Pakistan’s Risky Reliance on China Set to Grow

By Yigal Chazan

A fall out with the U.S. could leave Pakistan more vulnerable to Chinese economic muscle.

America’s recent break with Pakistan is likely to deepen Islamabad’s financial dependence on China, strengthening Beijing’s leverage over controversial plans to turn its South Asian neighbor into a strategic trade corridor.

Earlier this year, the United States suspended $2 billion in security assistance to Pakistan, its long-time regional ally, because of an apparent failure to crackdown on Islamic militants active in Afghanistan. The Trump administration followed up by lobbying the Paris-based Financial Action Task Force to place Pakistan on a watch list of countries with inadequate terrorist financing controls, which could severely undermine Islamabad’s ability to raise capital on international markets and deter Western investors.

The FATF move, to take effect in June, comes as Pakistan’s debt problems become ever more acute, compounded by foreign-exchange reserves dropping 27 percent in the last year and a widening current account deficit. A recent IMF report cast doubt over the country’s ability to repay the fund, just over four and a half years after its last bailout. Facing a possible default, and with the U.S. able to veto World  Bank and IMF decisions, Pakistan may turn to its ally China for extra loan assistance, leaving it in even greater hock to the regional superpower.

For a number of years, Chinese financial assistance has been helping to buttress the flagging Pakistan economy. It was the country’s largest lender last year. In recent months, it has extended some $1 billion of commercial loans to Pakistan and is reported to be negotiating another equivalent tranche. With Islamabad’s reinclusion on the FATF watchlist – it had been removed in 2015 – such provision will add to the already mountainous debt accruing from Chinese loans for the China-Pakistan Economic Corridor (CPEC), a series of energy and transport infrastructure projects geared to linking China’s western provinces to the Arabian Sea.

Beijing is investing some $60 billion in CPEC, the largest investment in the Belt and Road Initiative (BRI), which will extend Chinese influence across the Eurasian economies. It could help to modernize Pakistan, funneling funds into projects that few other investors will support. New power plants, roads, rail networks and a deep-water port are envisaged, with projects under way helping to drive Pakistan’s healthy GDP growth rate of more than 5 percent.

Supporters of CPEC say it will transform the country’s prospects. The Pakistan Business Council, an advocacy group, estimates that earmarked projects could amount to 20 percent of the country’s GDP over the next five years. But the loans the Chinese are extending are likely to saddle Pakistan with a huge debt burden. According to an Economist report last June, around two-thirds of loans for $28 billion of early projects were taken out on commercial terms, with interest at about 7 percent a year.

In December, leading Pakistani media reported that visiting IMF officials were “appalled” at the implications of the CPEC projects, their main concern focused on Pakistan’s repayment capacity. Separately the same month, the former Pakistani finance minister, Hafeez Pasha, warned that the government would run out of foreign currency reserves by September, triggering a financial crisis. He predicted that the only way out would be another IMF bailout, but warned that conditions would be tougher than in the past because of the change in U.S. policy towards Pakistan. “We may be told that CPEC’s size needs to be cut down,” he said. 

Some argue that China’s so-called debt-trap diplomacy – also affecting other recipients of BRI funds – enables Beijing to dictate the terms of investment projects and exert excessive leverage over its economic partners. Pakistan is particularly exposed because its reliance on Chinese funds to re-energize the country seems likely to deepen, now that the United States has backed away.

Already there are reported concerns among Pakistani decision-makers that many CPEC deals are bordering on exploitative. Analysts say debt repayments are not transparent and procurement and bidding procedures for projects significantly favor China, with Chinese companies winning contracts and using Chinese labor to complete them.

A striking example of the apparent asymmetry of some of the deals was revealed in November when the Federal Minister for Ports and Shipping Mir Hasil Bizenjo said that 91 percent of revenues to be generated by the port of Gwadar, a huge infrastructure project and critical CPEC staging post, will go to China. A minister responsible for promoting foreign investment in Pakistan, Naeem Zamindar, told Reuters this month some Western ‎ investors appeared reticent because of a false impression that Chinese firms would receive “exclusive advantages” and concessions, militating against a level playing field.

Pakistani officials continue to proclaim the long-term infrastructure and economic benefits of CPEC yet there are clearly concerns. In November, Pakistan removed the $14 billion Diamer-Bhasha Dam from the list of corridor projects because Chinese financial conditions, which included ownership of the facility, were “not doable and [went] against our interests,” according to Water and Power Development Authority Chairman Muzammil Hussain. Jitters over the terms of Chinese investments have also been evident in neighboring Nepal. Just months after agreeing to become an BRI partner, Kathmandu canceled a $2.5 billion hydroelectric dam project amid concerns over the competitiveness of the bidding process.

Sri Lanka provides a salutary reminder of why recipients of BRI funds need to be mindful of the long-term implications. In December, Colombo, which has been struggling to repay its Chinese loans, handed over the port of Hambantota to China on a 99-year lease as part a $1.1 billion deal that saw the Chinese firm developing the joint venture gain a 70 percent stake, a move seen by Sri Lankan opposition parties as an erosion of sovereignty. Sri Lankan politicians said the move was necessary to reduce the $8 billion owed to China for infrastructure projects.

In an apparent bid to diversify its sources of economic and security assistance in the wake of the fall out with Washington and concerns over becoming too reliant on China, Islamabad appears to have stepped up its rapprochement with Russia. The Cold War adversaries are planning to cooperate militarily to combat the Islamic State across the region and are reportedly negotiating multibillion Russian energy supply deals and investments. Of the latter, an offshore gas pipeline is under discussion and plans for a $2 billion LNG pipeline linking Lahore with Karachi, the first major Russian development in Pakistan for decades, are being finalized. Moscow is also reportedly keen on building energy plants for converting natural gas into fuel products.

Having Russia as an investment partner, albeit a nascent one, will calm the nerves of those in Pakistan who worry that Beijing currently holds all the cards. In the long term, Pakistan will clearly benefit from Chinese economic engagement, but in its haste to attract investment it must avoid giving Beijing license to dictate the terms of projects. Failure to do so could increase fears of economic colonization.