The Dragon’s in the Detail with ‘Chinese Kina’ – Part 2

This is Part 2 of “The Dragon’s in the Detail with ‘Chinese Kina'” – a two part series looking into China EXIM Bank’s K6 billion loan to PNG. Part 1 can be found here and should be read prior to Part 2.

The revelation that the China EXIM Bank loan to PNG is actually a comprehensive credit package in the vicinity of K10 billion (US$5 billion) falls in line with EXIM’s strategic model of finance associated with developing countries and best demonstrated by the bank’s foraging into a number of African states.

Of relevant interest here is Angola’s 2007 US$4.5 billion credit package, Nigeria’s initially proposed 2009 US$2.5 billion credit package, and Ghana’s 2010 US$10.4 billion credit package – all financed by China EXIM bank and intended for various infrastructure projects – including railway, roads, dams and power plants.

It is debateable whether this model of developmental finance is indeed a genuine model of capital development for developing countries, or simply a credit-package which undermines the ability of these states to cope with debt – a fear some Papua New Guineans hold.

But what is agreed though is that this model is conducive to long-term objectives of developing countries, largely because Chinese policy banks like EXIM, are state owned and offer concessional loans which have long maturities and low-interest rates – fiscal terms and conditions which are globally competitive enough to trump that of both commerical and concessional loans offered by other partners.

Based on EXIM’s experience in Africa, the OECD Development Centre reported that the bank’s concessional loan structure is guided – in general terms – by the following basic conditions:

“Chinese contractors must be awarded the infrastructure contract financed by the loan.

This is similar to concessionary finance of traditional donors and provides these companies with an entry point to set up a presence in host markets where they can bid for commercial contracts, independent of projects under the concessional loan agreements.

In principle, concessional loans are used for procuring equipment, materials, technology and services, with no less than 50 per cent of the contract’s procurement coming from China. The loan is denominated in Chinese Renminbi (RMB) and has a maximum maturity of 20 years.

A grace period of 3-7 years may be granted to the borrower, during which the borrower will only repay interest payments and not the principal. The interest rate [between 3-6 per cent] is subsidised and underwritten by Chinese Government finances.”

It is likely that these terms and conditions will also apply to EXIM’s credit package to PNG too.

And to support the above, a precedent already exists between China EXIM Bank and PNG via the US$300 million Pacific Marine Industrial Zone (PMIZ) where the bank provided a US$71 million concessional loan for its construction in 2010.

Under this agreement, a relatively unknown Chinese contractor called China Shenyang International was awarded the contract as per the conditions of the loan.

These included the requirement that  70 per cent of the project was to go exclusively to a Chinese developer using Chinese technology, labour and equipment – while restricting PNG firms to bid for the remaining 30 per cent.

In addition, China Shenyang International’s profit margin was dictated to be 20 per cent of the total contract value, while the loan structure included a grace period of 5 years and a loan repayment time of 15 years.

As an indication of how sketchy details surrounding EXIM’s conditions can be – former Minister for Commerce and Industry Gabriel Kapris – when naming the the developer to construct PMIZ, could not provide any further detail to the history, expertise or corporate profile of China Shenyang International – apart from the company’s name.

Although the questions of ‘what on’ and ‘how’ EXIM’s K6 billion loan will be expended are important to PNG – and must be answered and made public by Peter O’Neill – it really is secondary to the the issue of what exactly are the terms of repayment.

One of the key issues of the K6 billion loan which has captivated PNG’s domestic discourse is the issue of affordability.

The Opposition in particular has repeatedly highlighted this as a point of concern and have contended that the government has pre-committed the gas revenue from the PNG LNG Project, due to be banked into the State’s coffers in 2022, to pay back the loan.

But this doesn’t  quite make sense under China EXIM Bank’s strategy.

What The Opposition and it seems everybody has missed, and what I strongly suspect to be the case, is that EXIM’s K6 billion loan will not be paid back via the regular financial installments dictated in the standard terms and conditions of a loan and disbursed through the budget process under the Department of Treasury’s watch, but instead, it will be accommodated for through a concessional commodity-for-finance agreement where the State will provide China with a minumum daily supply of oil and/or LNG in exchange for the financing of its expenditure objectives.

It’s an explosive conclusion – but one that I’ve drawn logically given the rather bullish nature of the government’s promotion of the loan in light of unanswered questions and a reluctance to reveal key details.

(It’s either a commodity off-take agreement or the commitment to provide stakes in a number of permits containing undeveloped gas fields and in exploration permits as happened in Nigeria – I suspect the former).

Furthermore, it fits well with EXIM’s strategy.

One of the biggest hints to this possibility is Minister for Works Francis Awesa’s strong indication of the participation of China National Petroleum Company (CNPC) – China’s largest integrated energy company – in the EXIM Bank loan deal.

CNPC and Sinopec, China’s national oil corporation, are both state-owned enterprises that have signed comprehensive supply contracts with ExxonMobil as part of the PNG LNG Project; and both are beneficiaries of project assistance from EXIM too.

There would also be scope for this arrangement to continue and intensify when InterOil’s US$7 billion LNG project begins production in 2015 as another Chinese state-owned enterprise, China National Offshore Oil Corporation (CNOOC), has signed a Heads of Agreement with InterOil and PNG’s Petromin regarding the possibility of underwriting the project – or at the minimum, helping to finance the State’s equity in the project.

In addition – more recently, InterOil-led joint-venture Liquid Niugini Gas Ltd signed a 15yr supply contract with China too.

Any such commodity off-take agreement would be actioned through a joint venture arrangement with Petromin – PNG’s natinal oil, gas and minerals company, and be cushioned by the initial grace period provided by EXIM.

China EXIM Bank’s financing strategy that couples a commodity off-take agreement with the financing of infrastructure is known as the ‘Angola Model’.

Examples abound here with Angola paying its debt to China back with oil exports, Gabon with iron ore, Demoractic Republic of Congo with copper and cobalt, and Guinea with Bauxite. Several of these arrangements are current.

But there are some serious concerns with China EXIM Bank and its ‘Angola Model’.

Perhaps the best example is that of Nigeria which was to draw down US$2.5 billion from EXIM in 2009.

After the country transisitioned through elections, it was revealed by the incoming government that what was initially thought to be a US$2.5 billion concessionary loan credit package turned out to be US$500 million at a concessionary rate, and the remaining US$2 billion at EXIM’s commercial rate.

Furthermore, it has been recently revealed that PNG’s loan structure with EXIM regarding Madang’s PMIZ consists of highly controversial detail.

Perhaps most shocking is the revelation that the entire agreement entered into between the two parties, although signed and actioned in PNG, is to be “governed by and construed in accordance with the laws of China”.

It doesn’t bode well for Peter O’Neill and the EXIM’s K6 billion loan.

As more details of the concessional loan emerge (Works Minister Francis Awesa is due in China later this month to finalize the deal), we may be looking at another of “the well-priced ‘long term trade agreements’ or deferred payment, resource-backed commercial export credits, where the interest rate will be based on LIBOR plus a margin”.

Peter O’Neill must make public the terms and conditions surrounding the China EXIM Bank loan, and the fiscal strategies his government will use to manage and mitigate the risks associated with the loan.

These basic details and conditions of the loan structure need to be made transparent – its importance to PNG requires that this be the case.

At the end of the day, the buck stops with Peter O’Neill and Co to refuse loans that are not concessionary by nature, as the Dragon is indeed in the detail with ‘Chinese Kina’.

~ by Tavurvur on October 16, 2012.

19 Responses to “The Dragon’s in the Detail with ‘Chinese Kina’ – Part 2”

  1. One thing is for sure out of all this. The Chinese are more aggressive with loan terms, and willing to take as much more as they give. It seems to me that what we are seeing is the west in competition with the east. And PNG will still be the meat in the sandwich as usual, because of our dependence on foreign aid or loans, or however it is packaged, and given. Its up to this government to tread carefully. Its the old adage, ‘more money and resources means more problems’. Let argue it until the best package, which is transparent, and in the best interest of PNG is achieved.

    • ‘Pom Observer’ – PNG finds itself in the juncture of Asia and the West – not just geographically, but also economically. Chinese influence in PNG can not be understated. And this loan – however large it is – is an extension of China’s intention to be involved with PNG. The loan will be approved – in just what manner we wait to see. Rgds, Tavurvur.

  2. Its another boomarang aid from China…… if PNG has not ha enough of Ausaid…..NOT!!

  3. You raise legitimate concerns about the model that PNG’s loan is based on. China’s sure to be leveraging extensive commodity flow and a contract bonanza in this loan’s terms.
    And the PMIZ plan is in a mess by all accounts at present. Doubtful whether it will get off the ground in the form that it was originally intended.

    • ‘Johnny’ – Agreed. There is a real danger here that the government will let this loan get out of hand if it is not managed well. However, the details surrounding this loan is what really concerns me – the public just doesn’t know enough about the structure of the loan. And it’s worrying – particularly on what EXIM has done in Africa. Rgds, Tavurvur.

  4. Thanks @Tavurvur for shedding the light. Throughout the piece I was all agitated. I am hoping what you are indicating is not true but reading about how China has been doing business, all indications are that it will be so. Why is our Government so adamant that this amount of money will fix our immediate problems? All along YoYoNeil has been saying that we had money and now he is going out seeking a substantial amount of money. I agree to a degree that we do need some money to fix certain important infrastructure but like you said, we need to know the details. Its not his private business and can be kept between him and his board. PNG need to know what we and our future generations will be servicing these loans.

    • ‘Mazev’ – Fair point. My discussions with fellow PNGeans reveal that most people are against the China EXIM loan, but upon further discussion, it is revealed that they really don’t know much about it or EXIM.

      I personally feel that he case for the funding of the Highlands Highway – as the key infrastructure of national significance – is imperative. And this loan will help achieve that.

      The issue here though is the remainder of the K6 billion (possibly up to K10 billion) – how will this be managed?

      We don’t have enough detail – and Peter O’Neill must front up with it.

      Rgds, Tavurvur.

  5. Really interesting stuff. We’ll have to wait and see, but hopefully PNG won’t end up with the worst case PMIZ scenario. PMIZ was one of four projects funded by the 2006 Soft Loan Facility (the others being Huawei’s IGIS, GDFC’s UoG dormitories, and Somare’s Community College project) and is certainly the worst example of the four. But such projects don’t have to turn out badly, it’s up to the PNG side of the negotiations — after all, it’s a loan, so it’s PNG’s money.

    In the case of PMIZ, the politicians involved (we all know who they are) were more concerned with getting their snouts in the trough than negotiating a good deal for PNG, but this doesn’t have to be the case. The dorms at Goroka are being built to a high standard with no revocation of sovereignty, largely because the PNG side (the uni administration and the architect) stuck to their guns. And there was no outgoing politician involved in the deal (although that nearly led to them missing out on the loan!)

    The fragmentation of the loan facility suggested in Part 1 is therefore alarming — you could well end up with different contracts being negotiated with different PNG and Chinese partners. Some of them done well, others like PMIZ.

    An interesting thing to watch out for is which locally based Chinese contractors are pushing this loan – a recent post on the Chinese embassy website suggested that 13 of the top 20 Chinese companies in PNG described their business as construction/infrastructure contractors. COVEC PNG are the largest and most competent operator, but as PMIZ proves, that’s no guarantee of success (I’ve still got no clue on why a big project would be given to a city level SOE that barely has a functioning website. Maybe it was their turn, or maybe the big players wanted nothing to do with it..)

    • “Lapun Poro” – Thank you. I’m a big fan of your work by the way : ).

      The PMIZ deal is indeed a worrying predecessor to this latest loan facility – and as you highlight, it’s not the Chinese half which is more concerning, but rather the fact that we seem to lack the negotiation expertise to really nail home an agreement (of any sort) which actually favours PNG.

      I read your paper which talked about the Goroka Dorms – this shows that a win-win partnership can be achieved for all concerned. The fragmentation which I touched on Part 1 is of great concern. It appears that senior members of Cabinet each have their own idea of where and on what the EXIM loan should go to.

      I share your confusion as to why Shengyang won the PMIZ contract. As with all loans EXIM – there is considerable influence from the central government-focused ‘board’, so maybe it was an effort to decrease the risk of having too many eggs in one basket – and an opportunity to help up-skill another potential contractor. Rgds, Tavurvur.

  6. Some excellent points from you and from the comments as well. In addition I would make the following points:

    1) If loans are denominated in Chinese Renminbi PNG will be exposed to enormous currency risk should the Kina fall. Does GoPNG have a currency hedging strategy to protect the country and its balance sheet from an additional debt burden should the Kina fall over the term of the loan?

    2) If Chinese contractors are allowed a tidy 20% profit margin PNG is paying for this through the loan regardless of whether the contractors do a good job. Also there is no incentive for the contractors to be efficient in expending the funds and neither is there an incentive to do quality work.

    PNG could be left with a debt burden much larger than the value of the projects to the economy.

    3) If the contracts are governed by Chinese law this exposes PNG to legal sovereign risk and subjugates PNG to Chinese judicial processes and practices which are not renowned for fairness and impartiality. Is this not ceding sovereignty and hence a form of neo colonialism.

    Having said all the above, if best practices are followed and all concerns allayed, these type of loans have the potential to transform the economy, bring positive change to the country and modernise infrastructure that is crumbling.

    The above is not a critique of China but rather a challenge for PNG to negotiate the best terms and manage things in the best possible way.

    • ‘Ekologix’ – Excellent observations, particularly around your first two points. Maybe ‘Lapun Poro’ can shed some wisdom on these.

      In regard to your third point, I have just come across an article focusing on this condition which argues that it is unconstitutional (this is in regards to the PMIZ contract with Shenyang). See below:

      [Lawyer Tiffany Twivey, representing over 360 landowners on whose customary land the PMIZ would impact, says the contract must be scrapped because it is unconstitutional.

      “By attempting to oust the jurisdiction of the laws of Papua New Guinea as well as the National and Supreme Courts of PNG, the loan agreement is contrary to the Constitution, which states that the National and Supreme Courts have unlimited jurisdiction in Papua New Guinea,” Twivey said.

      “Therefore the loan agreement is illegal and invalid.”

      Twivey Lawyers will seek to have the loan agreement declared null and void when they appear in Madang Magistrate’s Court this Monday, October 22.]

      Presumably, if this is the case with the K6 billion, it will fall short too of PNG’s Constitution. Rgds, Tavurvur.

      • Thanks for the invitation, though don’t know how much wisdom I can shed, love your work too Tavurvur..

        Ekologix first point about currency is spot on. This is the major concern of Chinese contractors and could be used as a reason/excuse to do less and/or cut corners. With LNG coming online, there’s only one direction the Kina is heading against the RMB, or any other currency for that matter..

        Ekologix’s second point should be possible to be addressed during the negotiation of the contract, and subsequent MOAs. The key part is for the PNG side to maintain control over design, supervision and the sourcing of materials. In the case of roads and bridges, PNG has clear specifications for all of these things and they can easily be written in from the beginning. The contractor is sure to try things on, and in the case of the Goroka dormitories they certainly did (including the bit about all disputes being heard in a Chinese court), but the PNG side stuck at it, and GDFC have built (and are building) furnished dorms that are better than most student accommodation in Australia. By contrast, in Vudal U, they did a terrible job, because the PNG side had no leverage (it was a Chinese govt grant). Companies will try to cut corners and maximise profits, regardless of their nationality, but it’s just a matter of whether you let them get away with it. I’m sure the Jiangsu contractors mentioned below could do the same thing, if pushed. It’s not as though there aren’t plenty of building contractors in PNG.

        On the third point, it’s interesting that even Canada has fallen for this one – a friend recently wrote to me complaining of a pipeline being built with Chinese labour, with much the same conditions as the PMIZ deal. But there’s no reason any project should agree to this condition and in the case of the Goroka dorms Exim didn’t force the point. Indeed, Exim is generally staffed by idealistic 20 something technocrats looking to improve the reputation of their bank. Not an institution to necessarily be feared, and far less arrogant and more flexible than many of its Western equivalents. If approached with well developed proposals for design and materials, they are likely to agree to them. But if the PNG side is unable to even name the Chinese contractor you’re a long way from that point (I was at the interview with Mr Kapris, and he couldn’t name them beyond ‘Shenyang’, which is a bit like calling PNG Power ‘PNG’).

        I really think this could work out for PNG, but those negotiating the loan have to be awake at the wheel, not dozing with a mouth full of buai and dreaming of their apartment on the Gold Coast.

  7. Thank you very much Tavurvur for this important information.
    My MP gave most projects over 3million Kina in our Electorate to China Jiangshu International Ltd( chinese Contractor), to build Hospital facilities, High School facilities, Womens resource Centres in the District, but the materials used and the work done was very cheap and doesn’t worth the millions of Kina given. The buildings constructed were without furnitures, white goods.
    This shows how these chinese don’t really care about puting up a good job. If we happen to be given this loan under the terms and conditions mentioned, thats how these Chinese Contractors are going to be performing.
    On the other hand, where is Nigeria and all those African Countries that were given loans by the Chinese, are they deveoped?? Our Prime Minister and negotiators must look at this carefully before making any agreements.

  8. ‘Lapun Poro’ – Our negotiation skills are indeed poor. This needs to change. Mr. Kapris has failed the people of PNG abysmally in his dealing with PMIZ.

    Peter O’Neill has made mention of learning from the mistakes of the past – I would hope that negotiating a loan with EXIM, and then effectively managing the disbursement of that loan, and implementing successfully the objectives of the loan, would be one of them.

    We have seen considerable ‘leakage’ from the PMIZ deal. With K6 billion to throw around, I am absolutely shuddering at the thought of what could be lost here – and the opportunity cost for doing so. Rgds, Tavurvur.

  9. Tavurvur….its an interesting insight to this EXIM bank loan to PNG with your main concern regarding the detailed packages / conditions / MOUs surrounding this K6 billion.

    I have a question, which I heard rumours concerning the middle men, the so called consultant negotiating these deals. How much do they get as their fees which is paid for?…..I’ve heard rumors of about 10% of the total loan or may be around K10 million per deal………thanks

    [Edited by Tavurvur – I deleted a link to a YouTube Video which I deemed was irrelevant]

  10. Tavurvur, I may be late on this one but better late than never. I think we have sold our birthright for a bowl of noodle soup..absolutely ridiculous. Guys, I think our country has breakeven with this loan. The much hyped gas windfall probably is already tied to repaying this loan. Not much hope for the commoners. What do you think.? You do the math..

  11. Tavurvur… brilliant post… Bill Clinton mentioned ‘simple arithmetic’ in his endorsement speech for President Obama during the 2012 election… something our leaders seemed to have lost sight of. Feels a little like our leaders are overextending the financial obligations of our country… I’m disappointed although not surprised…

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