Valued at $62 billion, the China-Pakistan Economic Corridor (CPEC) is a focal point of the Belt and Road Initiative, China’s ambitious undertaking to enhance connectivity between Asia, Europe, and Africa. CPEC promises to create economic prosperity by turning Gwadar, Pakistan, into a trade hub that links China to the rest of Asia and Europe. However, with Pakistan’s economy suffering and in the midst of a bailout by the International Monetary Fund, Islamabad has been more carefully scrutinizing CPEC’s affordability. Pakistan has been coming to terms with the massive, unsustainable amount of Chinese loans it has taken to implement these projects.
Six years into this initiative, Beijing is beginning to acknowledge the growing international criticism about its distortive lending practices, and it is pledging to instill a greater level of openness, transparency, and sustainability. The Chinese government is taking steps to not only help Pakistan, which has been dubbed its “all-weather friend,” to restore its economic balance, but also to realize the true promise of CPEC.
Pakistan’s Economic Woes
Introduced under considerable fanfare in 2015, CPEC provides much-needed financing for infrastructure and energy pipelines that Pakistan could not entice other investors to underwrite. However, the expected payoff is unlikely to compensate for the sizable risks to which these investments expose the Pakistani economy. In addition to inflicting an enormous debt burden, opaque lending practices have caused numerous concerns over hidden debts and unfair terms that favor Chinese banks and companies. The case most used to illustrate the concern is China’s takeover of Sri Lanka’s Hambantota port in 2017, after the latter failed to repay its loans. This measure sent a chilling message to Pakistan and other Belt and Road partner countries, and it called for closer examination of the strings attached to BRI projects.
The sheer amount of Chinese investment in Pakistan, and the ensuing debt loads, validate the worry that Pakistan will become dependent on China. In five years, Islamabad’s total debt owed to Chinese banks is expected to rise to $100 billion. Not only have many projects been financed with unsustainably high interest rates, but Pakistan’s ability to repay these loans is threatened by a balance-of-payments crisis and rapidly shrinking foreign reserves. Further compounding these economic woes, Pakistan’s debt rating is sinking deeper into junk territory, and its security environment gives pause to foreign investors. Pakistan’s troubled economy has few current options aside from international bailouts or further dependence on China.
Prime Minister Imran Khan and his Tehreek-e-Insaf party were already CPEC-skeptic before Khan won the 2018 elections. The country’s shaky macroeconomics, coupled with concerns over the commercial viability of many CPEC projects, motivated the Khan administration to rethink the country’s dealings with China.
In late 2018, Islamabad established a special committee to scrutinize and scale back some projects, and even to put others on hold. In the past year, the government has already backed away from Chinese-funded energy and railroad projects, a trend that will likely continue in coming years due to the austerity measures imposed by the IMF bailout. This is in line with other emerging countries, such as Malaysia and Indonesia, who renegotiate previous BRI commitments that are deemed untenable, prompting China to offer concessions.
To soothe some of these concerns, Beijing has worked with Islamabad to convert some debt into a wide range of mixed funding models. These models offer a certain degree of repayment flexibility and incorporate grant components with reduced interest rates. Some debts are even forgiven, such as the conversion of a $230 million loan into grants for the construction of the Gwadar International Airport. But short-term debt relief like this can come with its own conditions. In the case of Gwadar, the conversion provided Beijing the sole right to construct the airport instead of relying on a competitive bidding process.
China has Taken the Hint
Starting late last year, Beijing began to adjust its approach. As a first step, it has broadened participation, welcoming countries such as Saudi Arabia and Turkey as partners in CPEC projects. This was seen as a trend toward multilateralizing CPEC. It represented a major shift in the traditionally monopolistic process by which Beijing initiated, financed, and operated projects, and arguably was introduced to combat criticism that parts of Pakistan were becoming a “Chinese economic colony.”
Just as importantly, it illustrated efforts to increase transparency in lending, procurement, bidding, and concessions. In fact, China’s new approach would encourage cooperation between Beijing and other partner countries to set forth standards of financing and contracting. It would also pave the way for deeper engagement from Beijing with the Paris Club, an international group of creditor nations that encourages sustainable treatment of bad debts.
Finally, last November’s arrangement to start settling bilateral transactions in Chinese yuan instead of U.S. dollars has important implications for how Pakistan will repay Chinese loans. Under this scheme, Pakistan would be able to protect its currency from further devaluation by maintaining its foreign exchange reserves in U.S. dollars, which would help stabilize its debt portfolio. This is a logical step toward the Chinese goal of internationalizing its currency by promoting the use of yuan in global trade, using Belt and Road as a platform.
While Pakistan probably cannot entirely evade the high cost of debt placed on CPEC projects, it can mitigate the debt crunch if Beijing stays flexible.
Looking ahead, the Chinese government and banks will be increasingly subject to free-market standards. This will happen as additional countries become involved in Belt and Road and the international community starts demanding more scrutiny and transparency in the contracting, financing, and implementation process.
It remains early days, but Beijing’s new approach presents an ideal and practical opportunity to reverse accusations that China uses Belt and Road to fuel a self-serving economic and political expansion in the region. If it stays on this path, China can restore its reputation as a true partner to Pakistan and other countries, and it can advance the concept of shared economic prosperity and security for the region.
Zoe Leung is senior associate with the EastWest Institute’s Asia Pacific program. The views expressed in this publication are solely those of the author and do not necessarily reflect the views of the EastWest Institute.