Implications of tied lending in new railway line

In May last year, it emerged that a China-based financier forced Kenya and Uganda to pick a Chinese company as the operator of the rail business on the standard gauge railway without public bidding.

State-owned China Exim Bank told Uganda that they would only get funding to build their section on condition that it agrees with Kenya to hire the Chinese contractor to run the line from Mombasa to Kampala.

Kenya would then be compelled to sign a deal with China Communications Construction Company (CCCC) — the firm building the Sh357 billion Mombasa-Nairobi line — to run the rail business.

“Recently Uganda went to engage the China Exim Bank and one of the conditions they were given is that between Uganda and Kenya, we must appoint one operator to do operations and maintenance of SGR between Mombasa and Kampala in order for the bank to consider any financing,” explained Mr Atanas Maina, the Kenya Railways managing director.

This was a classic case of tied aid and its implications.

Tied aid describes official grants or loans that limit procurement to companies in the donor country as in the case of the SGR operator.

COMPETITIVE TENDER

While Kenya had initially talked of seeking an operator through an open competitive tender and even in March started the search for transaction advisers to help procure an operator for the new line, the Transport ministry would later admit it was finalising a five­ year agreement with CCCC for the Chinese firm to run the SGR operations.

Studies show that tied borrowing, which comes with conditions that typically dictate that goods and services are sourced from the lending party, typically add 20 to 30 per cent to development project costs, versus untied lending.

Activists against tied aid note that the motivation of an aid-giver country is not the benefit of the aid recipient, but securing its own economic gains.

Tied aid therefore, they argue, often prevents recipient countries from receiving value for money for services, goods, or works.

To the giver country, aid is a form of investment.
For the recipient country, economic cost of the tied aid goes up.

Experts say the extent of this increase depends upon the conditions of aid and other attendant circumstances.

This, however, reduces the real value of the tied aid while the repayment obligations do not decrease.

REGULATORY BARRIERS

Proponents of effective aid are increasingly making a case for untying aid.

According to the Organisation for Economic Co-operation and Development (OECD), untying aid — removing the legal and regulatory barriers to open competition for aid funded procurement — generally increases aid effectiveness by reducing transaction costs and improving the ability of recipient countries to set their own course.

“It also allows donors to take greater care in aligning their aid programmes with the objectives and financial management systems of recipient countries,” says OECD.

Even then, a school of thought has been quick to defend the tying of aid, pointing out its advantages, especially for the recipient country.

For starters they argue that the volume of aid is “adequate, timely, and on an assured long term basis”. Under such conditions, there is also a high probability of aid being on concessional terms.

This is because according to this school of thought, for the aid-giver it reduces the risk of default by the recipient, and gives the giver “a better control” over the design, technology, location, and management, etc., of the funded projects.