Pakistan’s External Sector at Risk due to CPEC Debt

CPEC has been claimed as the saving grace of Pakistan, allowing the nation to escape, once and for all, from its economic maladies and ushering in a new age of economic prosperity. Observers, as well as myself, hope that the project will bring stability to the people of Pakistan and create economic opportunities for the population that will support a rising middle class and bring an end to the violence that has recently been plaguing the country.

International economic conditions have been extremely favorable for Pakistan as low oil prices and foreign loans have increased the country’s foreign exchange reserves. Furthermore, the IMF loan program, which concluded in August 2016, was used as a last resort so that Pakistan would not face a balance of payments crisis as foreign exchange reserves evaporated. Pakistan, as a result of the program, has experienced economic stability and taken reforms to improve the government’s fiscal policy. Yet, in October 2016, the IMF stated that, “international reserves, while having tripled over the programme period have not yet reached comfortable levels.” Furthermore, the IMF also highlighted the fact that the power sector and three other public enterprises had incurred losses amounting to Rs. 1.36 trillion (4.6% of GDP).  

Additionally, the most recent report from the State Bank of Pakistan (SBP) has raised further questions regarding the viability of the project (CPEC). The report stated that there was a net inflow of $1.1 billion from China in the form of loans and FDI in the first quarter of the fiscal year. However, this figure is misleading. Around $700 million of the $1.1 billion listed as a net inflow was taken as a commercial loan from the Chinese Development Bank so that Pakistan would be able to import $2 billion worth of machinery from China for the construction of projects under CPEC. This is highly worrisome as these loans were taken on commercial terms and so must be repaid to the Chinese with interest.

The problem appears to exacerbate as Pakistan has been experiencing a fall in exports, remittances, and FDI that further harms the creation of foreign exchange reserves. Recent figures have stated that FDI has risen by 10 percent, increasing overall investment to 52 percent ($1.82 billion). Yet, this figure is, again, misleading. Observers have stated that the rise in FDI has primarily been due to the classification of Eurobonds floated by the government through a loan and a surprise investment from the Netherlands amounting to $459 million. This is good news for Pakistan, as FDI has fallen continuously for the past three years, but does not eliminate skepticism surrounding the strength of the economy’s external sector.

Khurram Hussain, a Pakistani Journalist, asks if Pakistan is “now getting locked into a cycle of borrowing and imports under the garb of CPEC even as the more important pillars of the external sector – exports, remittances, and FDI – shrivel up?” Pakistan’s foreign exchange account continues to be burdened with loans that stem primarily from the Chinese. In an effort to strengthen the external sector, Prime Minister Nawaz Sharif has announced a Rs. 60 billion export incentive package to strengthen the nation’s exports. This is a step in the right direction as the improvements to infrastructure and energy production from CPEC will also improve the strength of the manufacturing sector, strengthening exports.

Nevertheless, Pakistan should be cautious as it negotiates with China on how to finance CPEC. It must be noted that the government of Pakistan has offered sovereign guarantees on all loans taken by domestic companies and is liable for them in the event any of the companies are unable to make loan payments. This would add to the debt and further drain foreign reserves eliminating the positive effects of CPEC. The SBP also does not know the terms on these loans and the effect it will have on outflows as the process to repay the Chinese begins as much of the project lacks transparency.