Since reports about the cancellation of a proposed US$20 billion railway line connecting China’s southern Yunnan province with Myanmar’s Rakhine western coast emerged in late July, conflicting accounts about the 1,200 kilometer project’s status have raised new questions about the neighboring countries’ commercial relations.

The controversy erupted with a local news report quoting Myint Wai, director of Myanmar’s Ministry of Rail Transportation, saying that the project had been “cancelled” after over three years of inaction on a 2011 agreement. A DPA report furthered the story

by quoting an anonymous Myanmar government official saying the Kyaukpyu-Kunming railway was popularly perceived as having “more disadvantages than advantages” and was cancelled in line with the “people’s desires”.

Yang Houlan, China’s Ambassador to Myanmar, contradicted that report, saying China had not abandoned the project. The state mouthpiece China Daily underscored that official line, reporting that an “unidentified Myanmar economic official” said that the project only needs “continued coordination”. The China Railway Engineering Corporation (CREC), the original Chinese investor in the project, meanwhile has been reluctant to respond to the conflicting reports.

The confusion stems in part from distinctions between the actual railway project and the Memorandum of Understanding (MOU) signed between CREC and the Myanmar Railway Ministry in April 2011. The MOU was the result of an initial agreement between the two sides about the construction of the railway, pending further feasibility studies and agreements on specific terms.

The MOU also stipulated that such agreements should be reached and construction should commence within three years of its signing. When the three year term expired earlier this year, the two sides had failed to reach agreements to commence building. The project as stipulated by the 2011 MOU was therefore officially no longer in the cards.

However, the expiration of the 2011 MOU does not mean that the entire Sino-Myanmar railway project is necessarily off the drawing board. With the dissolution of the commitment with CREC, the Myanmar government is now free to negotiate with any interested party to build the railway. New terms may thus be negotiated with or without consideration of the previous MOU.

The Myanmar government was apparently concerned about the length of the BOT (build, operate and transfer) period, which under the original MOU was as long as 50 years. That prolonged period would have meant delayed national ownership and reduced revenues for the Myanmar government. The proposed quality of the railway and its depreciation over the 50 year BOT period also raised concerns about the project’s valuation at the handover date.

On the other side, CREC had planned to arrange commercial loans from Chinese banks to fund the mega-project and had to calculate the costs and benefits to justify the investment. A much shorter BOT period naturally means CREC would not be able to generate enough returns to cover the principal and interest on the loans.

Many analysts had assumed that CREC had attempted to apply for concessional loans or foreign aid from the Chinese government to insure the profitability of the project. That’s because the railway is of strategic importance to China: it had been regarded as a key component of China’s Trans-Asia railway network and a critical element for developing a southwest strategic corridor to the Indian Ocean, a route for crucial imports that bypassed the congested Malacca Strait and hotly contested South China Sea.

Both endeavors aim to expand China’s regional economic presence and strategic influence. On a bilateral level, cancellation of the multi-billion dollar railway project would indicate a further deterioration of Sino-Myanmar ties, despite Beijing’s sustained bid to portray the relationship as strong and healthy.

Muddled motivations

To what extent these national level strategic considerations affected CREC’s commercial decision-making is not altogether clear. It is widely believed that CREC had private reservations about plunging into such a major project under the prevailing uncertain and “China-unfriendly” investment environment in Myanmar.

The investment climate soured for China with the September 2011 suspension of the partially built $3.6 billion Myitsone dam in Myanmar’s northern Kachin State. The massive dam, originally scheduled for completion in 2017 and designed to export 90% of its generated power to China, has not been resumed. While some Chinese investors, including lead investor Power Construction Corporation of China, have suggested more of the power could be used for local Myanmar demand, general suspicions about Chinese investment is still strong across the country.

Fears of a similar fiasco has deterred many Chinese investors, as well as the Chinese banks and government agencies in charge of loan decisions. For political and economic reasons CREC could not take the initiative to cancel the MOU, but a passive-aggressive lapsing of the agreement due to commercial disagreements apparently represented a diplomatic way out.

Whether Beijing endorsed the Chinese company’s decision to allow the MOU to expire is unclear. The strategic importance of the railway project to China’s overall westward strategy, its Indian Ocean ambitions and overall Sino-Myanmar relations transcends simple financial considerations. Even from a practical commercial perspective, to abandon the railway project at this point would be wasteful and unwise given the ongoing construction of the connecting Chinese portion of the railway (Kunming-Dali-Ruili).

Myanmar likewise wants the railway for its own mostly economic reasons. Most crucially, improved transportation networks are crucial to delivering national economic growth. For Myanmar’s underdeveloped and volatile western region, especially the Rakhine state where Kyaukpyu is located, the railway has both practical and symbolic significance. The railway’s promised connectivity is crucial for the success of the Kyaukpyu Special Economic Zone (SEZ), for which the government has high hopes.

While Myanmar desperately needs modern transportation infrastructure, the government is no longer willing to accept terms that are less than optimal to the national interest. The renewed availability of Western and other foreign capital after decades of isolation and stagnation caused by economic sanctions has made Chinese investment less appealing.

Some Myanmar analysts have pointed out that Japanese official development assistance offers considerably better terms than most Chinese investments. At the same time, Southeast Asian investors are also beginning to enter many of Myanmar’s “last frontier” markets. For fiscal year 2013/2014, Singapore, Malaysia, Thailand and Vietnam ranked among the top five investors in Myanmar; China dropped to eighth place with a total investment of less than 1% of the total amount in its peak year of 2010.

As both China’s ambassador to Myanmar and certain Myanmar officials stated in news reports, the Sino-Myanmar railway project is still under review. However, the MOU signed in 2011 between CREC and the Myanmar government is no longer valid and its not immediately clear that the two sides will easily agree to mutually acceptable terms.

China may need to accept a less optimal arrangement than the one outlined in the original now lapsed MOU, including more stringent commercial terms and even possibly a multi-party joint venture. Multi-party ownership would spread risk and mitigate the project’s Chinese identity. China does not need to own the railway outright to achieve its strategic and commercial goals and Myanmar would be unwise to reject a reasonable investment agreement as long as it serves the government’s development agenda and its “people’s desires”.

Yun Sun is a Fellow in the East Asia program at the Stimson Center, a nonprofit and nonpartisan think tank that studies peace and security challenges around the world.

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