Leasing of Hambantota port: Rationale, economic benefits and way forward

The Hambantota port has become a widely discussed topic in Sri Lanka today due to a number of reasons. The recent incidents following the government’s decision to lease it to a reputed port operator, including the views for and against this move, heated debates on this topic, demonstrations and protests by some segments of the workers, some politicians in the opposition and several lobbying groups, including the public, etc., have brought this topic to the forefront of the ongoing policy dialog.

It is observed that many of this opposition to the ongoing move is due to the lack of proper understanding about this initiative. Hence, it is important to enlighten the stakeholders, interested parties and the public about the rationale, economic benefits and way forward related to the decision for the long-term lease of the Hambantota port to provide the true picture about the government’s move.

Locational advantage
The Hambantota port is located on the southern tip of Sri Lanka within 10 nautical miles from the world’s busiest maritime lanes. It is ideally located at the intersection of the major international shipping routes. Approximately 200 to 300 ships sail through this route daily. The Hambantota port is strategically positioned in terms of domestic trade perspectives also. 

While it can serve the southern half of the country, it is directly linked with the Central and Eastern Provinces through roadway connections. This harbour has been important for the Sri Lankan economy since ancient times. It was first known to be operational around 250BC and was used as part of the Maritime Silk Route by the Arabian and Chinese merchants.  

The Hambantota port always had the potential to play a pivotal role as a vital base of maritime transportation in Sri Lanka. It has been embedded into the government’s vision of developing Sri Lanka as a logistical hub between Singapore and Dubai in the Asian Waters. In fact, the development of the Hambantota port to handle ships of the modern era was conceived as early as 1977 but the actual development process was delayed until 2008 due to various reasons. 

While the port of Colombo is expected to operate as a transshipment hub, the Hambantota port development was initiated with the view of developing it as an industrial port, given the land availability in the area, geographical location and the already built road network.

Construction and opening of port
The first phase of the Hambantota port development project commenced in 2008 and it became operational in November 2010. This phase comprised the construction of the basic port and other facilities, such as shipbuilding, bunkering, ship repairing and crew changing. 

The cost of the first phase was estimated to be US $ 361 million and it was funded by China’s Export Import (EXIM) Bank (85 percent) and the Sri Lanka Ports Authority (SLPA) (15 percent). However, due to unanticipated cost escalations, the project cost increased to US $ 508 million.

In addition, the construction of the bunkering facility and a tank farm commenced in October 2009 and was completed in 2011. Both in-port and offshore bunkering services are planned to be provided from this facility. US $ 76.6 million was spent on the tank farm and bunkering facilities. Further, an administrative building, consisting of 14 stories and 10,447 m2 space, was also built during Phase I of the project.

Phase II of the project commenced in November 2012 and at present, it has been completed substantially. This phase involves the construction of several berths (i.e. main, multipurpose, transition and oil berths), a feeder container terminal, an artificial island, a coffer dam and other yards and handling facilities and access roads.  Further, the entrance channel has been deepened from 16m to 17m at this stage. The estimated total funding requirement for Phase II of the project is US $ 808 million.

Investment for crane and other container handling equipment is yet to be mobilized to make the Hambantota port fully functional to achieve the anticipated return.  

Capacity and opportunities
Once completed, the Hambantota port will occupy an area of 1,815 hectares and according to the master plan, it will have the capacity to accommodate 33 vessels at a time. Once it is fully operational, it will be the world’s largest port built on land and will be able to handle up to five million 20-foot equivalent units (TEUs) per annum.

The port saves three days of sailing time and fuel for the ships, which are otherwise compelled to divert to the port of Colombo. This will increase Sri Lanka’s competitiveness as a maritime hub and raise the overall potential of the maritime industry. With the right investment, it can also offer other services, such as ship repairing, medical and water supply and logistic support, generating a significant amount of direct and indirect employment opportunities. The project is expected to be complemented by railway and highway networks, an oil refinery and associated facilities as well.

Financial performance of Hambantota port
Since the commencement of the commercial operations of Phase I in 2010, the performance of the Hambantota port has not been satisfactory as it has incurred substantial losses. Meanwhile, the annual debt service payments, which are currently made by the SLPA, amounted to about US $ 73 million (Rs.10.6 billion) in 2016. 

This situation has seriously threatened the financial viability of the project. In fact, the SLPA is compelled to divest a significant portion of its revenue to repay the debt incurred from the construction and loss-making operations of the Hambantota port. Making things worse, it is running at severe under-capacity at present.

Need for an alternative strategy
If this trend is continued further, the port will ultimately prove to be economically unsustainable and a massive burden on public finances, which will have to be borne through higher taxes levied on the public. This clearly shows the need for an alternative strategy to revive the port. 

It also leads to the legitimate question of how long the country can continue with this unfavourable situation without taking the appropriate remedial measures. At the same time, in order to harness the potential of developing the Hambantota port as an industrial port, it is important to attract foreign direct investments (FDI) and invite foreign industrialists to set up their factories in the Hambantota port towards promoting as a world-class industrial port in the future.

Prerequisites for effective revival of port
The revival of the port and improvement of its financial position depend mainly on two key prerequisites. First, in order to improve the performance, Hambantota has to be properly established as an industrial port, complemented by the provision of other port-related services. 

Second, the Hambantota port also needs a proper financial and business plan with an investor-friendly environment to promote the port among international ship operators. It has to be an attractive location for services beyond the ship. This requires the services of a company, which has vast experience in maritime operations and strong links with international maritime operators.

These requirements were among the major reasons to search for a private sector port operator, which can adopt a viable business model to increase port operations, generate businesses inside and around the port, largely expand its revenue base, generate direct and indirect employment through the development and efficient management of the port and improve its financial viability as against the continuation of the port as a debt-ridden liability to the entire country. Hence, the decision of the government to obtain private sector participation to run the Hambantota port efficiently has to be looked at considering all these factors within a holistic perspective.  

Burden on government coffers
The completion of the remaining work needs a substantial amount of further investment. In this context, the infusion of further capital to complete the project, by way of loans, virtually does not exist, given the already weak public finances of the country and the need for resolving the issues related to the Rs.9,500 billion debt burden of the country.

Making things worse, the government/the SLPA has the onerous responsibility of making debt service payments as well as bearing the losses of the Hambantota port. As the current situation is unaffordable for economy, an alternative arrangement is vitally important. 

Options for private sector partnership
After identifying the need for urgent action, the government considered three available options: i.e. (i) to go world-wide and call for proposals, (ii) calling for proposals from Chinese companies and (iii) conducting direct negotiations with the interested/nominated Chinese companies. 

Considering the urgent need to avoid further delays in getting reasonable return and other factors, the government decided to opt for direct negotiations with the interested Chinese companies, nominated by the government of China through the embassy in Colombo.

Joint venture for port
Debt/equity swaps are not possible in terms of the prevailing laws in China. However, the agreement currently being negotiated, can have the characteristics of a debt/equity swap while providing greater flexibility for the way in which the government of Sri Lanka can utilize the proceeds generated by the proposed transaction. The preferred option is a long-term lease while keeping a certain percentage of the stake with the government (SLPA).

Accordingly, a framework agreement has been signed between the SLPA and China Merchants Ports Holding Company (CMPCH). Under the initial proposal, an 80 percent stake to state-owned CMPCH and 20 percent to the SLPA has been proposed. Accordingly, negotiations are going on for the final terms and conditions, which will be agreed upon a mutually beneficial basis to both parties. The government has assured that under no circumstance, will Sri Lanka’s stake be less than 20 percent. 
Meanwhile, the government has appointed a seven-member new cabinet committee to review the negotiation process. Once finalised, the cabinet of ministers and parliament will be apprised of the proposed strategy and way forward.

Will government sell Hambantota port?
The government has categorically indicated that the Hambantota port will not be sold to anyone under any circumstances. The ongoing discussions are aimed at leasing of the port for a specified period while keeping a certain share of the ownership with the government under terms and conditions acceptable to the country, as indicated above. Hence, this will be a joint venture with the long-term leasing of the port, which will involve a company registered in Sri Lanka and operating under this country’s laws. By no means, this will be a sale of the Hambantota port to any private sector company.

Concession agreement
As part of the leasing process, a concession agreement, which will be completed after the due negotiations, is to be signed between the SLPA and CMPCH. 

It is extremely important to understand that entering into a concession agreement to develop the Hambantota port is not a new initiative by this government. In fact, the SLPA (as per the Act No. 51 (Section 7-1 (a)), with its powers to acquire/hold, take on lease, to give on lease, hire, pledge and sell or otherwise dispose of any movable or immovable property) did sign a Supply, Operate and Transfer (SOT) contract in 2014 related to the Hambantota port for a joint venture with the Chinese.  This SOT is now invalid as the conditions were not met. In this context, it is important not to be misled by false information on the genesis of the concession agreement.

Economic benefits of long-term lease of Hambantota port
There is no doubt that the Hambantota port will generate multiple benefits to the country, if managed effectively as a financially viable venture. As indicated above, given the lack of financial capacity of the government to put in place required prerequisites to achieve this, private sector participation has been encouraged. 

Accordingly, with the engagement of the Chinese company, this problem will be resolved and the port will be in a position to deliver the expected benefits. In this context, there will be a number of economic benefits accruing to the country with the successful completion of the long-term lease of the Hambantota port. These include the following: 

A. Immediate benefits
Inflow of FDI: With the conclusion of the negotiations and the signing of the final agreements, the government/SLPA will receive around US $ 1.1 billion (about Rs.165 billion) in 2017. This will entirely be an inflow of FDI to the country. Although FDI normally involves a significant import component (of around 65-75 percent), this transaction will not have such a significant portion of imports as the inflows are for an already built asset (Phase I).  

Strengthened balance of payments (BOP), external reserves and exchange rate: The receipt of US $ 1.1 billion will help improve the country’s BOP position as this will be an inflow to the financial account of the BOP. The major advantage of this inflow is its non-debt creating nature, which is particularly beneficial to the country at this juncture. It will be added to the country’s external reserves thereby strengthening the external position of the country. The increased foreign exchange reserves will help in providing greater stability to the exchange rate as well.

Positive impact on government budget: The government will have a number of alternative options in the way of utilising the foreign inflows of US $ 1.1 billion (about Rs.165 billion).
a. Utilising the funds to repay expensive foreign loans thereby reducing the interest expenditure and future debt burden of the country.
b. Utilising the funds for financing the budget deficit in 2017. If selected, this option will effectively reduce the domestic borrowing requirement of the government budget for this year helping to maintain lower domestic market interest rates.
c. Utilising the funds for liability management purposes, i.e. switching to longer maturities to reduce bunching of debt service payments.
d. Using a combination of these options.

B. Medium to long-term benefits
Royalty payments: Once the port operations are vested with the new joint venture, there will be royalty payments made to the government (SLPA) on a revenue sharing basis. This will commence once the port utilisation reaches a mutually agreed level of performance.

Benefits from development of Hambantota port: In general, ports function as gateways of international trade, which could contribute immensely to the development of the domestic economy, amidst the integrated global economy. There could be various input-output linkages associated with port services and past experiences have shown that ports and local economies have been mutually dependent upon each other. This enables the integration of the local economy to the national economy and then to the global economy. 

In the Sri Lankan context, the Colombo Port, over the years, has proved this proposition. The latest addition to this journey is the Hambantota port. Hence, the revitalisation of activities in the Hambantota port on a sustainable basis through the proposed joint venture will deliver the benefits similar to the Colombo port over the years.

With the new model to be adopted in the context of the Hambantota port, its operations will be enhanced thereby creating various linkages, involving people, entrepreneurs in the surroundings of the port area and other stakeholders, particularly in the Southern and Uva Provinces. 

More importantly, it will create employment opportunities over the years thereby enhancing the earning capacity of the people. There will be direct jobs, which are generated by activities at the port and induced jobs or those jobs supporting the local purchases made by the individuals, holding the direct jobs due to port activity.

Vast benefits from industrial zone: The government expects to develop the Hambantota port with industrial zones in the area. In this context, Chinese investors have already expressed the willingness to invest in Sri Lanka. In line with this, the Chinese government has made a separate request from the Sri Lankan government to provide them with 15,000 acres for the activities related to the proposed industrial zones. The government has principally agreed with this proposal and the prospective lands will be identified from state-owned properties. 

The land will be selected on case by case basis from the Hambantota District as well as from adjoining districts such as Moneragala. In fact, the Chinese government has also indicated that the investments in the proposed industrial zones would be around US $ 5 billion (Rs.750 billion) in the medium term. 

In this process, the government has already held the inauguration ceremony of the Sri Lanka-China Logistics and Industrial Zone in Mirijjawila, Hambantota on January 7, 2017. This will help generate a significant amount of employment opportunities as well as various backward and forward linkages between the industrial zone and the proximate areas. The government will ensure that there will be no activities taking place in the industrial zones, which are detrimental to the environment.

Way forward
There is no doubt that the Hambantota port can contribute immensely in the journey towards making Sri Lanka one of Asia’s modern, economic success stories during the next 10 to 15 years by becoming a strong and wealthier nation where people enjoy higher standards of living. Given the weaknesses in the government budget and the entire fiscal system in the country, the government or the broader public sector alone will not be able to finance the required investments to achieve this objective. 

Hence, the government is pursuing public-private partnerships (PPPs) and bringing in private sector partners and industries to the country to fulfil the much-needed investment requirements, which is a prerequisite for creating more employment opportunities. 

The decision to have a PPP based on a long-term lease for the Hambantota port has been taken in this context. The SLPA and CMPCH will come up with appropriate business models and commence operations towards reviving the Hambantota port after the finalisation and signing the relevant agreements. Once the Hambantota port has risen as a vibrant maritime hub in the southern tip of the country, there will be widespread economic benefits in the future, complemented by other social and political benefits.   

Hence, the need of the hour is to understand the true picture about the ongoing measures related to the Hambantota port by looking at it in a broader manner. It will be the duty of all of us, as responsible citizens in Sri Lanka, who anticipate a secure and prosperous future for all our sons and daughters, to take a pragmatic and open-minded view of the government’s efforts to bring prosperity to one of the lagging regions in the country. 

(The above is a paper circulated by the Development Strategies and International Trade Ministry among the media)