Sri Lanka’s Flawed Regulatory Framework Helped Spawn Bad Chinese Loans – Analysis

The special regulatory framework for unsolicited proposals was deeply flawed, says Verite Research 

While it is true that Chinese loans to Sri Lanka have tended to be unproductive and a drain on the island nation’s slender financial resources, Sri Lanka’s regulatory framework is also to be blamed for the sorry state of affairs. This framework, established in July 2010, is glaringly flawed, and as such, has been grossly misused to the detriment of the country, says a report entitled The Lure of Chinese Loans prepared by Dr.Subhashini Abesinghe and her colleagues for the Colombo-based Verite Research (https://www.veriteresearch.org/publication/the-lure-of-chinese-loans/). 

The report says that the Special Regulatory Framework used in the case of Unsolicited Proposals (UPS) to execute development projects was “not designed to facilitate efficient and effective utilization of the incoming funds.” 

Sri Lanka had a better and time-tested system with safeguards in the form of the Procurement Guidelines (PG 2006). But between 2010 and 2016, this was superseded in many cases in a bid to secure Chinese funds for ambitious post-war infrastructural development. Fresh schemes had to be devised to attract funds because accessing concessional finance from overseas had become difficult in view of Sri Lanka’s having been categorized as a Lower Middle-Income Economy in 2004. Sri Lanka had to seek alternative financing options, with lower costs and longer maturities. 

In this context, ‘export credit instruments’ came in handy. Some developing countries like China, came forward to provide funds for infrastructure investments through export credits. These were low-cost funds with longer maturities compared to commercial credit, but they required the borrower to purchase goods and services (including the contractor) from the country of the lender, Verite explains. This system contributed to economic development in foreign lands while keeping industries humming at home. In a sense, it was a win-win system. 

But the good in the system was subverted by Sri Lanka’s regulatory system which was weak. The loopholes in it were cynically exploited by interested parties to the detriment of the economy. Verite says.

Unsolicited Proposals; No Competitive Bidding

Sri Lanka also found it convenient to entertain Unsolicited Proposals (USPs). USPs are proposals put forth by an external entity of its own volition, i.e., without the government calling for such proposals. A considerable amount of money came into Sri Lanka through the USP route to execute gigantic projects.

Chinese State-Owned Enterprises (SOEs) made USPs with the backing of the Exim Bank of China. According to Verite, between 2005 and August 2010, six public-funded infrastructure projects worth USD 1,558 million had originated as USPs. These were implemented without going through a competitive bidding process. Of these six projects, three were funded by the EXIM Bank of China. The Mattala International Airport and the Hambantota Port were among them.se Chinese projects. These three projects accounted for 88% of the value of the six projects. They were also implemented “without going through a competitive bidding process” which had been the rule under the earlier system.

SCARC

To regulate and assess the USPs, a Standing Cabinet Appointed Review Committee (SCARC) was appointed in June 2010. The SCARC was required to independently assess the proposal, if necessary, with the assistance of a Technical Evaluation Committee/Project Committee. 

However, SCARC’s weakness was in the list of reasons that could be cited to justify a deviation from the normal procurement process.  “The reasons listed were far less stringent compared to the general framework and were only vaguely defined. Additionally, the decision-making process was made far more lenient by stating that deviations could be justified even if the USP met only one of the reasons listed, and by providing SCARC the discretion to decide whether the USP needed to be evaluated by an independent project/technical evaluation committee.”

“These weaknesses allowed officials to exercise a high level of discretion in decision-making, reducing the rigor of the decision-making process and making it prone to abuse/misuse,” Verite says.  

Several of the reasons for deviation listed were loosely defined, the report points out. “For example, to proceed with a USP without going through the competitive bidding process, the Ministry/Department’s initial assessment only needs to establish that the project “appears to be exceptionally beneficial to the country in terms of funding or otherwise”. 

Unlike the Procurement Guidelines of 2006 (PG 2006), which outlines what are “extraordinary circumstances”, the new rules do not set out any examples or illustrations of what would constitute “justifiable” circumstances to deviate from competitive bidding. “Hence, such criteria were open to subjective interpretation, which could lead to arbitrary and capricious recommendations being made by the SCARC,” Verite avers.

Further, in determining whether the funding is suitable/favorable, “the only factors that must be considered are the years of repayment (minimum 15 years) and the grace period (minimum 3 years). There is no reference to the rate of interest that is to be paid or the grant element of the loan.” 

According to the IMF, a loan to be considered a concessional loan, it must have a grant element of at least 35%. 

Verite points out that under PG 2006, when a deviation from competitive bidding is sought, it is mandatory to appoint a Standing Cabinet Appointed Procurement Committee (SCAPC) to evaluate the proposal, which will be supported by a Technical Evaluation Committee appointed by the Department of Public Finance. As such, under the general framework applicable for public sector infrastructure projects, when competitive bidding is foregone, the technical evaluation is carried out by an independently appointed committee. The Procurement Guidelines set out specific qualifications that the members of a Technical Evaluation Committee should possess.

In contrast, under the SCARC, independent technical evaluation of an unsolicited/stand-alone proposal is not mandatory. For example, the SCARC can make a recommendation on its own, or with the assistance of a Technical Evaluation Committee, Verite says. 

Water-Supply Project

Verite’s report uses the Chinese-funded and executed Gampaha, Attanagalla, Minuwangoda Integrated Water Supply Scheme (GAMWSS) to illustrate the flaws in the SCARC system. The contract to implement the project was awarded in 2013 to China Machinery Engineering Corporation (CMEC), which had submitted a USP without going through a competitive bidding process but with the recommendation of the SCARC and the approval of the Cabinet of Ministers. 

Despite concerns such as higher costs and the lack of experience and expertise being identified in the early stages by the committees appointed to evaluate the proposals, these had been overlooked in the approval process, Verite says. 

“Elements of corruption” were suspected in the decision-making process. As a result, the government failed to secure the expected concessional loan from the EXIM Bank of China. The expected rigor of the evaluation process was compromised by the Ministry and SCARC, which completely overlooked vital factors such as completion of the feasibility study, the environmental impact assessment, the terms and conditions of the funding, as well as the experience and the expertise of the company.” 

Further, the project had been delayed by more than seven years, depriving 400,000 people of the promised water connections, Verite points out. 

“Although the special framework succeeded in tapping into the large pool of financing from China, in the process of securing these funds, the country incurred numerous additional costs. The lack of visibility of these costs can lead to an over-estimation of the benefits of such funding and an under-estimation of the actual costs,” the study warns.

Additionally, “despite oversight institutions such as the Auditor General’s Department frequently reporting on financial and other irregularities related to the project, there was no evidence of any legal action being taken against the individuals involved. This is a key factor that contributes to the recurrence of these problems,” the report points out.