Nicaragua Canal: Fact or Fiction?

The Nicaraguan government announced plans to build an interoceanic canal last year, which, if realized, would provide a boost to the Nicaraguan economy and could pose an important competitive threat to the Panama Canal. Although constructing the so-called Nicaragua Canal is technically possible, doubts surrounding the economic feasibility, the environmental impact, and the capability of construction company HKND to manage this mega-project, have led many to question whether or not it will ever actually be constructed.

The Nicaraguan government announced plans to build an interoceanic canal last year, which, if realized, would provide a boost to the Nicaraguan economy and could pose an important competitive threat to the Panama Canal. Although constructing the so-called Nicaragua Canal is technically possible, doubts surrounding the economic feasibility, the environmental impact, and the capability of construction company HKND to manage this mega-project, have led many to question whether or not it will ever actually be constructed.

The government and HKND, which has been granted a concession to build and operate the Canal, unveiled the planned route for the Canal in July. The 278km-long shipping route would run from the mouth of Brito River in the Pacific Ocean, pass through the city of Rivas and the Tule and Punta Gorda Rivers, finally reaching the Southern Caribbean. More than one third of this route would cross through Lake Nicaragua. The Canal would have a width of 230m to 520m and a depth of 27.6m. It would allow for large ships to pass that currently cannot utilize the Panama Canal due to their size. Besides the construction of the Nicaragua Canal itself, the ambitious project includes the construction of two ports, an airport, a free trade zone, a resort, a power plant, a cement and steel plant, and land routes. Construction is set to begin near the end of this year and it is expected to be completed in December 2019.

From a technical point of view, experts largely agree that the project is feasible. Rivers would need to be widened and deepened and locks would need to be constructed to float ships up to Lake Nicaragua. An important tide differential between the two oceans poses a major engineering challenge, which is expected to be manageable. Doubts, however, have arisen regarding HKND’s capability to manage one of the world’s largest construction projects given that the company does not have any experience in overseeing major infrastructure projects.

Despite the fact that the Canal is technically feasible, many are doubtful that the Canal will ever actually be built. Key questions have emerged regarding the economic competitiveness of the Canal and the tolls to be charged, whether the country can benefit from the project, how such a huge construction project will be funded, the potential environmental consequences, and whether Nicaragua’s existing infrastructure can actually support the project. While several experts are very skeptical and see these challenges as too large to overcome, other analysts say that recent developments (i.e., the announcement of the planned route and the involvement of key international firms such as McKinsey and ERM) point to a higher chance that the project will actually move ahead. Nicaraguan citizens are much more optimistic than analysts. In fact, according to a 2013 poll, nearly 75% of those surveyed consider that the project is feasible and expect it to bring work and prosperity to the country.

HKND estimates total construction costs at USD 40 billion, which is equivalent to broadly four times the country’s GDP. However, several analysts point out that actual construction costs could actually be much higher. For instance, as stated by the newspaper La Nación, the administrator of the Panama Canal, Jorge Quijano, estimated construction costs at USD 70 billion. According to another publication that came out within the scope of the California Freight Mobility Plan, cost estimates range between USD 40 and USD 60 billion. According to an article from the Journal of Commerce, while USD 40 billion may be sufficient to construct a sea-level canal, the construction of locks in the, which HKND said are included in the scope, would cost much more. In addition, analysts doubt that such a construction project of this massive scope could actually be carried out within the five years that HKND announced projects.

During the construction phase the government expects that the project will foster economic growth significantly and generate much-needed employment through its direct impact on the economy and the multiplier effect. The government announced in 2013 that, if construction starts in 2014 and ends in 2018, it projects annual average GDP growth to more than double during the construction period. During those years, the government sees the economy growing at an annual average rate of 11.67%, versus just 4% to 5% average growth without the project. Furthermore, the government estimates that formal employment will reach about 2 million people in 2018 should the project go forward. This figure would triple the number of employed in 2012. The government also expects the Canal to significantly contribute to reducing poverty. Nevertheless, to date the government has failed to provide any estimates on the economic impact of the Canal beyond the construction phase, which is why one can only hypothesize about the government’s long-term expectations.

Analysts are holding back on estimating the potential impact of the Canal on the economy because the scarcity of publicly-available information hardly allows for a meaningful assessment. Against this backdrop, the Nicaraguan Foundation FUNIDES commented in a press release that, “if built, the Interoceanic Canal would have impacts on the national economy that are difficult to determine because of the magnitude of the project and the limited information available.” Nonetheless, Canal is very likely to increase employment, incomes and consumption during construction.

The long-term effects are, however, less clear. Under the 50-year concession, which is extendible to 100 years, Nicaragua will receive up to USD 10 million per year from the investors and will own just 10% of the Canal for the first 10 years. Ownership will then be gradually transferred to Nicaragua over the remaining years. Regarding employment, while HKND promised to create 200,000 jobs during operation, Nicaragua’s population can only benefit from this opportunity if the local labor force, which is largely untrained for the type of work involved, obtains the required qualifications. Additionally, some analysts see a risk in that the project could lead to a significant increase in construction costs, which would in turn accelerate inflation and could potentially drag on the competitiveness of other economic sectors. As a consequence, a dual economy could emerge in which activities related to the Canal prosper while all remaining sectors fall behind.

The economic feasibility of the Canal is equally difficult to assess given the lack of sound projections. McKinsey was hired to conduct an economic feasibility study, but results are still outstanding. HKND’s own projections are optimistic. The company claims that growing international trade volumes and the increasing size of container ships will create sufficient demand for the Nicaragua Canal and thus make it economically feasible, particularly starting in 2030. HKND emphasizes that the Nicaragua Canal would be complementary to the Panama Canal, not supplementary, since the Panama Canal alone will not be able to accommodate the total projected volume of maritime shipping. Furthermore, the Nicaragua Canal as planned will be able to transport bigger ships than the Panama Canal can, which would make it so that the market segment of the largest vessels of up to 23,000 TEU would have to use the Nicaragua Canal exclusively. Today the Suez Canal is the only transport route through which such vessels can pass as the Panama Canal can currently only accommodate vessels of up to 5,000 TEU. Once the expansion of the Panama Canal is completed it will be able to accommodate ships of up to 13,000 TEU. Furthermore, according to HKND, the Nicaragua Canal will compete with the Suez Canal because some routes, particularly from Asia to the East Coast of the United States, are shorter, which implies lower fuel costs and shorter travel times. Conversely, critics point out that demand for the Nicaragua Canal would only pick up in the longer term as today there are few large ships that will not fit through the expanded Panama Canal. It seems that that the Nicaragua Canal would struggle to compete with the Panama Canal for business from smaller ships.

Although neither HKND nor the government has made any statements regarding tolls, they are expected to exceed those of the Panama Canal because of the huge cost of the Nicaragua Canal. Due to its size, the Nicaragua Canal would require a great deal of maintenance and dredging to keep it open for traffic, which would lead to a combination of high operating expenses and capital costs that would be passed on to shipping. In addition, critics point out that the geographic advantage that was mentioned by HKND is not decisive as the shorter shipping routes would be offset by longer transit times through the Canal. In addition, the Nicaragua Canal would start as an unproven entity and its reliability must first have to be proven. This all casts doubts on the attractiveness of the project to potential investors.

Environmentalists are above all concerned with the potential damage to Lake Nicaragua, which is the country’s largest source of fresh water and is crucial for the wellbeing of many species. The dredging that will be required, potential contamination from ships, as well as infiltration from salt water and invasive species, put both water quality and ecosystems at risk.

The lack of transparency that characterizes the project has been highly criticized, too. Besides the questionable legality of the no-bid contract, critics point out that the project violates Nicaragua’s national sovereignty. Hardly any information has been made public, which limits the possibility for society to play an adequate role in the planning stage. Furthermore, expropriations for freeing up land are another main concern.

Nicaragua’s ambitious plan to build an interoceanic canal is garnering worldwide attention, particularly because the canal in neighboring Panama just celebrated its 100 anniversary and is close to completing a major expansion project. Building a new canal in Nicaragua would be an impressive engineering feat, but seems feasible from a technical standpoint. However, major questions have arisen as to whether this new canal will ever become operational or competitive as originally planned. The government and construction companies involved will have to overcome significant challenges if the Nicaraguan canal is to become a viable alternative.

*Note: In addition to macroeconomic analysis, FocusEconomics produces the LatinFocus Consensus Forecast, a monthly forecast based on 29 individual projections from investment banks, consultancies and think tanks. For more information, please contact us via www.focus-economics.com.

 

Author: Carl Kelly, Economist

Date: September 9, 2014


Twitter @FocusEconomics

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