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Pakistan and future of CPEC

PakObserver.net

Naveed Aman Khan

PAKISTAN needs to keep its focus on political stability for the success of its economy and thus CPEC. Politically, China is a stable country. For its success, Pakistan needs to follow Chinese model. The relationship between Pakistan and China underwent a strategic transformation in 2016 with the launch of the China-Pakistan Economic Corridor (CPEC), which reinforced the already strong ties between the two countries. Initial investment under the CPEC banner helped Pakistan overcome chronic electricity shortage and led to the upgradation of the country’s road networks. However, CPEC projects have also been associated with a strain on both the fiscal and current accounts, dragging down the pace of development during 2018. Although the current Pakistani government seeks a greater emphasis on industrial cooperation, we expect the original framework of the CPEC to remain largely intact with a strong focus on physical infrastructure.

With a total estimated value of around US$64bn, intended for dozens of projects spanning the energy, infrastructure and industrial sectors, the CPEC is China’s largest bilateral partnership under its Belt and Road Initiative (BRI). It was touted by the former PML (N) government as an economic lifeline which promised to deliver sorely needed foreign investment to the country. However, when the PTI formed a coalition government after the general election in July 2018, it tried to renegotiate the terms of certain projects and to reshape others. So far there have only been limited changes and the CPEC plans have largely been retained. Since coming into power, the PTI, led by Premier Imran Khan, has had to deal with harsh economic realities while deciding the future course of engagement with China.

Following a few years of moderate growth and rising aggregate demand, the economy started to slow down in 2018. After annual growth of 5.6% on average during fiscal years 2015-17 (July-June), Pakistan’s GDP grew by 5.4% in 2017-18, and expansion was expected to slow further in 2018-19. Meanwhile, the fiscal and current-account deficits ballooned to the equivalent of 5.4% and 5.8% of GDP respectively in 2018, compared with 5.2% and 3.9% of GDP respectively on average in 2016-17. The pressure on both the fiscal and current accounts over the last year and a half has been driven by a drastic increase in imports.

This is largely attributable to the highly capital-intensive nature of the CPEC projects undertaken so far, which have mainly focused on power plants and road infrastructure. This partly contributed to not only higher government spending, but also a drastic increase in imports, resulting in pressure on both the fiscal and current accounts. Consequently, a number of CPEC projects slowed down or were halted during the second half of 2018. According to the official definition of the initiative, which was mutually agreed between Pakistan and China, the CPEC is based on the so-called one plus four framework, which prioritizes Gwadar port, energy, transport infrastructure and industrial cooperation. So far, almost all of the completed and ongoing projects – with cumulative investment amounting to around US$19bn – have been in the power and transport sectors.

The power projects have been largely financed by Chinese firms and banks under the BOT (build-operate-transfer) model, while road projects have been carried out through a combination of bilateral loans from the Chinese government and fiscal outlays from Pakistan. The PTI-led government has indicated its intention to shift the focus of the CPEC more towards industrialization and socio-economic development. In particular, it wants to start activating the nine special economic zones that were originally planned under the CPEC, in the hope that Chinese industries will relocate or set up joint ventures with local parties in these zones. The Pakistani government is also keen to accelerate the development of Gwadar port, on the Arabian Sea in Balochistan province, with the aim of transforming it into a trade hub.

Notwithstanding the desire to streamline the focus of the CPEC towards deeper industrial development on the Pakistani side, the CPEC portfolio is likely to remain skewed towards the energy sector in 2019-20, with six ongoing power projects estimated to add a combined 6,910 MW of electricity to the national grid once completed. Alongside energy, transport infrastructure will continue to comprise a sizeable part of the initiative, with the largest project being the upgradation of the Karachi-Peshawar main railway line (“ML-1”), at an estimated cost of US$8.2bn. On the other hand, success in promoting industrialization in Pakistan under the CPEC via the planned special economic zones is likely to be limited. Although the government has promised reduced red tape and tax concessions, a broadly difficult business environment will continue to deter investors. Export-oriented Chinese firms facing rising labour costs at home could consider relocating to the SEZs in Pakistan where wages are much lower.

However, the lack of requisite skills and supply linkages in the local market is likely to present a problem, particularly for higher-end manufacturing segments such as electronics. Other markets, especially in South-East Asia such as Vietnam, are likely to remain much more competitive in attracting Chinese manufacturing. It is believed that China’s dominant role in Pakistan’s economy will continue to grow during the forecast period, even if the CPEC unfolds at a slower pace hereafter. The financial sector in particular is likely to receive further investment.

Key recent examples of this include the 40% acquisition of the Pakistan Stock Exchange by a consortium of three Chinese bourses in December 2016, and the full buy-out of Pakistan’s leading online retailer, Daraz, by a Chinese e-commerce giant, Alibaba, in May 2018. For Pakistan, despite some misgivings around debt obligations associated with the CPEC, China remains the largest source of foreign investment, as well as a key strategic ally. China-Pakistan cooperation has grown beyond the economic sphere to include defence and security. The CPEC will remain the fulcrum around which the two countries are set to enhance cooperation in the coming years. Pakistan needs to keep its focus on political stability for the success of CPEC.

(The writer is a freelance journalist based in Islamabad)

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