Chinese conditionalities Rohan Samarajiva At the recent Development Forum in Galle, Minister Sarath Amunugama stated that there

was no longer any need to kowtow to the World Bank and the ADB, because China is extending assistance for large projects without conditionalities. This makes sense for those accustomed to the heady wine of national sovereignty: no more diktat from foreigners; we do what we please in our own country. But let us see, concretely, what taking Chinese money means; what we gain by wiggling out of ADB conditionalities, with the help of the Chinese friends of the government. No hypotheticals; Actual case: The Katunayake Expressway. [There have been rumors and reports that the May 2006 Cabinet decision was suspended following adverse news reports; but there have also been reports that it has been reactivated. Therefore, the Cabinet Decision announced on May 11th, 2006 is taken as reflecting an official government position.] Fixed-price expressways There is consensus that Sri Lanka needs more roads, especially controlled-access highways (expressways for short). The planning for Sri Lankas first controlled-access highway that is actually being built, the Southern Expressway from Kottawa to Matara, started in 1988. Work was commenced by the Kumaratunge administration, was accelerated under Ranil Wickremesinghe, continued under Mahinda Rajapaksa as Highways Minister and is scheduled to be completed in around 2010, behind schedule and over budget. The 130.9 km highway is now expected to cost LKR 33 billion, revised upward from the original estimate of LKR 29 billion (almost 30 billion). In May 2006, the Cabinet approved a proposal to award the contract to build the expressway connecting the Katunayake international airport and Colombo to the China Metallurgical Construction Group. It is to be operated as a toll road, the first in Sri Lanka.

The 25.2 kilometer highway will cost USD 292.4 million dollars (approximately LKR 29.2 billion; almost LKR 30 billion). It is financed by a loan from a Chinese Bank, which it is hoped will be repaid at least partially by toll revenues. Then, there were news reports about the Kandy Expressway being built, again as part of a government-to-government deal outside normal procurement rules, by a Malaysian company. The cost? LKR 30 billion. Three highways over widely differing terrain and different distances (130.9 km, 25.2 km and approx. 130 km), each costing around LKR 30 billion. From being the country distinguished by the lack of a single expressway, Sri Lanka jumps to the forefront of new thinking on the subject, pioneering the concept of fixed-price expressways. Saga of the Katunayake Expressway Many people dont know this, but enormous concrete structure that one sees when exiting Colombo over the New Kelani Bridge (actually it can no longer be seen, because it has for some time served as the most expensive and robust structure used to support hoardings) is a remnant of the first highway connecting the airport to Colombo, commenced and abandoned after spending millions, during the first Sirimavo Bandaranaike administration in the early 1960s. If one happens to be on a daytime flight that circles over the lagoon from the South to land at the international airport and looks down, one can see the remnants of the second Katunayake highway, with built-up sections skirting the edge of the lagoon. This was a more recent effort during the Kumaratunge administration that ended up with the government compensating the contractors (Daewoo-Keangnam) to stop construction because it had run out of money to pay them. The Ministry of Highways website continues to state, even six months after the Cabinet decision, that the entire highway was expected to cost LKR 11.1 billion. The reserve price calculated in the course of designing the competitive process to select a contractor was approximately LKR 15 billion (USD 150 million). But the contract amount announced by the Minister of Highways, Jeyaraj Fernandopulle, after the Cabinet accepted the terms negotiated during and since the former President Kumaratunges farewell visit to China at the end of her term was LKR 29 billion (USD 292.4 million).

So in summary. The governments own website says the Katunayake Expressway will cost LKR 11.1 billion. The ADB, in the course of preparing a tender process for bidding out the work, estimated it could cost, at most, LKR 15 billion. During her farewell tour, the then President, Mrs Kumaratunge, canceled the competitive procedure and worked out a deal that did not include conditionalities with the Government of the Peoples Republic of China. After the presidential election, the new President and the new Highways Minister entered into further negotiations with the Chinese. End result was a contract for LKR 29 billion, double the reserve price set by the ADB and LKR 17 billion higher than the Ministry of Highways estimate. And the only truth about estimates of highway construction is that that they go up, so one should not be surprised if the actual bill is even higher. But, no conditionalities. No supplication before donors. A great victory for national sovereignty. Or is it? Price of no-conditionality? At the Galle Development Forum, the Central Bank Governor, Nivard Cabraal, said that the term donor is misleading, that multilateral financial institutions, namely the World Bank and the Asian Development Bank, are banks that lend us money that we have to repay. He was both wrong and right. He was wrong in equating the multilateral financial institutions and conventional banks. They do not earn profits for their shareholders, which includes the government of Sri Lanka. He is egregiously wrong with regard to funds obtained from the International Development Association (IDA), a member of the World Bank Group that has so far provided the bulk of funding for Sri Lanka. All IDA credits carry 0 percent interest. Some have a 0.5 percent commitment fee but even that is often waived. The grace period is 10 years and the repayment period is 40 years. The grant element has been calculated to be as high as 85 percent in some cases. What this means in common-sense terms is that borrowing USD 100 from the IDA is equivalent to getting a grant of USD 85 (that does not have to be repaid) and a loan of USD 15 on commercial terms, under optimal conditions. Deviations from the optimal occur because the country borrows in Standard Drawing Rights (SDRs), a basket of hard currencies (dominated by the US dollar and the Euro) and has to pay it back in 3

SDRs. So, the country bears the currency risk: if the currency depreciates against the basket, the grant element goes down. In cases like Sri Lanka, where the government is printing money and actively depreciating the currency, the 85 percent figure will not be achieved. Once a country reaches the IDA cut-off for a sustained three-year period it moves into being IBRD eligible and becomes a blend country (eligible for a certain amount of IDA funding, but having to use the conventional loan window also) for a while before "graduating" completely from IDA. The cut-off at present is USD 965 GDP per capita (set in 2005, with an exception for small island states such as the Maldives). Borrowing from the conventional window (the International Bank for Reconstruction and Development or IBRD) requires paying close to market rates. Although IBRD is financing remains cheaper than market rates borrowers often complain about the costs imposed by requirements such as. environmental standards and safeguards to build roads and other infrastructure. Now that Sri Lankas per capita GDP is over USD 1,000, our eligibility for concessional loans is declining. Yet even after we start borrowing from the non-concessional part of the World Bank Group, the International Bank for Reconstruction and Development, the financial terms will be less onerous than for loans from the private banks (for example, the effective interest rate on the three-year, USD 100 million loan obtained by the government from Citibank in December 2006 was approximately 6.5 percent; no grace period; no forty years to repay, etc.). But Governor Cabraal was also right. Loans have to be repaid: concessional loans, a little; commercial ones, a lot. No one said that the Cabinet approval was for an outright grant from the Government of China. The approval was for the China Metallurgical Construction Group to build the road, financed by a loan from a Chinese Bank. The highway is to be operated as a toll road, the first in Sri Lanka. The toll revenues are to be used to repay the loan, though of course, the government guarantees the loan and may end up paying for all or part of it. But governments dont make any money as such and cant repay anything. Definitely, the people we think of as government, advisors, ministers, and officials will not pay anything. If the loan is repaid from tolls, the users of the expressway will pay for it. If not, the tax payers will pay for it. Not the income-tax payers, but all tax payers, which means everyone who buys groceries and 4

everyone who rides a bus or a three-wheeler and therefore pays valueadded and other taxes. If the government of that time also finances its activities by printing money, there will be an additional contribution made by the populace because inflation is, in the words of the Deputy Governor of the Reserve Bank of India, a tax on the poor against which no hedges are available. In its normal functioning, the government mandates that all purchases have to be made through transparent tender procedures, set out in the Blue Book developed with much fanfare by the Kumaratunge administration during the 1990s. The rationale is that transparent tender procedures, though they eat up a lot of time of officials and can slow down procurement, yield low prices and more value for the publics money. As the Highways Ministrys own website states and the ADBs experts calculated, a competitive process would have resulted in the Katunayake Expressway being built for a price of around LKR 11-15 billion, LKR 14 billion lower than the amount approved by Cabinet. As far as it is known, the Chinese are not going to pave the expressway in gold. Give or take a few frills, the end result of the expressway that would have resulted from the ADBs conditionality-based process and the Cabinet approved exceptional process is a road that will take people from the airport to Colombo smoothly and in less than 20-25 minutes at any time of the day. So the LKR 14 billion is for getting rid of the conditionality. The ADBs conditionality was that transparent international competitive tender procedures should be used. It is a restatement of standard government procedure, perhaps with the additional elements of adhering to the ADBs procurement code and allowing international bidding. Is getting rid of these conditions with the help of the governments Chinese friends worth LKR 14 billion or more? To make that a little more understandable, the extra cost of LKR 14 billion is the equivalent of the government imposing a LKR 700 head tax on every single man, woman and child living in this country. Rebellions were started for lesser acts back in the early 19th century! Chinese conditionalities

It is a fact that the government and people of Sri Lanka have suffered from chronic completion anxiety regarding expressways. As we have seen, planning on the Southern Expressway started in 1988, almost 20 years ago. The intention to connect Katunayake to Colombo by a decent highway has been there for over 40 years. In this light, isnt it better that we get the thing built in any way possible? The damage caused by having everyone coming into the country navigate the current poor excuse of a road may be higher than LKR 14 billion. It was not long ago that no one could get to the airport because the entire road went under water (area residents claim that the flooding was caused by the half-built second Katunayake Expressway preventing the rainwater from flowing into the lagoon; a claim worthy of verification). But the Katunayake deal is about more than a highway. It is the thin end of the wedge that will take all or most major infrastructure projects outside the competitive bidding process and into the realm of so-called government-to-government transactions, as evidenced by the proposed deal with Malaysia re the Kandy Expressway and the many deals being reported about the ports in Hambantota and elsewhere. And the threat of going with the Chinese is causing the ADB and the World Bank to deviate from correct policies that would optimize benefits to consumers in the long run. The retreat from a correct regulatory model in the Colombo South Harbor is a case in point. As explained above, paying a higher price to escape a conditionality carries real costs. The extra LKR 14 billion has to be paid by someone, not a Minister. Either the tolls will have to be set so high that few will use the road, or taxpayers will have to pay the bill. If we start adding up the costs of Chinese bearing gifts, using LKR 700 per person for the Katunayake Expressway as basis, it will add up to something substantial. The government-to-government rationale that is used to justify the exclusion of these deals from normal procurement procedures is without substance. It is an extension of the logic used to justify exempting intra-government purchases from normal tender procedures. Even if we overpay a government department, it does not matter because the money goes from one pocket of the government to another. In addition, it is argued that government officials will not pay 6

bribes and offer kickbacks. After all, they get paid whether they bring business in or not. The extension is flawed. What goes from the pocket of the Sri Lankan taxpayer or tollpayer will go to a Chinese bank that will collect the full amount plus commercial interest, and then to the China Metallurgical Construction Group, and then perhaps into the pockets of various government functionaries. The only places they wont go into are the pockets of the taxpayer or tollpayer in Sri Lanka. Based on a survey of 11,000 businesspeople worldwide, Transparency International claims that companies in India and China are most prepared to pay bribes. In getting international business, governmentowned companies do pay bribes and kickbacks. Unless it is an outright gift from a foreign government, the incentives to offer bribe and kickbacks cannot be ruled out. The only safeguard against these actions is transparent procurement, the primary conditionality imposed by the multilateral financial institutions. This is a conditionality deserving of acclaim.