17 July 2019

Can CPEC Meet Pakistan’s Development Goals?

By James Pershing

In early June, Prime Minister Imran Khan agreed to Pakistan’s thirteenth IMF bailout in the last thirty years. Facing a balance of payments crisis and foreign exchange reserves insufficient to cover even three months of imports, Pakistan will assume austerity measures in order to receive $6 billion of rescue funds from the international lender. Khan, who once declared that he “prefer[red] death to the begging bowl,” now finds himself dependent on external financing to fulfill the lofty development goals on which he campaigned in 2018.

Perhaps the biggest target of austerity is the China-Pakistan Economic Corridor (CPEC), originally a $62 billion series of infrastructure projects aimed at improving Pakistan’s transport and energy infrastructure. Once viewed as Pakistan’s great hope for job creation and economic development, this leg of China’s Belt and Road Initiative (BRI) is subject to an estimated 60 percent spending cut in Pakistan’s latest budget. Cynicism around CPEC has flared as investment projects of questionable commercial viability have exacerbated Pakistan’s already severe fiscal and financial problems while failing to adequately address underlying obstacles to sustainable development.


Can CPEC still offer Pakistan a viable development path? Supporters of CPEC have long argued that expensive infrastructure investments would create short-term economic stress in Pakistan, but in the long-run, the new network of roads, ports, and power plants would spur development and improve Pakistan’s macroeconomic fortunes. Today, however, it is clear that both the IMF and Prime Minister Khan recognize that without serious reforms in Chinese lending practices and Pakistan’s own economy, CPEC may do more harm than good.

Challenges to CPEC’s Development Goals:

Pakistan has long identified its infrastructure gap as inhibiting sustainable economic development. The country’s debilitating power outages, inadequate road networks, and limited port capacity are obstacles to implementing the export-driven economic development model used by many of its successful Asian neighbors. Today, Pakistan is almost devoid of foreign investment, and higher energy and freight costs continue to render exports uncompetitive. The country’s export-to-GDP ratio—8.2 percent in 2017—is far behind neighboring countries such as Bangladesh (15 percent) and India (19 percent), and barely surpasses war-torn Afghanistan (5.9 percent). However, CPEC projects alone are incapable of solving Pakistan’s economic problems.

GEOGRAPHY

One of the stated goals of CPEC is to develop a maritime and land-based trade corridor from Gwadar port in Pakistan to Western China and Central Asia via the Karakorum Highway (KKH). However, because Pakistan is sandwiched between an unstable Afghanistan, an unfriendly India, and the Himalayan mountains, transportation through the trade corridor is expensive, onerous, and unlikely to facilitate increased overland trade. Estimates state that transporting cargo from Dubai to Shanghai over the KKH would take over twice as long and be sixteen times more expensive than China’s current route through the Strait of Malacca.

At the “entrance” to the corridor, the port of Gwadar has struggled to attract the 100 million tonnes of cargo which the original development master plan set as its objective. Today, the port is only serving one major Chinese shipping company which mostly carries construction materials for CPEC. Even in the event of increased traffic, Pakistan has forfeited 91 percent of all profits made by the Gwadar port to China for the next 40 years as part of the “Build-Operate-Transfer” financing scheme.

At the same time, the KKH passes through one of the most unstable geographies on earth, making plans to widen the highway nearly impossible and necessitating the closure of sections of the highway each winter. The presence of Baloch insurgents in Gwadar and terrorist training sites along the KKH further threaten the limited economic viability of the project. Alternate routes from Gwadar through war-torn Afghanistan and Central Asia have been written off for security reasons as well.

More broadly, CPEC construction itself has brought little economic value to Pakistan. Projects, once hailed for their promise to bring employment and wealth, have instead been built by Chinese labor, equipment, and materials. After over five years and $20 billion of realized investments, only 75,000 jobs have been created in Pakistan linked to CPEC – far short of the estimated 1.5 million jobs per year necessary to accommodate the country’s youth bulge and the 10 million new jobs promised by Imran Khan’s government.
ENERGY POLICY

A more reliable and inexpensive energy supply is key for realizing Pakistan’s goal of strong economic growth through increased productivity and export capacity. Prior to CPEC, large portions of the country were saddled with daily 10-hour blackouts which, combined with the country’s gas shortfalls, detracted an estimated 2-2.5 percent of GDP growth annually. Projections regarding Pakistan’s future energy production capabilities vary widely, but expectations have been tempered as implementation has slowed and projects have been canceled due to lack of commercial viability.

In 2014, then-Prime Minister Nawaz Sharif promised that CPEC’s energy projects would generate 17,000 MW of electricity annually, enough to meet domestic demand. By 2017, however, independent estimates of CPEC’s energy production were closer to half of the expected amount. In the summer of 2018, rolling blackouts again hit Pakistan’s major cities as deficits approached 7,000 MW in record heat.

The comparatively higher cost of CPEC-generated electricity, estimated to be 40 percent more per MW than a comparable ADB-financed project in Jamshoro, will only exacerbate this problem. While projects receiving ADB financing are required to receive competitive bids for construction and operation, no such bidding process exists for CPEC projects.

Dysfunctional government energy policies may ultimately be the limiting factor, however. The “circular debt” problem of Pakistan’s power sector—incurred when the government assumes the production and distribution costs of electricity by private companies but does not collect tax revenue necessary to offset costs—is the chief culprit. Without a major policy adjustment, energy will likely remain too costly and unreliable to increase Pakistan’s productivity or make exports cost-competitive.
FINANCIAL TRANSPARENCY

Not only are CPEC projects of dubious commercial viability, but aggressive and non-transparent Chinese financing terms have exacerbated Pakistan’s pre-existing debt and balance of payment crises. Without greater clarity on Pakistan’s CPEC financial obligations, it is impossible to adequately assess the impact of expensive Chinese loans. However, the opacity surrounding CPEC’s terms has stoked fears that CPEC subordinates Islamabad’s interests to those of Beijing in the form of high guaranteed returns on equity to Chinese investors and unaffordable national debt.

It is true that for years, Pakistan’s economy has suffered from an overvalued rupee, artificially low-interest rates, and pervasive tax evasion. Yet, CPEC debt obligations may just be the straw that breaks the camel’s back. Pakistan’s current account deficit has increased nearly 700 percent since CPEC’s inception in 2015—largely as a result of rising CPEC-related import spending—and overall external debt obligations exceed $100 million.


As a result, Pakistan's GDP growth rate is expected to fall from the 5.43 percent experienced in FY18. World Bank and Standard & Poor project 4.8 percent and 4 percent growth in FY19 respectively. Standard and Poor’s went further in 2019, revising its GDP growth prediction to an average of 3.6 percent over 2019-2022, and downgrading Pakistan's long-term credit rating from a “B” to “B-”. CPEC investments have helped saddle Pakistan with a debt burden it has little hope of paying back, threatening its development objectives.
What Must Be Done?

The conditions attached to Pakistan’s IMF bailout have the potential to improve CPEC’s development outcomes if they are strictly enforced. Steps to ensure Pakistan has a market-determined exchange rate and that energy subsidies are distributed appropriately are steps in the right direction to encourage exports, but more must be done.

First, it is crucial to increase transparency around CPEC contracts. Definitive information about Pakistan’s CPEC-related debt that demonstrates how indebted BRI client countries are liable to become could pressure Pakistan’s government to undertake and implement necessary macroeconomic reforms.

Second, Pakistan must be more rigorous in evaluating projects’ economic feasibility. Projects like those along the Karakorum Highway that are unlikely to advance Pakistan’s development goals should not be the source of debt. By attracting financing from multiple sources, Pakistan would have leverage to prioritize its own development goals and focus on higher quality projects.

Third, future investments should promote projects that economically empower local populations. To help stabilize Pakistan, develop rural regions, and attract FDI, it is paramount to make sure that currently marginalized populations directly benefit from infrastructure and energy investments.

Ultimately, Pakistan needs to reassert control of CPEC and accept serious economic and political reform. Only in a more transparent, stable, and sensibly regulated environment will Chinese infrastructure investment be able to generate economic development in Pakistan.

James Pershing is a recent graduate from the Harvard Kennedy School and a public policy researcher at the Belfer Center for Science and International Affairs.

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