Secrets of SGR contract with China: How Kenya got the short end of the stick

China's courting of Kenya though started before Gangnam in 2009 when Kenya's Ministry of Transport and the China Road and Bridge Company signed a Memorandum of Understanding in August of 2009. The MoU indicated that the initial steps of the project involved a feasibility study into the viability of the project.

The study was to be conducted by a nominee of the Chinese government- the China Road and Bridge Company- at no cost. In the years that followed though, it emerged that the free feasibility study was a calculated entry point for the Chinese into the project.

Later negotiations put the CRBC at the centre of the project, locking out any potential competition for the construction of the railway.

On May 17, 2010, less than a year after the signing of the MoU, the Kenya Railways Corporation put out a Request For Proposals for consultancy services for the preliminary design and environmental and social impact assessment for developing a modern, high-capacity standard gauge railway line between Mombasa and Malaba with a branch line to Kisumu.

Unknown to other potential suitors to the project, CRBC had a year's worth of a head start and ran the inside lane in the race to build the railway from Mombasa to Nairobi and beyond. By the time other companies considered jumping on the bandwagon, the Chinese firm was well into the completion of its free feasibility study.

This proved an incredible advantage to the Chinese company in the months that would follow. Being in control of the project from the very beginning meant it would not just have the advantage of an early investor, but it gave CRBC the confidence to go ahead and set contractual terms that had it at an advantage and the government of Kenya at a disadvantage.

Seven months after the official RFP by the Kenya Railways, CRBC was ready with its feasibility report, submitting it in January of 2011 complete with recommendations that would significantly alter the final project on both the technical aspect as well as the financial aspect.

Kenya Railways had put out an RFP for the development of a modern high-capacity standard gauge railway engine that would initially run between the two cities of Nairobi and Kisumu and connect Kenya to Uganda.

"The line may eventually be extended to Kigali, Rwanda and Bujumbura, Burundi," read the RFP.

In its feasibility, CRBC suggested a different approach - the maintenance of diesel engines with a slight adjustment to the railway lines; expanding them from a metre gauge to the more internationally acceptable standard gauge. This effectively shelved the original idea of creating a modern line.

The wheels begin to turn

The feasibility study was completed in January 2011 and presented to the Ministry of Transport. It wasn't, however, until the following year that the SGR began to shape up. In January of 2012, Kenya's embassy in Beijing, China, located on Road No. 4, Xi Liu Jie, a neighbourhood that also hosts the Embassy of the Republic of Guinea, the Embassy of Nepal as well as the Royal Embassy of Saudi Arabia, made contact with the Chinese government.

Central to the contact was to pass on a message from the Kenya Railways Corporation with regard to the feasibility study conducted by CRBC. The key message being Kenya Railways needed financial help from China to build a project whose feasibility study had been conducted by a Chinese company.

From that point on, CRBC's advantage was unassailable, and its officials quickly went back to the drawing board and developed a proposal that included a proposed financing scheme. This was submitted on May 29, 2012.

Just over a month after the submission of the proposal, Kenya Railways replied to CRBC.

"This is to notify you that the Kenya Railways Corporation has accepted your proposal dated 29th May 2012 for the construction of the construction of the Civil Works of the Mombasa- Nairobi Standard Gauge Railway Project for the amount of Ksh220,921,502,221.08 billion exclusive of all taxes, duties and other levies which include cess, value added taxes and so on." The letter of the award signed by the then Kenya Railways Managing Director Nduva Muli reads.

"The aforementioned amount is the contract price payable in consideration of the execution and completion of the services prescribed in the contact document... you are now required to give formal written unconditional acceptance of the offer and to produce a detailed and resourced program of works. This notification of Award shall lead to conclusion of a contract between parties which shall be confirmed through the signing of the contract agreement."

A few hours later, CRBC responded to the letter of award.

"This refers to your letter of award Ref: KRC/PLM/31/2012 dated 10th July 2012 awarding the above-captioned project to our company. We hereby give a formal unconditional acceptance of the award," the reply, signed by CRBC (Kenya) General Manager Li Qiang reads. "We look forward to signing the commercial contract with you at the earliest time."

That same month, government technocrats in conjunction with representatives from CRBC started working on the contract document. The articles of the initial drafts of the contract necessitated some back and forth between CRBC officials and representatives of Kenya Railways.

The Secret Contract

Forecasts from that Thursday, October 4, 2012 show that it was a hot day. As Kenya Railways and CRBC officials put pen to paper it looked, increasingly, that there could only be one winner in the deal.

Minutes from pre-contract signing negotiation meetings between the two teams obtained by The Standard point at negotiations heavily skewed towards the contractor with little fight with regard to negotiation put up by the government of Kenya.

The meetings were held between June 27, 2012 and August 30, 2012 at various locations. The two negotiation teams were made up of Solomon Ouna, Alfred, who was the General Manager Finance for Kenya Railways, Maxwell Mengich, Lucy Njoroge, Merianne Kitany, Stanley Gitari and David Mwadali.

CRBC was represented by its General Manager for the Kenya Office Li QIang, his deputy Xiong Shilling, Yang Jie, Zhou Yihua, Peng Dapeng, Li Changui, Li Ming and Gao Min Zhi.

Central to the negotiations during that period were the bill of quantities proposed by CRBC, the payment schedule that Kenya would be subjected to, the delivery of the engines, training and technical assistance of Kenyan citizens as well as other varied conditions of the contract.

When the eventual contract was signed, many key issues remained unresolved.

First, the payment schedule was rigid for a project of such magnitude dependent on many variables. The penalties for default or delay were quite clear.

"If the Contractor does not receive payment in accordance with Sub-Clause 14.7 [Timing of Payments], the Contractor shall be entitled to receive financing charges compounded monthly on the amount unpaid during the period of delay. Unless otherwise stated in the Particular Conditions, these financing charges shall be calculated at the annual rate of three percentage points above the discount rate of the central bank in the country of the currency of payment, and shall be paid in such currency. The Contractor shall be entitled to this payment without formal notice, and without prejudice to any other right or remedy," reads the penalty for default.

Additionally, the contractor, CRBC, was at liberty to vary the price of the contract in relation to external price indicators such as inflation and rising cost of building materials without notice.

"The contract price is to be adjusted for rises or falls in the cost of labour, goods and other inputs to the works by the addition or deduction of amounts determined by the formula prescribed," reads the clause on adjustments.

With this in mind, the contract also gave CRBC a freehand in pricing for the materials used for the construction of the SGR through the inclusion and approval of a non-binding bill of quantities. It is worthy to note that the original pricing of the bill of quantities for the project was produced by CRBC:

"Whereas non-binding bill of quantities is based on the feasibility study and the preliminary design, both parties agree that the quantity of the items shall be adjusted according to detailed design within the contract price," reads a clause within the contract. "During the execution of this contract, if the market price fluctuates and substantially affects either party, both parties shall negotiate a new unit price and adjust the quantity of items within the contract price."

The contract also specifies that all payments to the financiers of the deal, China's EXIM Bank, are to be made directly to financial institutions in China. 85 per cent of all payments are to be made in foreign currency - US Dollars at current Central bank of Kenya rates - while only 15 per cent of the payments can be made in local currency at an agreed exchange rate.

"In case of any discrepancy relating to percentages relating to local and foreign currency, the provisions of the loan agreement shall prevail," the contract states.

The contract also gives leeway to CRBC, the main contractor of the project, to present performance securities, first installment and retention money guarantees from banks with their principal offices in China or Kenya.

The contract also exempted CRBC from all taxes, duties and other levies such as cess, VAT, withholding tax, custom duties and other taxes.

"All custom duties and charges on importation of equipment, spare parts and materials etc shall be exempted," the contract reads.

There was also a strict time frame of 60 months attached to the project completion with a 6-month grace period. Any delays outside of this would result in a penalty of 0.0025 per cent of contract value per day.

"The delay damages shall be 0.0025 per cent of the contract price per day and shall not exceed the maximum of one per cent of the contract price," the specific contractual clause reads.

Delayed payments also carry punitive costs.

"In the event of the failure of the employer to make payment within the times stated in sub-clause 14.7 hereof - within 56 days of invoicing - The employer shall pay the contractor simple interest at LIBOR (London Interbank Offered Rate) plus 2% of foreign currency and a mean base lending rate issued by CBK of Kenya plus 2% for Kenya Shilling)," the contract reads.

LIBOR is the average interbank interest rate at which a selection of banks on the London money market are prepared to lend to one another. Currently the rates oscillate at around 3 per cent for overnight lending with a maximum of around 5.3 per cent for 12-month lending between banks.

No silver lining

Every morning hundreds of passengers line up for security searches at the SGR main terminus in Nairobi to head south to Mombasa and other towns in between. Others troop to Miritini to catch a ride in the opposite direction. All the while, cargo from docked ships at the Port of Mombasa are loaded onto the container flat wagons for the hinterland.

Yet, since it was launched, the SGR as a project is yet to break even. Running on losses year after year while still amassing debt to the Chinese government, quadrupling the country's debt burden to China in just 5 years.

Away from the debt, the cargo train, the main money maker of the project, is still operating below its design capacity of 22million tonnes of cargo every year. Data from the Kenya National Bureau of Statistics shows that in 2020, some 4.4 million tonnes of cargo were moved.