Author: Shebonti Ray Dadwal, Institute for Defence Studies and Analyses
Have the first fault lines started appearing in the China–Pakistan Economic Corridor (CPEC) — the flagship of China’s ambitious Belt and Road Initiative? Mere days before key CPEC decision makers from China and Pakistan were scheduled to meet on 21 November 2017 to review approved projects and discuss new schemes, Islamabad announced that the Diamer-Bhasha dam would no longer be a part of CPEC. Instead, Pakistan would finance the project by itself.
Will Pakistan be able to muster up the funds from its own purse? Towards the end of 2016, International Monetary Fund (IMF) Managing Director Christine Lagarde declared that Pakistan’s economy was ‘out of the crisis’ and that by 2018, growth rates would increase to a ‘robust’ 5.4 per cent. This is due to greater inflows of foreign investment, mainly from CPEC. Pakistan’s economy was also bolstered by falling oil prices, which stabilised the current account even as exports and foreign direct investment fell.
Now oil prices are climbing up again, and there is the prospect of oil prices further tightening by the end of 2018. The impact of this on the economy cannot be ignored given that Pakistan imports around 75 per cent of its oil consumption: every US$10 per barrel rise in international oil prices increases Pakistan’s yearly import bill by US$1.25–1.5 billion.
Considering that the benefits of CPEC are expected to materialise within the next year, the recent backpedalling on some CPEC projects is not good news. A day before the decision on Diamer-Bhasha was announced, China temporarily halted the funding of three projects related to CPEC’s road network and announced that ‘new guidelines’ would be issued from Beijing. The decision could affect over 1 trillion Pakistani rupees (US$9 billion) worth of road projects administered by Pakistan’s National Highways Authority.
The commitment to construct the beleaguered US$14 billion 4500 MW Diamer-Bhasha dam with domestic resources came as a surprise. Pakistan previously struggled to raise funds from international institutions for Diamer-Bhasha as it is located in the disputed Gilgit-Baltistan region, which India refers to as Pakistan-occupied Kashmir. Pending a resolution of the dispute between Pakistan and India, no third party involvement in the region is acceptable to New Delhi.
Diamer-Bhasha is not the only project that faces problems. The Chinese company responsible for the US$2 billion 660kV high-voltage direct current transmission line from Lahore to Matiari has substantially slowed operations due to disputes over the size of a revolving fund. Four coal-fired power plants in Tharparkar District that were scheduled to be commissioned in May 2020 have also been deferred to November of the same year. This delay could incur losses of billions of dollars — a loss exacerbated by the numerous other associated power projects also suffering problems of some sort.
These problems are not even likely to stay isolated: at present, about 15 energy projects (cumulatively valued at around US$22 billion with around 11,110 MW generating capacity) are part of the CPEC framework.
Further, Islamabad is experiencing problems accessing funding from foreign institutional investors. Pakistan’s US dollar reserves have fallen to US$15 billion, of which US$2.5 billion is comprised of loans received through euro bonds and sukuk (Islamic bonds). The current account deficit has doubled to US$5.013 billion in the first four months of fiscal 2018 due to growing imports, particularly for infrastructure development activities associated with CPEC projects. Moreover, if dollar reserves are depleted to US$10 billion, the economy would be plunged into dire straits as this is roughly the amount required for two months’ imports. If that happens, then Islamabad would be forced to seek an IMF bailout. To prevent this, Pakistan recently devalued its currency.
At the same time, despite the optimism displayed by Pakistani officials, Chinese funding for CPEC is also problematic. About 65 per cent (around US$28 billion) of the early project loans carry an interest rate of about 7 per cent. If Pakistan cannot pay back these loans, Islamabad may find itself in a situation similar to Sri Lanka, which handed over Hambantota port on a 99-year lease to China.
This corroborates an earlier IMF report that warned Pakistan of possible challenges in repaying Chinese loans, despite their potential to lift economic output. The report identified CPEC-related financial outflows as one of the most significant medium- to long-term risks facing Pakistan’s economy. Further, to reap the full benefits of CPEC, Pakistan would need to implement pro-growth and export-supporting reforms and foster a more attractive investment climate. This would require improved governance, security and downward exchange rate flexibility.
Given the current state of Pakistan’s politics and the grave security situation, it would require a gargantuan effort for Pakistan to restore its credibility — which means for now, its funding woes are likely to remain.
Shebonti Ray Dadwal is a Senior Fellow at the Institute for Defence Studies, New Delhi, where she heads the Non-Traditional Security Centre.