IN PAKISTAN’S CURRENCY CRISIS, CHINA IS THE PROBLEM AND THE SOLUTION

BY TOM HUSSAIN

Having racked up unsustainable bills in supporting Beijing’s infrastructure master plan, Islamabad is bailed out by China to the tune of US$1 billion – leaving it more dependent than ever on its ‘all-weather ally’. 

A last-ditch Chinese loan may have temporarily rescued Pakistan from a foreign exchange reserves crisis, but experts say Islamabad’s growing dependence on Beijing has become as much a liability as it is an asset.

The US$1 billion emergency loan released in the last week of June boosted Pakistan’s reserves enough to cover two months of imports, which have reached unsustainably high levels largely – and ironically – because of Islamabad’s commitment to the Belt and Road Initiative, Beijing’s plan to link Eurasia in a China-centred trading network.

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Pakistan’s imports of machinery have spiked as it takes on US$19 billion of power and infrastructure projects for the China-Pakistan Economic Corridor (CPEC) project that will link the Chinese province of Xinjiang to the Arabian Sea through Pakistan. Valued at up to US$62 billion and expected to be fully operational in 2030, the trade corridor is the largest component of the plan.In the first two years of the CPEC project, up to June 2017, Pakistan’s imports of machinery and transport equipment jumped 51 per cent to US$15.5 billion. Meanwhile, the economic relationship with China remains one-sided. While neither government has released detailed bilateral trade statistics, Pakistan’s imports of Chinese goods and services topped US$6.6 billion in the July-December 2017 period, nearly 10 times the volume of Pakistan’s exports to China.

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“Pakistan’s dependence on China has increased startlingly,” said A.A.H. Soomro, senior adviser for Tundra Fonder, a Stockholm-based emerging markets fund manager.

In addition to US$6 billion in financing for CPEC projects granted over the last two and a half years, China loaned Pakistan’s Finance Ministry more than US$5 billion during the financial year 2017-18. That is equivalent to half of Pakistan’s total foreign funding.

“Pakistan’s dependence on China for its economic stability is growing and how dependent it has become is obvious – US$5 billion in non-CPEC funding is a huge sum in Pakistan’s current situation,” said Mohiuddin Aazim, an economic analyst in Karachi. Pakistan, he said, had no choice but to turn to China because having refused to join the Saudi Arabia-led coalition waging a war in Yemen, it could no longer rely on Middle Eastern allies, whose own finances were weakening anyway. US assistance to Pakistan has petered out because of disputes over cross-border terrorism into Afghanistan and India. Pakistan narrowly avoided being placed on the “blacklist” of countries considered complicit in terrorist financing and money laundering by the Financial Action Task Force following a complaint by the US, Britain and France.

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“We have no choice but to look to China, even outside CPEC, when we are in trouble. This also suits China because, by offering us non-CPEC external financing, it can be seen in Pakistan as a real, though gradual, replacement for the US,” Aazim said. Since CPEC’s launch, consumption has thrived, largely due to improvement in electricity supplies from power generation projects. Pakistan’s economic growth accelerated to 5.6 per cent in the financial year 2017-18 from four per cent in 2014-15. But the corresponding external pressures have weighed on Pakistan’s economy, prompting the Asian Development Bank to downgrade its growth forecasts to about 5.1 per cent in 2018-19.

Pakistan’s external payments position has suffered as it overestimated its ability to arrange financing to plug gaps widened by spiralling imports and falling exports, stagnant remittances, and the loss of US financial assistance for counterterrorism operations. Its projections for foreign direct investment inflows have also proven too optimistic. Pakistan’s current account deficit has risen to nearly US$16 billion for the first 11 months of financial year 2017-18, from just US$4.86 billion for all of 2015-16. To bridge the deficit, the country has depleted its gross forex reserves to US$16.2 billion at the end of June, from a peak of US$23.5 billion in October 2016.

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Soomro said China had secured advantageous terms for CPEC, but these were not to blame for Pakistan’s forex woes. “The investment was necessary, even if these lucrative returns were unwarranted and anti-competitive,” he said. To boost exports, the central bank has devalued the rupee to the US dollar by about 15 per cent, making Pakistan’s currency the worst performer in Asia this year. It has also raised its policy lending rate by 75 basis points since January to 6.25 per cent to cool domestic consumption.

Without China’s billion-dollar loan, Pakistan’s forex reserves would have dipped beneath the two-month minimum needed for further loans from the World Bank.

This would have had serious implications for its ability to secure affordable loans from international markets. Moody’s last month downgraded Pakistan’s credit rating to negative from stable. To help its “all-weather” ally through to the completion of the “early harvest” phase of CPEC in late 2019, China will have to commit even larger levels of funding. The People’s Bank of China agreed in May to extend a currency swap agreement by three years and double it to 20 billion yuan.

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But further Chinese loans may not be so easily forthcoming unless Pakistan commits to structural economic reforms similar to those called for by the International Monetary Fund (IMF) under a US$6.6 billion loan disbursed between 2013 and 2017, according to the Global Times newspaper. “It’s possible we’re entering a virtuous cycle in which Chinese loans promote the development of the CPEC, and this then improves Pakistan’s debt repayment ability,” the Chinese state-owned tabloid said in May. “However, the South Asian country may need to propel economic reforms to ensure the effectiveness of the loans and allow the local economy to benefit more from CPEC projects. It is hoped that people will learn a lesson from the IMF’s operations,” it warned.

It would fall on Pakistan’s next government, due to take office after a general election on July 25, to decide whether to seek an emergency balance of payments bailout from the IMF. This would entail the disclosure of at least the headline terms of CPEC financing – something which China does not want to be made public.

Alternatively, the new administration could attempt to forestall a return to the IMF, because it would entail politically unpopular “ruthless” structural reforms to Pakistan’s economy and further increase the country’s external financing burden, analyst Aazim said. “It is a case of damned if we do, damned if we don’t,” he said. ■