The China Trap

Spearhead Analysis – 07.09.2016

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

Silk RoadThe much touted $45 Billion CPEC initiative has been hailed as a game-changer for Pakistan. Mystery still shrouds the terms and conditions of the $34 Billion energy investment and the $11 Billion infrastructure investment. So much so that even the Governor State Bank of Pakistan, at one point, had accepted that he was not aware of the exact terms of the agreement. The public unfortunately is clueless about the true benefits and costs of this unprecedented level of investment in Pakistan. We can rest assured that the controversial CPEC programme as part of the One Belt initiative by China will have potential far-reaching political, economic and financial consequences for Pakistan.

The Sri Lankan Example

In an article in Foreign Affairs, Jeff Smith reviewed the Chinese Investment in Sri Lanka. Parallels can be drawn with Sri Lanka where China started exploring its ambitions in 2005, through a ‘friendly’ relationship. For a long time, Colombo had fought a difficult and costly war with the separatist Tamil Tigers. It was at this point that Mahinda Rajapaksa came to power and decided to end the two decade long conflict. His options for outside help were limited with India declining to get involved and the USA halting military aid under the garb of Human Rights violations. China extended its hand in ‘friendship’, which Sri Lanka firmly grasped. The country received some $37 Million in military aid from China including strategic military hardware, and in addition by 2008 China was providing non-military aid of $1 Billion to Sri Lanka. The Tamil Tigers were successfully crushed by the Sri Lankan army by 2008.

In return, the ‘obliged’ Sri Lankan Prime Minister acceded to China’s regional interests and started the earnest support for the One Belt initiative. Sri Lanka with its strategically positioned ports was an attractive proposition for China with direct access to the MENA region (Middle East and North Africa). And so began a series of agreements with China: Sri Lanka signed the $1 Billion Hambantota Port project; the investment zone near Colombo port; and a Terminal in Colombo Port. Then in 2013 China won a 99-year lease contract to build the $1.4 Billion Colombo Port City with an outright ownership of 50 acres of Sri Lankan land by the Chinese.

After the completion of the Hambantota Port Sri Lanka was paying close to $30 Million annually in interest cost with marginal revenue due to the limited usage of the port facilities. Relations with China came under strain after the new elections, and the new President stated that, Sri Lanka would not offer preferential economic or security access to any one country. He placed Chinese projects under scrutiny, and cancelled the Colombo Port City project on corruption allegations and the China Harbour Engineering Company was separately accused of offering bribes. In January 2016, Chinese military contracts of approximately $400 Million were cancelled.  Indian pressures may have influenced Sri Lankan decisions and India may be acting because of its converging interests with the US as far as China is concerned.

However, Sri Lanka could not just walk away from its earlier commitments. China had invested a total of $5 Billion in Sri Lanka from 2005 to 2012, with only a paltry two percent as outright grants. The remaining Chinese investment comprised loans at very high interest rates. Sri Lanka’s external debt had climbed from 36% of GDP in 2010 to 94% by 2015. At present, Sri Lanka is servicing $8 billion in Chinese debt. In addition most of the loans from China were offered to buy Chinese equipment and services, engage Chinese labour and contractors, and purchase Chinese raw materials. Effectively, the money had just flowed back to China. While Sri Lanka has been able to renegotiate some of the terms of the financing in return for continued access to the Chinese, in the process they have contracted even more debt and are firmly placed in the grip of the China Trap.

CPEC

The Pakistan situation appears to closely resemble the Sri Lankan experience. The country is fighting the insurgents and needs the economic aid to bolster its economy. China has stepped in as the savior with the $45 Billion in investment in return for special privileges and access to the strategic Gwadar Port. There is little or no clarity on the terms of the investment by China and there in no information on the cost of funding, the level of grants, and the amount of outright loans. As in the case of Sri Lanka, most of the proposed investment would flow back to China for material, equipment and manpower acquisition. In addition the Chinese energy projects and access to the Port would provide them with a ‘permanent’ revenue streams from Pakistan in addition to the loan servicing charges.

Already bogged down by crippling levels of debt, with a major portion of revenues ear-marked for debt servicing, it is not clear what the additional burden would be on the Pakistan economy as a result of the Chinese investments. The controversial CPEC programme and the One Belt initiative will have consequences for Pakistan: it will burden Pakistan with additional debt, it will lead to increased regional rivalry and possible straining of relations with the USA, and it will raise questions about China’s use of economic power to further its strategic objectives in the region.

There is no doubt that the CPEC initiative is a potential game changer for Pakistan and for this reason it is most important that nothing should be allowed to create doubts and concerns in any quarter within the country. It is imperative that the Government comes clean on the terms of the investment and the future costs that would have to be borne by the coming generations. The CPEC will also trigger regional and internal political rivalries within Pakistan and could become a contentious issue in the next elections in the country. It is imperative that Pakistan develops a policy of peaceful co-existence with its neighbours and achieves internal unity. The CPEC initiative should benefit and unite Pakistan and today’s preferential access to China should not translate into a future China Trap from which it might be very difficult for Pakistan to wriggle out.

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