Spearhead Analysis – 17.10.2016

By Farrukh Karamat
Senior Research Coordinator, Spearhead Research

pakistan-imfIn a concluding note to Pakistan for the US$6.15 Billion three-year programme the International Monetary Fund (IMF), has presented an objective macro-economic review of the CPEC-related investments. As the projects start to come on-stream and the Chinese investors start to repatriate profits, there would be significant pressure from CPEC-related outflows. This would be on top of the burden in the form of loan obligation repayments for these projects, which will continue to rise post-2021. In the face of declining exports, potentially reduced remittances, and the financial burden from existing (and growing) debt, the CPEC costs could place heavy demands on the economy.

The expected CPEC-related growth in the economy, would help partially off-set the payments in the long run, however, the Fund acknowledges: “Reaping the full potential benefits of CPEC will require forceful pro-growth and export-supporting reforms.” There is a clear need for improving the business climate, governance structures, and the security situation as pre-requisites for the CPEC-related investments. The Fund has cited the CPEC-related outflows as one of the medium- to long-term risks facing Pakistan, and has called for “sound project evaluation and prioritization mechanisms based on effective cost-benefit analysis and realistic forecasts of macroeconomic and financing conditions” to mitigate potential risks. The need for “transparency and accountability in project management and monitoring,” has been emphasized, particularly for the Power Purchase Agreements (PPA) with the Chinese Independent Power Producers (IPPs).

Key Features Highlighted by IMF:

  • The current account deficit would be negatively impacted with the surge in project-related imports, which are expected to reach 11% (US$5.7 Billion) of the total projected imports till 2020.

  • The gross external funding needs are expected to reach US$11 Billion in the current fiscal year and US$17.5 Billion by 2020.

  • Estimated profit repatriation and loan repayment could touch a level of 0.4% of GDP in the long run.

  • Projected growth rate for the economy boosted to 5% in the current fiscal year, providing potential upside through investment and growth in the energy and transport infrastructure.

  • Estimated total investment of CPEC at US$44.5 Billion (16% of GDP in 2015-16), of which around US$28 Billion is allocated for ‘early harvest’ projects in the next few years, with the balance coming on-stream 2030 and beyond:

  • US$10 Billion is allocated for road, rail, and port infrastructure. Financing will be provided by the Chinese government and state banks at concessional rates.

  • US$18 Billion is allocated for energy-related projects, which will be funded through FDI by Chinese firms, with commercial loans from Chinese banks. The firms will operate as IPPs with electricity sales guaranteed through pre-negotiated power purchase agreements, including guaranteed tariffs.

  • Other CPEC infrastructure projects, on a smaller scale, are expected to be financed through a mix of concessional loans and grants.

The Fund has stated that, “The broader positive impact on the economy would be considerable.”

  • The energy sector projects are expected to add significant power-generation capacity to help mitigate the chronic electricity shortages and provide a boost for economic activity and exports.

  • The transport infrastructure projects would facilitate easier and lower-cost access to domestic and overseas markets, thus promoting regional and international trade, and boosting business investment and productivity.

Potential Game-Changer:

The potential hidden costs could place a considerable economic burden and as pointed out by IMF, transparency and accountability are absolutely crucial to avoid cost over-runs. It is vital to manage the costs, especially in the wake of security issues that have been repeatedly raised by the Chinese. Within the context of the evolving geo-political situation, Pakistan has provided specific assurances to ensure the safety of the Chinese workers and the security of infrastructure investments. The military had announced the creation of a ‘Special Security Division’ for the project and there is no doubt that this entails considerable cost. In a recent ECC meeting, the Federal government decided to raise the capital cost of all under-construction CPEC power projects by 1% to pay for the cost of the security force. Nepra was directed to include this cost escalation in the tariff given to these plants – the cost of the force was being added to the power tariff for the consumers. However, Nepra raised objections, and as negotiations continue, the security expenditure continues to grow, with no definitive figure on its exact impact. Such unaccounted costs could place a huge burden on the economy and consumer, as has been the case with the Circular Debt in the past. The well-intended advice of IMF should be heeded to ensure the viability and sustainability of the project.

Pro-growth and export-oriented reforms and prudent macro-economic policies are essential to realize the true benefits from the CPEC platform, alongside prudence in fiscal policy and strengthening of debt management for long term sustainability of the projects. All agreements should be negotiated to adequately incentivize the investors, while ensuring that the cost remains favourable for the country and the ultimate consumers. There is no doubt that CPEC has the potential to be a game-changer for Pakistan. This opportunity combined with the peace and order in the wake of the huge sacrifices by our Armed forces in their ongoing fight against terrorism should be leveraged to build the economy. Transparency and accountability over the financing of CPEC projects is crucial and the opportunity needs prudent management, given its long-term nature and for realization of the true benefits.