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China Taps Sri Lankan Port to Shift Trade Routes

One of China’s largest and most powerful state-owned companies, China Merchants Group, with total assets of $855 billion, is in the final stages of completing a $1.1 billion purchase of a 99-year lease for a majority stake in an underdeveloped deep-water container port in Hambantota, Sri Lanka.

Once under Chinese ownership, the port could serve to shake up current trade routes, but not without some work ahead.

The port was built for more than $1 billion on a turnkey basis by Chinese state-owned contractors and is owned and operated by the Sri Lankan government’s Port Authority.

In a column written in the Financial Times, Peter Fuhrman, chairman and chief executive officer China First Capital, a Greater China-focused boutique investment bank and advisory firm, wrote, “Hambantota’s future appears now about as bright as its present is dreary…Though the Chinese ambassador to Sri Lanka has pledged that Hambantota will one day resemble Shanghai, as of today, elephants in the nearby jungle are about as numerous as dockworkers or pedestrians.”

China Merchants will take over management of the port within the next month or so, Fuhrman said. The Hambantota port, under Sri Lankan government management, has been a bust, “a half-finished commercial Xanadu where few ships now call,” he wrote, adding that the port has lost more than $300 million since it opened.

China Merchants’ plan to turn things around will rest on two prongs. Its port operations subsidiary, Hong Kong-listed China Merchants Port Holdings, will take over management of Hambantota. It is the largest port owner and operator in China. Almost 30 percent of all containers shipped into and out of China are handled in China Merchants’ ports. The ports business earned a profit of $850 million last year.

China Merchants has what the Sri Lankan government’s Hambantota port operator could never muster: the operational skill, clout, capital and commercial relationships with shippers inside China and out to attract significant traffic to Hambantota, Fuhrman wrote.

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In addition, China Merchants will enlist other large China state-owned enterprises to invest and set up shop in an 11-square-kilometer special economic zone abutting the Hambantota port. The SEZ was created at the request of the Chinese government, with the promise of $5 billion of Chinese investment and 100,000 new jobs to follow. China Merchants is now drawing up the master plan. Some top Chinese state-owned enterprises are planning to move in, beginning with a huge oil bunkering and refining facility to be operated by Sinopec, as well as a large cement factory, and later, Chinese manufacturing and logistics companies, according to Fuhrman.

Sri Lanka’s geopolitical advantage

The scale of what’s planned in Hambantota, however, is shaping up to be far larger, Fuhrman said.

“The flag of Chinese state capitalism is being firmly planted on this Sri Lankan beachfront,” Fuhrman wrote. “Hambantota is only 10 to 12 nautical miles from the main Indian Ocean sea lane linking the Suez Canal and the Malacca Straits. Most of China’s exports and imports sail right past. An average of 10 large container ships and oil tankers pass by every hour of every day. From the Hambantota port office building, one can see the parade of huge ships dotted across the horizon.”

He said along with transshipping to India and the subcontinent, Hambantota will provide maintenance, oil storage and refueling for shipping companies. Sri Lanka is the smallest of the four subcontinental countries, with a population of 20 million compared to a total of 1.7 billion in India, Pakistan and Bangladesh.

Sri Lanka has one geographic attribute its neighbors lack: a deep-water coastline close to Indian Ocean shipping lanes and conducive to building large deep-water ports able to handle the world’s largest container ships and supertankers. This should make Sri Lanka the ideal transshipment point for goods and natural resources going into and out of the subcontinent, he said.

The Port of Singapore is now the region’s main transshipment center. It is three to four times as distant from India’s major ports as Hambantota. Singapore is now the world’s second-busiest port in terms of total shipping tonnage. It transships about a fifth of the world’s shipping containers, as well as half of the world’s annual supply of crude oil.

One Belt One Road

Fuhrman linked this investment to China’s One Belt One Road policy aimed at exerting China’s industrial and political influence throughout some 65 countries in Asia, Eastern Europe and North Africa.

He said even before President Xi Jinping’s initiative was announced, Sri Lanka was seen as a key strategic and commercial beachhead for China’s future trade growth in the 40 countries bordering the Indian Ocean. China and Sri Lanka have had close diplomatic ties since the early 1950s.

[Read more about One Belt One Road: Sourcing 2050: As China Goes, the World Follows]

Sri Lanka’s gross domestic product is $80 billion, less than one-tenth the total assets of China Merchants Group. Sri Lankan per capita GDP and literacy rate are both about double its subcontinental neighbors. While a hardly a business nirvana, it is often easier to get things done there than elsewhere in the region, Fuhrman wrote.

China Merchants Port Holdings is a powerful presence in Sri Lanka. It already built and operates under a 35-year Build-Operate-Transfer contract a smaller, highly successful container port in the capital Colombo that opened in 2013. It’s one of the few large-scale foreign direct investment success stories in Sri Lanka.

The plan is for the China Merchants’ Colombo port to mainly handle cargo for Sri Lanka’s domestic market, while Hambantota will become the main Chinese-operated transshipment hub in the Indian Ocean. Chinese SoEs are also in the process of building a port along the Pakistani coast at Gwadar and upgrading the main ports in Kenya.

“The direction of Beijing’s long-term planning grows clearer with each move,” Fuhrman wrote. “If not exactly a Chinese inner lake, the Indian Ocean will become an area where Chinese shipping and commercial interests will more predominate.”

Chinese building crews swarm across a dozen high-rise building sites in Colombo, he noted, with Chinese tourist arrivals set to overtake India’s. The main section of the unfinished highway linking Colombo and Hambantota was just completed by the Chinese.

China Merchants plans to invest between $1 billion and $3 billion to complete Hambantota port and turn it into the key Indian Ocean deep-water port, The port will be able to handle dry cargo, ships transporting trucks and autos, and oil tankers, as well as the world’s largest 400-meter container ships. Hambantota should lower prices and improve supply chains across the entire region, and so drive enormous growth in trade volumes—assuming power politics don’t intrude.

China and India have prickly relations, most recently feuding over Chinese road-building in the disputed region of Doklam on India’s northern border. India has balked at direct participation in One Belt One Road, and complains loudly about its mammoth trade deficit with China, now running about $5 billion a month.

Chinese exports to India have quadrupled over the past decade, despite India’s extensive tariffs and protectionist measures. Hambantota should allow India’s manufacturing sector to be more closely intertwined with Chinese component manufacturers and supply chains. That is consistent with India’s goal to increase the share of GDP coming from manufacturing, and manufactured exports, both still far smaller than China’s.

But India will almost certainly push back, if Hambantota leads to a big jump in its trade deficit with China, Fuhrman predicted.

India and Sri Lanka have a free-trade agreement that in theory lets Sri Lankan goods enter the vast market duty-free. Chinese manufacturers could turn the Hambantota free trade zone into a giant Maquiladora and export finished products to India. This would flood India with lowered priced consumer goods, autos, chemicals and clothing.

Bangladesh, Pakistan and Burma—smaller economies but friendlier with China—would likewise absorb large increases in exported Chinese goods, either transshipped from Hambantota or assembled there, he said.

“By itself, a Chinese-owned and operated Hambantota will almost certainly reconfigure large trade flows across much of Asia, Africa and Europe, benefiting China primarily, but others in the region, as well,” Fuhrman added. “It is a disruptive occurrence. While much of China’s [One Belt One Road] policy remains nebulous and progress uncertain, Chinese control of Hambantota seems more than likely to become a world-altering fact.”