26 May 2017

China’s silent debt bomb for Pakistan


Excessive liquidity making its way from Chinese banks to Pakistan does not bode well for its modest economy

History shows that when a country’s debt-to-GDP ratio climbs above 200 per cent, a red flag goes up. China’s total debt at $27 trillion is now 277 per cent of its GDP. At first glance, the principal worry for China is its over-leveraged state sector. Local governments have used cheap credit for years to fuel infrastructure growth. Many gleaming new Chinese cities built during the boom period are today ghost towns with unoccupied residential towers and empty streets.

Chinese GDP has slowed significantly from its breakneck speed of 10 per cent a year in the mid-2000s. China’s economic statistics are not entirely reliable and the official GDP growth rate of 6.8 per cent for fiscal 2017 can be discounted to around 5.5 per cent.

State and local government debt is a concern because most state enterprises have borrowed heavily from banks. Defaults could set off a banking crisis that will be difficult to contain. Li Yang, a senior researcher with the leading government think-tank, the China Academy of Social Sciences (CASS), said: “The gravity of China’s non-financial corporate debt is that if problems occur with it, China’s financial system will have problems immediately. It’s a fatal issue in China. Because of such a link, it is probably more urgent for China than other countries to resolve the debt problem.”

China’s debt bomb has not yet exploded and is not about to explode any time soon, for two reasons. One, the government is cash-rich and stands guarantee for most of the non-financial corporate debt owned by state enterprises who might default to banks — which again are state-owned and can, therefore, be bailed out. Two, China’s debt is largely funded by its high rate of domestic savings. This tends to make debt more stable than debt in countries whose borrowing is in foreign currencies.

And yet, China’s ballooning debt could have geopolitical consequences. Following last week’s Belt and Road Initiative (BRI) Summit in Beijing, China is preparing to widen its arc of influence well beyond Asia. Some of its grandiose projects in the China-Pakistan Economic Corridor (CPEC), a key part of the BRI, have begun to cause uneasiness even in Pakistan.

The Pakistani newspaper Dawn last week published ‘secret’ details of what China intends to do in the CPEC: “The main thrust of the plan actually lies in agriculture, contrary to the image of CPEC as a massive industrial and transport undertaking, involving power plants and highways. The plan acquires its greatest specificity, and lays out the largest number of projects and plans for their facilitation, in agriculture. In any plan, the question of financial resources is always crucial. The long-term plan drawn up by the China Development Bank is at its sharpest when discussing Pakistan’s financial sector, government debt market, depth of commercial banking, and the overall health of the financial system. It is at its most unsentimental when drawing up the risks faced by long-term investments in Pakistan’s economy. The chief risk the plan identifies is politics and security. ‘There are various factors affecting Pakistani politics, such as competing parties, religion, tribes, terrorists, and Western intervention,’ the authors write. ‘The security situation is the worst in recent years.’”

Thoughtful Pakistani commentators have started to question the CPEC on three grounds. First, that it focuses on agriculture rather than infrastructure and industry. Second, that it is based on high levels of debt that could be difficult for Pakistan to repay. And third, that it will use cheap Pakistani labour and raw materials for China’s benefit.

As the Dawn wrote: “Relying on the assessments of the IMF, World Bank, and the Asian Development Bank (ADB), Pakistan’s economy cannot absorb FDI much above $2 billion per year without giving rise to stresses in its economy. ‘It is recommended that China’s maximum annual direct investment in Pakistan should be around US$1 billion.’ Likewise, it concludes that Pakistan’s ceiling for preferential loans should be $1 billion, and for non-preferential loans no more than $1.5 billion per year.”

For India, the CPEC is an egregious violation of sovereignty. Prime Minister Narendra Modi is slated to meet Chinese President Xi Jinping at the Shanghai Cooperation Organisation (SCO) summit in Kazakhstan on June 8-9. Knowing your adversaries’ weaknesses, financial or otherwise, in advance is crucial, as the ancient Chinese military strategist Sun Tzu would have advised. Modi will be well prepared.

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