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Pakistan's IMF bailout adds to Belt and Road woes

By: Colby Smith

For the 13th time in 30 years, Pakistan needs the IMF. This time around, the government is planning to ask for up to $7bn—it's largest request from the Fund to date—in order to sidestep a full-blown balance of payments crisis.

For Pakistan, an IMF deal is a vital lifeline. For China, it represents another blunder for its $1trn-plus Belt and Road Initiative (known increasingly as BRI) at a time when many partnering countries are second guessing their involvement and even abandoning some projects.

With sizable twin deficits and a paltry $8.4bn stash of foreign currency reserves (not enough for even two months' worth of imports), Pakistan badly needs outside funding. The central bank's efforts to weaken its overvalued currency through multiple devaluations over the past year (five and counting) as well as hiking interest rates have done little to bring down the country's financing needs. Exotix's Hasnain Malik now puts the figure the government will need to borrow over the next three years at $15bn.

While taxes and its small, low-value export base explain much of Pakistan's fiscal and external imbalances, China also shoulders some of the blame—despite recent claims otherwise—for worsening the country's current account deficit, which the IMF believes will widen to 5.9 per cent of GDP by year-end. With 85 projects worth as much as $90bn in either the planning stages, under construction or completed, Pakistan has become a focal point of China's landmark BRI. The China-Pakistan Economic Corridor (CPEC) involves not only the building of roads, railways and ports, but also power plants and nuclear facilities, among others.

To break ground on any of these initiatives, Pakistan has had to import lots of raw materials from abroad, many of which come directly from China, and borrow directly from Chinese backers. So in exchange for modernised infrastructure, and the promise of economic growth that comes with it, Pakistan has had to stomach a worsening trade balance —the difference between a countries exports and imports—and higher debts.

Pakistan is not unique in seeing its fiscal position deteriorate because of its BRI connections, nor is it alone in voicing concerns about the inevitable liabilities that come with such lengthy, expensive construction projects that hinge repayment on benefits likely to be reaped long after debts come due. Several countries along the belt and road have come under similar strain, prompting some to rethink their financial relationship with China altogether as well.

In August, Malaysia's prime minister axed several multi-billion dollar projects, including the East-Coast Rail Link and two gas pipelines, citing concerns about runaway costs and affordability. Myanmar officials announced in June that they are reviewing and trying to revise down costs for a $9bn China-backed port. And Indonesia, Bangladesh and Thailand have turned away Chinese financing for new ports, rails and plants. According to Fitch Solutions, this year alone, nearly 38 projects have been cancelled or suspended, up from just 12 in 2016.

The sudden cooling towards Chinese lending should come as no surprise given just how skewed some of these relationship have become. Since 2014, China's trade surplus with BRI countries has grown tremendously, to more than $100bn as of last year, as the below chart from Standard Chartered's Kelvin Lau, Lan Shen and Bilal Kahn shows:

The surplus comes not from decreased imports by BRI countries, but from increased exports from China. Now, nearly 18 per cent of all Chinese exports are designated for BRI-linked shores, per Lau et al. again:

Larger, more economically fortified countries may be able to better manage these imbalances. For the most part, however, BRI countries are small, political dicey, and have little access to capital markets. Of the nearly 800 projects either in the planning or construction phases, the majority, according to Fitch Solutions, are considered high-risk not only from a geopolitical standpoint, but also when it comes to staving off debt distress.

Take Africa. China has long been the leading lender to the continent, but since the launch of the BRI, the pace has picked-up quite dramatically. With this increase in funding, China's share of external debt has ballooned. In Angola, for instance, China holds about 40 per cent of its external debt. In Cameroon, roughly 35 per cent, followed closely by Ethiopia and Zambia. Here's another chart from Standard Chartered's Lau, Shen and Kahn showing the breakdown:

Perhaps no African country demonstrates the debt-trap potential of China's BRI better than Djibouti. With a nominal GDP of roughly $2bn, the country has seen its public debt soar in recent years, from 50 per cent of GDP in 2014 to nearly 98 per cent of GDP three years later. According to the IMF, more than three-quarters of Djibouti's public enterprise external debt in 2016 came from the Export-Import Bank of China under commercial terms, rather than low interest rate concessions.

These figures may not even tell the whole story. Carmen Reinhart of Harvard University warns that Chinese lending, even from official sources, is exceptionally difficult to quantify. In fact, she tells Alphaville that the World Bank data likely miss much of the action.

In a forthcoming paper, Reinhart and her co-authors find that the average increase in debt across emerging markets that have received Chinese lending could be much greater than what is currently reported. Official figures could be underreporting as much as 15 per cent of GDP, although this is likely skewed to the upside as not all emerging markets are as indebted as others. A large proportion of BRI countries already have debt-to-GDP levels near 100 per cent. So if official figures are off by double-digits because of the intrinsic opaqueness of these contracts, many countries are in much worse financial positions that previously thought.

Had these countries borrowed from the IMF or a member the Paris Club, a group of creditor nations that help to negotiate debt restructurings, the process should repayment become impossible would be a fairly straight-forward and predictable process. As a non-Paris Club member, however, China handles things a little differently. Sri Lanka witnessed this last December when it was forced to hand over its Hambantota Port to China on a 99-year lease, to avoid default.

This kind of collateralised lending, which China tends to favour, has “teeth,” warns Reinhart:

It creates pecking orders for repayment and complicates dealing with economic crises in ways that perhaps countries had not digested at the time when they were initially so enthusiastic about their newfound lender.

If the honeymoon between Chinese lenders and BRI countries is now over, as Reinhart tells us is the case, how does China get its colossal initiative back on track?

For Jonathan Hillman at the Washington-based Center for Strategic and International Studies, it comes down to coordination. Since its founding five years ago, China's BRI has grown far beyond its initial mandate and now spans a stretch of 80 countries inhabited by roughly two-thirds of the world's population. Here's where Hillman thinks things went awry:

Policy statements have stretched the BRI to the Arctic, cyberspace and outerspace. The reaction of most people upon learning about the BRI is amazement at its general scale, followed quickly by confusion about its specifics. The BRI promises it will be everything for everyone. But the further it expands, the less it means.

Of course the BRI isn't all bad. It has brought modernised infrastructure to places that badly need it. Trade between partnering countries has also grown enormously. But all of these benefits risk tarnish should China fail to address or responsibly manage the debt distress oftentimes left in the BRI's wake.

At the IMF and World Bank annual meetings in Bali this week, the IMF's Maurice Obstfeld warned Pakistan against wracking up “excessive debts” to China.

Other BRI countries may wonder when a belt becomes a chain.


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