Feb 9, 2023

Mawazo Writing Africa

Writing about the main

Mombasa Port: How auditor-general misread China’s SGR contracts

In December 2018, a leaked letter from Kenya’s Court of Accounts sparked a rumor that Kenya had staked out its busy Mombasa Portas security for the China-funded standard gauge railway. Our new investigation shows why the safety rumor is false.

< p>Former Comptroller General Edward Ouko completed the National Port Authority’s 2017/18 audit. He warned that Port Authority assets – of which the Port of Mombasa is the most valuable – risk being taken over by China Eximbank if Kenya defaults on $3.6 billion in rail loans.

The profitable port of Mombasa is East Africa’s most important international trade gateway. The railway began operating in 2017 and was intended to seamlessly connect the port to Kenya’s capital, Nairobi, and landlocked countries beyond.

Kenyan fears mirrored another story that was widely shared in early 2018. In this story, China was said to have “seized” Hambantota Port in Sri Lanka when the island nation was struggling to repay Chinese loans. This charge of “debt trap diplomacy” later turned out to be a myth, but not before stoking fears of other major Chinese projects.

The Chinese and Kenyan governments both denied that the Port of Mombasa was a security but offered no explanation. Confused by the leaked letter, our team of international trade law and project finance scholars and practitioners spent months collecting primary documents and mapping out the project’s contractual structure.

To our surprise, we discovered that the side rumor from a seemingly tiny but critical misinterpretation by the Auditor-General. The chief auditor misidentified the Port Authority as the borrower responsible for repaying China’s railway loans. He accused Kenya’s government of “expressly guaranteeing” that the Port Authority’s assets could be used to repay the Chinese loan by waiving state immunity. The Auditor-General was wrong on both counts.

For the Auditor-General and many others, the debate about the railroad and the Port of Mombasa was complicated by terminology and practice. These are routinely used in the law and business of international project finance, but are unfamiliar outside of that area.

Although some public education would have been necessary, the declassification of the contracts (which the Kenyan Supreme Court is only the last imposed by the government) required a week) could have prevented the Auditor-General’s error and allowed for a debate on facts rather than rumours.

Map the project

The four key players in the Funding for the Standard Gauge Railway was Kenya’s National Treasury (the borrower), Kenya Railway Corporation (the project company), Kenya Ports Authority and China Eximbank (the lender). The figure below shows the complicated contractual and payment arrangements.

Kenya’s Ministry of Finance outlined the railway’s financing arrangements and credit improvements in a 2013 briefing to the Kenyan Parliament. The government had arranged several credit enhancements to increase the financial attractiveness of the costly project and make it ‘bankable’.

This included a ‘take or pay’ agreement signed between the national railway company and the Port Authority was signed . As part of this 15-year agreement, the Port Authority committed to moving (or “carrying”) a minimum amount of cargo on the new railroad each year. If freight deliveries fell below the agreed annual level, the Kenyan Port Authority would use its own revenues to cover (“pay”) the shortfall.

The Port Authority is thus the main customer of the standard gauge railway, not its security. The Ministry of Finance also pledged that the Railway Development Levy, a 1.5% tax on Kenya’s imports, would support the project.

The mistakes

One of our key findings is that the chief auditor the government was wrong to designate the Port Authority of Kenya as a borrower. If the Port Authority were a borrower, it would have co-signed the Chinese loans and would be equally responsible for repaying them. But the Port Authority is in no way a borrower.

Clause 17.5 of the Four Party Agreement, which the Auditor-General quotes in his report, explains the relationship: “Each of the borrowers, the Kenya Rail Company and the Port of Kenya Authority agrees…”

Our legal expert immediately established that this relates to three entities: Kenya’s Ministry of Finance (the borrower), the Railway Company and the Port Authority.

But this distinction was overlooked by the Auditor-General, who erroneously rewrote the clause to refer to two entities: “each of the borrowers, in this case the Kenya Railways Corporation and the Kenya Ports Authority…”

The Auditor-General then referred to clause 17.5 to say that the Port Authority was a borrower and therefore its assets were at risk. The examiner accused the port authority of not having disclosed this during the examination. The Auditor-General made false assumptions that influenced his opinion on the Port Authority’s responsibilities.

What does the waiver of state immunity mean?

The Ministry of Finance, the Port Authority of Kenya and Kenya Railways Corporation signed all “State Immunity Waivers.” Because all three were involved in various contracts as a whole. Under international law, sovereign states and entities controlled by them enjoy sovereign immunity. This means that they are generally immune from lawsuits and cannot be compelled to appear before a foreign court or tribunal or enforce a judgment rendered outside their borders. However, few international banks offer credit when there is no possibility of arbitration in the event of a dispute and no legal recourse to recover their money if the borrower defaults.

A published cache of loan agreements signed by Cameroon was signed with banks and export credit bureaus from Austria, India, Germany, Spain, Turkey and the UK show that all of these clauses are required. As one American attorney noted,

Omission of a waiver of government immunity in an international commercial loan agreement would be professional misconduct.

There is a whole, however There is a large gap between a general waiver of government immunity and the listing of a specific asset such as a port as collateral.

Our results clear up similar rumors that borrowing governments are pawning strategic assets such as land or ports in exchange for Chinese finance to have. These include Zambia (Kenneth Kaunda Airport), Uganda (Entebbe Airport) and Montenegro (Port of Bar).

Debt-trap diplomacy remains concerned that borrowers’ strategic assets are being directly (and intentionally) compromised by Chinese banks will fail the proof test.

Deborah Brautigam
Bernard L. Schwartz Professor of International Political Economy, Johns Hopkins University