to power, is also designed to be kept secret, as captured in clause 17.7 of the loan pact.

This raises questions on the Freedom of Information requirements by the Kenyan Constitution.

"The borrower (Kenya) shall keep all the terms and conditions hereunder or in connection with this agreement strictly confidential.

"Without the prior written consent of the lender (China), the borrower shall not disclose any information hereunder or in connection with this agreement to any third party unless required by applicable law," the confidentiality clause reads.

PORT

After concerns were raised last month that KPA could potentially be seized in case of a default in loan repayment, Chinese officials disputed the claim in carefully worded statements.

Chinese Foreign Ministry Spokesperson Hua Chunying said: "We have checked with the relevant Chinese financial institution and found that the allegation that Kenyan side used the Mombasa Port as a collateral in its payment agreement with the Chinese financial institution for the Mombasa-Nairobi Railway is not true."

It is a statement that could be true if viewed with a narrow lens, considering that there is no specific reference to the port in the contract seen by the Sunday Nation, but the sweeping statement that makes all assets fair game bears the trap.

The Chinese have repeatedly rejected accusations that they were involved in debt-trap diplomacy by burdening poor countries with unsustainable loans.

On Thursday, Ms Dena told the Sunday Nation there was no confidentiality clause blocking the public release of the entire SGR contract.

"It has nothing to do with secrecy, we have been on holiday and we are still settling back.

"There is no diplomatic barrier preventing Kenya from making the loan deal public. The document will be made available even this week to everyone through the media houses," Ms Dena said.

COLLATERAL

Law Society of Kenya Nairobi Branch Chairman Charles Kanjama said the secrecy clause is standard for such agreements.

He is however concerned the sovereignty waiver on the assets and relying on Chinese laws are signs of doubt by the lender.

"The agreement is being made in Kenya, the railway is built in Kenya and the assets they are talking about are in Kenya, so why is it being governed by the laws of China?

"Had there been more transparency or choices of who funds the railway then Kenya may have got a better deal," Mr Kanjama said.

Daly and Inadmar Advocates partner and cross-border commercial contract specialist Shitul Shah said lending countries only ask for collateral when they have questions on the "credibility" of the borrower.

ARBITRATION

But even more intriguing is the clause in the contract that says any disputes on the loan would only be resolved in Beijing through the China International Economic and Trade Arbitration Commission (Cietac).

"The arbitration award shall be final and binding on both parties. The arbitration shall take place in Beijing," the agreement says, effectively blocking other international commercial dispute resolution avenues.

Kenya has further signed never to dispute the choice of Cietac as an arbitrator and to take its decision.

Mr Shah said although parties to a contract have the freedom to agree on which law would govern the agreement, China's choice of the arbitrator and the specification that the arbitration would he held in Beijing is "suspect".

"Normally, you would need an independent arbitrator, because this is about mediation, which should be made neutral and impartial by all means.

"Specifying the mediator and the unneutral ground to carry out the mediation is suspect. This can be challenged in law," Mr Shah, who also practices in New York and London, told the Sunday Nation.

LOAN

Other experts with knowledge of Kenyan government contracts, who spoke in confidence, said a neutral country or organisation is usually preferred.

One gave the example of a controversial Sh30 billion pipeline security commercial contract Kenya signed in 2017 with the Israeli company Rafael Advanced Defense System limited whose arbitration clause nominates London.

In the SGR contract, the Exim Bank also makes it a mandatory requirement that the commercial loan be insured by the China Export and Credit Insurance Corporation (SinoSure).

All charges regarding the management of the loan, which run into billions of shillings, are to be paid by Kenya.

Apart from the $1.6 billion commercial loan and $1.6 billion concessional loan from the China Exim Bank to build the first phase of the SGR, several other loan deals have been signed, stirring debate on Kenya's ability to repay.

FEASIBILITY

The ongoing second phase of the SGR between Nairobi and Naivasha costs at least Sh160 billion.

The deal signed in December 2015 is similarly skewed against Kenya.

The phase between Naivasha and Malaba, whose funding has not been secured, is expected to cost Sh500 billion.

Like the first phases, this would include supply of locomotives, wagons and coaches.

However, the financial viability of the SGR passenger and freight service has remained a subject of debate since its launch in May 2017.

CRBC, the Chinese operator of what is the biggest single infrastructure project since independence, is reportedly paid at least Sh1 billion per month to run the service.

Auditor-General Edward Ouko is yet to release any report on the SGR as required by law for a project of such magnitude.

His office did not immediately respond to our enquiries on whether there was any audit report for the project that started in 2014.

CARGO

Aware of the heavy burden the project was going to have on a developing economy like Kenya's, the Chinese negotiators made sure they were well-protected.

For example, the agreement specified a 'take-or-pay' basis agreement with KPA, ensuring commitment to have cargo from the port transported on the railway line to guarantee its use and revenues.

Before the deal was sealed, Kenyan negotiators found it hard to assure China that indeed most cargo would pass through the SGR.

In a compromise, the government saddled KPA with long-term Service Purchase Agreement and a 'take or pay' deal with Kenya Railways Corporation to facilitate efficient movement of cargo and attract business for the railway.

"This is a key issue for the Bank," Exim bank officials said during the negotiations in a strategy that put the port at the centre of the deal.

REVENUE

Yesterday, Transport and Infrastructure Cabinet Secretary James Macharia said there was no cause for alarm.

"KPA guaranteed the quantum of cargo to be ferried by SGR vide the "Take or Pay" Agreement in order to ensure its financial viability.

"Already the volume of cargo is way ahead of the anticipated quantum. For example, the operation has hit 15 train pairs in a day, which was the projected volume by mid 2019.

"Further, with the ongoing investment in clinker and bulk cargo handling, the actual turnover will outstrip projections over the life of the loan repayment period, thus resulting in excess cash flows and reserves. This will mitigate any loan repayment risks on a sustainable basis," he said.

But in another strategy to secure the Chinese lenders, according to the contract, two escrow accounts were set up with full control of the Chinese - especially at default or when railway revenues fail to meet the loan obligations.

The agreement states that while the revenue account would be in Kenya Shillings, the repayment one would be in US Dollars.

Any costs associated with the running of the accounts are to be borne by Kenya.

ESCROW

One alternative source of funding for Kenya to cover its part in financing was agreed to be the establishment of the Railway Development Levy on all imports into the country.

The government also in its financing model for the project would initiate road transit toll levy, green tax in new vehicle registration and an insurance levy, fuel levy and the sale of the current Metre Gauge Railway -- assets estimate to be capable of raising Sh41 billion.

There would also be various port levies on imports and exports in addition to a road haulage tax to discourage the use of trucks and divert some cargo to the railway.

The Chinese lender, according to the contract, has the prerogative to open an account in Kenya's name and keep records of the loan balance.

Kenya, which has little control over the account, is expected to accept the bank records as the outstanding balance.

STUDY

Further, the deal stipulates that even if Kenya gets alternative funds to offset the loan in lumpsum, the Chinese bank has the right to refuse such payment or give conditions before accepting.

This option would also require advance notice, making the loan hard to buy off.

Some of the skewed clauses appear to have been noticed years before the actual agreement was signed but the warnings were ignored -- before those who raised the issues later changed tune.

One such person was then-KRC managing director Nduva Muli, who would later be appointed Transport Principal Secretary when the Jubilee administration took over before being forced out in 2015 over corruption allegations.

After receiving budget allocation in 2011 to conduct a feasibility study, Transport Permanent Secretary Cyrus Njiru abruptly blocked the process.

"I have therefore been directed to advise you not to go ahead with the study as this is not consistent with the consensus within government," the PS wrote.

LEVERAGE

In a memo (No. 3073) to the Board of Directors, Mr Muli warned that Kenya would get a bad deal if it did not carry out its own feasibility study to find out the most suitable route, cost and financing modalities, in line with "normal practice in infrastructure projects".

Other important aspects would be environmental impact, rolling stock requirements and projected traffic data.

But Mr Muli would later realise the Chinese had been secretly conducting their own feasibility study, and his March 16, 2008 letter was three months late. He received their report six days later. Nevertheless, he made his point.

"The government does not have information to safeguard its interest during negotiation of the proposed G-to-G (government-to-government) arrangement and also during construction to ensure the envisaged specifications and benefits of the new railway line are achieved," he wrote to the board, claiming Kenya Railways had been sidelined.

When Kenya Railways finally gave its assessment of the Chinese study, it was scathing. The Chinese were overly optimistic.

There were no market study or financial modelling reports to indicate viability. The study also lacked an environmental and social assessment.

WARNING

Kenya Railways analysis pointed out that the projected cost was higher per kilometre and the speed was slower for both passenger and freight services.

The Kenyan experts also noted: "The study appears to be generous with bridges/tunnels forming 7.2 percent of the total length of the line (including 60 long bridges). In addition, it is also over-generous with the number of stations. This could have inflated the cost of the line.

"A railway (unlike a road) must be designed, built and operated as a business for profitable taking in order to avoid the expensive investment turning into a white elephant. The study by CRBC falls short of delivering a bankable project."

The warnings were never heeded. A year after coming to power, President Kenyatta's administration would seal the deal, dismissing all concerns.

The cost, which was first set at Sh220 billion, later jumped to Sh327 billion as publicly available information on the real amount kept changing.

CORRUPTION

Land acquisition costs would also climb 10 times to Sh30 billion.

Mr James Shikwati, who runs an African think tank on public policy, says China's deals with a country depend on how the leaders present themselves on the negotiation table. He blames Kenya's 'tenderpreneur' culture by the elites for the bad deal.

The Inter Region Economic Network founder said China invests in the US and Europe and the contracts they enter into are fairer, a concept he refers to as 'water taking the shape of the bottle'.

In other words, the Chinese simply play along the way the hosts allow.

"It is time we start changing our political elite ecosystem where people only care about their cut in the deal and it doesn't matter whether it is viable or how expensive it is," Mr Shikwati told the Sunday Nation.

China is now Africa's single largest trading partner and continues to bag and fund mega infrastructure projects.

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