Africa: Why Djibouti’s China debt is raising the alarm

Posted on Jan 8 2019 - 7:43pm by Editor

EUROMONEY

7 January 2019

by CHRIS WRIGHT

Djibouti-aerial-780

Djibouti’s access to the sea means transportation accounts for 70% of the national economy

Euromoney is standing at Doraleh container terminal in Djibouti watching the good ship Callisto being unloaded on a busy wharf. It sounds an obscure place. But this is the perfect vantage point from which to understand the geopolitical importance of the small African state and some important things about China’s Belt and Road Initiative (BRI).

In front of us is the Bab el-Mandeb Strait, which links the Red Sea to the Gulf of Aden and the Indian Ocean. Through this bottleneck, just 18 miles across to Yemen at its narrowest point, as much as 20% of all global exports and 10% of total oil export transits pass by, most of it to or from the Suez Canal.

Behind, across about 40 miles of Djibouti’s parched volcanic landscape, is Ethiopia and behind that a host of other landlocked African states. Since the coastline south of here for more than 2,000 miles belongs to lawless Somalia, Djibouti’s port represents the only way Ethiopia and its interior neighbours can get their goods to and from the sea.

This strategic location is the reason that the transportation sector accounts for 70% of the national economy; it is the reason a new railway has been built to Addis Ababa, funded, built and operated by China. It is the reason China has invested in the port, the free-trade zone and fresh water infrastructure. And it is also the reason that Djibouti is uncommonly popular with other people’s armies. There are 4,000 US troops at Camp Lemonnier, as well as military bases for the French, Italians and Japanese – and, most recently, the Chinese, who have their first overseas military facility here next to the port. The US and Chinese bases are about six miles apart – nowhere else in the world do the two nations have naval camps in such proximity.

There is one more reason Doraleh container port matters: it is at the heart of a dispute that raises important questions about the scope, nature and intentions of the BRI.

Djibouti-dock-780

Doraleh container terminal

Alarm bells

China is everywhere here, and just lately that has started to ring alarm bells.

In February 2017, the IMF put out a country report on Djibouti, revealing some startling statistics: that public external debt had risen from 50% to 85% of GDP in two years; that 77% of government-guaranteed external public enterprise debt was owed to China Eximbank; and that in 2016 alone, that institution had lent $1.456 billion to projects in Djibouti. The IMF said then Djibouti was at: “High risk of debt distress, as all debt sustainability indicators are above their thresholds for a prolonged period.”

In March 2018, the Center for Global Development identified Djibouti as one of eight countries at the greatest risk of debt distress as a consequence of BRI-related financing. The report forecast that in 2017 Djibouti would take on debt equivalent to 88.1% of GDP and 87.5% in 2018, the vast majority of it due to China.

Later in 2018, Citi put out a report saying that public and publicly guaranteed debt hit almost 98% of GDP in 2017 and that China accounted for 90% of all loans contracted from 2014 to 2016.

“It is easy to see how debt can increase dramatically on the back of mega infrastructure projects to which China has played a disproportionately large role,” Citi said.

“We are not exclusive to anyone. It’s not China versus the West, that’s not the narrative we are looking for. We are looking simply to serve our population” – Ilyas Moussa Dawaleh, Djibouti finance minister

None of this would bother the rest of the world particularly, were it not for what has happened in Sri Lanka, with the Hambantota port passing to Chinese control after Sri Lanka was unable to pay the debts it owed to China its construction.

The US, in particular, fears the same thing happening with Djibouti’s vital port. Indeed, it fears that is the intention: the deliberate manufacture of a debt trap that can only be escaped by ceding key infrastructure.

In November two US senators, Marco Rubio and Chris Coons, wrote to US secretary of state Mike Pompeo and secretary of defence James Mattis raising concerns about Chinese influence in Djibouti. This followed marine general Thomas Waldhauser, the senior US military officer for Africa, telling a Congressional hearing that the US military would face “significant” consequences if China controlled the port.

The perspective in Djibouti itself is rather different, where there is some bemusement at all the attention.

“We find the narrative globally a little bit incorrect,” says Ilyas Moussa Dawaleh, Djibouti’s minister of economy and finance, speaking to Euromoney at a new centre for entrepreneurship, where workers toil to put the finishing touches to the building before its official opening the following day. “To be honest, it’s because it is coming from China. It’s not about anything else.”

There are two issues here – the level of debt and who it is owed to.

Three arguments

On the debt load, Djiboutian leaders tend to make three arguments. First, that so much of Djibouti’s economy is informal and does not appear in official numbers that the actual ratio of debt to GDP is far lower than it appears.

Second, that recent numbers have been distorted by heavyweight projects, which will be paid down over many years and will be operational for generations.

And finally, if you run a country with the needs that Djibouti has – 41% of the country is officially poor and 23% in extreme poverty, according to the IMF, with unemployment at 39% – you are going to accept funding for potentially transformational infrastructure when it is offered.

They also argue that the GDP of Djibouti will increase dramatically as a consequence of the projects, making the capacity to pay down debt far stronger.

Ilyas-Moussa-Dawaleh-160×186 Ilyas Moussa Dawaleh, Djibouti finance minister “We are expecting to double GDP in five years’ time,” says Dawaleh. “Because GDP will be increasing faster, so the proportion of the debt will be less than what we are observing today.

“To me, the loans, the debt of Djibouti doesn’t represent the whole picture,” he says. “What matters is how strong and disciplined we are in terms of our macro-fundamentals, and how our public enterprises, which are benefiting from these loans, will perform in order to generate enough revenue to pay back their loans.”

Payback will not come from the state budget, he says, but the projects themselves.

Some are more ambitious still. The chairman of Djibouti Ports and Free Zones, Aboubaker Omar Hadi, says true GDP, including the informal sector, will quadruple, not double, in five years.

Assessing the true debt burden requires more than simply comparing total loan volumes to GDP. What actually matters is the term of the debt and the nature of the projects it is attached to. Over two days in Djibouti City, Euromoney believes it has gained a clear sense of the debt picture and how the circumstances of the lending vary widely from one project to another.

There are five big projects underway in Djibouti with Chinese involvement, with many more to follow. They are: the Doraleh container port, in which China is an investor, having bought 23.5% of the shares in the port’s owner for $185 million; the Doraleh multi-purpose port, next door, involving a $580 million loan from Export-Import Bank of China; the Djibouti International Free Trade Zone (DIFTZ), which involves a $250 million loan from China Development Bank; a water pipeline with Ethiopia, involving a $322 million loan also from Eximbank of China; and the Addis Ababa-Djibouti railway, Djibouti’s end of which involved a $490 million loan from Eximbank of China.

It is important to understand that the circumstances of each loan are different and that this will have serious consequences for the country’s ability to repay.

According to minister Dawaleh, the ports and water loans are on a concessional basis of around 2% flat over a 20-year term, with a grace period of around seven years before repayments start. For such well-appointed ports, that should be achievable.

Djibouti Ports and Free Zones chairman Hadi paints a slightly different picture. He says that for the Doraleh multi-purpose port, the funding was a mixture of 85% concessional funding at 1.85%, and 15% on commercial terms, at about 3%. Still, that balances out at about the level Dawaleh suggests.

Djibouti-International-780

Djibouti-International-780 China Development Bank’s loan on DIFTZ is different again, in that it only involved a three-year grace period before loan repayments are due.

And then there is one important outlier.

“The railway,” says Dawaleh, “is different.”

Indeed it is.

Restructuring

The Djibouti-Addis Ababa railway is a signature BRI project: ambitious, cross-border and iconic. It is 756 kilometres long, cost $4 billion and has a capacity of 24.9 million tonnes of freight annually. It provides landlocked Ethiopia with an efficient way of getting its goods to the sea through the port at Doraleh.

It is also in trouble.

Dawaleh says that the railway loan, of which Djibouti is on the hook for just under $500 million, was extended on commercial terms from Eximbank of China, at Libor plus 3%, and apparently with a far shorter grace period than is the case on the port and water pipeline loans.

“This is what we are trying to discuss and negotiating with our friends from China Eximbank, and we are very much optimistic about getting better conditions,” he says. “In the railway, commercial conditions cannot be the best conditions to really feel comfortable in the repayment capacity. So the Chinese government are very supportive… to help us in decreasing the stress of that project.”

This is a long way of saying the loan needs to be restructured.

It perhaps didn’t help that Ethiopia was so desperate for the railway.

“In that project we were really only the follower, Ethiopia took the lead, because most of that project is in Ethiopia,” says Dawaleh.

Ahmed Osman, governor of the Central Bank of Djibouti, agrees.

“At the beginning, we saw the price and we said it is not good for this kind of project,” he says. “But at the same time it was the pressure from the Ethiopia side that everybody had to keep it on trend.”

Either way, it is clear that the debt, on the original terms, is not sustainable.

Djibouti-train-300

Old French railway, now replaced by Chinese-backed infrastructure projects

It is not as if there is a fear of a Sri Lanka-style reclamation of the infrastructure, because it never really stopped being Chinese in the first place. The railway was built chiefly with Chinese labour and all operations on it until 2023 are undertaken by the state-owned China Railway Group and privately owned China Civil Engineering Construction Corp. Although Djibouti and Ethiopia’s government do legally own the railway, they really have almost nothing to do with its operation yet.

And this project is a reminder that problems with debt repayment are not necessarily good news for China either. In October, at a BRI conference in Hong Kong, Wang Wen of China Export and Credit Insurance Corporation – known to most as Sinosure – made some unusually forthright comments about the railway.

He said it had cost Sinosure close to $1 billion in losses. The debt had had to be restructured already because of underuse caused by power shortages, he said.

“Ethiopia’s planning capabilities are lacking, but even with the help of Sinosure and the lending Chinese bank it was still insufficient,” he said, according to the South China Morning Post, which was attending the conference.

He also named other China-backed projects he felt had suffered from poor preparation, including a sugar refinery and a railway in Latin America.

“As Chexim [China Eximbank] gets extended, how many defaults can they weather?” asks one adviser familiar with BRI deals. “They have an enormous amount of reserve capital, but at a certain point everyone faces constraints, and getting the assets back is not always a win.”

There is a separate question of whether or not China ever expects to be repaid for some of these loans, although it says it does.

“Borrowers rarely repay sovereign debt, which is evidenced by overall debt levels since the 1970s expanding significantly globally,” says Jason Elder, partner at Mayer Brown in Hong Kong. “Existing debt just gets recycled and very few borrowers ever repay. That feeds into the question of appropriate levels of sustainable debt.

“So, for Djibouti, the ministry of finance will be carefully balancing these considerations when determining its sovereign funding strategy,” he says. “Does it plan to borrow, build and repay, or perpetually roll the debt over?”

Parag Khanna, managing partner of FutureMap and author of a new book called ‘The future is Asian’, which includes detailed coverage of BRI, makes another point.

“Since when do we look at cross-border infrastructure projects from the standpoint of commercial returns?” he asks. “When in history has that ever played out as a good story? The entire history of infrastructure, cross-border or domestic, is loss leaders.”

It is also sometimes forgotten that debt can be taken out in other ways. Djibouti is not a regular in the international capital markets, but could presumably borrow if it needed to, albeit it a high yield.

Still, while all these points are relevant to the railway, it does appear that the other projects, and the ports in particular, ought to be able to find their way to successful operation and repayment.

Except there is a problem.

Concession terminated

There is another reason Djibouti’s relationship with China is in the headlines, which brings us back to the Doraleh container terminal. In February 2018, the Djibouti government terminated a 50-year concession that had been granted to DP World, the Dubai-based state-owned port operator, to control the Doraleh container terminal.

It did this after a period of mounting dissatisfaction with the way DP World was running the port and a belief that it was being deliberately underused. Although the relationship between Djibouti and DP World goes back to the Dubai company’s management of the city’s old port from 2000, the dispute stems from a contract signed in 2006 to govern DP World’s role on the Doraleh container terminal.

Hadi tells Euromoney that the contract – covering a joint venture agreement, management contract and concession agreement – was “unbalanced.”

Specifically, although the majority shareholder in the container terminal venture was Djibouti with 67%, it had a minority vote with none of the protections that would normally be afforded to a minority shareholder, he says.

He claims the agreement said that Djibouti directors could not vote against DP directors on the board and that the contract stipulated that Djibouti could not build any port facility or free zones for the next 50 years anywhere in the country.

So why did they sign it? Hadi says this was done by a predecessor who subsequently turned out to have a consultancy agreement with DP World to be paid $1.2 million a year and hence was not representing Djibouti’s best interests.

“Our line of defence was that there was only one party on the contract,” Hadi says. “There were not two parties.”

None of this has got very far in the eyes of international law. DP World pursued its objections in the London Court of International Arbitration and the High Court of England and Wales, winning judgments in both. Djibouti has said it will ignore both rulings.

DP World has put out a series of statements arguing its position. One, on August 4, for example, said: “Today’s statement by the Djibouti government [ignoring the arbitration court ruling] demonstrates that Djibouti does not recognize the international rule of law.

“The Djibouti government’s repeated statements that the port concession has proved contrary to the fundamental interests of the Republic of Djibouti do not bear scrutiny.”

It added: “In light of that indisputable success, and the fair and reasonable terms of the concession, the government’s attempts to terminate it cannot have anything to do with the fundamental interests of the people of Djibouti.”

Another, on September 5, after gaining an injunction from the High Court to restrain Djibouti’s port company, PDSA, from treating its joint venture with DP World as terminated, said: “Although PDSA is the majority shareholder of the DCT joint venture company, it is DP World that has management control of the company.”

“We have to develop something for the new generation who are coming. If investors are Chinese or Norwegians, it doesn’t matter to us” – Ahmed Osman, Central Bank of Djibouti

Hadi has no interest in these judgements. “A company cannot control the whole coastline of a country for 50 years. This is against the sovereignty of the country.”

This is all a matter for Djibouti and Dubai. But the reason it has captured international attention is because of the identity of the company that is running the neighbouring Doraleh multi-purpose port, China Merchants Port Holdings, which also happens to be the company that is running the port Sri Lanka has just ceded to China.

The narrative globally is that China has muscled its way into a terminal that DP World had the right to run for 50 years and that this is evidence of how BRI is being used to further Chinese political, strategic and even military influence.

However, the reality may be more complicated.

China Merchants Port Holdings is a 23.5% shareholder in PDSA, a stake it took for $185 million. It is involved in the running of the container terminal, the new multipurpose port and the free-trade zone.

The DIFTZ, whose first phase of high-capacity warehouses and industrial clusters is shown to Euromoney, is a 60/40 venture between Djibouti and three Chinese companies, chiefly China Merchants Ports but also Dalian Port Authority and IZP. If it reaches its planned capacity, DIFTZ will be a $3.5 billion project spanning 4,800 hectares, the largest free-trade zone in Africa.

Hadi doesn’t think the presence of the Chinese has much to do with the dispute.

“We are very surprised that DP World are talking about that as the main reason for our conflict, because they accepted when we were bringing China Merchant into the equity,” he says.

He has photos of DP World’s chairman at the signing ceremony and the ground-breaking ceremony of Doraleh multi-purpose port, he says, with China Merchants Ports present.

“So why now has China Merchants become a problem?” Hadi asks. “They are using that argument of China to worry the US.”

He also points out that its arguments with DP World pre-date by some time China Merchants Ports having any involvement in Djibouti.

Big money, good terms

The point everyone in Djibouti makes is that the reason they are borrowing from China is because China is offering big money on good terms.

“We don’t understand why everyone now is panicking about One Belt One Road,” says Hadi. “Money is a commodity, we buy money, and the price of that money is the interest rate. If the US and Europe want to offer the same thing, we are ready to consider and compare, but we have nothing to compare today.”

Finance minister Dawaleh adds: “We are not exclusive to anyone. All of our friends remain friends to us. It’s not China versus the West, that’s not the narrative we are looking for. We are looking simply to serve our population.”

It is simple economics, he says: “If I can get the same conditions [from the West] as I’m getting from Eximbank, I’ll be more than happy. If I can get better than what China is offering to us, I’ll be much more happy. I don’t just have to deal with one partner.

“But China are the ones taking risks. Maybe some friends are not happy hearing that, but that is the reality.”

Central bank governor Osman says this line of thinking helps to explain the railway loan.

“Almost 95% of Ethiopia’s exports come through Djibouti, so it was very important to find a solution,” he says. “The railway was a project we were trying to find a solution for, for 20, 30 years, with French people, German people – we have tried everybody to attract investment. But we didn’t succeed.”

So when China came, “we didn’t have any hesitation for that project,” says Osman, “because of the impact on the productivity and development of the country.

“We in Djibouti have a different community,” he adds. “I am Somali origin; he [pointing to a colleague] is Afar [a distinct ethnic group native to the Horn of Africa]; another is Arab. We don’t care the nationality you are from. So long as you have the capacity to construct, you are welcome. Chinese? Welcome. American? British? French? Welcome.

“We have to develop something for the new generation who are coming. If investors are Chinese or Norwegians, it doesn’t matter to us.”

Could what happened in Sri Lanka happen here?

“I think the feasibility study was not properly done there,” says Hadi. “Even if Sri Lanka kept the port, it is losing money because it has no traffic. That is not our case.”

He says volumes of container traffic are up 32% since the takeover from DP World.

Dawaleh adds: “At this point in time, we have no concerns about loans being repaid. The port is functioning well, better since we took it over.”

He does ask what the difference is in accepting foreign direct investment from a country and the sort of debt-equity swap that has been seen in Sri Lanka.

“Do we consider we lose our sovereignty by allowing investment in a port?” Dawaleh asks. “Then why should we consider we are losing sovereignty when we take a loan?

“Our sovereignty is not negotiable. We took it back from colonialism only 40 years ago, and we are very much jealous of our sovereignty and independence.”

Full article: https://www.euromoney.com/article/b1clfx2rfvlhx6/africa-why-djiboutis-china-debt-is-raising-the-alarm?copyrightInfo=true

About the Author