Walter Molano | The CPEC conundrum
Published:Friday | July 17, 2020 | 12:09 AM
Natural resources are normally distributed around the globe, and they can take many forms. For example, they can come in the form of commodities.
Saudi Arabia sits on a vast expanse of hostile deserts, but buried under the subsurface is a veritable ocean of oil and gas. Other countries have large populations. Japan has very few natural resources, but its large population allowed the relatively small nation to punch well above its weight category.
Other countries use their geographic location as their source of comparative advantage. Singapore was a very poor country when it declared its independence. However, its strategic location astride one of the busiest waterways in the world, allowed it to become rich and prosperous. Pakistan is taking a similar route. Even though one of its main comparative advantages is its huge population, Pakistan has decided to focus its economic development as the back-door entrance to the Chinese hinterland.
Since 2013, the Chinese government has poured more than US$60 billion into the creation of the so-called China-Pakistan Economic Corridor, CPEC, which included the construction of new roads, pipelines, railroads and ports. Beijing took out a long-term lease in the deepwater port of Gawadar, perhaps the most important of the so-called string of pearls.
This is a reference to the network of ports that China is building across the Indian Ocean to promote its trade, products and protect its sea lanes of communication, and it has triggered reverberations in the international arena, because it has helped cement the natural rivalry between China and India, as well as between Pakistan and India. It has also become another thorn in the side of Karachi’s relationship with Washington.
It is a bold move for such a poor country that relies heavily on foreign assistance and credit. The government recently received a US$1.4-billion emergency loan from the International Monetary Fund, IMF, to help out with the COVID-19 crisis. It is also asking for bilateral debt relief under the G20 initiative. A misstep with Washington could easily scupper such aid.
Nevertheless, the deepening ties between Pakistan and China have been an important source of investment, employment and GDP growth. For the last six years, Pakistan’s average real GDP growth has been about 4.5 per cent y/y. This is significantly higher than the country’s population growth rate of two per cent y/y, thus meaning a real improvement in per capita income.
Unfortunately, the onset of COVID-19 forced the government to introduce a lockdown. As a result, the IMF expects the economy to shrink by 1.5 per cent y/y in 2020. Of course, Chinese investment has not come without strings attached. The Belt and Road Initiative has mainly benefited China, and some of the investments have come in the form of debt, so Pakistan’s debt levels have been rising.
Last year, the country’s external debt-to-GDP ratio jumped to 26 per cent from 22 per cent the year before. Much of the new debt has been from China. The problem is that most of these obligations are short term.
Pakistan has only six major sovereign bond issues. However, the yield curve has been flattening, suggesting concerns about the government’s ability to service its obligations. The short end of the curve has moved up more than the long end over the last two months. A look at the amortisation schedule shows that five out of the six major bond issues amortise over the next six years. Not surprisingly, Moody’s recently placed the single-B country under review for a possible downgrade to triple-C.
Balance of payments the clue
A look at Pakistan’s balance of payments may provide a clue as to the deteriorating trend. Although its external debt is relatively low, its current account deficit is high at 4.8 per cent of GDP. Moreover, it only has US$7 billion in net international reserves – and falling. The country is also very dependent on remittances as a source of hard currency, bringing in more than US$16 billion a year. The good news is that transfers rose 4.6 per cent in May, but there are concerns that inflows will decline.
Like many poor countries, one of Pakistan’s major exports is its population. Approximately 8.8 million Pakistani’s work abroad, with more than half of them working in the GCC countries. GCC, or the Gulf Cooperation Council, is a political and economic alliance of six Mideast countries, namely Saudi Arabia, Kuwait, the United Arab Emirates, Qatar, Bahrain, and Oman.
Most Pakistanis toil in the construction sector, but many are also employed in services. The problem is that the double whammy of the COVID-19 pandemic as well as the collapse in oil prices has left the GCC reeling, which could threaten the employment of many of these individuals.
Another reason for concern is the deterioration of Pakistan’s fiscal accounts. In 2019, the country’s fiscal deficit widened to 5.6 per cent of GDP from 1.7 per cent the year before. Unfortunately, the shortfall is slated to grow this year, mainly due to the coronavirus.
The decline in economic activity, along with higher healthcare costs, is pushing revenues down and costs up. Therefore, the situation does not look so good for Pakistan. It is a stressed sovereign credit, with CPEC as the only glimmer of hope – but an expensive one.
Dr Walter T. Molano is a managing partner and the head of research at BCP Securities LLC.