For centuries, until European occupiers developed Galle, a port by the Walawe river estuary was Sri Lanka’s main gateway to the rest of the world.

The port called Magampura in Hambantota, straddling the east-west shipping route, was a centre for trading spices, the most sort-after commodity from the island. For hundreds of years, the spice trade flourished due to great demand and limited supply.

During the reign of Ruhuna’s kings, advanced irrigation management had made growing rice and other crops possible year-round. However, unlike rice, farmed with managed water in the dry zone, spices required rain. It’s the twin monsoons that rained on the slopes of the island’s central hills and valleys that provided conditions for growing spices. Magampura was the gateway from where Ruhuna’s salt and food crops traded for inland spices were shipped overseas. With hundreds of ships, weapons and a willingness to use both, Chinese Admiral Cheng Ho’s fleets visited the island a few times. A stone plaque at Galle records that Admiral Ho kidnaped the local ruler and took him and his family back to China. The island’s international nature can be understood by the fact that the Galle plaque is in four languages – Chinese, Persian, Arabic and Tamil. At the time, Sri Lanka was clearly globalised. Long before Europeans discovered Asia’s cosmopolitan, intellectual and commercial life, the island now called Sri Lanka was integrated with these.

After the occupying Dutch and British shifted activity to the Galle harbor, the port at Hambantota went into quiet decline. Hambantota’s present day revival reinforces the importance of thousand-year-old commercial links and networks across the seven seas.

Ominously or not, China, whose Admiral Cheng Ho humiliated a kingdom by kidnapping the monarch, is playing the critical role in the emergence of Sri Lanka’s deep South. China’s gigantic government-controlled businesses have taken over the development and management of the modern Magampura seaport, and propose to establish industries in the 400-acre complex, and another almost 3,000 acres outside the port it will receive as part of the agreement. In vision, scale and potential impact, the project is unsurpassed by any in the region.

After plundering European occupiers left 70 years ago, Sri Lanka’s fortunes somehow became linked to South Asia. In a laggard region, the island was the best place for a long time. Home to around a sixth of the world’s people, one by one, South Asian nations led by India, Bangladesh and then Sri Lanka started dreaming of a better future.

Bangladesh has firmly ditched crisis-prone politics, India resolutely pursues structural reforms and Sri Lanka prioritised building infrastructure. The first ships entering Magampura Mahinda Rajapaksa Port, the spiritual successor to the well-known ancient harbor in the same region that no longer existed, was to be a game changer. However, the colossal construction cost, equipment unavailability and the absence of any other strategy resulted in no economic contribution from the port, and loan repayment threatened to bankrupt the government-owned Sri Lanka Ports Authority, the port’s owner.

To overcome the loan service difficulty, the government was compelled to swap its debt for equity with the Chinese in a deal involving entities controlled by the two states.

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T COMPLETION of the second phase, the port financed by China cost $1,316 million. Its first phase, although not equipped to handle containers, consists of two 600-meter long berths, a 310-meter bunkering berth and a 120-meter small craft berth, all at a 17-meter depth alongside the quay. Phase two of the development would add six more berths, making a total of eight berths, excluding ones for bunkering and small crafts.

Critics of the debt-to-equity swap suggest the deal is disadvantageous for Sri Lanka in four areas: the valuation, the extent of tax breaks, its impact on the Colombo port, and the Hambantota port’s unproven backward integration for job creation and generating business opportunities for companies here.

Hyperbole is not unexpected from a government. But, in the choices made about the establishment and operation of the Magampura port, the Mahinda Rajapaksa administration’s incompetence and disregard of any commercial sense was beyond any hype.

The case for a Southern port was well-established, and a 2005 feasibility study by a Danish consultancy proposed a three-stage development. Construction commenced in January 2008 by China Harbour Engineering Company and Sinohydro Corporation, financed on commercial terms by China’s Exim Bank. Vanity quickly trumped commercial sense. No investors were secured for establishing the services needed to operate a non-containerised port. Instead, an incomplete port was readied for opening five months ahead of schedule in November 2010, before the contractor could remove rocks from the port’s mouth, to coincide with then-President Mahinda Rajapaksa’s birthday.

Of course, the rocks prevented large ships from entering the port’s deep basin. Underwater blasting to clear the obstructions later cost the government an additional $40 million, raising the first phase’s cost (including admin building and tank farm for bunkering) to $650 million and requiring almost two more years to complete.

Almost a decade since Magampura’s construction commenced and seven years since the first ships sailed in, the port’s revenue was not even remotely adequate to service the loans obtained for construction, when its sale (99-year lease) to China was finalised.

In 2015, the port’s total income was $16.5 million (Rs2.4 billion). In 2016, revenue was around the same. When loan repayment commences on the $1.27 billion borrowed, following the initial grace period, one estimate calculated the annual repayment at $96 million.

Given the tough financial choices facing the country, swapping equity for a debt settlement was inevitable. The Chinese expect to invest $600 million to equip the port, a level of funding Sri Lanka couldn’t afford on its own. Given SLPA’s poor record in managing businesses, compared to private competitors, it’s also an unnecessary risk for taxpayers. At Hambantota, everything was bungled. A ship fuel supplying service (called bunkering) with a loan-funded investment of 14 tanks and a 1.2 kilometer pipeline connecting them to the waterfront was suspended due to heavy losses resulting from ‘bunkering irregularities’.

[pullquote]Despite the tax breaks, the purchase price is not foreign investment that flows into the ‘real’ economy. Instead, it’s one big company horizontally acquiring another[/pullquote]

Aside from dominating banking, the government operates an unprofitable airline, owns hotels, an insurance company, a telecoms firm and most utilities. Many of these investments are loss-making, even with a monopoly, while profits at others are sub-optimal.

The port sale to China is controversial due to the transaction’s unconventional nature. Ports aren’t assets governments sell outright (a 99-year lease is as good as a sale for anyone living today). Instead, like at Colombo, the government (SLPA) remains the owner and public-private partnership concessions are awarded to private consortia to invest, build and operate container or other terminals. Colombo’s privately controlled terminals SAGT and CICT are 35-year concessions compared to Hambantota’s 99 years.

Few private companies have the ability to invest up to $2 billion as the Chinese have now undertaken to do to purchase an equity share and equip the port. For all its posturing about regional security, the Indian government cannot match Chinese financial or management heft, and could not take on the port. Hopes that public-private partnerships might return to their heights from the 1990s, when Sri Lanka Telecom was listed and the SAGT deal was signed, have dimmed. Instead, an unconventional deal, a questionable valuation and lack of transparency cloud the Hambantota port deal.

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ENTRAL TO GROWING foreign investments will be companies seeking a foothold in South Asia as India emerges a major consumer and economic power. Offering inducements such as land to build factories and a low corporate tax are usual. However, sweeping corporate tax breaks to the Hambantota port investment are questioned for their long tenure. Private investments in ports aren’t new. SAGT and CICT managed terminals have set the precedent on taxation, royalties and dividends, generating a steady cash flow to the government and port owner SLPA.

Hambantota International Port Group and Hambantota International Port Services Company, the two firms investing and managing the port and its service infrastructure, have been granted a 25-year corporate tax holiday, which commences seven years after the concession agreement’s signing, thus extending the tax break to 32 years. Usually, large infrastructure projects are loss making in the early years.

The longest income tax holiday allowed under the Strategic Development Act is 25 years.

Other tax breaks for the two companies developing the port include exemptions from dividend tax for 26 years, withholding tax for seven years, VAT for seven years and Port & Airport Development Levy for seven years. In addition, it’s exempt from CESS charged under the Export Development Act, NBT, excise taxes and customs duty on the import of project-related items and expatriate staff exempt from PAYE, all for seven years.

Tax breaks were approved in parliament after the Hambantota concession was granted. Despite its poor economic utility, the Hambantota port was an existing business. By valuing it at $1.4 billion and accepting $1.12 billion as sales (lease) proceeds for majority stakes in two companies controlling the port results only in an ownership change.

Despite the tax breaks, the purchase price is not foreign investment that flows into the ‘real’ economy. Instead, it’s one big company horizontally acquiring another. The acquisition itself will not change anything. To argue that the Chinese plan to invest up to $600 million is what got the tax break then needs to be linked to the investment when it happens.

For an investment even larger (an estimated $800 million), the John Keells-promoted Waterfront hotel, condos and project received a 10-year income tax holiday and a further 15 years of income tax at half the rate prevailing for the hotel sector or 6% annually, whichever is lower. As South Asian economies expand, interest from foreign investors is only likely to grow to invest in businesses that can reach these newly affluent consumers. Then, prospects for the kind of foreign investment that lifts productivity will start to look even brighter. Generous tax breaks, without links to investment, employment or productivity outcomes, and going beyond those available for Sri Lankan businesses, may appear ill-conceived.

A source familiar with the negotiations concedes that the Chinese were demanding. With few other options left, which the Chinese would have appreciated, Sri Lanka’s negotiating position was weak. Without the support of specialists, developing countries usually also make poor deals for themselves.

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NCE EQUIPMENT has been installed, Hambantota will have eight deep water berths compared to the nine at the Colombo port. So far, it’s not publicly announced how fast its new Chinese owners will containerise the port. The concession agreement includes a condition to prevent Hambantota from undercutting Colombo port on domestic cargo, but naturally all other services and transshipment cargo is open to market pricing.

More than the geographical advantage against Colombo, the Southern port under complete Chinese control will have the freedom to recruit talent from anywhere in the world, and may not suffer the disruption of unions and bureaucracy that affects even the private sector-managed terminal in Colombo.

Due to the lack of space, the 300-acre Colombo port is challenged with accommodating any logistic-related services in its premises. Logistics firms say red tape and the lack of space are major obstacles for developing the industry.

Foreign investment, even when it’s due to selling an existing asset like the Hambantota port, make a country more productive. Investors from overseas bring know-how and cutting-edge capital assets. Chinese companies are also likely to invest in the new port, which is adjacent to a 3,000-acre industrial zone.

Since the project has long-term tax breaks and an ability to hire foreign workers, the only foreseeable benefit will be for Sri Lankan businesses to invest in ventures within the Chinese port and in the industrial zone that will link them to global supply chains.

Otherwise, if productivity growth is low, wage growth will be too. Creaky infrastructure will compound the issue in the country, while an efficient setup in the Hambantota port and zones will create an oasis of wealth due to its efficiency. If many Sri Lankans don’t work there and local businesses haven’t invested, the industrial renaissance will pass the rest of the country by. But that’s conjecture. Nothing so far suggests that the Chinese will be as unwise to close the port and industrial zone to the rest of the country, operating it as an enclave. However, they will also not be able to compel businesses here, many of which are protected from competition, to seize the opportunity.

If businesses cannot get things done themselves, even the most energetic politician will struggle to set up factories and generate one million jobs over the next few years. Resentment to globalisation will rise if foreigners are seen to benefit disproportionately from the opportunity here. The problems snowball from there: jobs with poor productivity retard peoples’ prospects for advancement.

Sri Lankans also have a peculiar attitude to work, complain employers. Their expectations on rewards are disconnected from productivity. When British occupiers grew tea, they had to import labour as Sri Lankans refused to work in plantations since they were established 150 years ago. If the Chinese receive a different reaction to the British will be known in a few years.

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N ANCIENT EGYPT, cassia and cinnamon fetched a high price as they were essential for embalming. More widely, spices were used to preserve food and make the poorly preserved palatable. Today, however, spices are seasoning and flavouring for food. They are still essential to prepare a good meal, but no longer difficult to obtain. Once in decline, the ancient Magampura harbour never regained its place as other agricultural produce, like tea, began to take precedence in exports, and decades later, industrial goods began to fill ships.

However, for the Southern port, its reemergence as a trading post may bring the story full circle as Sri Lankan businesses now have an opportunity to become part of global supply chains. Shipping spices formed the backbone of early international trade. That role has now been taken over by global supply chains; and with the Chinese port, Sri Lanka has an opportunity to join the global trading order.