https://ftalphaville.ft.com/2018/07/24/1532410200000/Belt-and-Road--or-debt-trap-/
yesterday
By: Colby Smith
Pakistan’s 106 million registered voters head to the polls on Wednesday to elect a new government. Whichever of the two leading candidates prevails—either an ex-cricket hero or the brother of the now-jailed former prime minister—will have to decide not if, but when, he will go knocking on the IMF’s door.
The IMF has long been the prevailing crisis manager for (and watchdog of) emerging-market economies when they hit trouble. Bailouts are sizeable, and always come with strings attached. These are known quantities, and given the IMF's coordination with the Paris Club, an informal group of creditor nations that help to negotiate debt restructuring, there are mostly standardised loan terms that borrowing countries have come to expect. In recent years, though, emerging markets have looked to another pocketbook: China.
As a non-Paris Club member, the way China's capital is disbursed and the terms under which it is repaid fit no mold. While that might look like freedom for any country that has felt stifled by the IMF's typical laundry list of structural reforms, it comes with its own set of unique risks.
For example, China agreed to lend Pakistan $5bn, half its total foreign funding, for the fiscal year ending in June. That may have looked like a lifeline for the country, which had a stated goal to “ not go back to the IMF programme.” But after four devaluations in seven months and a forecasted financing gap of about $16bn over the next three years, Pakistan is facing another balance of payments crisis.
Because it imports the majority of its oil, the sharp increase in prices this year has decimated Pakistan’s current account balance. And despite the economy expanding at its quickest pace in 13 years (5.8 per cent), its deficit widened more than 40% in the fiscal year ending in June, to $18bn.
Although there is no official peg, the government has attempted to shore up its currency, which Exotix’s Chris Dielmann deems overvalued by as much as 25%. Between that and its mushrooming import bill, Pakistan has burned through about $9bn of its scant stockpile of foreign reserves since 2016. As it stands, the country has an additional $9bn stashed away—but this sum is not enough to cover two months’ worth of imports, according to CEIC. If only its most liquid hard-currency assets are measured against similar liabilities, Pakistan’s central bank has even less to work with. Bilal Khan at Standard Chartered finds that the country’s net international reserves have already dropped below levels reached the last time Pakistan sought the IMF's help.
When the next IMF bailout comes, it will be the country’s 13th since 1988. So what explains Pakistan’s “ unique proclivity,” as Masood Ahmed of the Center for Global Development puts its, to flirt with near-crises every few years? Taxes and exports.
On the first point, less than 1 per cent of the country’s working population file income returns. Corporations are equally deft at avoiding the tax man. Of the 72,000 or so firms registered with Pakistan's SEC in 2016, less than half filed returns. And of those that filed returns, half paid no tax at all.
On the second point, exports make up just 7.6% of the country’s GDP. That’s nearly 17 percentage points less than than the average for middle-income countries overall. What the country does export tends to be low-value-added products, like cotton and rice. As a result, Pakistan relies on an ever-decelerating flow of remittances and outside funding, which makes it highly susceptible to external shocks. Add to this an overvalued exchange rate, which has become somewhat of a point of national pride for the government, and the result is macroeconomic distress.
Enter the China-Pakistan Economic Corridor (CPEC).
This collection of infrastructure and trade projects, valued at up to $63bn, has become the centerpiece of China’s $1 trillion-plus Belt and Road Initiative (BRI). The BRI, which is seven times the size of the US’s Marshall Plan to rebuild Europe after World War II (in today's dollars), all but guarantees that this time will be different for Pakistan.
From shoddy ports and expressways to inefficient power plants, the Chinese-funded CPEC aims to resolve many of the shortcomings that have stifled Pakistani manufacturers. And now that more than half of China’s planned projects there are underway, says Dielmann, a disorderly devaluation or full-blown currency crisis is unlikely to be in Beijing’s interests. That is why China has been quick to pull out its wallet to buffer Pakistan’s reserves and double its currency swap agreement . Jonathan Anderson of Emerging Advisors Group shows how much the flow of loans to Pakistan have surged since 2015:
But as much as Chinese funding helps to fix Pakistan’s financial foibles and development woes, the BRI has created problems, too.
Raw materials are required to construct buildings, bridges and roads, and Pakistan has to bring in all of them from abroad. Between June 2015 and 2017 (the first two years of the CPEC project), Pakistan’s imports of these kinds of goods increased 51 per cent. By June 2021, machinery imports for proposed power plants and transport hubs are set to top $27bn. So part of Pakistan’s growing import bill —and therefore its deteriorating balance of payments—traces back to the Middle Kingdom.
Granted, Pakistan can pay for Chinese goods chiefly because China lent it the money in the first place. But eventually, these loans need to be repaid. Unfortunately for Pakistan, its bills will likely arrive before the economic gains that will be used to pay for them are accrued. The IMF has warned about this. Infrastructure financing, says Managing Director Christine Lagarde, should not be considered a free lunch:
“These ventures can also lead to a problematic increase in debt, potentially limiting other spending as debt service rises, and creating balance of payment challenges. In countries where public debt is already high, careful management of financing terms is critical. This will protect both China and partner governments from entering into agreements that will cause financial difficulties in the future.”
The Center for Global Development, a Washington-based think tank, warns that Pakistan is one of 23 countries already susceptible to debt distress. Of the 8 countries with the most risk of falling into a BRI debt trap, Pakistan takes the top slot, because China is charging relatively high interest rates on its loans. Unlike the 2-2.5 per cent concessional rates reported elsewhere, Pakistan’s are said to be nearly double that.
Paying back this debt hinges on successful projects. And the projects' success hinges on Pakistan's ability to fix many of the political and economic issues that have eluded the country for decades, as this Standard Chartered table lays out:
There’s a lot of red here, and the longer-term outlook is decidedly uncertain. Of course, all of this depends on the repayment terms China sets out, which are unknown. But if the past is to set a precedent, China’s response could range from write-offs to port seizures.
Pakistan may already be growing wary. In November, it withdrew a request for Chinese financing for a $14bn dam on the River Indus. According to one Pakistani official, the conditions were “not doable and against our interests.”
yesterday
By: Colby Smith
Pakistan’s 106 million registered voters head to the polls on Wednesday to elect a new government. Whichever of the two leading candidates prevails—either an ex-cricket hero or the brother of the now-jailed former prime minister—will have to decide not if, but when, he will go knocking on the IMF’s door.
The IMF has long been the prevailing crisis manager for (and watchdog of) emerging-market economies when they hit trouble. Bailouts are sizeable, and always come with strings attached. These are known quantities, and given the IMF's coordination with the Paris Club, an informal group of creditor nations that help to negotiate debt restructuring, there are mostly standardised loan terms that borrowing countries have come to expect. In recent years, though, emerging markets have looked to another pocketbook: China.
As a non-Paris Club member, the way China's capital is disbursed and the terms under which it is repaid fit no mold. While that might look like freedom for any country that has felt stifled by the IMF's typical laundry list of structural reforms, it comes with its own set of unique risks.
For example, China agreed to lend Pakistan $5bn, half its total foreign funding, for the fiscal year ending in June. That may have looked like a lifeline for the country, which had a stated goal to “ not go back to the IMF programme.” But after four devaluations in seven months and a forecasted financing gap of about $16bn over the next three years, Pakistan is facing another balance of payments crisis.
Because it imports the majority of its oil, the sharp increase in prices this year has decimated Pakistan’s current account balance. And despite the economy expanding at its quickest pace in 13 years (5.8 per cent), its deficit widened more than 40% in the fiscal year ending in June, to $18bn.
Although there is no official peg, the government has attempted to shore up its currency, which Exotix’s Chris Dielmann deems overvalued by as much as 25%. Between that and its mushrooming import bill, Pakistan has burned through about $9bn of its scant stockpile of foreign reserves since 2016. As it stands, the country has an additional $9bn stashed away—but this sum is not enough to cover two months’ worth of imports, according to CEIC. If only its most liquid hard-currency assets are measured against similar liabilities, Pakistan’s central bank has even less to work with. Bilal Khan at Standard Chartered finds that the country’s net international reserves have already dropped below levels reached the last time Pakistan sought the IMF's help.
When the next IMF bailout comes, it will be the country’s 13th since 1988. So what explains Pakistan’s “ unique proclivity,” as Masood Ahmed of the Center for Global Development puts its, to flirt with near-crises every few years? Taxes and exports.
On the first point, less than 1 per cent of the country’s working population file income returns. Corporations are equally deft at avoiding the tax man. Of the 72,000 or so firms registered with Pakistan's SEC in 2016, less than half filed returns. And of those that filed returns, half paid no tax at all.
On the second point, exports make up just 7.6% of the country’s GDP. That’s nearly 17 percentage points less than than the average for middle-income countries overall. What the country does export tends to be low-value-added products, like cotton and rice. As a result, Pakistan relies on an ever-decelerating flow of remittances and outside funding, which makes it highly susceptible to external shocks. Add to this an overvalued exchange rate, which has become somewhat of a point of national pride for the government, and the result is macroeconomic distress.
Enter the China-Pakistan Economic Corridor (CPEC).
This collection of infrastructure and trade projects, valued at up to $63bn, has become the centerpiece of China’s $1 trillion-plus Belt and Road Initiative (BRI). The BRI, which is seven times the size of the US’s Marshall Plan to rebuild Europe after World War II (in today's dollars), all but guarantees that this time will be different for Pakistan.
From shoddy ports and expressways to inefficient power plants, the Chinese-funded CPEC aims to resolve many of the shortcomings that have stifled Pakistani manufacturers. And now that more than half of China’s planned projects there are underway, says Dielmann, a disorderly devaluation or full-blown currency crisis is unlikely to be in Beijing’s interests. That is why China has been quick to pull out its wallet to buffer Pakistan’s reserves and double its currency swap agreement . Jonathan Anderson of Emerging Advisors Group shows how much the flow of loans to Pakistan have surged since 2015:
But as much as Chinese funding helps to fix Pakistan’s financial foibles and development woes, the BRI has created problems, too.
Raw materials are required to construct buildings, bridges and roads, and Pakistan has to bring in all of them from abroad. Between June 2015 and 2017 (the first two years of the CPEC project), Pakistan’s imports of these kinds of goods increased 51 per cent. By June 2021, machinery imports for proposed power plants and transport hubs are set to top $27bn. So part of Pakistan’s growing import bill —and therefore its deteriorating balance of payments—traces back to the Middle Kingdom.
Granted, Pakistan can pay for Chinese goods chiefly because China lent it the money in the first place. But eventually, these loans need to be repaid. Unfortunately for Pakistan, its bills will likely arrive before the economic gains that will be used to pay for them are accrued. The IMF has warned about this. Infrastructure financing, says Managing Director Christine Lagarde, should not be considered a free lunch:
“These ventures can also lead to a problematic increase in debt, potentially limiting other spending as debt service rises, and creating balance of payment challenges. In countries where public debt is already high, careful management of financing terms is critical. This will protect both China and partner governments from entering into agreements that will cause financial difficulties in the future.”
The Center for Global Development, a Washington-based think tank, warns that Pakistan is one of 23 countries already susceptible to debt distress. Of the 8 countries with the most risk of falling into a BRI debt trap, Pakistan takes the top slot, because China is charging relatively high interest rates on its loans. Unlike the 2-2.5 per cent concessional rates reported elsewhere, Pakistan’s are said to be nearly double that.
Paying back this debt hinges on successful projects. And the projects' success hinges on Pakistan's ability to fix many of the political and economic issues that have eluded the country for decades, as this Standard Chartered table lays out:
There’s a lot of red here, and the longer-term outlook is decidedly uncertain. Of course, all of this depends on the repayment terms China sets out, which are unknown. But if the past is to set a precedent, China’s response could range from write-offs to port seizures.
Pakistan may already be growing wary. In November, it withdrew a request for Chinese financing for a $14bn dam on the River Indus. According to one Pakistani official, the conditions were “not doable and against our interests.”
