The China-Pakistan Economic Corridor (CPEC) has generated a lot of attention both regionally and globally. China has pledged to invest north of US$ 46 billion in infrastructure and energy projects in Pakistan, with many considering it to be a game changer for a country that has till now been on the peripheries of it’s regional economy despite its demographic and geographic potential. Pakistan has been struggling to cope with its energy and infrastructure needs through its indigenous resources. So, CPEC is an opportunity for the country to develop it’s infrastructure and capital resources faster, thus kick-starting economic growth. However, for an economy with a GDP of around US$ 270 billion, an investment pledge of US$ 46 billion is a sizable undertaking. Of the US$ 46 billion, US$ 28 billion comprises projects that are scheduled to be completed by 2020 (including those in the power sector). The bulk of this undertaking is in the form of debt financing which will have to be paid through amortized payments over a 10-year period. And this is where the country’s financial managers should remain vigilant to avoid any major financial disaster heading the country’s way.
Pakistan’s balance of payments is far from stable. A large trade imbalance is a continuous strain on the country’s current and financial accounts. The country’s exports compose around half of its imports (46% in 2016) and the trade deficit in 2016 was a whopping 9% of the GDP. Over the years, the remittances from Pakistanis living abroad have been a balancing force that eases pressure on the current account that is highly strained by a large trade deficit. The bulk of these remittances are contributed by Pakistani’s working in oil-rich Gulf Cooperation Council (GCC) countries, with Pakistanis in Europe and North America being other main contributors. In recent years, owing to a slowdown in global economic activity and crashing oil prices, there has been a considerable pressure on remittances. Starting July, the remittances have started experiencing a sharp fall. Remittances were 3.8% lower for the Jul-Sep 2016 quarter as compared to same period last year. For the same period, exports fell by 9% owing to global economic uncertainties and slowdown. This highlights troubling times for the country’s balance of payments going forward.
In this context, when one adds the impact of CPEC payments to the country’s balance of payments, it makes matters more complicated. Many of the early harvest projects are in the power sector with 75%-80% of the financing coming in the form of debt to be amortized over a 10-year horizon. This means, after completion, starting 2020, anywhere between US$ 1.3 billion to US$ 2.5 billion will have to be paid in debt servicing for these projects. To put this amount in perspective, the country paid around US$ 4.5 billion in external debt servicing in 2016. Adding CPEC commitments will increase debt servicing by 30%-60%. Around 2020, Pakistan also has refinancing due of its US$ 1 billion Eurobonds. So, even if one ignores all of the other external debt commitments the country has piled up in the last three years, CPEC and Eurobond refinancing alone pose a major challenge for the country on the debt-servicing front. The problem will get more complicated if financial markets remain in turmoil at the time due for refinancing of Eurobonds.
To deal with the situation, Pakistan seems to have limited options. The country’s protectionist industrial base has made it harder for the country to be an exporting powerhouse. Without a radical long-term plan of reforms and a push to explore new markets, a major boost in exports will be evasive. Also, with a global economy in distress and protectionism and anti-immigration reigning high, options for low-skilled labor (something Pakistan has relied on in the past) are fast shrinking thus putting a drag on remittances. Additionally, the country has a very limited high-skilled workforce that may be able to find traction abroad in the current economic landscape. This will make it harder for remittances to fill the foreign exchange gap. Therefore, the country can count on two options to bridge the forex gap. One is to hope that with the activity generated by CPEC projects, FDI will increase. This is a reasonable expectation and part of the anticipated current account deficit can be bridged by FDI flows.
And then there is an option of a financial bailout. If push comes to shove, the country will have to revert to financers for a bailout package. Anticipating this, Americans may be thinking that this will be their opportunity to bring Pakistan back under increased American financial influence by helping it have a bailout package through the International Monetary Fund and other global financial institutions. However, it seems that this time around, the source of choice for a bailout will not be Washington but Beijing. The Chinese have never done this sort of economic intervention abroad, but with the expanding Chinese financial footprint globally, four years seem ample time to evolve such mechanisms. In the meantime, it will not harm brainstorming what the Sino-Pak bargain will be then.
Image Source: umairadeeb (Flickr)