Arif Rafiq. Asian Affairs. Volume 50, Issue 2. June 2019.
Introduction
The China-Pakistan Economic Corridor (CPEC) is among the more advanced Belt and Road Initiative (BRI) projects, with $18.9 billion in CPEC projects initiated or completed as of December 2018.
Given the close strategic ties between Beijing and Islamabad, and the popularity of China among Pakistanis, CPEC serves as a valuable BRI case study, providing insights into how the programme has operated in a country with limited initial political barriers to Chinese aid and investment. China and Pakistan have had robust diplomatic and defence relations since the late 1960s. Economic ties have, however, remained weak. CPEC marked the start of a venture into unchartered waters with respect to the bilateral relationship.
At the outset, when CPEC was formally launched in 2015, 82 per cent of Pakistanis had a favourable opinion of China, according to a poll by the Pew Global Attitudes Project. The only country that had a more favourable opinion of China that year was China itself.
Given the strength of the strategic partnership, and favourable opinions of China in Pakistan—at least at the aggregate level—this was a unique starting point when compared to other BRI countries that have had a more ambivalent perspective on China. Many of the barriers to success in other BRI countries, such as long-standing anti-China sentiment or resentment of ethnic Chinese persons, do not exist in a prevalent form in Pakistan. But there have also been similar and unique barriers to the successful implementation of BRI in the Pakistani context, including corruption and political wrangling.
Four years since its formal launch, CPEC demonstrates the lure of easy financing from Beijing for developing economies and the perils of poor planning by recipient countries. In the short-term, CPEC has not served as the transformative force as which it was originally billed. Instead, it has exacerbated Pakistan’s macroeconomic imbalances, contributing to a surge in the current account deficit and helping create another boom–bust economic cycle.
Objections over a lack of equitable geographical distribution of CPEC’s projects in its early stage resulted in additions from smaller provinces, bloating the portfolio and weakening its coherence and economic viability. As it stands, CPEC is a series of energy and infrastructure projects without an anchoring, structured economic plan. To continue successfully, it will have to be retrofitted with one. Beijing and Islamabad are taking steps to retool CPEC as a vehicle for sustainable economic growth. But this is a difficult task for Pakistan in a phase of austerity and reform.
What is CPEC?
The China-Pakistan Economic Corridor is a connectivity project that aims to link Kashgar in China’s landlocked western region of Xinjiang with Pakistan’s Arabian Sea coast, an area home to two established ports—Karachi and Port Qasim—and the Chinese-operated port of Gwadar.
The CPEC portfolio has been said to consist of projects totalling upwards of $62 billion in cost. But this is a fluid figure. Pakistan may not have the capacity to absorb this entire amount of aid and investment. What is more salient is that the amount of aid and investment that has come into the country through CPEC is quite considerable.
Presently, $18.9 billion in CPEC projects have been initiated or completed, according to the Chinese Embassy in Islamabad. This figure includes two sets of coal-fired power plants that now provide electricity to the grid in Pakistan—both of which were completed in relatively short time.
Roughly 70 per cent of the potential CPEC expenditures are for electric power projects, most of which are coal-fired plants. Though they are regarded as private investment, there is an inter-governmental role. Sovereign guarantees have been provided for repayment. Pakistan has agreed to set up a “revolving fund” to ensure that at least 22 per cent of the estimated electric power charges are repaid to Chinese state-owned enterprises that serve as independent power producers supplying electricity to Pakistan’s public utility companies.
The idea is—or, at least, was—to address Pakistan’s electric power deficit and inefficiencies in its ground infrastructure, paving the way for investments in the country’s agricultural and industrial sectors. However, there have been complications along that road.
Punjab Moves at the Speed of China
CPEC is one of the more advanced Belt and Road-linked corridors, at least with respect to the total cost of initiated and completed projects. The $18.9 billion figure demonstrates that CPEC has also been an effective medium through which to fast-track the completion of infrastructure projects. The CPEC portfolio includes a few projects that have been on Pakistan’s wish list for quite some time, going back to the 1990s. Pakistan had failed to push many of these projects forward because of the significant legal, political, and security risks the country poses to foreign investors. Also inhibiting investment is a colonial-era designed bureaucracy that is ill-equipped to serve as a facilitating or catalyzing force in today’s global economy.
Through the ad-hoc CPEC bilateral framework, many projects were able to achieve financial closure and even become operational at a speed not typically associated with a country like Pakistan. Several of the projects have been completed much earlier than one would see in any country other than China.
The major completed projects were launched and completed during the tenure of the previous government run by the Pakistan Muslim League—Nawaz party (PML-N). Several key projects were located in the PML-N-run Punjab Province, or even sponsored by the PML-N-run provincial government and personally directed by the chief minister, Shahbaz Sharif. And so a phrase was coined to characterize this rapid completion of projects: “Punjab speed.” The inference was that the province of Punjab was able to match the speedy delivery that has been associated with infrastructure projects in China. So “China speed” had been matched by “Punjab speed.”
CPEC was also a somewhat effective mechanism for Pakistan to overcome reputational disadvantages. From 2013 to 2015—the period in which CPEC was initiated and launched—Pakistan had seen a resurgence of anti-state jihadist networks and was in the midst of a failed process of negotiations with the Tehreek-e Taliban Pakistan network. In mid-2014, the Pakistan Army launched Operation Zarb-e Azb. The year ended with the horrific school massacre in Peshawar. But since then, terrorist attacks have dropped precipitously each year, reaching their lowest levels in 15 years in 2018. But in 2013, Pakistan was regarded as one of the world’s most dangerous countries and few were willing to invest in it. So CPEC served as a critical morale booster for Pakistan.
Worsening the Economic Disequilibrium
Speed alone is not a meaningful benchmark for sustainable development. The primary motivation for “Punjab speed” was political. The Punjab-based PML-N sought to complete major energy infrastructure projects, including those through CPEC, before the 2018 general elections. The Pakistani economy, however, was unable to absorb this amount of investment in this short period of time, which required the import of heavy machinery. Pakistan is also a net energy importer. So along with the rise of crude oil and LNG prices from 2016 into mid-2018, CPEC-related imports widened Pakistan’s current account deficit. Pakistan’s forex reserves plunged, putting the country on the verge of a balance of payments crisis.
To avoid a balance of payments crisis, Pakistan is in talks with the IMF for a bailout. It has received or will receive short-term assistance from China, Saudi Arabia, and the United Arab Emirates. Pakistan is also attempting to pair short-term lending with foreign direct investment from these very sources.
The Pakistani economy, however, will once again slow. Public spending is being heavily cut. The rupee was devalued on several occasions in 2018. Interest rates and inflation are rising. Annual growth is estimated to slow over the short-term from a rate of close to six per cent in 2018 to around four per cent in the short term. “Punjab speed” served as an accelerant to Pakistan’s boom–bust cycles, which the country has seen repeatedly over the past few decades. This has prevented Pakistan from achieving long-term sustained growth as compared to regional countries like Bangladesh and India.
While CPEC gave momentum to a country where governance has largely been associated with lethargy, the lure of easy project financing also clouded decision-making, pulling Pakistan away from a path of responsible economic planning. In the immediate term, it has strengthened the disequilibrium in the Pakistani economy rather than serving as a transformative force.
Disincentivizing Reform
Continuing with the question of transformation, CPEC may have also disincentivized reform—particularly in the power sector but also with respect to the judiciary.
Pakistan’s previous government focused on ramping up power generation and reshaping the country’s fuel mix, but once CPEC gained momentum, it lagged on combatting theft of electricity as well transmission and distribution losses in the grid. The grid itself still is unable to handle more than approximately 22,000 MW of electric power. Energy sector reform, including dealing with liquidity problems in the power sector, has also stalled. Inter-company arrears within the electricity system continue to accumulate. And Pakistan has struggled to pay some of the CPEC independent power producers whose projects are now supplying electricity to the grid. As Pakistan’s installed power generation capacity grows, so will the indirect liabilities of the Pakistani government, if non-payment and losses from the grid continue at the same pace.
While power supplied through CPEC may bring down electric power price rates in Pakistan, it is more expensive or par with Pakistan’s competitors, especially when factoring in the incentives or effective subsidies provided to Chinese companies. Pakistani consumers will continue to struggle to afford the electricity offered to them. Pakistani electric supply companies will also continue to struggle to collect payment and arrears. Realistic pricing of electricity, keeping Pakistani income-levels in mind, is critical to electric-sector reform. Unfortunately, the previous government focused mainly on increasing installed capacity. And Chinese state-owned enterprises were focused on maximum profit generation, with guaranteed returns on investment of 30 per cent or more for many of these projects.
Continuing with the subject of reform, much of the success of CPEC—and at least from a project management perspective—is due to ad hoc parallel structures created to facilitate Chinese aid and investment. But there is no major effort to reform the overall judicial system and improve the investment environment, especially when it comes to contract enforcement.
CPEC has addressed much to the uncertainty by doing away with open bidding, providing easy access to project financing, and enabling the redress of concerns and grievances through an ad hoc bilateral framework and offering Chinese companies informal, preferential access to Pakistani decision-makers. But for non-Chinese investors, Pakistan remains a market with a high degree of legal and political risk. This is why there has been an uptick in foreign direct investment (FDI) from China—at least from state-owned enterprises—but not sustained investment from elsewhere. There is now is likely to be a rise in FDI from Saudi Arabia and the United Arab Emirates, but the impetus for these investments may be geopolitics rather than domestic economic reforms.
Pakistan’s (now former) Supreme Court Chief Justice had discussed creating an arbitration system for foreign investors similar to the system that exists in the UAE. But political leaders have yet to initiate a dialogue let alone prepare legislation on such reforms.
Pakistani regulatory authorities have also weakened as a result of political and diplomatic pressure to push CPEC forward. It is these entities, such as the National Electric Power Regulatory Authority, that should be independent from external influence and improving their capacity and capabilities is key to improving overall governance in the county.
So as CPEC’s fifth year begins, it can be said that the surge in Chinese investment has contributed to an economic bubble in Pakistan—and to prevent that bubble from bursting, the new government in Islamabad has little choice but to slow the economy, recalibrate spending priorities, and push forward systemic reforms.
It is important to keep in mind a longer term view when observing CPEC as well as the Belt and Road Intiative. Past is not necessarily prologue. And if these long-delayed reforms are actually implemented over the next three to five years, CPEC could actually be identified as one of the contributing factors. While CPEC has induced what will be Pakistan’s likely return to the IMF again later this year for the 22nd time in the country’s history, as a result of direct pressure from the IMF and indirect coaxing from China, CPEC may also end up having induced Pakistan to take up electric power sector, regulatory, and taxation reforms previous governments deferred.
CPEC: A Rudderless Ship?
Moving ahead, CPEC will have to be retrofitted with an actual economic master plan. There is a CPEC “long-term” plan that was released in 2017. But it is largely a notional plan uninformed by a comprehensive feasibility study and forecasting. The CPEC long-term plan is an aspirational document that proposes three phases stretching over 15 years. It is now obvious that it does not guide decision-making by officials in China and Pakistan. Several developments make his clear.
First, there is no clarity on what is the firm basis for the inclusion or exclusion of projects from the CPEC portfolio. These factors are neither explicitly stated, nor can they always be inferred. For example, there are Chinese-funded electric power projects in Pakistan, such as a set of nuclear power reactors in Punjab and Sindh, that are not included as part of CPEC. And there are road projects that are part of what Pakistan describes to be the CPEC road network, such as the M-8 Motorway, but they are not funded by China or managed through CPEC. In fact, some are wholly funded by the government of Pakistan. Ultimately, the question of what does it mean for a project to be included as part of CPEC has yet to be clearly answered. For example, municipal rail projects that have no relevance to a regional economic corridor are included as part of CPEC.
Secondly, industrialization is one of the main goals of CPEC, but rates for electricity produced by CPEC power plants are relatively high, despite the significant incentives being given to Chinese-state owned enterprises. This suggests that Beijing’s goals to prop up troubled state-owned enterprises has been a priority over fuelling long-term growth in countries that receive Chinese aid and investment. Expensive energy will impede Pakistan’s efforts to make its exports competitive and move away from an unsustainable import-based growth model.
Thirdly, there is a great deal of ambiguity and uncertainty surrounding overland Sino-Pakistan trade, despite the heavy expenditures. What type of future economic activity justifies the Pakistani government taking out upwards of $2 billion in loans to realign the Karakoram Highway, so that connects it to China? There is presently no investment from China in industrial centres that would leverage this connectivity in the coming years. Those funds would have been better spent improving connectivity with the Karachi area, which is home to Pakistan’s two main ports. On account of budget cuts, the motorway connecting Pakistan’s two largest cities, Karachi and Lahore, will be incomplete for the foreseeable future. While the Multan-Sukkur section of the motorway will be completed this year (through CPEC), the Hyderabad-Sukkur section that was to be funded by the government of Pakistan has been cancelled or delayed for now.
Continuing on the issue of overland Sino-Pakistan connectivity, we speak of a China-Pakistan Economic Corridor, but we only know of the investments on the Pakistani side. What is being constructed on the Chinese side? And how will Pakistan be impacted by the internment of more than one million Uighur Muslims? Can this area, linked to Pakistan via the $2 billion upgraded KKH, really serve as a hub of regional economic activity?
Finally, there are no reliable figures on the projected impact of CPEC. The economist of Pakistan’s planning commission during the previous government presented a fantastically absurd estimate of $6-8 billion in annual toll revenue and fees earned by Pakistan through CPEC. He had estimated over $150 billion in China’s global trade to be routed through CPEC by 2020. It is worth noting that in $80 billion in non-oil trade passed through the Jebel Ali Free Zone in 2017.
The Road Ahead
For CPEC to succeed, the metrics for judging its progress will have to change. They are a means to peg government allocations toward concrete economic and development goals. Since its genesis, the main metric so far has been the size of CPEC: a project that began at $46 billion and then ballooned to $62 billion. Pakistani officials in the previous government had boasted about the growing size of the CPEC portfolio, though the growing size, through loans and indirect liabilities, also increased their challenges. Pakistan had effectively been competing with itself.
The true impact of CPEC should be determined by its impact on job creation, logistics efficiency, productivity, and exports. The present government in Islamabad appears to be retooling CPEC to some extent along these lines. But the opposition, including a minister from the previous government, have accused it of reducing the size of CPEC by cancelling or deferring some projects. Islamabad will have to resist the temptation to bloat CPEC with projects that lack an economic rationale right now.
CPEC will have to be retrofitted with an overarching plan that partly tries to leverage the infrastructure that has or will be coming on line. A year-long period to revisit and retune CPEC, as suggested by the new advisor to the Pakistani prime minister on trade, was a perfectly sensible suggestion. But the idea was shot down because of opposition within Beijing and Islamabad.
However, China and Pakistan are taking steps to retool the CPEC framework. At the December meeting of the China-Pakistan Economic Corridor joint coordination committee or JCC, the two countries agreed that CPEC would now focus on agriculture, industrialization, and socio-economic development. In January, Prime Minister Imran Khan also included the Gwadar Port among CPEC’s priorities going forward.
While all of these elements are more or less part of the original CPEC plan, they have taken precedence over initiating new electricity and infrastructure projects. There are two major reasons for this shift in emphasis: Pakistan’s current account deficit woes and the Pakistan Tehreek-e Insaf emphasis on human development.
Beijing has also reportedly pledged $1 billion in development assistance over the next three years to Islamabad. It goes unmentioned in a statement released by the Chinese embassy in Islamabad after the JCC. But the claim was made by a Balochistan provincial minister in December and unnamed officials in a Voice of America report. If such a pledge has indeed been made, it would reflect Beijing’s responsiveness to the priorities of the new government in Islamabad, which has placed human development and social service delivery above infrastructure.
While China has paired some of its investments in Pakistan’s poorer regions with goodwill projects, these have largely been modest given the size of the two countries. Many or most of these projects have effectively been corporate social responsibility projects by Chinese state-owned companies. Beijing will now reportedly provide grants that cover “education, health, vocational training, drinking water and poverty alleviation projects.” The programme could also include an anti-poverty pilot project.
China can also share with Pakistan lessons from the ecological and environmental impact of its three decades of rapid economic growth. Climate change, deforestation, and water management are also on the joint working group’s agenda. China has made major strides in recent years in reversing environmental degradation and adopting sustainable agricultural practices.
A new set of agricultural projects are likely to be funded through the CPEC portfolio, including the channelization of an 180 km stretch of the Indus River in Sindh. But for CPEC to transform Pakistan’s agricultural sector, it will have to go far beyond large-scale irrigation projects.
At the December CPEC JCC meeting, China and Pakistan also signed a memorandum of understanding (MOU) on industrial cooperation. The MOU identified textiles, materials, minerals, and petrochemicals as areas of focus. If investments in these areas do materialize, they would be through the CPEC special economic zones or SEZs.
The CPEC SEZs—most of which were proposed before CPEC was launched—continue to face the same difficulties as other Pakistani industrial zones. Most prominent among these are inadequate electricity and gas supplies. According to the chairman of Pakistan’s Board of Investment, none of the planned CPEC and non-CPEC SEZs have available more than 10 per cent of the electricity and gas supplies provisioned for them. Pakistan continues to face natural gas shortages despite having secured several short-term and long-term LNG supply deals. Public sector mismanagement and corruption are rampant. Merely making the SEZs a priority will not resolve the problems with gas supply. Pakistan needs to be clear on exactly what purpose the SEZs serve. What is the distinct proposition that they offer as compared to investment elsewhere in Pakistan? What barriers to investment do they help overcome?
CPEC is far from the “debt trap” as critics claim. Like any large-scale public expenditures, it has been vulnerable to rent-seekers—including Chinese state-owned enterprises, competing Pakistani government ministries, as well as local politicians and politically-connected business barons in Pakistan. They have unmoored CPEC from its basic goal of enhancing connectivity and economic growth from western China into coastal Pakistan. To contain these rent-seeking forces, and for CPEC to serve as a catalyst for sustainable economic growth, it will require a structured plan for CPEC that ties future expenditures toward specific economic and development objectives and pushing forward systemic reforms in Pakistan. Given Pakistan’s history, this is a radical proposition. But it is by no means impossible.