24 August 2018

One Belt, Many Headaches

By Phillip Orchard

As Beijing planned it, Pakistan was to be the centerpiece of its sprawling Belt and Road Initiative. Centered on what’s being called the China-Pakistan Economic Corridor, China has pledged backing for some $62 billion in port, road, rail and other projects along a 1,700-mile (2,700-kilometer) belt connecting a deep-water port at Gwadar to Kashgar in the western Chinese region of Xinjiang. CPEC embodies Belt and Road’s grandest strategic and economic ambitions. If successful, it would open a critical trading route to the Indian Ocean, allowing China to bypass chokepoints in the Pacific. It would help modernize underdeveloped economies in remote, restive regions of China, expand China’s commercial influence, pull Pakistan more firmly into its orbit, and counterbalance India’s warming military relationship with the U.S. and its allies. 

Yet, CPEC is also proving host to some of BRI’s thorniest challenges. On Aug. 11, for example, Baloch separatists targeted a bus carrying Chinese engineers to a CPEC project, killing three in the suicide attack. Unlike in past attacks on CPEC projects, the separatist group said this one directly targeted Chinese nationals. Meanwhile, CPEC has helped push Pakistan further into a debt crisis, putting the project at the center of the burgeoning U.S.-China competition in the region and likely forcing Beijing to dig deeper into its wallet. These challenges aren’t going to derail CPEC; in fact, China may be able to exploit them. But one way or another, the road ahead is likely to get only rockier. 

Security Risk or Strategic Opportunity?

The Aug. 11 attack on Chinese engineers is just the latest in a string of low-level incidents targeting CPEC projects. In Balochistan alone, militant attacks on CPEC projects are estimated to have killed 44 workers and injured more than 100 (most of them Pakistani) from 2014 to 2016. Yet, at this point, the security challenges have proved largely manageable for Beijing. The estimated 40,000-70,000 Chinese nationals working in the region have been targeted directly only a handful of times. This is no small feat considering CPEC’s 1,700-mile route runs through some of Pakistan’s most restive areas – in addition to Balochistan, Kashmir in the northeast and Khyber Pakhtunkhwa to the west. Chinese projects will, at minimum, complicate age-old disputes between local opposition and the state in these regions.

Beijing has gotten ample help from Islamabad, which allocated some $17 million this year to CPEC security. Most of this is going to a Special Security Division, consisting of some 9,000 soldiers and another 6,000 paramilitary troops, launched specifically to protect Chinese nationals and CPEC projects. Provincial governments are also pitching in. The Khyber Pakhtunkhwa government, for example, is expected to stand up a new 4,200-member security force to secure China’s ever-expanding footprint.

China has also found ways to take matters into its own hands. In February, Pakistani officials and several tribal sources told the Financial Times that Beijing had been holding secret talks with Baloch militants for more than five years. China has deep experience with protecting its far-flung investments in this way. For example, China has become an indispensable arbiter in the patchwork of ethnic rebellions in northern Myanmar, home to a proliferating number of Chinese mining and infrastructure projects. It’s had success navigating the treacherous militant landscape in the Afghanistan-Pakistan region as well. In 2000, a senior Chinese diplomat was reportedly able to secure cooperation from Taliban leader Mullah Mohammad Omar to prevent Uighur militants from conducting attacks in Xinjiang. Four times in the past decade, Beijing has blocked U.S. and Indian bids at the U.N. to designate Masood Azhar, the leader of the anti-India militant group Jaish-e-Mohammed, as a “global terrorist,” presumably in exchange for protection for Chinese projects in Kashmir and on both sides of the Afghan border.

Still, the Chinese Embassy in Pakistan has repeatedly warned that security risks are likely to worsen, and Beijing has signaled that it has little tolerance for failure from Islamabad on the security front. Shortly after two Chinese teachers in Balochistan were kidnapped and killed by Islamic State militants last year, for example, Chinese President Xi Jinping publicly snubbed Pakistani President Nawaz Sharif at a Shanghai Cooperation Organization summit. If attacks on Chinese nationals intensify, it won’t be hard to imagine Beijing pushing for a more direct role – say, something akin to its presence in South Sudan, where thousands of Chinese troops have been deployed as peacekeepers to protect Chinese oil interests. China has a massive and largely idle military that is almost entirely bereft of combat experience, after all.

In this way, while the security risks with CPEC may be a headache for Beijing, they’re also opening strategic opportunities. Beijing is keen to extend its security footprint in South Asia and into the Indian Ocean basin. It wants naval access to the deep-water port it’s building at Gwadar, or possibly the green light from Islamabad to build a dedicated naval and air base farther to the west in Jiwani, close to the Iranian border. (Unconfirmed reports claim that preliminary talks on the Jiwani base were held in December.) It’s looking for leverage to discourage India from wading into China’s various disputes in Southeast Asian waters. And it’s hell-bent on denying Uighur militants sanctuary in the Himalayas and on smashing up support networks for their operations in Xinjiang. Theoretically, at least, making Pakistan more dependent on its security partnership with China would advance each of these aims.

Of course, the more China goes down this route, the more it may create militant resistance to Chinese projects, prove politically untenable for any government in Islamabad, and put the future of CPEC further in doubt. Indeed, the separatists behind the Aug. 11 suicide attack in Balochistan said their motivation was China’s provision of arms to Pakistan for use against Balochistan’s national struggle. Beijing may conclude that it can’t afford the great responsibilities that come with great power – that getting bogged down with another country’s intractable problems is a tried and true way for an aspiring superpower to get overextended and collapse under its own weight (see: the Soviets). In Pakistan, as in other BRI countries in which Beijing is sinking money into commercially infeasible projects no one else would touch, China is grappling with this dilemma on the financial front as well.

The Pitfalls of Debt-Trap Diplomacy

Put simply, the economics of CPEC are a mess, and the $62 billion project is likely contributing to a financial crisis that newly elected prime minister and cricket legend Imran Khan will have to manage. Over the past 20 months, Pakistan’s foreign currency reserves have dropped by half, to less than $10 billion, while the Pakistani rupee has lost nearly 20 percent of its value against the U.S. dollar since the beginning of the year. Its current account deficit has grown more than 40 percent in just two years. Its external debt is approaching 30 percent of gross domestic product. Pakistan’s chronic financial woes predate CPEC; Islamabad has gone through 12 balance of payments support programs with the International Monetary Fund just since 1980, including a $6.6 billion program that was completed only two years ago.

It’s hard to say exactly how much CPEC is making matters worse, in part because the project is notoriously opaque. In late 2015, the governor of the State Bank of Pakistan conceded that the government was not clear on how much of the funding pledged by Beijing was debt, aid or equity. But the terms that have been released don’t give much confidence in Pakistan’s ability to live up to its end of the bargain. For example, Pakistan reportedly guaranteed Chinese power plants annual returns as high as 34 percent over the next three decades. Islamabad is believed to be on the hook for any shortfalls, not to mention dollar-denominated debt repayments that at the moment are looking ever-more expensive as the U.S. dollar surges. Pakistan’s last government insisted it had gotten a handle on the issue, asserting that the country’s total annual debt repayments and profit expatriation by Chinese companies would be below $1 billion for the next five years – and that lengthy repayment periods give Islamabad ample breathing room. Still, at minimum, rising imports of Chinese materials needed for CPEC projects are considered a major driver of the balance of payments crisis.

The new government in Pakistan has little choice but to seek an estimated $12 billion to $14 billion bailout – the country’s largest ever. Pakistani officials are reportedly planning to first turn to the IMF, from which Pakistan is eligible to receive around $9 billion. However, on July 30, U.S. Secretary of State Mike Pompeo said the U.S., the second-largest vote-holder in the IMF, would oppose an IMF rescue if it meant using IMF funds (to which the U.S. contributes) to repay Chinese lenders.

This poses a problem for Beijing: If Pakistan agrees to terms with the IMF that include prying open the books on CPEC – and if the terms made public expose Chinese predatory lending– it would undermine China’s BRI ambitions elsewhere at a time when a number of BRI partners have been seeking to cancel or renegotiate projects. Of course, it would also risk an anti-China political backlash in Pakistan itself. The alternative is for Beijing to carry more of the rescue burden itself, but this means throwing more good money after bad. (Over the past year, China has provided some $5 billion in new lending to Pakistan, including a $2 billion emergency loan shortly after the general election late last month.) To date, the value of CPEC projects that have broken ground amounts to less than a third of the total pledged, so completing CPEC as envisioned by Beijing could mean a lot more good money disappearing into the Himalayan ether.

On the one hand, the more Pakistan becomes indebted to Beijing, the more leverage Beijing will have for strategic issues – such as permission to build that shiny new naval port. This scenario is what foreign leaders are referring to when warning about China’s “debt-trap diplomacy.” (Sri Lanka’s BRI experience is illustrative in this regard. China backed a commercially dubious deep-water port and airport project and, once Sri Lanka realized just how far revenue projections were going to fall short, secured a 99-year lease for the warship-accessible port.) Yet, while China may be growing rich, it can’t afford to give its BRI partners a blank check, particularly while it’s scrambling to manage its own debt crisis at home. Indeed, Beijing has begun scrutinizing BRI projects more closely and leaning on state firms to find ways to boost revenue. In the first half of 2018, Chinese foreign direct investment channeled to BRI projects dropped 15 percent year-over-year. Indeed, in Pakistan, a $9 billion flagship rail line has been put on hold.

The downside of being a creditor nation is that, if you really need the money back – or if you really need the project you’re financing to be completed and (in China’s case) serve fundamental strategic imperatives – the debtor holds quite a bit of leverage and incentive to keep asking for more. The same logic applies loosely to whatever Beijing is promising militants in BRI states to get them to hold their fire. China’s experience in Pakistan is showing just how much strategically motivated beneficence can be a double-edged sword. 

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