CPEC and Burgeoning Debt: A Vicious Trap for Pakistan

Where on one side Pakistan has achieved a high rate of economic growth which shows that its economy is moving forward in the right direction while on the other, there are some parameters which indicate that everything is not going well and there is something that is worrying for Pakistan's economy. Pakistan's foreign exchange reserves are constantly falling. During the week ended May 18, 2018, the State Bank of Pakistan’s gross reserves dropped $479 million to only $10.32 billion due to payments on account of external debt servicing. The reserves are barely enough for two months of imports and are below the International Monetary Fund’s adequacy levels.

In order to deal with this sharp decline in foreign exchange reserves, Pakistan has recently received a loan of $ 1 billion from China and due to this hardship, Pakistan has to roll over another loan taken from China sometimes back in 2012. And China has agreed to roll over this loan of $500 million that it has placed with the State Bank of Pakistan (SBP) as the country’s official foreign currency reserves remain in a precarious position despite taking $44 billion in foreign loans in the past around five years. The People’s Bank of China, through China’s State Administration of Foreign Exchange (SAFE), had deposited $500 million with the SBP in June 2012. The loan is going to mature in the first week of June this year.

What China does further?

In addition to the $500-million loan rollover, China was expected to increase the SAFE deposit limit by $500 million to $1 billion. Apart from this, another $1 billion in Chinese foreign commercial loan is being negotiated. Pakistan has already taken $2.2 billion in commercial loans from China in the current fiscal year. It is also holding negotiations to take $200 to $350 million in commercial loans from Gulf banks.

This week, Pakistan and China also extended the currency swap arrangement between the SBP and People’s Bank of China for three years in respective local currencies. The swap limit has been increased from 10 billion to 20 billion Chinese Yuan and from Rs165 billion to Rs351 billion. On May 25, SBP increased key discount rate by 50 basis points to 6.5% after putting off the increase twice earlier.

Pakistan’s loan appetite!

Pakistan’s external debt and liabilities swelled over 42% to $92 billion by April this year, according to State bank of Pakistan’s data. The current Pakistan Muslim League- Nawaz government has got foreign loans of $44.2 billion to repay maturing debt, provide cushion to foreign currency reserves and finance the import bill.

Federal government of Pakistan posted a record budget deficit of Rs4.81 trillion for July-April of the current fiscal year, which is equal to 4.3% of gross domestic product (GDP). When the PML-N government came to power in June 2013, the budget deficit was 6% of GDP excluding circular debt payments.

Here is a big chunk of loans also exist in the foreign exchange reserves. The $10.32-billion gross foreign currency reserves include loans of $6.13 billion the central bank has acquired from domestic banks to inflate the reserves.

Elections ahead: Temptation galore!

Pakistan’s Prime Minister Shahid Khaqan Abbasi on May 25 approved an honorarium equal to three basic salaries for federal government employees. This came despite opposition from the finance ministry that estimated its impact in the range of Rs100 billion to Rs125 billion. The honorarium has been announced for all federal government employees and attached departments, including armed forces.

If the decision is implemented, the budget deficit for the current fiscal year would jump close to 7% of GDP. This excludes the circular debt that has been parked outside budget books.

Alarming CPEC: a boon or ban?

The CPEC is behind this constant deterioration of economy of Pakistan, an ambitious project to be considered as a game changer of Pakistan. The world's most prominent financial institutions have questioned the feasibility of this scheme. After the Managing Director IMF Christine Lagarde, the president of the Asian Development Bank Takehiko Nakao has also described the practicality of the scheme as suspicious.

At the 51st Annual Meeting of the Board of Governors, Asian Development Bank (ADB) President Takehiko Nakao acknowledged Pakistan has progressed. But he also had words of caution for the over $300-billion economy.

President Nakao also said that connectivity is important and the ADB is willing to cooperate but at the same time, economic reality and feasibility should be considered. “If we invest in borrowed money then we need economic return. If countries borrow too much without assessing economic viability it would cause issues in repayment. He also said that “I agree with Christine Lagarde’s concern. Owing to the presence of ideas like BRI, we should consider debt sustainability issues thoroughly”.

This is notable that few weeks ago, at a Belt and Road conference in Beijing, IMF Managing Director Christine Lagarde stated that the Belt and Road Initiative (BRI) can provide infrastructure financing to countries, but it should not be considered “a free lunch”. She also expressed concerns over the increase in global debt due to BRI, which would pose balance of payment challenges.

According to Pakistan’s newspaper Express tribune’s financial expert, In June 2019, Pakistan will owe Beijing $19 billion. But the interest rate on those loans averages an astronomical 7% per annum, payable over 25-40 years. According to experts’ calculations, the cost of servicing the debt owed to China will average $7 to 8 billion per year, for the next 43 years, starting from now. To begin with, that will be between 0.5 to 1% of Pakistan’s Gross Domestic Product (GDP).

The remarks make sense since GDP growth will hit a 12-year high at the end of the current fiscal year, according to official figures. From 4.1% in fiscal year 2014, GDP growth has surged to 5.8%. The PML-N may have missed its target but an improvement has been made.

Pakistan’s total debt has surged to Rs22.8 trillion as of December 2017, owing to loans under the China-Pakistan Economic Corridor (CPEC), borrowings to maintain foreign reserves and infrastructure, and floating Euro and Sukuk bonds.

What began as an investment project of $46 billion has now grown to $62 billion. This means that over the next 30 years the country will be repaying billions of dollars.  But is the government of Pakistan ready to cope with the apprehensions and cautioned of adverse implications of this so called ‘Game Changer” project?